USCA1 Opinion

United States Court of Appeals

For the First Circuit
____________________

No. 95-1995

MERRY LOU SHAW, ET AL.,

Plaintiffs, Appellants,

v.

DIGITAL EQUIPMENT CORP., ET AL.,

Defendants, Appellees.

____________________

No. 95-1996

LEONARD WILENSKY, ET AL.,

Plaintiffs, Appellants,

v.

DIGITAL EQUIPMENT CORP., ET AL.,

Defendants, Appellees.

____________________

APPEALS FROM THE UNITED STATES DISTRICT COURT

FOR THE DISTRICT OF MASSACHUSETTS

[Hon. Joseph L. Tauro, U.S. District Judge]

___________________

____________________

Before

Torruella, Chief Judge,

___________

Cyr and Lynch, Circuit Judges.

______________

____________________

Sanford P. Dumain,
__________________

with whom

David J. Bershad, James P.

_________________ _________

Bonner, Milberg, Weiss, Bershad, Hynes & Lerach, Glen DeValerio,

______ ________________________________________ ______________
Kathleen Donovan-Maher,
_______________________

Berman,
DeValerio & Pease,
_____________________________

Schiffrin, Schiffrin & Craig, Ltd.,

_________ ________________________

Joseph D. Ament,
_______________

Richard
_______

and Much,
_____

Shelist, Freed, Denenberg, Ament, Bell & Rubenstein, P.C., were

___________________________________________________________
on brief, for the Shaw appellants.
____

Thomas G. Shapiro, with

___________________
Grace, Haber & Urmy,
_____________________

whom

Edward F. Haber,
________________

Shapiro,
________

Glen DeValerio, Kathleen Donovan-Maher,

_______________ _______________________

Berman, DeValerio & Pease, Fred Taylor Isquith,

_________________________ ___________________

Peter C. Harrar,
_______________

Wolf, Haldenstein, Adler, Freeman

& Herz, L.L.P.,
_______________________________________________________

Richard
_______

Bemporad, and Lowey, Dannenberg, Bemporad & Selinger, P.C., were

________
_____________________________________________
on brief, for the Wilensky appellants.
________

Edmund C. Case, with whom

_______________
Birnbach,
________

Jordan D. Hershman, Deborah S.

___________________ ___________

Testa, Hurwitz & Thibeault,

____________________________

Randall W. Bodner,
__________________

John D. Donovan, Jr.,

______________________

Daniel J. Klau, and

_______________

Ropes & Gray were

_____________

on

brief, for the Shaw appellees.

____

Edmund C. Case,
_______________
Birnbach,
________

with whom Jordan D. Hershman,

___________________

Testa, Hurwitz & Thibeault,

____________________________

Deborah S.
__________

John D. Donovan, Jr.,

______________________

Randall W. Bodner, Daniel J. Klau, Ropes & Gray, Gerald F. Rath,

_________________ ______________ _____________ ______________
Robert A. Buhlman,
_________________

Bingham, Dana & Gould,

______________________

Michael J. Chepiga,
___________________

Daniel A. Shacknai,
___________________

and

Simpson, Thacher & Bartlett were

_____________________________

brief, for the Wilensky appellees.

________

____________________

May 7, 1996
____________________

on

LYNCH,

Circuit Judge.
_____________

Plaintiffs,

purchasers

of the

securities of Digital Equipment Corp., appeal from the district

court's dismissal of

violations

of the

two consolidated

federal securities

class actions

laws.

alleging

Both complaints

assert that there were misleading statements and nondisclosures

in

the

registration

connection

with

statement

a public

and

prospectus

offering of

stock.

prepared

in

That offering

commenced on March 21, 1994, just 11 days prior to the close of

the

quarter then in progress,

and about three

weeks prior to

the company's announcement of an unexpectedly negative earnings

report for that quarter.

One of the complaints further alleges

that defendants made fraudulently optimistic statements to

public in the period

leading up to the offering.

the

The district

court found that neither complaint identified any statements or

omissions actionable

both

under the

securities laws

for failure to state a claim.

alleged misstatements

and omissions

and dismissed

We agree that many of the

do not provide

a legally

cognizable

basis

conclude that

relating to

for

the

plaintiffs' claims,

also

in both complaints

the registration statement and

prospectus for the

claim.

We further find

portions of the complaints

requirements of Fed. R.

the

we

a limited set of allegations

March 1994 offering does state a

the surviving

but

district court's

Civ. P. 9(b).

decision in

remand for further proceedings.

-3-

that

satisfy the pleading

Accordingly,

we affirm

part, reverse in

part, and

I.

Background
__________

Digital

world's

services.

company

had

Equipment

Corporation ("DEC")

largest suppliers of

Founded

in 1966.

burgeoned

in 1957,

By

into

computer hardware,

it first became

the early 1990's,

$14

company's success story,

billion

million.

its

one

of the

software and

a publicly

in yearly

revenues.

however, would not last forever.

first-ever quarterly

held

the company's success

1992, the company had fallen on hard times.

reported

is

The

By

In January 1992 it

operating

loss

of $138.3

Faced in the ensuing months with operating losses in

the

range

company

some

of $30

decided to

35,000

process,

these

million to

engage in

employees over

$311

million per

radical surgery,

the course

including its founder and CEO.

of

quarter, the

cutting loose

15 months

in the

To cover the costs of

actions, the company accumulated "restructuring" charges

totalling

close

to $3.2

billion

in

fiscal years

1990-1992

combined.

In the midst of its financial woes, however, the company

took some

steps to restore its health.

In February 1992, DEC

had introduced a new product, the "Alpha" chip.

was hailed

restore

the

as a

technological advance that

company's fortunes.

In

installed a new CEO, Robert B. Palmer.

The Alpha chip

could potentially

mid-1992, the

company

He took the helm in the

fall

of

that

strategies

year, as

the

company

continued to

implement

to help its Alpha technology gain acceptance in the

-4-

marketplace

vitality.

and

At

to

the

bring

time Palmer

absorbed

over $3 billion in

and

been losing

had

the

company

took

back

over, the

losses for the

money at

the

rate of

to

financial

company

had

prior three years

approximately $3

million

per day.

Under

the new management,

it appeared that

the company's financial hemorrhaging had finally begun to slow.

On

January 14, 1993, DEC reported a loss for the second

quarter of fiscal year 1993 that

anticipated by analysts.

another

quarter

expectations.

of

was far smaller than had been

That promising result was followed by

losses,

Then, on July

but

within

28, 1993, the

Wall

Street's

company announced

its first profitable quarter since before the 1992 fiscal year,

reporting a net profit of $113.2 million for the fourth quarter

of

fiscal year 1993.

expectations, but

That result was slightly below analysts'

a stark improvement over

the operating loss

of $188.1 million (and overall loss of $2 billion) reported for

the comparable quarter in the prior year.

Still,

on October

20, 1993,

DEC announced

loss of

$83.1

million for

over the $260.5

year,

19,

the first quarter

million loss

of 1994,

for the same

an improvement

quarter the

but worse than analysts had been predicting.

1994, the

losses for

January

company

the

1, 1994,

announced

second quarter

of $72

of

million.

another setback,

fiscal year

The loss

On January

reporting

1994,

was

prior

ending

worse than

analysts had expected and was virtually identical to the losses

for that period the prior year.

-5-

It was against

1994,

filed

giving

various

this backdrop that

with the

the company the

classes of

later, DEC

SEC

through its

"shelf" registration

option to

debt and

DEC, on January

issue up

to $1

equity securities.

underwriters conducted an

$400 million in depositary

21,

statement

billion in

Two months

offering of

shares of preferred stock, pursuant

to the "shelf" registration, a prospectus dated March 11, 1994,

and a prospectus supplement dated March 21, 1994.

commenced on the

date of the prospectus

one

week later on March 28, 1994,

the

third fiscal quarter.

The offering

supplement and closed

four days before the end of

All 16 million depositary shares of

preferred stock were sold,

at an offering

price of $25.

DEC

raised a badly needed $387.4 million.1

Less

announced

than three

an

quarter that

loss

operating

weeks later,

loss of

had ended on April

on April

over

$183

2, 1994.

15, 1994,

million

This

DEC

for the

third quarter

was far greater than analysts had been expecting, and the

largest that the

of fiscal 1993.

company had reported since

It bucked the positive trend of reduced losses

under the company's new management.

price of

the first quarter

the newly

The announcement sent the

distributed preferred stock

tumbling from

the offering price of $25 to $20.875 by the close of trading on

April 15.

The common stock fell from $28.875 to $23 during the

____________________

1.

Because

the offering

was

conducted pursuant

to a

"firm

commitment"

underwriting

offered shares to the

turn

arrangement,

DEC

sold

all of

underwriters at a discount, who

sold the shares to the public.

the

then in

Thus, DEC's proceeds were

less than the total offering amount.

-6-

same period, and to

$21.125 by the

close of the next

trading

day.

In its April 15 announcement, the company also disclosed

that it had decided to "accelerate [its] on-going restructuring

efforts" and

"also consider further restructuring."

despite a representation in

that

"[t]he

restructuring

presently

following

Corporation

reserve of

planned

the March 21 prospectus supplement

believes

$443

that

million is

restructuring

the

remaining

adequate to

actions."

cover

Eventually,

the close of fiscal year 1994, DEC announced on July

14, 1994 that it

workforce and

would cut almost one-fourth of

take an additional

fiscal year 1994

as

This was

charge of

its remaining

$1.2 billion

for

(beyond the $443 million remaining in reserve

of March 21) to cover the costs of additional restructuring

activities.

II.

Description of the Actions

__________________________

These

two lawsuits

were

filed on

Tuesday, April

19,

1994,

two business

April 15, 1994.

all

persons who

days after

the company's

announcement of

One, the Wilensky action, brought on behalf of

________

purchased

offering, asserts claims

shares in

the

under Sections 11,

the Securities Act of 1933 ("Securities Act")

March 1994

public

12(2), and 15

of

against DEC, its

Chief Executive Officer (Robert B. Palmer), its Chief Financial

Officer

(William Steul), and

banking firms,

seven underwriting or investment

representing a purported defendant

-7-

class of 65

underwriters who participated in the offering.

Shaw action, advances claims under

____

the

and

pendent

misrepresentation, on

stock

Sections 10(b) and 20(a) of

Securities Exchange Act of 1934

10b-5,

between January

claim

behalf of

19

and

The second, the

of

("Exchange Act") and Rule

law

negligent

all purchasers of

DEC common

April

common

15,

1994

(the

"Class

Period").

At

the heart of both complaints are two sets of claims.

First, plaintiffs

assert that DEC management

material facts concerning

the

the large

had knowledge of

losses developing

during

third fiscal quarter of 1994, and that the defendants were

under

market

March

a duty

to

disclose such

in connection

21, 1994.

with

material

the public

information to

the

offering conducted

on

Second, both the Wilensky and Shaw plaintiffs

________
____

contend that the representation made in the March 21 prospectus

supplement

concerning the

"restructuring reserve" was

plaintiffs

allege,

"adequacy"

of

the

then-remaining

materially misleading.

additionally,

that throughout

The

the

Shaw
____

Class

Period,

the defendants made fraudulently optimistic statements

to

public

the

artificially to

concerning

DEC's future

inflate the market

prospects

value of

in

order

DEC shares,

and

that these statements were actionably false or misleading.

The defendants

filed motions

Civ. P. 9(b) and 12(b)(6).

to dismiss under

Fed. R.

The district court consolidated the

cases, stayed

all discovery, and then

The

court ruled,

district

inter

dismissed both actions.

alia,

that defendants

had

-8-

violated

statements

no

duty

were

not

to

disclose

misleading,

and

that

bespoke

otherwise not actionable as a matter of law.

the

defendants'

caution,

or

were

The court granted

the defendants' motions to dismiss under Rule 12(b)(6), without

reaching

whether

requirements

in

the

complaints

of Rule 9(b).

satisfied

the

These appeals followed.

part and reverse in part.

pleading

We affirm

For clarity, we discuss each of

the two actions in turn.

III.

The Section 11 and 12(2) Claims

_______________________________

(Wilensky Action)
________

Sections 11 and 12(2) are enforcement mechanisms for the

mandatory

1933.

disclosure

Section

registration

registration

requirements of

11

imposes

statement,

liability

and

statement "contained

material fact or omitted

the

on

Securities Act

on

signers

underwriters,

an

untrue

of

if

statement of

to state a material fact

of

the

required to

be stated therein

not misleading."

any person

make

15 U.S.C.

who "offers

prospectus or

statement

or necessary to make

or

Section 12(2) provides that

sells" a

security by

means of

oral communication containing a materially false

or that "omits to state a material fact necessary to

the statements, in

which they were made,

"person

77k.

the statements therein

purchasing

the light of

the circumstances under

not misleading," shall be liable

such

security from

77l(2).

-9-

him."

to any

15 U.S.C.

The Wilensky plaintiffs assert claims under Sections 11,

________

12(2), and

15,2 alleging

prospectus

filed

offering

state

that the registration

in connection

with

contained materially false

material information

the

statement and

March 1994

public

statements and omitted to

required

to be

provided therein.

The thrust of the Wilensky complaint is that defendants knew as

________

of the March 21 date

facts portending

quarter

of fiscal

failure to

of the 1994 public offering,

the unexpectedly

1994 that

disclose these

large losses for

were announced

material facts in

of material

the third

later, and

that

the registration

statement

the

and prospectus violated

Wilensky
________

registration

plaintiffs contend

statement

and

Section 11.

that

the

prospectus

Additionally,

statement in

the

characterizing

as

"adequate" the company's then-remaining "restructuring reserve"

of

$443

million

was

materially

false

and

misleading,

in

violation of both Sections 11 and 12.

The defendants parry by attempting to reduce plaintiffs'

claims to an argument that the company was required to disclose

its internal forecasts about the outcome of the third

_________

They argue

that the plaintiffs' position

the securities laws impose

quarter.

is untenable because

no duty upon a company

to disclose

internal projections, estimates of

quarterly results, or other

forward-looking information.

also say that the statement

They

concerning the adequacy of the company's restructuring reserves

____________________

2.

