Opinion ID: 186545
Heading Depth: 2
Heading Rank: 2

Heading: SEC Disclosure

Text: 33 Under Rule 10b-5, it is unlawful for anyone, in connection with a security transaction, [t]o make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements . . . not misleading. . . . 17 C.F.R. § 240.10b-5(b). The Supreme Court has defined materiality under Section 10(b) and Rule 10b-5 as a substantial likelihood that a reasonable shareholder would consider it important in deciding how to vote. Basic Inc. v. Levinson, 485 U.S. 224, 231-32, 108 S.Ct. 978, 99 L.Ed.2d 194 (1988) (internal quotation and citation omitted). The Court further explained that if there is a substantial likelihood that a reasonable investor would have viewed the misleading or omitted fact as significantly alter[ing] the total mix of information, it is material. Id. (internal quotation marks and citation omitted). 34 The SEC found Rockies Fund petitioners in violation of Section 10(b) and Rule 10b-5, as well as Section 13(a) and Rules 12b-20, 13a-1, and 13a-13, for filing misleading quarterly and yearly disclosures. Specifically, the SEC found three kinds of violations — misclassification, overvaluation, and improperly claimed ownership of Premier stock. According to the SEC, Rockies Fund petitioners misclassified and overvalued Premier stock in five quarterly filings in 1994 and 1995 and its 1994 yearly filing. Additionally, the SEC determined that the Fund misreported ownership of 200,000 Premier shares in its September 30, 1995, quarterly filing.
35 Rockies Fund petitioners admit that the Fund misclassified its Premier holdings in several SEC filings. Those filings incorrectly labeled the vast majority of the Fund's shares of Premier stock as unrestricted when only 750 were actually held as unrestricted shares. The Fund should have listed the shares as restricted in each filing; listed as unrestricted, the statements qualify as untrue under Rule 10b-5. 36 The Fund petitioners do, however, challenge the materiality of the misclassification. In its opinion, the SEC determined that the misclassifications were material in two ways. First, the misclassifications affected the value of the Premier holdings — and, therefore, the Fund's financial statements. Second, the misclassifications caused the Fund's holdings to appear more liquid than they really were. In addition, Premier occupied a large percentage of the Fund's total assets, magnifying the effect of any misinformation about Premier. Under these circumstances, a reasonable investor certainly would have viewed the misclassification as significantly alter[ing] the `total mix' of information. See Basic, Inc., 485 U.S. at 231-32, 108 S.Ct. 978 (citation omitted). 37 The Rockies Fund petitioners also argue that they lacked the requisite intent under Rule 10b-5. The SEC found it implausible that the Fund directors could have overlooked this kind of error in six separate filings. The Fund weakly disputes the SEC's scienter determination, but the SEC's opinion has ample support. Premier represented a large part of the Fund's holdings — between ten and forty percent. An attentive director would have rectified the error absent extreme abdication of ordinary care. In addition to the simple misclassification, each filing used valuation language only appropriate for unrestricted shares. Therefore, substantial evidence supports the SEC's finding of reckless indifference and extreme recklessness.
38 Examining the same quarterly filings, the SEC also found that the Fund overvalued its Premier holdings. The SEC centered its analysis on the Fund's 1983 prospectus, the Fund's only public statement on valuation procedures. The prospectus endorsed four methods of valuation, none of which the Fund used to value Premier. Instead, the Fund settled on the quoted market price as Premier's value. The SEC found that, unmoored from its prospectus, the Fund used an ad hoc process that mainly consisted of rubber-stamping Calandrella's recommendations. The SEC concluded that the prospectus — and good accounting practice — would have directed a different approach: valuing restricted stock by discounting the shares from the unrestricted market price. 39 According to the SEC, standard accounting practice supports the prospectus's methodology and regards it as improper to value restricted stock at the unrestricted market value. The SEC determined that discounting would have resulted in an appreciably lower valuation. Petitioners offered no evidence of a discernible reason for choosing market price as the appropriate value. Accordingly, we find the SEC's overvaluation findings are supported by general accounting practice and the Fund's own prospectus. 40 The Fund counters that, even if it technically overvalued Premier stock, the prospectus sheds no light on the materiality of the valuation. Furthermore, it says the overvaluation, if any, caused no actual harm. Materiality, however, does not require a showing of actual harm to investors. Graham, 222 F.3d at 1001 n. 15. The SEC supported its finding of materiality, concluding that an overvaluation of the Fund's largest asset would have been significant information for potential Fund investors. In addition, as the Fund's only public statement about valuation, the prospectus does contribute to the overvaluation's materiality. Because the Fund rejected its publicly stated valuation procedures and did not discount its largest holding, substantial evidence supports the SEC's finding. 41 Citing the Fund's inconsistent and slipshod valuation methodology, the SEC found a reckless disregard for the accuracy of Premier's stock valuations. The Fund disputes the finding, claiming reliance on counsel for procedures adopted in 1994. But even if true, much of the testimony showed that the Fund used no set procedure — whether developed by counsel or not — for valuing its holdings, instead generally relying on Calandrella's recommendation to the board. Such a haphazard process for valuing the largest holding of the Fund constitutes an extreme departure from the standards of ordinary care that should have been obvious to all the Fund's directors. See Steadman, 967 F.2d at 641-42.
42 The SEC found that the Fund falsely claimed ownership of an additional 200,000 Premier shares in its September 1995 filing. Rockies Fund petitioners claim that the Fund had made a valid oral agreement for the shares in time for its September 1995 quarterly report. The SEC found otherwise, concluding that the oral agreement lacked two essential elements, price and amount, required by Colorado contracts law. 43 The parties dispute the meaning of the relevant statute. For securities transactions, Colorado law at the time required a writing sufficient to indicate that a contract has been made for sale of a stated quantity of described securities at a defined or stated price. Colo.Rev.Stat. Ann. § 4-8-319(a) (West 1995) (repealed 1996). This provision requires the contract to have a defined quantity and price, but the Fund asserts that the amount and price need not be set until the time of the writing. The contract, however, is the oral agreement, not the writing. The oral contract itself must have the defined quantity and price in order to be valid. Therefore, the Fund did not establish ownership until its directors approved the purchase amount and price in November 1995, well after the September filing. 44 The 200,000 shares comprised 46% of the Fund's Premier holdings and 11% of its total securities holdings. The SEC substantiated its finding that the ownership error was material based on the magnitude of the impact such a purchase would have on the Fund. 45 The SEC also found the requisite scienter. Calandrella, as agent, personally participated in the negotiations and knew the status of the purchase agreement. When he approved the quarterly report and its associated misrepresentation, he acted with at least extreme recklessness. Accordingly, substantial evidence supports the SEC's finding of a Section 10(b) and Rule 10b-5 violation.