Opinion ID: 2176586
Heading Depth: 2
Heading Rank: 1

Heading: Hibbard Brown's Direct Involvement in the Fraud

Text: The Commissioner argues on appeal that the Chancery Court erred by reversing the Commissioner's finding that Hibbard Brown either actively or tacitly encouraged the conduct of its agents. The Commissioner's finding of liability was based on its analysis of Hibbard Brown's Weekly Research Notes. According to the Commissioner, these Notes contained numerous misleading statements and falsehoods evidencing a pattern of dishonesty within the firm. The Court of Chancery, however, found that Hibbard Brown was not intimately implicated in the wrongdoing, and did not affirm any of the Commissioner's findings of direct liability other than the violations based on the market maker nondisclosure. The Court of Chancery reversed the Commissioner's findings of direct involvement in the fraud apparently because there was no material and substantial evidence of such involvement in the record. [3] We agree with this assessment. In the Company Comments section of the Weekly Research Notes, Hibbard Brown favorably describes the prospects of a number of companies. These descriptions normally include a discussion of the company's business, financial results, recent developments, management's views, and Hibbard Brown's assessment (usually positive) of the company's prospects. The comments are therefore a combination of specific facts, predictions and statements of opinion. The Commissioner placed substantial importance on its finding that the Research Notes contained numerous misleading statements and falsehoods. A close scrutiny of the Commissioner's opinion, however, reveals very few actual misrepresentations. Federal courts have recognized that [s]tatements about future events that are plainly expressions of opinion and not guarantees are not actionable under the federal securities laws. Hershfang v. Citicorp, 767 F.Supp. 1251, 1256 (S.D.N.Y.1991). See also Friedman v. Mohasco Corp., 929 F.2d 77, 79 (2d Cir.1991) (holding that Rule 10b-5 claims based on an opinion of financial advisors regarding the expected market value of securities to be issued in a merger did not state a cause of action). An optimistic prediction regarding a company's future prospects is not a falsehood absent evidence that it was not made in good faith (i.e., not genuinely believed to be true) or that there was no reasonable foundation for the prediction. E.g. Eisenberg v. Gagnon, 766 F.2d 770, 776 (3d Cir.), cert. denied sub nom., Weinstein v. Eisenberg, 474 U.S. 946, 106 S.Ct. 342, 88 L.Ed.2d 290 (1985); Ciresi v. Citicorp, 782 F.Supp. 819, 822 (S.D.N.Y.1991), aff'd mem., 956 F.2d 1161 (2d Cir.1992). It is also not per se improper to recommend a company simply because its past history is unimpressive. The fact that a company turns out to be unprofitable does not establish that an earlier prediction of future profitability is fraudulent. See Eisenberg, 766 F.2d at 776 (holding that [i]n establishing scienter with respect to projections and opinions, it is insufficient to show ... that a forecast turned out to be incorrect) (citation omitted) (emphasis in original); Design Time v. Synthetic Diamond Technology, 674 F.Supp. 1564, 1571 (N.D.Ind.1987) (Without more, an allegation of faulty economic prognostication will not support an inference of fraud). Most of the Commissioner's criticism of the Research Notes is based on hindsight and second-guessing. For example, in discussing News Communications, Inc. in the November 6, 1989 issue of Research Notes, Hibbard Brown observes that the growth forecast for this company is reaching fruition and predicts that [w]ithin the next 12-18 months we believe that News Communications can achieve annual revenues in the vicinity of $8 million.... The Commissioner seems to criticize these statements by pointing to the company's $1,249,011 net loss for fiscal 1990. Nevertheless, Hibbard Brown's predictions were made in the context of News Communications' results for the quarter ending August 31, 1989, which were discussed in the Research Notes and indicated a substantial increase in both revenues and profits over the same quarter for the preceding year. The Commissioner has not cited any evidence to show that those predictions were manifestly unreasonable in light of the contemporaneous positive quarterly results. Even though Hibbard Brown's forecasts proved to be incorrect, the Commissioner's second-guessing does not constitute material and substantial evidence of fraudulent conduct. [4] The fact that Hibbard Brown recommended highly speculative companies in its Research Notes is not evidence of fraud since that publication is distributed to a variety of potential customers. Many investors may prefer to buy risky ventures in the hope that the rewards of discovering a future corporate giant will offset the losses from the many companies which fail. Such a strategy may well be appropriate if the investor has a diversified portfolio and is not deceived about the risks. In fact, a number of the securities purchased by Krieger and Flynn were sold at a modest profit, though such gains were reinvested in stocks which suffered substantial losses. The fraud is not what stocks Hibbard Brown recommended, but instead how they were described by the brokers selling them. Martone and Hart, not Hibbard Brown, bear the direct responsibility for concealing the risks associated with the securities they were selling to persons they knew were not well-suited to investing in highly speculative ventures. [5] The only concrete misstatement found by the Commissioner is in the Research Notes dated May 14, 1990, which stated that Children's Creative Workshop, Ltd. was expected to open its first prototype store by the end of that summer. The company's Form 10-Q financial report for the quarter ending January 31, 1990, indicated that the company was not in a position to open the new store until additional financing was obtained. This Form 10-Q was filed with the Securities and Exchange Commission on April 27, 1990, a little over two weeks before the May 14, 1990 issue of Research Notes. We do not find the misstatement in the May 14, 1990 Research Notes to be sufficient to show either a pattern of dishonesty or management approval of fraudulent behavior. Even though Hibbard Brown probably should have been aware sooner of the information in the Form 10-Q, it is certainly plausible that the drafters of the Research Notes were unaware of the statements contained in the Form 10-Q that had been filed only two weeks previously. Moreover, the erroneous information was corrected in the July 16, 1990 Research Notes. Finally, the May 14, 1990 misstatement, as a matter of law, could not support a finding of liability under section 7303(2) in the circumstances presented here. Flynn purchased his shares of Children's Creative Workshop in September and October of 1989, over six months before the misstatement. A violation of section 7303(2) cannot be predicated on after-the-fact statements since neither the in connection with requirement nor the reliance element can be established. Accordingly, we conclude that the Commissioner's finding of direct involvement by the management of Hibbard Brown in the fraud perpetrated by its agents is not supported by material and substantial evidence. The Court of Chancery was therefore correct not to affirm that finding and the violations premised on it. [6]