Section 15

"control" those

imposes derivative

liability upon

liable under Section 11 or 12.

persons who

See 15
___

U.S.C.

77o.

-10-

is

not

actionably

misleading

Finally, defendants contend that

when

considered

in

context.

the complaint fails to allege

sufficient

facts

and

the underwriter

defendants were statutory "sellers" subject to

liability under

Section 12(2).

A.
__

establishing that

DEC

We evaluate each set of arguments separately.

Actionability of Alleged Nondisclosures Under Section 11

________________________________________________________

The proposition that silence, absent a duty to disclose,

cannot

be

actionably

securities law.

10,

13 (1st

misleading,

Cir. 1990)

a duty to inform the

suggest that

fixture

in

(en banc).

Equally settled

1994);

market whenever present circumstances

the future may bring

Capri Optics

is that

do not themselves give rise

a turn for the

worse.

Serabian v. Amoskeag Bank Shares, Inc., 24 F.3d 357,

________
___________________________

Cir.

federal

See, e.g., Backman v. Polaroid Corp., 910 F.2d

___ ____ _______
______________

accurate reports of past successes

to

is a

Profit

Sharing

v. Digital

See
___

361 (1st

Equip.

_____________________________

Corp., 950 F.2d

_____

5, 7-8 (1st

Cir. 1991).

possession of material nonpublic

duty

to disclose

it.

See
___

_______________

In short, the

mere

information does not create a

Roeder v. Alpha Indus., Inc., 814

______
___________________

F.2d 22, 26 (1st Cir. 1987) (citing Chiarella v. United States,

_________
_____________

445 U.S. 222, 235 (1980)).

To focus here

on a

duty to disclose

however, would be to miss the obvious

This action

statement

arises out of an

and prospectus

stock offering.

those

in the

abstract,

in favor of the obscure.

allegedly defective registration

filed

in connection

with a

public

The obligations that attend the preparation of

filings embody

nothing if

-11-

not

an affirmative

duty to

disclose a broad range

of material information.

MacLean v. Huddleston, 459 U.S.

_______
__________

Cf.
___

Herman &
________

375, 381-82 (1983). Indeed, in

the context of a public offering, there is a strong affirmative

duty

of disclosure.3

U.S. 185,

provide

195

See
___

(1976) (the

Ernst & Ernst v.

______________

Securities

Hochfelder, 425
__________

Act "was

designed

to

investors with full disclosure of material information

concerning public offerings").

The question

here is not whether

defendants were under

an abstract duty to disclose information -- clearly, they were.

The

issue, rather,

obligation

to

is whether the

disclose

defendants had

information

of

the

type

a specific

that

the

plaintiffs complain was omitted from the registration statement

and

prospectus.

information is

separable

The

subject to

from

information

that

disclosed,

which

materiality.

task of

normative

whether

particular

mandatory disclosure is

not easily

judgments

the securities

depend,

deciding

in

See generally
______________

about

laws

should
______

essence,

on

Victor

the

kinds

of

require to

be

conceptions

Brudney,

of

A Note On
___________

____________________

3.

In

Roeder, this

court

alluded to

three situations

that

______
could give rise to a duty to disclose material facts:

(i) when

an insider trades in

basis of

material

nonpublic

the company's securities on the

information;

(ii)

regulation requires disclosure; and

previously made
inaccurate,

a statement

incomplete,

undisclosed information.

misleading

Roeder,
______

or

fact that is
in

light

false,
of

the

9 F.3d 259,

267 (2d

Cir.

cert. denied, 114 S. Ct. 1397 (1994); Backman, 910 F.2d

_____ ______
_______

at 12-13; Greenfield v.
__________
Cir.

statute

814 F.2d at 27; see also In

_________ __

re Time Warner, Inc. Sec. Litig.,

__________________________________
1993),

(iii) when the company has

of material

or

when

Heublein, Inc., 742 F.2d 751,

______________

1984), cert. denied,

____________

469 U.S.

1215 (1985).

decide here

whether these three

situations are the

that

trigger a

disclosure,

could

duty

of

necessarily would do so in every case.

-12-

758 (3d

We

do not

only ones

or whether

they

Materiality and Soft Information Under the Federal Securities

_______________________________________________________________

Laws,
____

75 Va. L.

suffices

Rev. 723, 728

(1989).

to say that the determination

nondisclosures in this case

For

our purposes, it

of whether the alleged

provide a legally sufficient basis

for the plaintiffs' claims cannot be severed from consideration

of the basic policies

underlying the disclosure obligations of

the applicable statutes and regulations.

We conclude that we cannot say that DEC was not required

to disclose material information

concerning its performance in

the quarter

time of

in progress

public offering.

Nor can

at the

the

March 21,

we conclude, as a matter of

1994

law and

on

these pleadings,

that DEC

was not

in possession

of such

material nonpublic information at the time of the offering.

1.
__

The Insider Trading Analogy

___________________________

In

understanding

requirements

helpful

to

attending

the

nature

public

conceptualize DEC

of

offering of

(the

corporate

the

disclosure

stock,

it

is

issuer) as

an

individual insider transacting in the company's securities, and

to examine the disclosure obligations that would then arise.

There is

no doubt that an

in possession of material

individual corporate insider

nonpublic information is

prohibited

by the federal securities laws from trading on that information

unless he makes public disclosure.

from trading.

He must disclose or abstain

See SEC v. Texas Gulf Sulphur Co., 401 F.2d 833,

___ ___
______________________

848

(2d Cir.

(1969);

1968)

(en banc),

see also SEC v.

________ ___

cert. denied, 394

_____________

MacDonald, 699 F.2d

_________

U.S.

976

47, 50 (1st Cir.

-13-

1983)

(en banc).

A central justification for the "disclose or

abstain" rule is to deny

profit

corporate insiders the opportunity to

from the inherent trading advantage

they have over the

rest of the contemporaneously trading market by reason of their

superior access to information.

See Shapiro
___ _______

v. Merrill Lynch,
______________

Pierce, Fenner & Smith, Inc., 495 F.2d 228, 235 (2d Cir. 1974);
____________________________

SEC v. Texas Gulf Sulphur Co., 401 F.2d 833, 848 (2d Cir. 1968)
___
______________________

(en banc).4

The rule

insiders

would

material

information,

associated

"beating

8.2,

("The

otherwise

have

and

273-75 (1986);

both the

to delay

minimizes

the diversion

the market."

at

Fischel,

with

eliminates

of

the

any

C.

that

disclosure

efficiency

resources

See Robert
___

Frank

incentives

of

losses

by insiders

to

Clark, Corporate Law

______________

H. Easterbrook

The Economic Structure of Corporate Law

_________________________________________

&

Daniel R.

288 (1991)

lure of trading profits may induce people to spend a lot

of effort and other resources "beating the market"; . . . [T]he

prompt

disclosure of

extinguish the

information

by the

trading opportunity.

affected firm

will

When everyone

knows the

(noting that

the other

truth, no one can speculate on it."5).

____________________

4.

See also
_________

Brudney, supra,
_____

major justification
is

to

increase

at 735

for requiring trading insiders to disclose

the

quality

available to investors, thereby

and

quantity

of

information

facilitating efficiency in the

allocation of capital).

5.
this

Judge Easterbrook and

beating-the-market

mandatory disclosure.
_________
voluntarily
reasons,

They

Professor Fischel ultimately

concern

company

justification

for

argue that companies normally will

disclose material bad

if

as

reject

news, because,

consistently

fails

to

among other
make

such

disclosure, the market will discount the value of the company's

securities

by

the

increased

probability

-14-

that

it

is

in

The policy rationale for

carries over to

to

an

contexts where a corporate

individual,

transaction.

is

Courts,

the

of the

McCormick
_________

Cir.

1994)

party

including

corporation trading in its own

purposes

the "disclose or abstain" rule

"disclose

or

issuer, as opposed

contemplating

this one,

have

stock

treated

securities as an "insider"

abstain"

rule.

v. Fund American Cos., Inc., 26 F.3d

_________________________

(collecting

cases) ("[T]he

See,
___

for

e.g.,
____

869, 876 (9th

corporate

issuer

in

possession of material nonpublic

insiders in

the same

information, must, like other

situation, disclose that

information to

its shareholders or refrain from trading with them."); Rogen v.

_____

Ilikon Corp., 361

_____________

Kohler Co.,
___________

319

F.2d 260,

F.2d 634,

268 (1st

638

(7th

Cir. 1966);

Cir.

Kohler v.
______

1963); Green
_____

v.

Hamilton Int'l Corp., 437 F. Supp. 723, 728-29 (S.D.N.Y. 1977);

____________________

VII Louis

Loss & Joel Seligman, Securities Regulation 1505 (3d

_____________________

ed. 1991) ("When the issuer itself wants to buy or sell its own

securities, it has

C.

Langevoort,

Prevention
__________

a choice: desist or disclose.");

18 Donald

Insider Trading: Regulation, Enforcement &

______________________________________________

3.02[1][d],

at

(3d

rel.

1994)

("Issuers

themselves

may buy or sell their own securities, and have long

____________________

possession
thereby

of

undisclosed

increasing the

capital.
recognize,

Id.
___
the

at

material

company's

288-89.
argument

raising

authors

disclosure

also

becomes

the short-term interests

is under pressure to

in the company's financial

id. at 169 (discussing

___

the

of

differ from its long-term interests,

for example, where management

rapid turnaround

as

voluntary

considerably weaker in contexts where

of the company's managers

information,

long-run costs

However,
for

negative

performance.

the "agency" problem in the

tender offers).

-15-

engineer a

See
___

context of

been

held

to

Conceptually,

an

obligation

extending

the

of

full

insider

disclosure

trading

. . . .

prohibition to

instances of issuer insider trading makes perfect sense.").

Just

as an individual

insider with

material nonpublic

information about pending merger or license negotiations

not

purchase

disclosure,

purchase
________

the

of its

his

company's

company

itself

own stock,

undisclosed information.

securities

may

if it

See, e.g.,
___ ____

without

not engage

is in

could

in

making

such

possession of

Rogen, 361 F.2d

_____

such

at 268.

By extension, a comparable rule should apply to issuers engaged

in a stock offering.
________

Otherwise, a corporate issuer selling its

own securities would be left free to exploit

trading

advantage, at

disclosure

of

the expense

material

completion of the

its informational

of investors,

nonpublic negative

offering.

by delaying

news

Cf. Ian Ayres,

___

until after

Back to Basics:
________________

Regulating How Corporations Speak to the Market, 77 Va. L. Rev.

_______________________________________________

945,

959-60

(1991) (describing

laws impose needed discipline,

internalize

the costs

the argument

that securities

because companies do not always

of failing to

provide the

market with

accurate information that would lower stock prices).

2.

The Statutory and Regulatory Scheme

___________________________________

Analogizing a corporate issuer

subject

law

to the "disclose

illustrates

to an individual insider

or abstain" rule

the policy

reasons

of insider trading

supporting

a comparably

strong

disclosure

offering.

We look

mechanism

in

the

to the explicit

context

of

statutory and

public

regulatory

-16-

framework to determine whether the Securities Act provides such

mechanism,

and

whether

the Wilensky
________

complaint

states

legally cognizable claim for nondisclosure under Section 11.

Section

11 by its terms

provides for the imposition of

liability

if a

registration

statement, as

of its

effective

date: (1) "contained an untrue statement of material fact"; (2)

"omitted

to

state

material

fact required

to

be

stated

therein"; or (3) omitted to state a material fact "necessary to

make

the

77k(a).

statements

therein

not

misleading."

of these three bases

unique

to Section 11; neither Section

nor Section

contains

U.S.C.

The plaintiffs' claim of nondisclosure relies on the

second

Act

15

10(b) or

of liability.

Rule 10b-5

comparable language.

issuers, under

pain of

preparing registration

12(2) of the Securities

under the

It is intended

civil liability,

statements and

material information required

That predicate is

by the

not

Exchange Act

to ensure that

cut corners

that they

in

disclose all

applicable statutes

and

regulations.

Bloomenthal

(1996

See Huddleston,
___ __________

et al.,

ed.)

as

at 381-82;

Securities Law Handbook

________________________

("Congress

Securities Act

459 U.S.

an

. . .

in

devised

14.08,

Section

terrorem remedy

Harold S.

that

11

would

at 663

of

the

. . .

encourage careful preparation of the registration statement and

prospectus.").

The

information

registration statement is

Section 7(a)of

"required

spelled out

the Securities Act, 15

-17-

to

be

both in

U.S.C.

stated"

in

Schedule A

to

77g(a), 77aa,

and in

various regulations promulgated by the

its statutory authority.6

less

essential

to

the

Those rules and

statutory

outlines of the statute itself.

SEC pursuant to

regulations are no

scheme

than

the

general

Cf. Touche Ross & Co. v. SEC,

___ __________________
___

609 F.2d 570, 580 (2d Cir. 1979).

In

this

case,

DEC

conducted its

March

offering pursuant to a registration statement

Item 11(a) of the

1994

public

on SEC Form S-3.

instructions to Form S-37 requires

that the

issuer (registrant) describe in the portion of the registration

statement comprising the prospectus:

any and all material changes in the registrant's

_________________________________________________
affairs which have occurred
_______
latest fiscal year
statements
report to

for which certified financial

were included
security

been described

since the end of the

in the

holders and

in a report on

latest

annual

which have

not

Form 10-Q or Form

8-K filed under the Exchange Act.

Instructions to Form S-3, Item 11(a) (emphasis added).

To

understand

the

scope

disclosure requirement, it is

of

the

"material

changes"

helpful to understand the nature

____________________

6.

Section

7(a)

of

the

"registration statement
and be accompanied
may

by

rules or

appropriate in
investors."

