Opinion ID: 748183
Heading Depth: 2
Heading Rank: 1

Heading: The Total Debt-to-Total Capitalization Ratio Guideline

Text: 40 Plaintiffs' claims under this heading are claims of nondisclosure. When an allegation of fraud under section 10(b) is based upon a nondisclosure, there can be no fraud absent a duty to speak. Lorenz, 1 F.3d at 1418. In general, Section 10(b) and Rule 10b-5 do not impose a duty on defendants to correct prior statements--particularly statements of intent--so long as those statements were true when made. See In re Phillips Petroleum, 881 F.2d at 1245. However, [t]here can be no doubt that a duty exists to correct prior statements, if the prior statements were true when made but misleading if left unrevised. Id. To avoid liability in such circumstances, notice of a change of intent [must] be disseminated in a timely fashion. Id. at 1246. Whether an amendment is sufficiently prompt is a question that must be determined in each case based upon the particular facts and circumstances. Id. 41 In the present case, plaintiffs allege that defendants' statements in the months leading up to the merger with Snapple improperly omitted mention of a planned increase in the total debt-to-total capitalization ratio guideline. The district court, discounting the allegation, found that [n]o reasonable investor could interpret the Leverage[total debt-to-total capitalization] Ratio Guideline as an absolute restriction on Quaker's ability to take advantage of a corporate opportunity which might cause Quaker to exceed the Leverage [total debt-to-total capitalization] Ratio Guideline. 928 F.Supp. at 1386. On this appeal, in urging the correctness of the district court's determination, defendants contend that plaintiffs are unable to establish the first element of a claim under § 10(b) and Rule 10b-5: the materiality of defendants' repetition of Quaker's upper 60-percent range total debt-to-total capitalization ratio guideline after the merger with Snapple became a probability.
42 The Supreme Court set forth the standard for materiality of an omitted statement under § 10(b) and Rule 10b-5 in Basic, Inc. v. Levinson, 485 U.S. 224, 108 S.Ct. 978, 99 L.Ed.2d 194 (1988). Plaintiffs in Basic had been stockholders in Basic Incorporated, a company whose directors, in December of 1978, approved a friendly tender offer from Combustible Engineering Inc. to acquire Basic's common stock. The December 1978 announcement was the culmination of over two years of negotiations between Basic and Combustible--a period during which Basic on three occasions publicly denied that merger discussions or other developments likely to have significant effect on share values were pending. Plaintiffs sold their holdings in Basic subsequent to the first of Basic's public denials. After the merger, plaintiffs sued Basic and those who had been Basic directors during the two years leading up to the merger. Plaintiffs alleged that Basic's public denials were material misrepresentations which had, to plaintiffs' detriment, weakened the market in Basic's stock. 43 In Basic, the Court adopted in the context of § 10(b) and Rule 10b-5 the standard of materiality set forth in TSC Industries, Inc. v. Northway, Inc., 426 U.S. 438, 96 S.Ct. 2126, 48 L.Ed.2d 757 (1976), a case arising under § 14(a) of the 1934 Act. See Basic, 485 U.S. at 232, 108 S.Ct. at 983-84. The Basic Court approved, for cases involving undisclosed merger plans, the principle that [a]n omitted fact is material if there is a substantial likelihood that a reasonable shareholder would consider it important in deciding how to [proceed]. Id. at 231, 108 S.Ct. at 983 (quoting TSC Industries, 426 U.S. at 449, 96 S.Ct. at 2132). Under this standard, there must be a substantial likelihood that the disclosure of the omitted fact would have been viewed by the reasonable investor as having significantly altered the 'total mix' of information made available. Id. 44 In Basic, the Court rejected a proposed bright-line test that preliminary merger discussions do not become material until 'agreement-in-principle' as to the price and structure of the transaction has been reached between the would-be merger partners. Basic, 485 U.S. at 233, 108 S.Ct. at 984. In its place, the Court called for a fact-specific inquiry: Whether merger discussions in any particular case are material ... depends on the facts.... No particular event or factor short of closing the transaction need be either necessary or sufficient by itself to render merger discussions material. Id. at 239, 108 S.Ct. at 987. 