Court Opinion

ID: 6928820
Source: CourtListenerOpinion
Date Created: 2022-07-23 23:45:27.981164+00
Date Added: 2024-06-11T16:07:02.992932
License: Public Domain

WINTER, Circuit Judge,
dissenting:
I respectfully dissent. In my view, Time Warner’s purported scheme to float a variable-price rights offering at an artificially inflated price is at odds with many long-standing assumptions of the securities laws and thus does not suffice to establish scienter for purposes of a Rule 12(b)(6) motion. Moreover, it is expressly contradicted by the complaints.
I
First, the area of agreement. I agree that the allegation that Time Warner’s failure to disclose active consideration of the variable-price rights offering was material in that it rendered prior statements arguably misleading. Under Kronfeld v. TWA, 832 F.2d 726 (2d Cir.1987), cert. denied, 485 U.S. 1007, 108 S.Ct. 1470, 99 L.Ed.2d 700 (1988), a trier may find that the disclosure of one possible financial strategy (or strategies) is misleading when another strategy with substantially more negative implications for investors is also being seriously considered. In Kron-feld, a failure to disclose consideration of the complete severing of ties with a subsidiary was held to be material in light of the disclosure of less drastic strategies. Id. at 736. Because the drastic severance alternative had yet to be considered by the parent’s board, Kronfeld establishes a rather inclusive test of materiality, and the complaint here alleges facts more compelling than those in Kronfeld. It therefore cannot be dismissed on materiality grounds.
Because I view the complaints in a somewhat different light than my colleagues, I will set out in some detail what I regard to be the pertinent allegations. Time Warner had taken on considerable debt and had a balloon payment coming up. This was not news to the market for its shares. Over the course of time, various officers of Time Warner made statements regarding strategic alliance conversations and the benefits of such alliances. These benefits sometimes involved the penetration of new markets or the development of new products, frequently involved the infusion of cash that would be available to pay off the debt, and sometimes involved both. Analysts responded favorably, noting that they anticipated the consummation of strategic alliances, sales of Time Warner assets, or other “restructurings,” any of which would enable the company to meet its debt payments.
Given the somewhat loose use of the term “dilution” in this litigation and my view of the scienter issue set forth infra, two matters must be emphasized. First, when a debt-ridden company raises cash by a strategic alliance, a sale of an asset, or a restructuring, the parties providing the cash will demand interests in the company that dilute the existing common shares in the sense that it will reduce their share of equity. Indeed, it is inconceivable that any strategic alliance could have been consummated by Time Warner without sharing, and diluting, equity interests. Second, investors who do not care about control also do not care about dilution. They care about share value, and that value may (in this case would) increase as a result of a diluting infusion of cash brought about by a strategic alliance or even by an issue of additional common stock.
The failure to consummate a strategic alliance and subsequent resort to the issuance of new shares, therefore, would, if the offering here was a traditional offering of common shares, be dilutive but not injurious. Indeed, some of the analysts quoted by the complaint for the purpose of establishing misrepresentations contemplated asset sales that would dilute the equity by shrinking it or restructurings that might include the issuance of more dilutive shares. These analysts nevertheless expected share value to increase. In my view, therefore, Time-Warner’s failure to disclose active consideration of an equity of*273fering did not make its prior statements misleading.
However, the offering here was not your standard equity offering. The variable-price rights offering — although not consummated, it is the offering that allegedly rendered prior statements misleading — was restricted to existing shareholders. This was news in light of the prior statements because it indicated that outside capital was not available. It thus indicated that the only source of capital available for the debt payments were the loeked-in shareholders of Time Warner who might lose all if the company defaulted on the debt. Moreover, the variable-price rights offering was dilutive but in a very different sense from that indicated by my colleagues. If all shareholders exercised their rights, each would purchase one new share for $105. If only 60% exercised the rights, those shareholders would purchase 1% shares for $63. As the complaints allege, therefore, the offering was coercive because shareholders hoping to minimize their losses would feel compelled to come up with fresh money. Unlike an infusion of capital from outside that would dilute but also benefit shareholders, this new issue of equity would necessarily lessen the value of the common shares because existing shareholders had either to put up more money or to incur a disproportionate loss in value. In light of the prior statements, therefore, active consideration of the variable-price option should have been disclosed under Kronfeld, 832 F.2d at 737.