Securities Act

shall contain such

regulations

U.S.C.

require as

the public interest

15 U.S.C.

77s(a)

or for

77g(a); see also

________

(granting

that

the

other information,

by such other documents,

(granting SEC similar authority

15

provides

as the Commission
being

necessary or

the protection
15 U.S.C.

of

77j(d)

with respect to prospectuses);

SEC broad

authority to

"make,

amend,

and

rescind

such

rules

and

regulations as

necessary to carry out the provisions of this [Act],

rules

and regulations

governing

may

be

including

registration statements

and

prospectuses").

7.

The provisions of the

SEC constitute
framework.

registration forms prescribed by the

an integral

part of the

See 17 C.F.R.
___

regulatory disclosure

230.400, 230.401, 239.0-1 et seq.

_______

-18-

of

Form

S-3.

Form S-3

available only to certain

is

a streamlined

registration form

well-capitalized and widely followed

issuers about which a

is

significant amount of public information

already available.8

registrant on Form S-3 accomplishes

disclosure

in

part

by

reference

its

most

recent Form

pursuant

incorporating in

to the Exchange Act.

Item 12(a).

10-K

the

and

prospectus

Forms

See Instructions
___

by

10-Q filed

to Form S-3,

Unlike registrants on more broadly available forms

(such as S-1), a Form S-3 registrant is not required separately

to furnish

in the prospectus the information

303(a) of Regulation S-K, 17 C.F.R.

discussion and

contained

in

229.303(a) ("Management's

analysis of financial condition

operations"),9 because

the

that

information

Exchange

incorporates by reference, which

Act

required by Item

is

filings

and results of

presumed

that

to

Form

be

S-3

are themselves subject to the

requirements of Regulation S-K.10

The primary purpose

of the

____________________

8.

To be eligible to register on Form S-3, an issuer must have

been subject to public reporting

requirements for at least one

year, filed all reports required

under the Exchange Act

as Forms 10-Q

and 10-K) timely during the past

meet certain other requirements

and stability.
al., supra,
_____

9.

Item

year, and must

relating to financial strength

See 17 C.F.R.
___

239.13; see also Bloomenthal et

________

5.05[1][b], at 212-13.

303(a)

information, of
had

(such

or that

requires
"any known

the

the

disclosure,

trends or uncertainties

registrant reasonably

material

favorable

or

revenues

or income

from

among

unfavorable

expects

impact on

other

that have

will have
net

continuing operations."

sales
17

or

C.F.R.

229.303(a)(3)(ii).

10.

By

contrast,

permit incorporation
in the

prospectus

Regulation S-K.

a registrant

on Form

by reference) must
the information

S-1 (which

does not

independently furnish

required

by Item

303

See Instructions to Form S-1, Item 11(h).

___

-19-

of

"material changes" disclosure requirement

is to

ensure that

update
______

of the

incorporated

provided

in

the prospectus

information

Exchange Act

those

of Item 11(a), then,

provides investors

required to

be

disclosed in

filings, including

filings

concerning

with an

the

the information

"known

trends

and

uncertainties" with respect to "net sales or revenues or income

from continuing operations."

In this case, the

17 C.F.R.

229.303(a)(3)(ii).

date of the final prospectus

for the

March 1994 offering and the

statement was March

of

DEC's

21, 1994.11

latest fiscal

Prior

year was

1993), and the last Form 10-Q

quarter

effective date of the registration

to that date,

July

3, 1993

the end

(fiscal year

filed by the company was for the

that had ended on January 1, 1994 (DEC's second fiscal

quarter).

The

contains

sufficient

disclose

in

question,

the

then,

allegations

registration

is

whether

that

the

complaint

defendants

statement

any

failed

to

information

regarding "material changes" in DEC's "affairs" as of March 21,

1994,

that had

reported

fiscal

in

occurred since July

the Form

year 1994.

alleges, then

If

10-Q filed

3, 1993 and

for

the Wilensky
________

the complaint sets

had not been

the second

quarter of

complaint adequately

forth a cognizable

so

claim of

nondisclosure under Section 11,

namely, that defendants failed

____________________

11.

The

effective date

of

the

registration

purposes of Securities Act liability is

the

final

prospectus.

5.05[2][f] at 216.

See
___

statement

for

the "speaking date" of

Bloomenthal

et

al.,

supra,
_____

The parties do not dispute that March 21,

1994 was the effective date of the registration statement.

-20-

to include in the

registration statement information "required

to be stated therein."

3.
__

The Alleged Nondisclosures

__________________________

Plaintiffs argue that defendants

failed to comply

with

Item 11(a) by omitting three categories of information from the

registration

contend

that

embarked on

prices

and

increasing

products.

disclose

sales

statement

and

defendants

prospectus.

failed

to

disclose

a risky marketing strategy

sacrificing

"market

profit

that under

representatives

the

plaintiffs

that

DEC

had

that involved slashing

margins

penetration" of

Second, plaintiffs

First,

in

the

the company's

hopes

of

Alpha chip

assert that defendants failed to

company's compensation

were being

paid

scheme,

its

"double commissions,"

again to the detriment of the company's profit margins.

Third,

and

most centrally, plaintiffs allege that, by the date of the

March 21 offering, defendants were in possession of, yet failed

to disclose,

material knowledge

third fiscal

quarter would be an

We dispose of the

of facts indicating

that the

unexpectedly disastrous one.

first two claims of nondisclosure,

and then

focus our discussion on the third.

a.
__

The

plaintiffs'

strategy":

Marketing Strategy
__________________

defendants

claim of

the

provide

decisive rejoinder

nondisclosure concerning

relevant

strategy were in fact

aspects

and

to

the

the "marketing

consequences

prominently disclosed, both in

of

the

the text

-21-

of

the

prospectus

reference.12

quarter ending

For

and

in

example, in

October 2, 1993

documents

its Form

incorporated

10-Q filing

(the first

quarter of

by

for the

fiscal

year 1994), the company explained its reported decline in gross

profit margins as follows:13

The decline in product gross margin resulted from

the decrease in product
in

the

mix

of

product

sales, a continued shift

sales

toward

low-end

systems

which

competitive
currency

typically

pricing

carry

pressures

fluctuations,

lower
and

margins,

unfavorable

partially

offset

by

manufacturing cost efficiencies.

The

Corporation

competitive
systems.

has

adopted

price structure
Given

this

an

for

aggressive,
its

pricing, as

Alpha AXP

well

as the

factors described in the preceding paragraph, the

Corporation

expects

to

experience

continued

downward pressure on product gross margins.

This statement, in

elsewhere

to

conjunction with related disclosures

in the prospectus

"competitive

margins,

pricing

"competitive

Corporation,"

and incorporated filings relating

pressures,"

pricing

an "industry

found

declining

actions

trend toward

gross profit

taken

lower

by

the

product gross

____________________

12.

As

required by Item 12

the

March

11, 1994

of the instructions

prospectus

reference the company's Form

to Form S-3,

specifically incorporated

10-K filing for fiscal

by

year 1993

(as amended by

Form 10-K/A dated March 11, 1994), and its Form

10-Q filings for the quarterly periods that ended on October 2,

1993 and January 1, 1994.

13.

Since

the

complaint

registration statement

alleges

and prospectus,

nondisclosures
the court may

in

the

look to

the text of those materials and the incorporated SEC filings to

determine whether the plaintiffs' allegations are well founded.

See
___

Kramer v. Time Warner, Inc., 937

______
__________________

F.2d 767,

774 (2d Cir.

1991).

We discuss more fully later the circumstances in which

a court

may look outside

the four corners

deciding a motion to dismiss.

-22-

of a complaint

in

margins,"

and

"persistent

together obviate

intense

pricing

the plaintiffs' claim that

to disclose the company's

competition,"

defendants failed

adoption of a price-cutting strategy

to boost the "market penetration" of its Alpha-based systems.

b.
__

"Double Commissions"
____________________

The plaintiffs'

claim of a failure

to disclose "double

commissions" also fails to make out a Section 11 violation.

To

the

of

extent

that

mismanagement,14

laws.

(1977);

the

it is

claim

not

comprises

cognizable

allegations

under the

securities

See Santa Fe Indus., Inc. v. Green, 430 U.S. 462, 477-80

___ _____________________
_____

In re Craftmatic Sec. Litig., 890 F.2d 628, 638-39 (3d

____________________________

Cir. 1989) (stating that

plaintiffs cannot circumvent Santa Fe

________

by simply

pleading

disclose management

F.2d 104, 106 (3d

lack

of any

mismanagement claim

as

failure

practices); see also Hayes v.

_________ _____

Cir. 1992).

allegations

Otherwise, the

establishing a

to

Gross, 982
_____

claim fails for

plausible theory

of

materiality.

The complaint does not allege that

have

some intrinsic

significance

complain, rather, that DEC

"double commissions"

to investors.

failed to tell the market

Plaintiffs

that the

commission-based compensation scheme, instead of boosting sales

as it was

losses.

supposed to

do, was contributing

This argument is problematic.

acknowledges, DEC publicly announced

to the

company's

As the complaint itself

the switch from a salary-

____________________

14.

The

complaint's

assertion

that

"DEC

implemented

its

commission

program

and

set

sales

quotas

without

careful

evaluation" is an example of such an allegation.

-23-

based

compensation scheme

to the

produced the double commissions.

complaint,

quarter

the switch

of 1994,

plaintiffs do

not

was

but some

incentive-based model

Furthermore, according to the

made not
___

during the

two years earlier,

allege that

that

any

third fiscal

in 1992.
____

material changes

to

The

the

compensation scheme were implemented after that time.

Whatever

the bearing of DEC's incentive-based compensation scheme on the

company's expenses

public

had

in relation to its

at least

a year's

worth

revenues, the investing

of hard

financial data

(through the second quarter of fiscal 1994) to evaluate whether

the

commission

margins,15 or

Plaintiffs

system

instead, as

company

their

working

(for the

own theory

and the

increase

between the time

last prior

second fiscal

the claim

gross

shrink them.

there were any material changes

of commissions

offering

to

plaintiffs allege, to

do not allege that

in the payment

public

was

Form

quarter of

that DEC

of the

10-Q filed

1994), and

failed to

payment of "double commissions" amounts to naught.

March

by the

so on

disclose the

c.
__

We

that

Operating Results Prior to End of Quarter

_________________________________________

turn to

the complaint's central,

defendants failed,

offering,

in connection

overarching claim

with the

March public

to disclose material factual developments foreboding

disastrous quarter-end

results.

In evaluating

this claim, we

____________________

15.

The payments made to

component

of

the

sales representatives constituted

company's

quarterly

expenses,

and

the

aggregate effect of such payments could have been determined by

examining the

company's quarterly earnings

in the required SEC filings.

-24-

data, as disclosed

accept arguendo
________

its

the complaint's allegations16 that

possession as

information

performance,

the March

concerning

losses

there was a duty

registration

21

offering date

the company's

indicating

unexpectedly large

whether

of

statement and

that

nonpublic

ongoing quarter-to-date

the

for that

DEC had in

company

quarter.

to disclose such

prospectus

would

suffer

We ask,

then,

information in the

under

"material changes" under Item 11(a) of Form S-3.

the

rubric

of

We focus upon

the defendants' primary legal arguments on this point: that DEC

was under no duty to disclose "intra-quarterly" results or

other

information

concerning

its

third

any

quarter performance

until

as

after the quarter ended; and that defendants had no duty

of March 21, 1994

to disclose any

internal projections or

predictions concerning the expected outcome of the quarter.

A central

goal underlying the

the securities laws

the

is to promote

securities markets.

See
___

disclosure provisions of

fairness and efficiency

in

Central Bank of Denver, N.A. v.

_____________________________

First Interstate Bank of Denver, N.A., 114 S.

_______________________________________

Ct. 1439, 1445

(1994) ("Together, the Acts embrace a fundamental purpose . . .

to

substitute

philosophy

of

full

disclosure

for

the

philosophy of caveat emptor." (internal quotation omitted)); In

__

re LTV Sec. Litig., 88 F.R.D. 134,

___________________

disclosure

of

accurate

145 (N.D. Tex. 1980).

firm-specific

information

The

enables

____________________

16.

As

discussed

allegations in
under

the

below,

based

on

the

character

the Wilensky complaint, the

________

Securities Act

are

not

of

the

plaintiffs' claims

subject

to the

pleading

investing in

one firm

requirements of Fed. R. Civ. P. 9(b).

-25-

investors

versus

to compare

another,

valuable uses.

and

the prospects of

enables

LHLC Corp.
__________

capital to

flow

to

its

most

v. Cluett, Peabody & Co., 842

_____________________

F.2d

928, 931 (7th

Cir.), cert.
_____

Acme Propane, Inc. v.

__________________

denied, 488 U.S.

______

926 (1988);

Tenexco, Inc., 844 F.2d 1317,

_____________

cf.
___

1323 (7th

Cir. 1988) (securities laws aim at ensuring the availability to

the investing public of information not otherwise in the public

domain).

The

availability

information is also essential to

of

reliable

the market's ability to align

stock price with a security's "fundamental value."

Kahan,

firm-specific

See
___

Marcel

Securities Laws and the Social Costs of "Inaccurate"

_______________________________________________________

Stock Prices, 41 Duke L. J. 977, 988-89 (1992).

____________

The need for issuers to disclose material information is

crucial

in the context

of a public

offering, where investors

typically must rely (unless the offering is "at the market") on

an

offering

price

underwriters of

(explaining

the

requirements

to

Accordingly,

the

stock

offering

determined

the offering.

disclosure

are

more

the

See Kahan,
___

heightened

companies

by

need

to

engaged

in

requirements

stringent than,

issuer

and/or

supra, at
_____

target

public

1014-15

disclosure

offerings).

associated

for

the

with a

example,

the

regular periodic disclosures called for in the company's annual

Form

10-K or quarterly

Act.

See id. at 1014-15 & n.163.

___ ___

The

need

for

Form 10-Q

complete

filings under

and

prompt

the Exchange

disclosure

is

particularly keen when a corporation issues stock pursuant to a

-26-

"shelf registration" under SEC

public

offering of

(permitting

Rule 415(a), as DEC did

March 1994.

registration

of

See
___

securities

"continuous" or "delayed" basis).

permits

covering

"for

company to

230.415(a)

to be

issued

on

The shelf registration rule

single registration

statement

a certain quantity of securities (register securities

the shelf"),

years,17

file

17 C.F.R.

in its

with

the

and

then

over

appropriate

period

updates

of

of

up

to

two

information,18

issue

installments

statement (take

instantly,

in

of

securities

the securities

amounts

underwriters deem

and

at

that

"down from the

times

most propitious.