45 Subsequent to Basic, this court has had occasion to address with greater particularity the standard of materiality to be applied, in a securities-fraud action, to a motion to dismiss: [M]ateriality is a mixed question of law and fact, and the delicate assessments of the inferences a reasonable shareholder would draw from a given set of facts are peculiarly for the trier of fact. Shapiro v. UJB Financial Corp., 964 F.2d 272, 281 n. 11 (3d Cir.), cert. denied, 506 U.S. 934, 113 S.Ct. 365, 121 L.Ed.2d 278 (1992). Therefore, [o]nly if the alleged misrepresentations or omissions are so obviously unimportant to an investor that reasonable minds cannot differ on the question of materiality is it appropriate for the district court to rule that the allegations are inactionable as a matter of law. Id. 46 Applying the standard set forth in Shapiro to the pending case, we note first that the emphasis on a fact-specific determination of materiality militates against a dismissal on the pleadings. The complaint identifies three separate documents in which Quaker described its total debt-to-total capitalization ratio policy: the 1993 Annual Report issued October 4, 1993 (Our guideline for leverage in the future will be to maintain a total debt-to-total capitalization ratio in the upper-60 percent range), Complaint at p 22; the Form 10-Q filed in November 1993 (The Company has decided to increase its guideline for leverage in the future to the upper-60 percent range), Complaint at p 24; and the 1994 Annual Report issued September 23, 1994 (At the end of fiscal 1994, our total debt-to-total capitalization ratio was 68.8 percent on a book-value basis, in line with our guideline in the upper-60 percent range), Complaint at p 32. None of these statements was actually incorrect at the time of its publication. Even the last, which plaintiffs assert was false when made, in isolation appears a straightforward statement of fact; there is no indication that as of the end of fiscal 1994 Quaker's total debt-to-total capitalization ratio was anything but 68.8%. 47 But, of course, the statements were not made in isolation. Rather, by including the total debt-to-total capitalization ratio guideline in the 1993 Annual Report--indeed, by setting it forth in at least three separate places in that document--Quaker may well have created the reasonable understanding among investors that the ratio guideline was a number to which Quaker attached considerable significance. And any such understanding could well have been reinforced by the iteration of the ratio guideline in the November 1993 Form 10-Q and the 1994 Annual Report published on September 23, 1994. Taken together, the statements could indeed have induced a reasonable investor to expect either that the ratio guideline would remain in the upper-60 percent range, or that Quaker would announce any anticipated significant change. That is, it would have been entirely reasonable for an investor to assume that if defendants believed, as of September 23, 1994, that Quaker's total debt-to-total capitalization ratio would soon change significantly, the company would have said so in its Annual Report for fiscal 1994 issued on that date. As noted earlier, Smithburg had stated in a letter contained in Quaker's 1993 Annual Report that [o]ur guideline for leverage in the future will be to maintain a total debt-to-total capitalization ratio in the upper-60 percent range (emphasis added); there is no evident reason to confine the phrase in the future to the single year after the initial announcement. 48 In sum, in the present case, we find that a trier of fact could conclude that a reasonable investor reading the 1993 Annual Report published on October 4, 1993, and then the 1994 Annual Report published on September 23, 1994, would have no ground for anticipating that the total debt-to-total capitalization ratio would rise as significantly as it did in fiscal 1995. There was after all no abjuration of the upper 60-percent range guideline. The company had predicted the rise from 59 percent to the upper 60-percent range in the 1993 report and that rise had occurred by and was confirmed in the 1994 report. Therefore, it was reasonable for an investor to expect that the company would make another such prediction if it expected the ratio to change markedly in the ensuing year. 49 The district court held that [t]o require Quaker to disclose the possibility it might seek loans to finance an acquisition is tantamount to requiring the disclosure of the acquisition negotiations. 928 F.Supp. at 1383. But plaintiffs do not argue that Quaker should have stated that the guideline would be adjusted to finance an acquisition. The more relevant question is whether Quaker could have communicated a projected increase in the level of the total debt-to-total capitalization ratio guideline without alerting investors to the impending merger with Snapple. There is reason to believe Quaker had the ability to do just that. The company had announced plans to increase the ratio substantially in its 1993 Annual Report for a variety of reasons unrelated to acquiring other companies. Quaker then observed in its 1994 Annual Report, in a paragraph discussing the ratio guideline, that among other things increased debt had allowed the company to acquire four businesses. Defendants do not argue that the 1993 announcement alerted investors to Quaker's potential acquisition of these four businesses. Thus, Quaker's own actions strongly suggest that a change in a ratio guideline can be projected without explicitly or implicitly alerting the investment community. 50 Furthermore, even if an announced change in the ratio guideline would have alerted the reasonably savvy investor to an imminent acquisition, the Supreme Court has made clear that it is not the role of the courts to interfere with the policy of disclosure chosen and recognized in the securities laws. Basic, 485 U.S. at 234, 108 S.Ct. at 984-85. We think that creating an exception to a regulatory scheme founded on a prodisclosure legislative philosophy, because complying with the regulation might be 'bad for business,' is a role for Congress, not this Court. Id. at 239 n. 17, 108 S.Ct. at 987 n. 17. 