II
My disagreement with my colleagues concerns the complaints’ allegations with regard to scienter, or in this case the motive for the alleged failure to make timely disclosure. There is certainly no self-evident motive. The variable-price rights offering was a drastic step, to be sure, and very bad news, but the timing of the announcement seems rather irrelevant. The complaints allege that appel-lees failed to make early disclosure because of the fear that potential partners would be scared off by the bad news. That is implausible, however. News that Time Warner could raise fresh cash from its shareholders would be welcome news to potential partners concerned about the burden of debt. That news thus might cause negotiations close to agreement to succeed. It appears, however, that no alliance conversations were ever that close to an agreement.
The scenario relied upon by my colleagues to establish motive is that Time Warner management failed to disclose consideration of the variable-price rights offering to inflate the price at which that offering could be sold so that the dilutive effect would be minimized. The legal and logical flaws in this scenario seem rather plentiful. As a threshold matter, the complaints, as discussed infra, at times contradict it. This scenario also was not argued in the district court, its source being a single paragraph in appellants’ 49-page brief in this court.
Most important, the scenario is wholly implausible in light of the nature of the variable-price rights offering. Time Warner management was not seeking to minimize the dilutive effect on existing shareholders. To the contrary, as the complaints vigorously allege and as discussed supra, the variable-price rights offering created a disproportionate dilutive effect on non-exercising shareholders as a means of coercing shareholders to exercise the rights. The notion that the existing shareholders would continue to rely upon long-gone statements regarding fresh capital in the face of the coercive rights offering is entirely far-fetched. The complaints allege in great detail that the rights offering “shocked the investment community,” was viewed by analysts as an admission that Time Warner was unable to find fresh money from outside, and had “ang[ered]” shareholders. How the management of Time Warner might have expected any other reaction, much less continued faith in weeks-old statements that outside capital was available, defies common sense. The very existence of the variable-price rights offering was a tangible, high-profile, and unmistakable negation of the earlier statements. That indeed is the reason that a failure to make timely disclosure is a material omission. SEC v. Texas Gulf Sulphur Co., 401 F.2d 833, 849 (2d Cir.1968), cert. denied, 394 U.S. 976, 89 S.Ct. 1454, 22 L.Ed.2d 756 (1969).
*274Moreover, the management of Time Warner knew at all pertinent times that such an offering had to be preceded by the filing of a registration statement with the SEC followed by a statutory waiting period. Securities Act of 1933, § 5, 15 U.S.C. § 77(e) (1988); id. § 8(a), 15 U.S.C. § 77h(a) (1988). That registration statement would have to reveal the failure of the strategic alliance talks and the fact that holders of Time Warner’s common shares who would not or could not come up with more money would find their interests diluted. Securities Act of 1933, § 7(a), 15 U.S.C. § 77g(a) (Supp.1991) & Sched. A. That information would become public when filed, and investors would have several days to assimilate it before the rights offering could be sold. When it was filed on June 6, the registration statement, in the words of one complaint, “shocked the investment community,” while by its own terms the registration statement could not be effective before June 17.
This scenario posits a management that expects that the disclosure of the failure of the strategic alliance conversations and resort to a coercive rights offering would not be fully assimilated by shareholders during the waiting period. It also posits that a substantial number of shareholders would continue to give credence to statements that were weeks old and flatly contradicted by the registration statement.
My colleagues express skepticism about the usefulness of the efficient market hypothesis (while quoting a rather uncritical acceptance of it by the Supreme Court) in Basic, Inc. v. Levinson, 485 U.S. 224, 246-27, 108 S.Ct. 978, 991-92, 99 L.Ed.2d 194 (1988). However, the notion that markets impound available information relatively promptly in share prices, at least in widely traded companies, pervades securities law. Most pertinent is the statutory provision for a waiting period after the filing of a registration statement. One purpose of the waiting period is to allow ample time for the information contained in the statement to be absorbed by investors. Indeed, that is why acceleration of the validity of a registration statement depends in part on whether the information contained in it has been widely disseminated. SEC Reg. C, Rule 461(b), 17 C.F.R. § 230.-461(b) (1993).