(explaining that the

under

the

registration

shelf") almost

company

See Clark, supra,

___
_____

shelf registration process

and

its

at 751

enables firms

to pinpoint the timing of offerings to the issuer's advantage);

see generally
______________

Jeffrey

N.

Gordon

&

Lewis

A.

Kornhauser,

Efficient Markets, Costly Information, and Securities Research,

______________________________________________________________

60 N.Y.U. L. Rev. 761, 819-20 (1985).

____________________

17.

shelf registration

under Rule

415 may

only cover

an

amount of securities that "is reasonably expected to be offered

and

sold within two years

the registration."

18.

For

from the initial

17 C.F.R.

example,

Rule

effective date of

230.415(a)(2).

415(a)(3)

requires

that

shelf

registrant comply with Item 512(a) of Regulation S-K, 17 C.F.R.

229.512(a)(ii), which requires that a registrant file a posteffective amendment to an initial

registration statement "[t]o

reflect in the prospectus any facts or events arising after the

effective

date

individually
change

in

or
the

of
in

the

registration

the aggregate,

information

set

statement."

-27-

statement . . .
represent

forth

in

the

which,

fundamental

registration

The

that

social benefit

of the

it can enable an issuer to

capital.

See Clark,
___

that, by

shelf registration

decrease its costs of raising

supra, at 751.
_____

permitting securities

rule is

The concomitant risk is

to be

offered on a

"delayed"

basis, the rule may adversely affect the quality and timeliness

of the

disclosures made in connection with the actual issuance

of securities.

6499,

See Shelf Registration,

___

SEC Release Nos.

33-

34-20384, 35-23122, 1983 WL 35832 (SEC), *2 ("Shelf Reg.

Rel.");

see also
_________

rationale

securities

for

limiting

may

information

'registration

I Loss

be

sold

&

the

is

when

considering

for

the shelf'

Seligman,

time

supra,
_____

during

which

that

investors

an

offering.

runs

the

at 355

registered

need

risk that

("The

current

To

permit

investors

subsequently

will

outdated

stale

or

concerns,

assured

offered

securities

information.").

the SEC, in adopting

that

registration

serve

be

to ensure

that

and

In

amendments

prospectus

investors are

the

basis

response

Rule 415 in

"[p]ost-effective

statement]

on

to

of

these

its current form,

[to

the

initial

supplements

[would]

provided with

complete,

accurate and current information at the time of the offering or

sale of securities."

(SEC), *9.

The SEC

Shelf

"to use the shelf

omitting

required

(SEC), *10.

1983 WL

explained that registrants

permitted

statements when they

Reg. Rel., supra,

_____

would not

registration rule as

information

from

become effective."

their

Id.,
___

35832

be

a basis for

registration

1983 WL

35832

-28-

Based

on

concerns

about

Rule

415's

effect

on

the

adequacy and timeliness

of disclosure, the SEC

chose to limit

the availability of the

rule, in the context of

primary stock

offerings, to the widely-followed companies (like DEC) that are

eligible

C.F.R.

to register

securities on

230.415(a)(1)(x); SEC Rel.

SEC Form

S-3.19

See 17
___

No. 33-6499, 1983 WL 35832

(SEC) at

theory

*5; I

Loss & Seligman,

supra, at
_____

361 & n.90.

The

was that the concerns about adequacy of disclosure were

less prominent in the case

of "S-3" registrants, because those

companies are precisely the ones that in the ordinary course of

their

businesses

"provide a

corporate information

stream

to the marketplace

information is broadly

digested and

steady

of high

and whose

disseminated[] . . . and

synthesized by

financial analysts."

quality

corporate

is constantly

Shelf Reg.

Rel., supra, 1983 WL 35832 (SEC), *5.

_____

Defendants

of

Form

assert here that the disclosure requirements

the Securities Act and regulations, including Item 11(a) of

S-3,

should be

interpreted

mandate the provision of

so

that they

would

never
_____

current information about a company's

performance in the quarter in progress at the time of

offering, so

long as the

company satisfies its

annual periodic disclosure obligations

That argument cuts severely against

a public

quarterly and

under the Exchange Act.

the very reason the

shelf

____________________

19.
made

As an exception to
the shelf

limited

the Form S-3 limitation, the

registration rule

circumstances

not

available in

relevant

230.415(a)(1)(i)-(ix); Bloomenthal et

here.

-29-

certain other
See
___

al., supra,
_____

at 235-36; I Loss & Seligman, supra, at 362-63.

_____

SEC also

17

C.F.R.

5.12[1]

registration rule was made available to issuers like DEC:

"S-3"

companies would

provide

the market

with a

stream of high quality corporate information.

offerings

because

to

be made

it envisions

inconsistent with

refuge in its

the

on

a "continuous"

"continuous"

this rationale to

continuous

The rule permits

or

"delayed" basis

disclosure.

It would

permit an issuer

periodically-filed Forms 10-Q

that

or 10-K to

be

to take

avoid

obligation to disclose current material facts in its shelf

offering prospectus.

Absent some mechanism requiring a registrant to disclose

internally known, material nonpublic information

pertaining to

quarter in

progress, the

enabling the

issuer to

would

give

announcement the

from the shelf

pinpoint the

company

requiring

concerning

provides

negative

time its offerings

to be completed prior to the

issuer

to

"material changes"

of securities

current

from previously

or abstain" rule governing insider

advantage.

Cf.
___

Item 11(a) of Form S-3,

disclose

a mechanism -- comparable

strategic behavior.20

earnings

public release of

a naked informational trading

the

offering,

This would allow companies to exploit

Gordon & Kornhauser, supra, at 819-20.

_____

by

procedure, by

timing of its

anticipating

ability to

the known negative news.

what amounts to

shelf registration

information

reported data,

in effect to the "disclose

trading -- to prevent

such

____________________

20.

Of

course, if

the

issuer desires

not

to disclose

the

information prior to quarter's end, then the flexibility of the

shelf registration

procedure permits

the issuer to

"delay" a

-30-

In

the

face of

these

concerns, DEC

plaintiffs' claims of nondisclosure

they

seek

disclose

to

impose liability

its internal

that the

are without merit, because

upon

projections
___________

argues

DEC

for

about the

a failure

outcome of

to

the

third quarter

of

fiscal 1994.

The

federal securities

laws

impose no obligation upon an issuer to disclose forward-looking

information such as internal

projections, estimates of

future

performance, forecasts, budgets, and

similar data.

In re Verifone Sec. Litig., 11 F.3d

___________________________

865, 869 (9th Cir. 1993);

In re Convergent Technologies Sec. Litig.,

__________________________________________

(9th

Cir.

Section 11

1991).

Plaintiffs, however,

claim is concerned

projections, but of current

in

its

company

possession as

was

respond, in turn, that

948 F.2d 507,

insist

that

516

their

the nondisclosure

of

information that DEC allegedly had

of March

incurring in

not with

See, e.g.,
___ ____

the

21,

1994 about

ongoing

under a system of

quarter.

"losses" the

Defendants

quarterly reporting,

"losses" cannot be realized until a quarter has ended, and that

because

the quarter

in question

1994, whatever information

did not

DEC had as

end until

of March 21

April 2,

concerning

that quarter necessarily must have been forward-looking, in the

nature

of a projection or forecast, which it had no obligation

to disclose.

DEC's

assertion that

argument elevates

form

over

substance.

DEC's

companies do not realize "losses" as such until

____________________

planned offering until

after the quarter is completed

results from the quarter are publicly reported.

-31-

and the

quarter has

But it does

the

ended is,

not follow that DEC's

ongoing quarter

looking.

First,

That

that

as of

contention

it assumes

evidence

of course,

March 21

Second,

inferences that

must have

relies on

were

material information about the

time.

only information concerning

that plaintiffs

defendants

largely unexceptionable.

been forward-

two faulty

could not

actually

in

components.

adduce adequate

possession

of

ongoing quarter at the relevant

it assumes that the potential

could be drawn from

unreliability of

current information about

operating results as of eleven days before the end of a quarter

absolutely protects that information from mandatory disclosure.

The first premise is

a Rule 12(b)(6)

inconsistent with the standards governing

motion to

dismiss.

The

second confuses

the

issue of materiality with the duty to disclose.

Defendants

posit, in essence, that there can never be a

duty to disclose internally known, pre-end-of-quarter financial

information,

might

be

because

drawn

any inferences

from

such

about

information

the

could

quarter that

be

rendered

unreliable by later developments in the same quarter, such as a

sudden

surge of

profitable

withstand scrutiny.

implies

an

Present,

important

future

sales.

This

position does

known information that

outcome

mandatory disclosure merely because

is

not

not

strongly

immune

from

it does not foreordain any

particular

outcome.

The

information

must be

disclosed

duty), poses

a classic

question

whether

(assuming the

such

present

existence of

materiality issue: given

that at

any

-32-

point in a quarter, the remainder of the period may not

the

quarter-to-date, is

there a

sufficient probability

unexpectedly disastrous quarter-to-date performance

mirror

that

will carry

forward

to

investor

the end

would

of the

likely

quarter,

consider

such that

the

interim

a reasonable

performance

important to the overall mix of information available?

As desirable as bright-line

rules may be, this question

cannot be answered by reference to

so would

(1988).

such a rule.

be contrary to Basic, Inc.

___________

To try

to do

v. Levinson, 485 U.S. 224

________

The Supreme Court there refused to adopt a bright-line

approach

to

discussions

determine

create

consummation to become

at

what

sufficient

material.

"agreement-in-principle" test).

as defendants

stage

would have

us do,

preliminary

probability

of

merger

actual

See id. at 237-39 (rejecting

___ ___

So here.

We decline to adopt,

hard and

fast rule

that

current information concerning a company's operating experience

is

never

quarter

to

subject to

disclosure until

which

information

the

after

the end

pertains.

of the

Rather,

the

question is whether the nondisclosure of interim facts rendered

the prospectus materially

with the

does

incomplete.

An

issuer's compliance

periodic disclosure requirements of

not per se preclude

_______

such undisclosed

the Exchange Act

facts

from being

material.

By the same token,

an

issuer

engaging

in

we reject any bright-line rule

public offering

disclose interim operating results

-33-

is

obligated

that

to

for the quarter in progress

whenever it perceives a

may

possibility that the quarter's results

disappoint the market.

Far from it.

Reasonable investors

understand that businesses fluctuate,

and that past success is

not a guarantee of more of the same.

There is always some risk

that the quarter in progress at

the time of an investment will

turn out

to be

worse than

of

variability

market

for the issuer

takes

this

risk

anticipated.

into

account

The

in

evaluating the company's prospects based on the available facts

concerning

the

issuer's

past

historical

performance,

its

current

financial

uncertainties.

aside, the

depends

condition,

But,

present

strong-form

ability of market

efficient

allege

nonpublic information

and

here, the

future

market theories

observers to evaluate

upon the information publicly

as plaintiffs

trends

a company

available to them.

issuer

is in

possession

indicating that the quarter

If,

of

in progress

at the time of the public offering will be an extreme departure

from the range of

results which could be anticipated

currently available

basic

statutory

information,

policies

it is

favoring

consistent

disclosure

to

based on

with

the

require

inclusion of that information in the registration statement.

We

claims

do not

mean to

imply, however,

similar to those asserted

be disposed

of as a matter of law.

that nondisclosure

by plaintiffs here can never

In many circumstances, the

relationship between the

nonpublic information that plaintiffs

claim

disclosed and

should

events that

have been

the undisclosed information

the actual

results or

supposedly would have

-34-

presaged will be so attenuated that the undisclosed information

may be

deemed immaterial as a matter of law.

F.3d at 867-70 (affirming

Cf. Verifone, 11
___ ________

dismissal of claim that registration

statement allegedly failed

development that

came

to light

BancTexas Group, Inc., 989

_____________________

1993)

(affirming

to disclose information

515-16

four months

(same,

months later);

Krim
____

F.2d 1435, 1439, 1449-50 (5th

summary

prospectus failed to disclose

matured

six

concerning

judgment

disallowing

claim

v.

Cir.

that

information of developments that

later); Convergent,
__________

where prospectuses

in

948 F.2d

March

at 509-11,

and August

1983

allegedly failed to disclose negative developments announced in

February 1984); Zucker v. Quasha, 891 F. Supp. 1010, 1012, 1018

______
______

(D.N.J.

1995)

(dismissing

complaint

based

on

alleged

nondisclosure in March 31 registration statement of information

relating to results of period ending July 2), aff'd, __ F.3d __

_____

(3d Cir. 1996)

where the

(table, No. 95-5428).

allegedly

In such

undisclosed information

circumstances,

is

sufficiently

remote in time or

causation from the ultimate events

it

forewarned,

purportedly

nondisclosure may

the

be indistinguishable

plaintiff's

from a claim

of which

claim

of

that the

issuer should have divulged its internal predictions about what

would come of

the undisclosed information.

Cf. Verifone,
___ ________

11

F.3d at 869 (characterizing plaintiffs' claims of nondisclosure

of "adverse material facts and trends" as of March 13 as claims

that defendants

failed to disclose forecasts

released to public on September 17).

-35-

of news actually

Here, however,

days prior

the prospectus in question

to the end of the quarter in progress.

was filed 11

The results

for that quarter turned out to be, by all accounts, the product

of

more than a minor

business fluctuation.

must, the plaintiffs' allegation that

was in

possession of information about

to-date performance (e.g.,

____

Accepting, as we

DEC, by March 21,

1994,

the company's quarter-

operating results) indicating

some

substantial likelihood that the quarter would turn out to be an

extreme departure from publicly known trends and uncertainties,

we

cannot conclude as a matter of

of

the litigation

that such

mandatory disclosure under the

Item 11(a) of

Wilensky
________

Form S-3.

plaintiffs'

law and at this early stage

information was

not subject

to

rubric of "material changes" in

We conclude,

complaint as

accordingly, that

to this

theory states

the

legally cognizableclaim under Section11 of theSecurities Act.21

____________________

21.