51 We recognize that it is quite likely that Quaker and Snapple had not yet agreed on the precise terms of their merger by the beginning of August 1994, or indeed even until shortly before the deal was announced on November 2 of that year. But plaintiffs do not allege that the terms of the agreement were set by the opening of the proposed class period in early August. Instead, they urge that, whatever the terms of the agreement may have been by the time of the purported false or misleading statements, it must by then have been clear to defendants that the merger would compel Quaker to take on sufficient additional debt to raise the total debt-to-total capitalization ratio to a level far higher than the upper-60 percent range. 7 We think that a reasonable fact-finder could so find. 52 We hold, therefore, that defendants have failed to establish that plaintiffs can prove no set of facts in support of their claim which would entitle them to relief. The complaint alleges facts on the basis of which a reasonable factfinder could determine that Quaker's statements regarding its total debt-to-total capitalization ratio guideline would have been material to a reasonable investor, and hence that Quaker had a duty to update such statements when they became unreliable. 8
53 Defendants offer as an alternative basis for affirmance the complaint's alleged lack of compliance with the requirements of Federal Rule of Civil Procedure 9(b). 9 That rule dictates that [i]n all averments of fraud or mistake, the circumstances constituting fraud or malice shall be stated with particularity. Our cases warn, however, that focusing exclusively on the particularity requirement is too narrow an approach and fails to take account of the general simplicity and flexibility contemplated by the rules. Craftmatic Securities Litigation v. Kraftsow, 890 F.2d 628, 645 (3d Cir.1989). Because, in cases alleging corporate fraud, plaintiffs cannot be expected to have personal knowledge of the details of corporate internal affairs, we have relaxed the particularity rule when factual information is peculiarly within the defendant's knowledge or control. Id. Nevertheless, even under a non-restrictive application of the rule, pleaders must allege that the necessary information lies within defendants' control, and their allegations must be accompanied by a statement of the facts upon which the allegations are based. Id. 54 In Craftmatic, we held that where a projection is alleged to have been issued without a reasonable basis and knowingly and recklessly, a complaint must allege not only the dates, the speaker, and the actual projections at issue and that there was no reasonable basis for the projections, but also facts indicating why the charges against defendants are not baseless and why additional information lies exclusively within defendants' control. Id. at 646. In Shapiro v. UJB Financial Corp., 964 F.2d 272 (3d Cir.1992), we refined the Craftmatic standard, holding that a boilerplate allegation that plaintiffs believe the necessary information 'lies in defendants' exclusive control,'  if made, must be accompanied by a statement of facts upon which their allegation is based. Id. at 285 (citing James W. Moore and Jo D. Lucas, Moore's Federal Practice p 9.03 at 9-29 (1991) (where the facts are in the exclusive possession of the adversary, courts should permit the pleader to allege the facts on information and belief, provided a statement of the facts upon which the belief is founded is proffered)). Specifically, we required that [t]o avoid dismissal in these circumstances, a complaint must delineate at least the nature and scope of plaintiffs' effort to obtain, before filing the complaint, the information needed to plead with particularity. Shapiro, 964 F.2d at 285. We directed that plaintiffs thoroughly investigate all possible sources of information, including but not limited to all publicly available relevant information, before filing a complaint. Id. 55 The complaint in the case before us directly addresses these standards. Paragraph 43, for example, restates the Shapiro standard word-for-word, then goes on to list the sources of information which plaintiffs have reviewed. App. at 36. The proffered list of publicly available information is expansive, including filings with the SEC, annual reports, press releases, recorded interviews, media reports on the company, and reports of securities analysts and investor advisory services. 10 Further, plaintiffs--presumably cognizant that their efforts were required to be not limited to publicly available information--consulted with and obtained the advice of an expert in financial analysis in connection with the meaning and method of calculation of [Quaker's] leverage ratios and the implications of defendants' decision to change [Quaker's] leverage ratio. App. at 37. Finally, the complaint makes the requisite assertion that the underlying information relating to defendants' misconduct and the particulars thereof are not available to plaintiffs and the public and lie exclusively within the possession and control of defendants. Complaint at p 44. 56 The complaint therefore meets the requirements of Rule 9(b). Accordingly, we hold that Rule 9(b) does not offer a viable alternative ground for dismissal.