In Texas Gulf Sulphur, we indicated that an insider might trade on previously confidential information within a reasonable period of time after information was disseminated on the Dow Jones tape. 401 F.2d at 854. Although no doubt unintended, my colleagues’ belief that the market cannot fully absorb what was headline information in the financial press over a period of many days would seem quite inconsistent with Texas Gulf Sulphur. Moreover, the SEC’s adoption of Form S-3 was based on the view that filings with the SEC by widely traded companies are quickly absorbed in the price of shares. See Adoption of Integrated Disclosure System, Securities Act Release No. 6383, 47 Fed.Reg. 11,380 (1982).
Finally, although there are weak forms of the efficient market hypothesis, a fairly strong form has been adopted by the Supreme Court. See Basic, Inc., 485 U.S. at 246,108 S.Ct. at 991 (“Recent empirical studies have tended to confirm Congress’ premise that the market price of shares traded on well-developed markets reflects all publicly available information....”). Indeed, one of the striking ironies of my colleagues’ ruling is that the complaints in the present matter stress the efficiency of the market for Time Warner shares and never allege even the possibility that the strategic alliance statements had, or could have had, a lingering effect after June 6. To the contrary, one complaint alleges that the market “reacted promptly to disclosure” that the quest for strategic partners had failed. While my colleagues suggest that the efficient market hypothesis is flawed, each of the complaints alleges it as an operative fact so far as Time Warner stock is concerned. Each complaint thus states that Time Warner stock “traded on an active and efficient market,” or uses similar language. Of course, these allegations are intended to establish appellants’ reliance upon the material omission. See Basic, Inc., 485 U.S. at 243,108 S.Ct. at 989. The result of the present ruling is that appellants are allowed to establish reliance in their pleadings by stressing the efficiency of the market in Time Warner’s shares while estab*275lishing scienter by positing a market that cannot absorb a current registration statement’s negation of weeks-old information. This inconsistency seems rather stark in light of the facts that the statements concerning strategic alliance conversations promised no success while the announcement of the variable-price rights offering unambiguously disclosed the failure of those conversations. Nevertheless, plaintiffs avoid dismissal on the claim that investors would continue to harbor unwarranted optimism as a result of the earlier statements notwithstanding the company’s later straightforward admission of failure.
It is not my position that one must simply assume the efficiency of markets, although the strength of such an assumption is greatest in the case of widely traded companies, like Time Warner, whose affairs are closely followed in the financial press. However, allegations of delays in the absorption of information, the existence of “bubbles,” or other inefficiencies should be made with some precision. In the present matter critical ambiguities — as well as the internal contradiction concerning the issue of reliance noted above — shroud my colleagues’ views of the operation of capital markets. For example, the present ruling suggests, as1 noted, that the legally designated waiting period is too short for the market to absorb information in a registration statement. If so, how can we be confident that disclosure on May 1 would have led to any greater absorption?
The only description given of the supposed imperfection is a suggestion that markets may work efficiently “when disclosures are proper [but] it is not beyond doubt that they may not fully correct for prior misleading information once a necessary disclosure has been made.” (emphasis in original) I doubt the validity of this proposition. It appears to posit that if A, Inc. truthfully projects high earnings and later states, again truthfully, that it now expects only to break even, the market can absorb the downgrading. It also seems to posit that if A, Inc. falsely projects high earnings but later states truthfully that it now expects only to break even, the market cannot fully absorb the downgrading. This does not seem plausible to me.
Nor can I find an explanation of why the inefficiency of the market is only on the up rather than on the down side. Why doesn’t the dashing of hopes as to strategic alliances and the adoption of a coercive, variable-price rights offering lead to overcorrection instead of undercorrection? More pertinently, why would Time Warner management expect— actually, count on — undercorrection?
Neither Time Warner nor its shareholders, who must pay the costs of defending and settling this action, profited from any delay in announcing the variable-price rights offering. The argument regarding a motive for such delay posits a scenario that is inconsistent with assumptions underlying securities law, statements in the complaint, and any plausible understanding of the operation of capital markets. I would affirm the dismissal of the complaint.