It bears

reemphasizing

that

the

plaintiffs'

claim

is

sustainable

only to the extent it relates to the nondisclosure

of

material

"hard"

information,

information in the nature

Sec. Litig., 784 F.
___________
11 F.3d 865

opposed

of projections.

to

"soft"

See In re Verifone
___ _______________

Supp. 1471, 1482 (N.D. Cal.

(9th Cir. 1993); see generally 2

_____________

supra, at 622 n.66.

_____
a forecast

as

1992), aff'd,
_____

Loss & Seligman,

Although DEC had no obligation to disclose

of results for the quarter

in progress at the time

of

the offering, it was permitted to

do so.

to

disclose

projection,

such a

forward-looking

If it had chosen
and if

the

projection was made with reasonable basis and in good faith, it

would
See
___

have been protected by

SEC

Rule 175,

Mullane,
_______
64 F.3d

the SEC's safe harbor provision.

17 C.F.R.

230.175;

see also
________

Arazie v.
______

2 F.3d 1456, 1468 (7th Cir. 1993); Searls v. Glasser,

______
_______
1061, 1066

(7th

Litigation Reform Act of

Cir. 1995);

cf. Private
___

Securities

1995, Pub. L. No. 104-67,

102, 109

Stat. 737, 749-55 (creating

forward-looking

statements).

disclose projected

expanded statutory protection

Furthermore,

had DEC

results, such a disclosure

rendered the "hard"

for

chosen to

(if reasonable)

could very

well have

underlying

the projection immaterial as a matter of fact or of

-36-

interim information

B.
__

Actionability
of Statement Concerning
Restructuring
_________________________________________________________

Reserves
________

The

Wilensky
________

plaintiffs

also

allege

that

the

registration statement and prospectus for the March 21 offering

contained

materially

false

and

misleading

actionable under both Sections 11 and 12(2).

the statement of DEC's

million

presently

restructuring

restructuring reserve

misleading, in light of information

the company.

1.
__

Background
__________

They contend that

"belie[f]" as to the "adequacy"

then-remaining $443

planned

statement

actions"

was

of the

"to

false

cover

and

contemporaneously known to

The

"restructuring

reserve"

referred

to

in

the

prospectus supplement originated as a $1.5 billion charge taken

by DEC

at the close

1992) as part

the company

of its fiscal

of the company's

"to achieve

year 1992 (ended

ongoing efforts to

a competitive cost

June 27,

streamline

structure."

The

reserve was intended to cover the anticipated costs of employee

separations,

facilities

relocations, and

consolidations,

related expenses.

similar restructuring charges of

asset

retirements,

The company

had absorbed

$1.1 billion and $550 million

in fiscal years 1991 and 1990, respectively.

____________________

law,

unless the market would have had some reason to discredit

the projection, thereby creating a substantial

likelihood that

reasonable investor

information

might still

important

to

the

have found

total

mix

the underlying
of

information

available.

-37-

During fiscal year

1993, DEC took

a number of

actions

consistent with the $1.5 billion dollar reserve recorded at the

end

of fiscal year 1992.

3,

1993),

the

By the

remaining

approximately $739 million.

end of the fiscal year (July

reserve

During

was

reported

to

the first two quarters

be

of

the

next fiscal year, the

reserve, so that by the

company continued to

draw from the

end of the second quarter

(January 1,

1994), the reserve stood at approximately $443 million.

Form

10-Q

for

that

quarter, dated

incorporated by reference

prospectus

million

in

1994

into the registration statement

was

"adequate"

planned at that time.

the prospectus supplement dated

statement,

4,

(and

and

at issue here), DEC stated its belief that the $443

reserve

activities

February

In its

with its

to

cover

restructuring

This statement was repeated

March 21, 1994.

immediately surrounding

The full

context, was

follows:

While spending for R&E

and SG&A

[research &

engineering]

[selling, general & administrative]

declining, the Corporation

expense levels

is

believes its cost and

are still too high

for the level

as

and

mix

of

total

operating

Corporation is reducing
its

product

revenues.

The

expenses by streamlining

offerings

and

selling

and

administrative practices, resulting in reductions

in employee population, closing and consolidation
of

facilities

spending.

and

reductions

The Corporation

believes

remaining restructuring reserve

is

adequate

restructuring

to

actions.

continue to take
level of costs

cover

in discretionary

of $443

presently
The

that

million
planned

Corporation

actions necessary to

-38-

will

achieve a

appropriate for its revenues

competitive for its business.

the

and

As events turned

were in fact taken

the company's

later in fiscal year 1994.

announcement

million loss for

Palmer

out, additional restructuring

on

April

the third fiscal

stated that

he

At

15, 1994

the time of

of

quarter of 1994,

had already

charges

the

$183

defendant

instructed management

to

"accelerate [the company's] on-going restructuring efforts" and

that

the company

achieve [its]

would

goals."

company announced on

fiscal year 1994)

"consider

In

line

July 20,

that it

further

restructuring

to

with these

statements,

the

1994 (just after

had decided to

the close

take an

of

additional

restructuring charge of $1.2 billion in fiscal year 1994 (ended

June 30, 1994).

2.
__

Whether the Statement Was Misleading

____________________________________

Although defendants were

of

the remaining

statement and

required to disclose the

restructuring

reserve

prospectus as affecting the

and capital resources,22

as adequate was
________

arguably voluntary.

the remaining $443 million

an obligation

to

But

registration

company's liquidity

the characterization

not, DEC's description of its belief

it

in the

size

of the

reserve

whether voluntary or

as of March 21, 1994 that

reserve was "adequate" carried with

ensure that

the representation

was not

____________________

22.

Item 303(a)

of Regulation S-K requires

include in its Exchange

K),

which

in

turn

registration statements

the registrant to

Act filings (e.g., Forms 10-Q

____
are

incorporated

on Form S-3, a

by

and 10-

reference

into

description of "trends

or any

known

affecting the
"material

demands, commitments,

events or

registrant's liquidity, and of

commitments for

capital

uncertainties"

the registrant's

expenditures."

17 C.F.R.

229.303(a)(1)-(2).

-39-

misleading.

See
___

Roeder,
______

814 F.2d

Amoskeag Bank Shares, Inc., 24

___________________________

("[I]f a defendant

or

'solid'

even

at

26; cf.
___

F.3d 357, 365

Serabian
________

(1st Cir. 1994)

characterizes . . . reserves as

though

it

knows

they

are

v.

'adequate'

inadequate

or

unstable, it

exposes itself

to possible liability

[under the

securities laws]." (quoting Shapiro v. UJB Financial Corp., 964

_______
___________________

F.2d 272, 282 (3d

Cir.), cert. denied, 506 U.S.

_____ ______

934 (1992)));

cf. also In re Wells Fargo Sec. Litig., 12 F.3d 922,

________ ______________________________

Cir.

1993), cert. denied, 115

_____ ______

S. Ct. 295

(1994).

930 (9th

Plaintiffs

assert that defendants failed to meet that obligation.

The

that

DEC

supplement

of

undeniable purport of

had no

plans

plaintiffs

of

to engage in actions

restructuring

remaining

as

in

charge

"reserve."

say, because

the "adequacy"

the date

DEC knew

the

prospectus

that would require the taking

beyond

This

of

statement is

the

was

as of

$443

false

million

or

March 21,

then

misleading,

1994 that

further

restructuring actions

company

back on

quarter

setback,

remaining

be

the

would be

right track

and that

these

after

put the

its impending

actions

would deplete

third

the

reserve and require further restructuring charges to

taken.

Defendants reply, as the district court noted, that

whatever the

natural implication of the

its

sufficiently

context

"adequacy" statement,

"bespeaks caution"

misleading inference from the

of law.

necessary to

to

render

any

statement immaterial as a matter

We do not agree.

-40-

The

"bespeaks

shorthand for

or

caution"

doctrine

"is

the well-established principle that

omission must be

considered in context."

essentially

a statement

In re Donald J.
_______________

Trump Casino Sec. Litig., 7 F.3d 357, 364 (3d Cir. 1993), cert.
________________________
_____

denied, 114 S. Ct. 1219 (1994); see also Rubinstein v. Collins,

______
________ __________
_______

20 F.3d

160, 167 (5th

that when

estimates,

Cir. 1994).

It

embodies the principle

statements of "soft" information

opinions,

or

projections

cautionary disclosures that adequately

are

such as forecasts,

accompanied

by

warn of the possibility

that

actual results

"soft" statements

securities

F.2d

875,

may not

laws.23

879

or events may

See Romani v.
___ ______

(1st

differently, the

be materially misleading

Cir.

under the

Shearson Lehman Hutton, 929

______________________

1991);

Raffensperger, Hughes & Co., 65

_____________________________

1995);

turn out

see
also
__________

F.3d

1392, 1404

Harden
______

(7th

v.

Cir.

In re Worlds of Wonder Sec. Litig., 35 F.3d 1407, 1413__________________________________

14 (9th Cir. 1994) (collecting cases), cert. denied, 116 S. Ct.

_____ ______

185 (1995); Rubinstein, 20 F.3d at 166-68; In re Trump, 7 F.3d

__________
____________

at 371-72;

F.2d

I. Meyer Pincus & Assocs. v. Oppenheimer & Co., 936

_________________________
_________________

759, 763

(2d Cir. 1991).

In

short, if

a statement is

couched in or accompanied by prominent cautionary language that

clearly

disclaims or

discounts

the drawing

of a

particular

inference,

any

claim

that

the

statement

was

materially

misleading because it gave rise to that very inference may fail

as a matter of law.

In re Trump, 7 F.3d at 364.

___________

____________________

23.

The

Litigation

doctrine

has

been

Reform Act, supra,

_____

codified
Pub. L. No.

Stat. at 750.

-41-

in

the
104-67,

Securities

102, 109

Here, however,

preclude

a claim

materially

the bespeaks

that

the reserve

misleading.

forward-looking

caution doctrine

"adequacy" statement

The "adequacy"

aspect

and

an

does not

aspect

statement has

that

was

both a

encompasses

representation of present fact.

In its forward-looking aspect,

the

DEC

statement

suggests

that

would

restructuring charges in the near-term future.

oriented aspect, it represents

had

no

current

intent

take

no

In its present-

that as of March 21,

to undertake

further

activities

1994, DEC

that

would

require any such further restructuring charges to be taken.

the extent

statement

that plaintiffs allege that

encompasses

fact, and that

____

the

the reserve "adequacy"

latter representation

such a representation

To

was false or

of

present
_______

misleading

when made,

rendered

Harden,
______

the surrounding cautionary language

the statement

65

F.3d

caution doctrine

at

immaterial as

a matter

1405-06 (explaining

cannot

could not have

that

of law.

the

render misrepresentations

See
___

bespeaks

of

"hard"

fact nonactionable).24

Furthermore,

to the extent that

plaintiffs allege that

the "adequacy" statement implies

a hiatus on new restructuring

charges

we

for

surrounding

the

near

future,

context warns

against

do

such

not

think

that

an implication

sufficient clarity to be thought to bespeak caution.

the

with

See Fecht
___ _____

____________________

24.

Cf. also Securities Litigation

________

No. 104-67,

102, 109

Reform Act, supra, Pub. L.

_____

Stat. at 750 (providing safe

harbor to

statements

couched

in

cautionary

language

only

if

the

statements are identified as forward-looking).

-42-

v. Price Co., 70 F.3d 1078, 1082 (9th Cir. 1995), cert. denied,
_________
_____ ______

64 U.S.L.W. 3688 (1996).

that

DEC will "continue

ambiguous

activities

The prospectus supplement does state

to take actions,"

whether those "actions"

other than

refer to

those "presently

but it

is at best

any restructuring

planned."

Thus, one

might

easily interpret

the purportedly

cautionary statement,

especially in light of the "adequacy" characterization, to mean

that

the

company's

ongoing

"actions" will

continue

covered by the existing restructuring reserve.

to

be

If it was true,

as plaintiffs allege, that defendants knew as of March 21, 1994

that DEC's

actions

taking

performance in the third

on a

scale

of additional

and schedule

quarter would precipitate

that would

restructuring

necessitate the

charges,

the

"adequacy"

statement may well have been materially misleading.

We

pleadings,

cannot conclude,

that the

as a

matter of

actionability of

law and

the "reserve

on these

adequacy"

statement is precluded by a context that bespeaks caution.

The

cautionary statements to which defendants point did not provide

an unambiguous

warning of the possibility that

DEC might take

additional restructuring

charges in the

near future --

as it

turned out, a charge of $1.2 billion in the fiscal year then in

progress.

See
___

id. at 1082 (bespeaks caution doctrine provides

___

basis for

dismissal

as matter

minds could not disagree

of law

"only when

as to whether the mix

___

reasonable

of information

in the [allegedly actionable] document is misleading" (emphasis

in

original)); Rubinstein,
__________

20

F.3d at

-43-

167-68 (stating

that

questions of whether

may

we

disclosures were sufficiently

not always be resolved as a

hold that the district

plaintiffs'

allegations

supplement's

description

"adequate"

fail

to

matter of law).

court erred in

pertaining

of

state

the

Accordingly,

concluding that the

to

the

restructuring

claim

cautionary

under

prospectus

reserve

Sections

11

as

and

12(2).25

C.
__

Whether Defendants Are Statutory "Sellers"

__________________________________________

As

an

alternative

court's dismissal of the

that the

basis

for affirming

the

district

Section 12(2) claim, defendants argue

Wilensky plaintiffs have failed

________

adequately to allege

their status

complaint

as statutory "sellers."26

adequately alleges

underwriter

defendants.

We conclude

"seller" status

The dismissal

that the

only as

of the

to the

Section 12(2)

claim as to the other defendants will accordingly be affirmed.

____________________

25.

Defendants argue that, as a matter of fact, the market was

well aware in January 1994 or earlier that DEC might eventually

be forced to take further restructuring charges in fiscal
1994.

year

This, however, does not address whether the disclosures

in the prospectus supplement

matter of law.
this point

themselves "bespeak caution" as a

Moreover, the evidence cited by

goes far beyond

the allegations of

defendants on

the complaint.

While evidence of actual market knowledge might be proper grist

for
it

the summary judgment mill

cannot properly

be

on the question of materiality,

considered in

evaluating whether

the

plaintiffs' complaint is legally sufficient to survive a motion

to dismiss under Rule 12(b)(6).

26.

The

district

court,

having

dismissed

the

plaintiffs'

claims on other grounds, did not reach this issue.

course,

affirm

the

district

independently sufficient

court's

ground.

See
___

We may, of

dismissal

on

any

Crellin Technologies,
______________________

Inc. v. Equipmentlease Corp., 18 F.3d 1, 13 (1st Cir. 1994).

____________________________

-44-

In Pinter
______

Court

sued as

v.

Dahl, 486
____

described in detail the

"sellers" under Section

U.S. 622

(1988), the

class of defendants

12(1) of the

Supreme

who may be

Securities Act.

See id. at 641-44.

___ ___

sue

and

language

be

sued

used in

Section 12(2) defines the

thereunder

in

Section 12(1).

persons who may

language identical

Thus, Pinter's
______

to

the

analysis of

"seller" for purposes of Section 12(1) applies with equal force

to

the interpretation of

e.g.,
____

Ackerman v.
________

"seller" under Section

Schwartz, 947
________

F.2d 841,

12(2).

See,
___

844-45 (7th

Cir.

1991); In re Craftmatic Sec. Litig., 890 F.2d 628, 635 (3d Cir.
____________________________

1989); Moore
_____

v. Kayport Package Express, Inc., 885

______________________________

F.2d 531,

536 (9th Cir. 1989); Wilson v. Saintine Exploration & Drilling

______
________________________________

Corp., 872 F.2d 1124,

_____

1125-26 (2d Cir. 1989); Dawe v. Main St.

____
________

Management Co., 738 F. Supp. 36, 37 (D. Mass. 1990).

______________

person who "offers or sells" a security may be liable

under Section 12 to

any person "purchasing such

__________

security from
____

him."

77l(2)

Although

15

U.S.C.

(emphasis

"purchasing from" language in

added).

the

the statute literally appears to

contemplate a relationship between defendant and plaintiff "not

unlike

traditional contractual

642, the Pinter

______

limited

to

purchaser.

Court held

those

who

See id. at
___ ___

privity," Pinter, 486

______

that Section 12

actually

645.

pass

This is so

U.S. at

liability is

title

to

not

the

suing

because even

"[i]n

common parlance," a person may "offer or sell" property without

actually passing title.

agent

Id. at 642.
___

For example,

a broker or

who solicits a purchase "would commonly be said . . . to

-45-

be among

the

those 'from' whom the buyer

agent

himself

Furthermore,

did

pass

because "solicitation

investor is most likely

found

not

'purchased,' even though

title."

is the

Id.
___

stage at

to be injured," id. at
___

at

644.

which an

646, the Court

it consistent with the policies of the statute to permit

imposition

of

liability

on

a non-owner

of

securities

who

"successfully

solicits"27

the

securities, provided that the

in part by

a desire to

plaintiff's

purchase

of

the

solicitor is "motivated at least

serve his own

those of the securities owner."

financial interests

or

Id. at 647.28
___

The Pinter Court limited its holding in ways that govern

______

the result here.

from"

The

requirement

of

Court held that

Section

the "purchasing

12 limits

the

liability to "the buyer's immediate seller" and

cannot recover

against his seller's seller."

at 643 n.21 (citations omitted).

. . .

imposition

of

thus, "a buyer

Pinter, 486 U.S.

______

Second, the Court stated that

proof the defendant caused a plaintiff's purchase of a security

______

is not enough

to establish that the

sale for Section 12 purposes.

defendant "solicited" the

See id. at 651 (explaining that

___ ___

____________________

27.

Section

"sell"

to

2(3)

of the

include,

solicitation of an

Securities

among

other

offer to buy, a

security, for value."

Act

15 U.S.C.

defines "sale"

notions,

"every

or

. . .

security or interest in

77b(3); see Pinter, 486 U.S.

___ ______

at 643.

28.

The

Court reasoned

that where

persuading another to purchase

the

buyer, it

'purchased'
difficult to

would

from

be

him,"

motivation in

securities is solely to benefit

"uncommon
and

a person's

to

that such

characterize the person's

Pinter, 486 U.S. at 647.

______

-46-

say

that

motivation

the

buyer

makes

it

act as "solicitation."

"[t]he

'purchase

defendant's

rejecting

from' requirement

relationship

with

12

focuses on

the

plaintiff-purchaser"

and

use of a test under which defendant could qualify as

seller if

he

was a

"substantial

transaction to take place).

"participat[ion]

in

causing

soliciting the

the

Court indicated that

in a sales transaction or

subject him to Section 12 liability.

defendant must be directly

factor" in

Finally, the

a person's "remote" involvement

mere

the

of

purchase"

his

does not

See id. at 651 n.27.

___ ___

involved in the actual solicitation

of a securities purchase in order to qualify, on that basis, as

a Section

12 "seller."

See In re Craftmatic, 890 F.2d at 636;

___ ________________

Capri v. Murphy, 856 F.2d 473, 478-79 (2d Cir. 1988); Dawe, 738
_____
______
____

F. Supp. at 37.

We

apply these

The March 1994

commitment"

statement

contend

principles

public offering

underwriting, as

and prospectus

otherwise.

In

to the

Wilensky complaint.
________

was made pursuant

disclosed

supplement.

a firm

issuer of the securities sells all

in

the

to a

"firm

registration

The plaintiffs

do not

commitment underwriting,

the

of the shares to be offered

to one or more underwriters, at some discount from the offering

price.

Investors thus purchase shares in the offering directly

from the underwriters (or

underwriters), not

March 21, 1994

broker-dealers who purchase from the

directly

from the

prospectus supplement

issuer.

In fact,

represented that

the

"[DEC]

has agreed not to, directly or indirectly, sell, offer or enter

-47-

into any agreement

to offer

or sell, shares

of [the

offered

stock]."

Because the

does not pass

issuer in

title to

a firm

commitment

the securities, DEC

underwriting

and its

officers

cannot be held liable as

they

actively

securities

to

"solicited"

the

further their

own

manner of a broker or

644-47.

than a

"sellers" under Section 12(2)

plaintiffs'

financial

vendor's agent.

unless

purchase

of

motives, in

the

See Pinter 486

___ ______

U.S. at

Absent such solicitation, DEC can be viewed as no more

"seller's seller," whom plaintiffs would

have no right

to sue under Section 12(2).

See id. at 644 n.21; PPM Am., Inc.

___ ___
_____________

v.

Supp. 860,

Marriott Corp.,
______________

Louis

Loss

&

853 F.

Joel

Seligman,

874-75 (D.

Fundamentals
of Securities
_____________________________

Regulation 1000-01 (3d ed. 1995) ("[I]t seems

__________

12

Md. 1994);

quite clear that

contemplates only an action by a buyer against his or her

__________

immediate seller.
_________________

That is to say,

in the case of the typical

'firm-commitment

underwriting,'

the

ultimate

investor

can

recover only from the dealer who sold to him or her." (emphasis

in original; footnotes omitted)).

The

purported

Section

factual allegations in the complaint supporting the

status

of

12(2) sellers

defendants'

statement,

DEC

are sparse,

involvement

prospectus,

effect the sale of

and the

in

and

individual

and all

preparing

other

Under Pinter, however, neither

______

pertain

the

"activities

the[] securities to the

defendants

as

to those

registration

necessary

to

investing public."

involvement in preparation of a

-48-

registration

relating

prospectus

to

demonstrates

the

the

plaintiff that
_________

Pinter,
______

Although

nor

sale

of

kind of

at 651

the complaint

"activities"

standing

statutory seller status.

& n.27;

Shapiro, 964
_______

also contains a

that each defendant "solicited

in the purchase

securities,

in

alone,

relationship between defendant and

___________________________________

could establish

486 U.S.

participation

F.2d at

See
___

286.

conclusory allegation

and/or was a substantial factor

by plaintiffs" of securities in

the offering,

the Supreme

which a

about

Court specifically rejected a

defendant's being

a sale

a "substantial factor"

could establish

Pinter, 486 U.S. at 651.

______

is a legal term

statutory seller

Furthermore, the

of art in this context.

to dismiss under

Rule 12(b)(6),

pleaded facts as

true, but

"bald

assertions"

or

proposed test under

status.

See
___

term "solicitation"

In deciding a motion

a court must

it need not

in bringing

take all

credit a

legal conclusions.

well-

complaint's

Washington Legal
_________________

Found. v. Massachusetts Bar Found., 993 F.2d 962, 971 (1st Cir.
______
________________________

1993)

(1st

(quoting United States v.

_____________

Cir. 1992)).

offering

was

Here it

conducted

AVX Corp., 962

_________

is

pursuant

undisputed that

to

firm

F.2d 108, 115

the

public

commitment

underwriting,

allegation

and plaintiffs'

that

the issuer

bald and

and

factually unsupported

individual

officers of

the

issuer "solicited" the plaintiffs' securities purchases is not,

standing alone, sufficient.

While,

involved

on a

in a firmly

different

set of

allegations, an

underwritten public offering

-49-

issuer

could be a

"seller"

for purposes

of

Wilensky
________

complaint does not

Section

12(2),

we hold

that

the

contain sufficient non-conclusory

factual allegations which, if true, would establish that DEC or

the

individual

complaint

does

defendants

adequately

defendants directly

literal

sense

underwriting

supplement

qualify

of

as such.

allege

that

sold securities to the

passing

arrangements

of March 21, 1994.

title),

disclosed

the

underwriter

plaintiffs (in the

consistent

in

the

the

with

the

prospectus

We conclude that the plaintiffs

have adequately alleged statutory

underwriter defendants,

However,

seller status as against the

but not against DEC

defendants.

IV.

The Section 10(b) Claims

or the individual

________________________

(Shaw Action)
____

The plaintiffs

in the

Sections

10(b) and 20(a)29

1934, 15

U.S.C.

thereunder,

private

17

Shaw action assert

____

of the Securities

78j(b), 78t(a), and

C.F.R.

action

240.10b-5.

under

Section

claims under

Exchange Act of

Rule 10b-5 promulgated

The

implied

10(b)

and

Rule

right

of

10b-530

____________________

29.

Section 20(a) provides for derivative liability of persons

who "control"

others found

to be

primarily liable under

the

Exchange Act.

30.

Section

10(b)

proscribes the

"use

or employ[ment],

in

connection with the purchase or sale of any security, . . . any

manipulative

or

contravention of
may

prescribe."

unlawful

deceptive

device

or

contrivance

such rules and regulations

15

U.S.C.

78j(b).

in

as the Commission

Rule 10b-5

makes it

"[t]o make any untrue statement of a material fact or

to omit to state a material fact necessary in order to make the

-50-

complements the civil enforcement function provided by Sections

11

and

12(2)

statements

and

prospectus, or

securities,

statements

to

of

the

Securities

omissions made

in connection

create

or omissions

Act

in

by

for

of material

beyond

registration statement,

with an initial

liability

reaching

false

fact in

distribution of

or

misleading

connection with

trading in the secondary

114 S. Ct.

market.

See Central Bank of Denver,

___ _______________________

at 1445; Eckstein v. Balcor Film Investors, 8 F.3d

________
______________________

1121, 1123-24 (7th

Cir. 1993),

cert. denied, 114

_____ ______

S. Ct.

883

(1994).

In

addition

to

proving

that

the

defendant

materially false or misleading statement or omitted to

material

fact necessary to make

made

state a

a statement not misleading, a

Rule 10b-5 plaintiff, unlike a plaintiff asserting claims under

Section

the

11 or 12(2) of the Securities Act, must establish that

defendant acted

reliance

on

with scienter,

the defendant's

See Holmes v. Bateson, 583

___ ______
_______

and that

the plaintiff's

misstatement caused

F.2d 542, 551 (1st Cir.

his injury.

1978); see
___

also San Leandro Emergency Medical Group Profit Sharing Plan v.

____ _______________________________________________________

Philip Morris Cos., Inc., 75 F.3d 801, 808 (2d Cir. 1996).
________________________

same standard of materiality,

The

however, applies to claims under

Section 10(b) and Rule 10b-5 as to claims under Sections 11 and

12(2) of the Securities

Act.

Income Portfolio, Inc., 36

______________________

See
___

Lucia v. Prospect St. High

_____
__________________

F.3d 170, 172 n.3 (1st

Cir. 1994).

statements made, in the light of the circumstances

under which

____________________

they were

made, not

misleading . . . in

purchase or sale of any security."

-51-

connection with

17 C.F.R.

the

240.10b-5(b).

Finally, a plaintiff asserting

alleged

"circumstances

particularity."

The

plaintiffs.

nondisclosures

intent,

that

market price of

market

caused

constituting

fraud

. . .

with

Fed. R. Civ. P. 9(b).

Shaw
____

nondisclosure

securities fraud must plead the

plaintiffs

and

advance

misstatement

They

allege

championed

further

and misstatements

defendants'

conduct

DEC common stock,

the plaintiffs

the

to

were

that

made

same

by

claims

of

the

Wilensky
________

those

alleged

with

artificially

fraudulent

inflated the

and that this fraud

suffer damages.

on the

The Shaw
____

plaintiffs also

allege

that defendants

committed

actionable

fraud by making optimistic statements to the public (outside of

any SEC filing)

the

Class

concerning the company's

Period,31

disregarded nonpublic

was

even

though

they

prospects throughout

knew

or

information indicating that

recklessly

the company

then in dire straits, as was ultimately disclosed on April

15, 1994.

to disclose

The defendants respond that they were

the information identified by

under no duty

plaintiff, and that

none of the statements attributed to them was materially false,

misleading, or otherwise actionable.

A.
__

Nonactionability of Loosely Optimistic Statements

_________________________________________________

____________________

31.

The Class Period (here, January 19 through April 15, 1994)

constitutes

the

time

period

during

putative plaintiff class purchased

We

limit

our

analysis

of

by

defendants

within the

members

of

the

shares of DEC common stock.

the Shaw
____

affirmative misrepresentation to

which

plaintiffs'

claims

of

the statements allegedly made

Class Period.

See In re Clearly
___ ______________

Canadian Sec. Litig., 875 F. Supp. 1410, 1420 (N.D. Cal. 1995).
____________________

-52-

The Shaw
____

plaintiffs allege

number of fraudulently optimistic

that the defendants

made a

statements about DEC through

media

outlets

press

releases issued

by the

after

analyzing

of

plaintiffs,

(e.g., newspapers
____

each

and trade

company.

publications) and

The

the statements

identified

In most circumstances, disputes

allegedly false

the trier of

176.

by

the

held as a matter of law that none was sufficiently

material to support a claim of securities fraud.

at

district court,

But not

every unfulfilled

expression of

corporate

as misstatement, can give rise

issue of materiality

See Lucia, 36 F.3d

___ _____

be reserved for

See Basic, 485 U.S. at 236; Lucia, 36 F.3d

___ _____
_____

optimism, even if characterized

to a genuine

over the materiality of

or misleading statements must

fact.

We agree.

under the securities

at 176 (leaving open possibility

laws.

that some

materiality determinations may be made as a matter of law).

In

particular,

courts have

immaterial

as

affirmation

numbingly

matter

commonly

familiar to

statements

clearly

demonstrated

heard

the

law

from

willingness to

certain

corporate

marketplace --

kind

of

managers

find

rosy

and

loosely optimistic

that are so vague, so lacking in specificity, or so

constituting

the opinions

reasonable investor could

of

of

of

the

speaker, that

no

find them important to the total mix

information available.32

See, e.g., San Leandro, 75 F.3d

___ ____ ____________

____________________

32.

Under the common law of fraud, courts typically would find

such statements to be
no

reasonable

insufficient

person
to

mere "puffing" or sales talk

could

support

rely,
claim.

and

thus
See,
___

upon which

to be
e.g.,
____

legally

Greenery
________

Rehabilitation Group, Inc. v. Antaramian, 628 N.E.2d 1291, 1293

__________________________
__________

-53-

at 807, 811 (holding not actionable statement that the

company

"expect[ed] . . . another year of strong growth in earnings per

share"); Hillson Partners Ltd. Partnership v.

__________________________________

F.3d

204,

213

(4th

fraudulent statement

achieving the

Cir.

1994)

was: "[the

most profitable

Caere Corporate Sec. Litig.,

___________________________

Adage, Inc., 42
___________

(similar,

company] is on

year in

its

where

alleged

target toward

history"); In re
______

837 F. Supp. 1054,

1057-58 (N.D.

Cal. 1993) ("[The company

Colby v.
_____

is] 'well-positioned' for growth.");

Hologic, Inc., 817 F. Supp.

_____________

204, 211 (D. Mass. 1993)

("Prospects for long term growth are bright.").

Review

immateriality

of

vaguely

as a matter of

optimistic

law may be

cases involving a fraud-on-the-market

such

cases,

the

statements

actionably misleading

statements

for

especially robust in

theory of liability.

identified

by

plaintiffs

In

as

are alleged to have caused injury, if at

all, not through the plaintiffs' direct reliance upon them, but

by dint of the statements' inflating effect on the market price

of the security purchased.

See Basic, 485 U.S. at 241-47; Rand

___ _____
____

v. Cullinet Software, Inc., 847

________________________

F. Supp. 200,

205 (D.

Mass.

1994).

When

corrects,

losses.

the

truth is

investors who

disclosed

bought at

and the

the inflated

Those losses can be deemed to have been

defendants'

statements,

even

market

absent

self-

price suffer

caused by the

direct

reliance

by

____________________

(Mass. App. Ct. 1994), rev. denied, 417 Mass. 1103 (1994); Webb
____ ______
____

v. First of Mich. Corp., 491 N.W.2d 851, 853 (Mich. App. 1992);
____________________
Rodio
_____

v. Smith,
_____

587

A.2d 621,

624

(N.J. 1991);

Zogarts, 14 Cal.3d 104, 111-12 (1975) (en banc).

_______

-54-

Hauter
______

v.

plaintiffs,

because the statements were presumptively absorbed

into and reflected

by the

security's price.

See Basic,
___ _____

486

U.S. at 243-44 (quoting In re LTV, 88 F.R.D. at 143).

_________

This presumption of investor

of

stock prices has the

for plaintiff

its

market

primary effect of

the

reference to

obviating the need

presumption

focus of the materiality inquiry.

case

integrity

purchasers to plead individual reliance.

underlying rationale,

critical

reliance on the

the

hypothetical

also

But by

shifts

the

In a fraud-on-the-

"reasonable

whom materiality is gauged, must

investor,"

by

be "the market"

itself, because it is the market, not any single investor, that

determines the price of a publicly traded security.

See In re
___ ______

Verifone Securities Litigation, 784 F. Supp.

_______________________________

1471, 1479 (N.D.

Cal.

thus

1992) ("The

inquiry

from

fraud-on-the-market theory

whether an

individual

investor

shifts the

was fooled

to

whether the market as a whole was fooled."), aff'd, 11 F.3d 865

_____

(9th Cir. 1993); see also In re Apple Computer Sec. Litig., 886
________ ________________________________

F.2d

1109, 1113-14 (9th Cir. 1989), cert. denied, 496 U.S. 943
_____ ______

(1990); cf. Easterbrook & Fischel, Corporate Law, supra, at 297

___
_____________ _____

(explaining how unsophisticated investors

"take a free ride on

the information impounded by the market").

Thus, a claim that a fraud was perpetrated on the market

______

can draw

no sustenance

from allegations that

defendants made

overly-optimistic statements, if those statements are ones that

any

reasonable

recognize

as

investor

nothing

(ergo,

more

the

than

market)

would

kind

self-directed

of

easily

-55-

corporate puffery.

granted that

Apple

The market

is not so

individual investors

Computer,

886 F.2d

at

easily duped,

sometimes are.

1114;

Wielgos v.

See
___

even

In re
_____

Commonwealth

_______________

_______

____________

Edison Co., 892 F.2d 509, 515 (7th Cir. 1989); see also Raab, 4
__________
________ ____

F.3d at 289-90 ("[T]he market price

by vague

statements

arbitrageurs

security,

rely

not

predicting

on

mere

facts in

expressions

of a share is not inflated

growth.

. . .

determining

of

the

optimism

Analysts

value of

from

and

company

spokesmen." (citations omitted)).

This is particularly so with

respect

actively traded

and closely

Cf. LTV, 88 F.R.D. at

___ ___

144 (citing

to the

securities of an

followed company like DEC.

empirical studies

efficiency

stocks

demonstrating that assumptions

are strongest

with

respect to

about market

"[t]the prices

of

of larger corporations, such as those listed on the New

York Stock Exchange").

While we have no

per se rule
___ __

managers

think

occasion or intention to adopt

that expressions of optimism uttered

can never
_____

that

in

this

support a

case,

claim of

the

misleading are

by corporate

securities fraud,

statements

outside

registration statement and prospectus identified

as actionably

here a

-- with one

of

we

the

by plaintiffs

exception discussed

separately below -- by their nature, too patently immaterial to

support a fraud-on-the-market claim.

We agree

claim

with the district

of securities

statements

made

by

fraud

court, for example,

cannot lie

defendant

Steul

-56-

on

the basis

(DEC's

that a

of

the

chief financial

officer)

in January

earnings

results for the quarter just ended.

as saying

1994,

in reaction

that the company's

chip products was

progress quarter

We

be

to

immaterial)

company

disappointing

Steul was quoted

transition to selling

its Alpha

"going reasonably well" and that the company

"should show

hold

to the

over quarter, year

similarly not

Steul's

comment

was "basically on

actionable

of

over year."

(because

January 19,

track"; his comment

1994

patently

that

the

of January 20,

1994 that

"DEC was a

very healthy company";

defendant Robert

Palmer's statement of the same date that he was "confident that

DEC

was pursuing the right strategy"; and the February 8, 1994

statement by DEC's head of European operations (not a defendant

here) that he

"be

able

calendar

half.

was "pretty optimistic"

to stabilize

year 1994 and "start

These statements

"substantial

likelihood"

investor" -- let

altered

U.S.

[its] revenue"

at 231-32

mix of

(quotation

all so

obviously

of being

the first

would

half of

in the second

fail to

"viewed by

pose any

the reasonable

"as having significantly

information available,"

omitted), that

deemed immaterial as a matter of law.33

____________________

in

to grow revenue"

alone the market --

the total

that the company

they are

Basic, 485
_____

properly

33.

Plaintiffs additionally argue that several forward-looking

statements

allegedly

commencement of
to a

"duty to

during
Steul

October

than

defendants

update," which defendants

the Class Period.

in

by

prior
_____

the Class Period (January 19,

of

restructuring actions
smaller

made

the

that

over the

last

four

the

the

1994) gave rise

purportedly violated

Plaintiffs point to
1993

to

a statement by

company's

fiscal year "will

quarters";

continuing

probably be

September

1993

statement that "[s]ervice revenues have continued to grow"; and

-57-

B.
__

Importance of Context: the "Break-Even" Statements

__________________________________________________

The Shaw plaintiffs allege

____

23,

and March 29,

1994, DEC made

following statements to the

"[w]e are

losses

or was

responsible for the

public, on those respective dates:

operating very close to

very close to

even."

that on January 20, February

break-even"; and

Plaintiffs assert

break-even"; "we're running

"we are very

close to

break-

given the

magnitude

of the

that

actually disclosed to the public on April 15, 1994, the

"break-even"

statements must

have

been false

when made

and

constituted actionable fraud.

Putting

aside for

the moment

adequately

alleged

that

fraudulent

intent,

the statements,

____________________

these

whether plaintiffs

statements

when

were

read in

made

have

with

isolation,

statement by defendant Palmer

prospect of turning a profit

fiscal

year

company

1994.

might be

1993 that the

was a "reasonable expectation" in

Whatever
subject

on November 4,

the

to a

circumstances

duty to

in which

"update" information

previously disclosed, we do not think that the pre-Class Period

statements identified by
trigger

any

such

plaintiffs are of the kind that could

duty.

The

alleged

statement

"service revenues"

constitutes a statement of

not alleged

false, and

to be

basis for a duty to update.

other alleged
that

statements

as such,

of any

positive

does not

are cautiously

future, and "lack the

projections

that

might

1993), cert. denied, 114 S.

_____ ______

likely

that

statements

any
would

disclosure of
announcement

75 F.3d at
comments" of
"duty

to

have

been

optimism).
DEC's

extinguished

financial information

later

9 F.3d 259,

Ct. 1397 (1994); see

___

811 (finding no

update"

sort of

require

267 (2d Cir.

"subdued general

See San
___ ___

They express, at most, "only the hope

In re Time Warner, Inc. Sec. Litig.,

___________________________________

San Leandro,
___________

The

comments

instance.

correction."

also
____

provide the

optimistic

in the first

company" for a positive

definite

historical fact

See Serabian, 24 F.3d at 361.

___ ________

would not be actionable

Leandro, 75 F.3d at 811.

_______

regarding

in the

duty to update

Moreover,

it seems

pre-Class
by

the

Period

company's

negative earnings

of January 19, 1994, the first day of the alleged

Class Period.

-58-

provide reason for pause.

described

optimism

immaterial

as the

that

as

isolation, to

can

The statements cannot accurately

kind of

be

diffuse expressions

deemed,

matter of

law.

by

their

Rather,

be statements quantifying

operating inflows as more

of opinion

nature,

be

or

obviously

they appear,

in

the company's current

or less approximating outflows, thus

inviting

quarter

an

inference

might turn

that the

end

out likewise.

context surrounding the statements.

the

"break-even" statements

results

The

for the

rub, however,

third

is the

When evaluated in context,

do not

give rise

to a

claim of

securities fraud.

In

deciding a motion to dismiss

a securities action, a

court may properly consider the relevant entirety of a document

integral

though not

to or explicitly

attached to

motion into one for

987

F.2d

1, 3-4

problem of looking

relied upon in

the complaint, even

the complaint, without

summary judgment.

(1st Cir.

1993)

converting the

See Watterson
___ _________

v. Page,
____

(explaining that

the main

to documents outside the

complaint -- lack

of notice to plaintiff -- is dissipated "[w]here plaintiff

has

actual

notice . . .

framing

and has

the complaint"

relied upon

(quoting

these documents

Cortec Indus., Inc. v.

____________________

in

Sum
___

Holding L.P., 949 F.2d 42, 48 (2d Cir. 1991), cert. denied, 112
____________
_____ ______

S. Ct. 1561

Romani,
______

plaintiff

isolated

(1992)); see also San Leandro,

________ ___________

929

F.2d at

could

879 n.3.

maintain

statement from a

a claim

Were the

of

75 F.3d at 808-09;

rule

fraud

by excising

document and importing

-59-

otherwise, a

an

it into the

complaint,

plainly

even

though

non-fraudulent

statement.

We

look to

the

surrounding

meaning

to

the

context

imparts

allegedly

the full context

of the

wrongful

"break-even"

statements attributed to defendant Steul.34

The

in a

first time the "break-even"

statement appeared was

Boston Herald article headlined "Digital falls short with

$72.1M

loss," published on January 20, 1994, the day after DEC

had announced its disappointing earnings results for the second

quarter

of

fiscal year

1994.

The article

attributed

following statement to Steul:

The $72 million loss represents

of revenues, Steul said.
close to break-even.

only 2.2 percent

"We are operating very

It's a lot of money, but on

the

the other hand it's small compared to what losses

have been in the past."

Steul would not say when

Digital will again be profitable.

give

you an

estimate because

much

uncertainty

in

the

"I hesitate to

we just

have too

immediate

future"

[paragraph structure omitted].

It is

to

plain that Steul's "break-even"

the fact

that

reported for the

the $72

million

second quarter
______

characterization refers

loss that

had just

of fiscal year

1994 was,

fact, only a small percentage of the company's total

The

statement cannot

comment on

company's

reasonably be

the current status

third quarter.

understood as

or anticipated

Since

been

in

revenues.

a material

results of

the

plaintiffs do not allege that

____________________

34.
even"

The

full text of the

statements

complaint,

have

news articles in

appeared,
been provided

and
to

which
us

are
in a

which the "breakcited

in

the

jointly-prepared

appendix.
nor

Plaintiffs have not objected to the district court's

the defendants' making reference to the full text of those

articles.

-60-

the

characterization

of

"close

to

break-even"

placed

an

actionably fraudulent spin on DEC's second quarter results, the

______

statement in that context can be of no moment.

The second "break-even" statement appeared in a February

23, 1994 Wall Street Journal article.

___________________

obtained

an "internal"

The article's author had

DEC finance

review, and

divulged its

contents as follows:

"We're

running very

[internal]

review

uncertain

for

close to
says,

next

review concludes

though

"revenue

is
The

that Digital "will still

be in

and that managers

two-plus

the

quarters."

turnaround for the

conservation."

break-even,"

next two

or three

quarters"

should "focus heavily on

There is a chance,

cash

it adds, "if

we keep at Q2 spending levels, that we can make a

profit this

fiscal

confirmed many
he wouldn't

While

Mr.

Palmer

of these points

in an interview,

make any forecast.

"This is a large

organization that
started,

year."

and

we

was

in deep

still

have

trouble

when

to

way

I
go"

[paragraph structure omitted].

The

context

review,

of the

as reported,

"break-even"

statement

in the

sufficiently bespeaks caution

any forward-looking connotation that

internal

to render

could otherwise be

taken

from the statement immaterial as a matter of law.

Conductron Corp.,
_________________

552

F.2d 797,

806

n.28

(8th

Cf. Polin v.
___ _____

Cir. 1976)

(holding that statement by company that it "saw a 'possibility'

of a break-even soon" was immaterial as matter of law, since it

was

phrased so

denied, 434
______

as

to "bespeak

U.S. 857 (1977).

caution

Given

in outlook"),

cert.
_____

the statements attributed

to the internal review that "revenue is uncertain for next two-

plus quarters"; that "[DEC] will still be in turnaround for the

next two or three quarters"; that "we still have a

-61-

way to go";

and

given

coupled

Palmer's reported

with

the

absence

refusal

of

any

to

specifics

authoritativeness or timeliness

of the

reasonable

market)

investor

importance to

(nor

the

make any

forecast,

regarding

"internal" report,

could

any forward-looking connotation

the

no

have

attached

of the

"break-

even" statement described in the article.

A similar analysis applies to the "break-even" statement

that appeared in the

March 29, 1994 issue of

In that article, defendant

very

close to break-even.

Financial World.
_______________

Steul was quoted as saying

If it hadn't

"We are

been for currencies,

and had we been able to ship

been in

the black in

everything ordered, we would have

the second quarter."

Street Journal piece, neither

______________

nor

the

Shaw
____

statement was

complaint

As with

the Wall
____

the Financial World piece itself

_______________

specifies

actually made.35

the

date

on

But, again, Rule

which

the

9(b) issues

aside, the "break-even" comment is most naturally understood as

looking backward to the

the

future.

second quarter of fiscal 1994,

not to

Furthermore, to the extent that any other meaning

could be discerned, it is directly negated by other

qualifying

comments attributed to Steul in the same article, including the

following:

What Digital needs at

Steul, "Wall

this point is time.

Street always

Says

wants quick results,

but it took a couple of years to get where we are

and

it will take more than

a couple of quarters

to turn it around."
____________________

35.

It is

unclear whether

the statement quoted

in Financial
_________

World had been freshly made by Steul, or was recycled from pre_____
existing sources.

The Shaw complaint does not specify.

____

-62-

This warning that favorable results would be slow to come is

far cry from a

"prediction of a break-even year," which is how

plaintiffs

characterize

because plaintiffs

committed

by

Steul's

allege

that

statements

a fraud

on

communicated

in

analyst's article,

it is only

the

one

article

prospects.36

not err

is

On the

of

comments.

Additionally,

the

market

this

fair to note that

skepticism

about

financial

the tenor of

DEC's

facts as alleged, the district

in concluding that

was

future

court did

the "break-even" statement

in the

Financial World piece was immaterial as a matter of law.

_______________

C.
__

Actionability under Section 10(b) of Omissions

______________________________________________
and Misleading Statements in the Registration
_____________________________________________
Statement and Prospectus
________________________

The

remaining statements

Shaw plaintiffs to be fraudulent

____

and omissions alleged

under Section 10(b) and

by the

Rule

10b-5 relate

DEC's March

to the registration statement

1994 stock offering.

and prospectus for

These alleged misstatements

and omissions are identical to those that underlie the Wilensky

________

plaintiffs'

Securities

claims

Act.

under

We

Sections

conclude

11

that the

and

12(2)

of

the

Shaw
____

plaintiffs may

pursue their Section 10(b) claim based on these alleged defects

____________________

36.

For

example, the

expressing

article quotes

skepticism

about

DEC's prospects,

"Reasonable as [Steul's comments

sound,

recall

that it

Steul's boss boasted

three

years and

was

and

analysts

cautions:

concerning a turn-around] may

only last

that Digital

over 83

statements by

September

was on its

billion of

red ink."

[1993] that

way back
We

after

need not

decide here whether an allegedly misleading statement appearing

in one source can be rendered immaterial as a matter of law, at

the

pleading stage,

different source.

by third-party

commentary

in that

or a

-63-

in the registration statement and prospectus.

that the

extent,

behalf

Shaw complaint
____

we also

the

Shaw
____

survives Rule

conclude

that the

complaint

was

Because we

12(b)(6) only

putative

brought

to that

class on

must

be

hold

whose

narrowed

accordingly.

Material

omissions

and

misleading

statements

in

registration statement and prospectus are, in addition to being

actionable

under

the

Securities

Act by

purchasers

in

the

offering, also actionable under Section 10(b) and Rule 10b-5 by

contemporaneous

purchasers

in the

aftermarket,

provided, of

course, that the additional elements of liability (scienter and

reliance)

are established.

See
___

Stock Litig., 991

_____________

F.2d 953,

Raytheon Mfg. Co.,

_________________

188 F.2d

Huddleston,
__________

459

U.S.

at

proposition that the 1934

of

In re Ames Dept. Stores Inc.

_____________________________

963 (2d

Cir. 1993);

783, 786-87 (2d

383

("[I]t

is

fraud-on-the-market

rationale.

Cir. 1951);

hardly

Act and the 1933 Act

the same conduct.'" (citation omitted)).

claim,

this

Fishman v.
_______

cf.
___

novel

'prohibit some

In the context of

principle

has

simple

The registration statement and prospectus speak not

only to

those who purchase in the

market.

If an

misleading

condition

issuer's

statement of

or

omits

offering, but to the entire

registration

fact

about

material

statement contains

the company's

information

financial

required

to

be

disclosed, the impact of

such statements or omissions, to

the

extent

not

the

material,

securities

would

necessarily be

limited

covered by the registration statement.

-64-

to

There is no

logical

could

reason that

not

serve as

a registration

statement and

a vehicle

an alleged

for

prospectus

fraud

market, affecting all of the company's securities.

on the

Thus, even

though the Shaw plaintiffs purchased shares of DEC common stock

____

in

the

aftermarket,

offering,

encompass

their

any

not

preferred

fraud-on-the-market

material

registration statement.

We hold,

shares of

misstatements

claims

or

stock

may

omissions

in the

properly

in

the

See In re Ames, 991 F.2d at 963-64.

___ __________

then, that the same

allegations of misleading

statements and omissions in the Wilensky complaint that state a

________

claim under Sections

11 and

12(2) also

form the

basis of

cognizable claim

allegations in

under Section 10(b)

the Wilensky
________

and Rule

10b-5.37

complaint which we

The

found lacking

are similarly without force in the Shaw complaint.

____

D.
__

Limitation of the Shaw Class

_________________
_____

____________________

37.

In so

holding, we do not intend to create a private right

of action under Section

10(b) for violations of any

SEC rule.

Our

holding is limited to the proposition that, in the context

of a

public offering, plaintiffs who (through the market) rely

upon the completeness of a registration statement or prospectus

may sue under Section

10(b) and Rule 10b-5

for nondisclosures

of material facts omitted from those documents in

the applicable

SEC rules

F.2d

(suggesting

at 12-13

trading

may

create a

and regulations.
that SEC

duty

Roeder, 814 F.2d at 27 (same).

______
F.3d at

930 n.6 (declining to

to

violation of

Cf. Backman,
___ _______

regulations and

disclose under

Rule

insider

10b-5);

But cf. In re Wells Fargo,

_______ _________________
reach the issue).

910

12

A different

rule

would

lead

to the

plaintiff being able

company's

for

securities

failing

result

to sue an individual
for

nonpublic information,
itself

anomalous

the

disclose

able to
the

a Rule

10b-5

insider selling his

nondisclosure

but not being

to

of

same

of
sue the

material

issuer

information

in

connection with an offering.

-65-

Our conclusion

but only to the extent

omissions

that the Shaw complaint

____

it is based on the same

that form the basis

of the surviving

states a claim,

statements and

claims in the

Wilensky complaint,
________

made.

The Shaw
____

requires

an important

adjustment

plaintiffs allege that they were

to

be

injured when

they purchased DEC common stock at prices that were inflated as

result of misleading statements and omissions by DEC and the

individual

defendants.

The

represent a

class of persons

January

and April

19

named

plaintiffs

who purchased DEC

15, 1994.

purport

to

stock between

However, because

the only

allegations

in the Shaw complaint that state a claim are those

____

that depend

upon the purported misstatements

the registration statement

21,

1994 --

it follows

shares on or after
___________

when

disclosure

as of its

that only

and omissions in

effective date --

March

those who

purchased their

March 21, 1994 (and before

April 15, 1994,

occurred)

could

have

suffered

cognizable

injury.

Of the four plaintiffs named in the Shaw complaint, only

____

Gary Phillips is alleged to have made his purchase within those

two limiting dates; thus only his claim may be reinstated.

district court's

dismissal of the

named plaintiffs is

affirmed.

On

claims of

the three

other

remand, the district

court

should require the Shaw plaintiffs to amend

____

redefine the "Class Period" accordingly.

V.

Rule 9(b)
_________

-66-

The

their complaint to

Defendants argue, as

the

district court's

an alternative basis for affirming

dismissals, that

both the

Wilensky and
________

Shaw complaints fail to meet the requirement of Fed. R. Civ. P.

____

9(b)

that claims of fraud be pleaded with "particularity."

We

ask first whether the dictates of Rule 9(b) apply to the claims

asserted in the Wilensky complaint, and answer in the negative.

________

We then test the allegations of the Shaw complaint and conclude

____

that it satisfies Rule 9(b).

A.
__

Whether Rule 9(b) Applies to the Wilensky Complaint

________________________________
_________

Rule

. . ., the

stated

with

9(b) mandates

circumstances

that "[i]n

constituting fraud

particularity."

threshold question

all averments

Fed.

is whether

the

R.

Civ.

. . .

P.

of fraud

shall

9(b).

Wilensky complaint,
________

be

The

which

sets forth claims under Sections 11 and 12(2) of the Securities

Act, contains any "averments of fraud."

Fraud is not an element of a claim under either

11

or 12(2), and a

altogether

any

Shapiro, 964 F.2d

_______

plaintiff asserting such

allegations

at 288;

of

scienter or

Section

claims may avoid

reliance.

See
___

Lucia v. Prospect St. High Income

_____
__________________________

Portfolio, Inc., 769 F. Supp. 410, 416 (D. Mass. 1991), aff'd,
________________
_____

36

F.3d 170

(1st Cir.

requirements of

violations

1994).

Sections 11

However, despite

and 12(2), a

establish

complaint asserting

of those statutes may yet "sound[] in fraud."

v. Eastland Financial Corp., 755

_________________________

1991).

the minimal

For

example,

if

F. Supp. 1123,

plaintiff

violations of Sections 11

-67-

were

to

and 12(2) as

Haft
____

1126 (D.R.I.

attempt

to

well as the

anti-fraud provisions

in

single

complaint

conduct, fraud

action."

In

might

Hayduk v.
______

such a case,

would

of a

be said

unified

to "lie[]

through allegations

course

at the

Lanna, 775 F.2d 441, 443

_____

the particularity

of

fraudulent

core of

the

(1st Cir. 1985).

requirements of

Rule 9(b)

probably apply to the Sections 11, 12(2), and Rule 10b-5

claims alike.

of the claim

"It is the allegation of fraud, not the 'title'

that brings the policy concerns

9(b)] . . . to

accord
______

of the Exchange Act

Shapiro,
_______

the forefront."

964 F.2d

at

[underlying Rule

Haft, 755 F.
____

Supp. at

287-88 (applying

Rule

1133;

9(b) to

Section 11 and 12(2) claims "grounded in fraud"); Lucia, 769 F.

_____

Supp. at 416-17 (same).

As

avoids

the

district

grounding

allegations of

its

fraud.

court noted,

Section

11

to disclose, those allegations

of

reliance.

fraud,"

Otherwise,

and

Wilensky complaint
________

12(2) claims

on

any

Although the complaint does assert that

defendants actually possessed the

"averments

the

cannot be thought to constitute

absent

any

information that they failed

any

claim

allegation

of

of

scienter

nondisclosure

and

of

material information would be transformed into a claim of fraud

for purposes of

the

Wilensky
________

Rule 9(b).

complaint

was

In the circumstances, we hold that

not

subject

to

requirements of Rule 9(b).

B.
__

Whether the Shaw Complaint Satisfies Rule 9(b)

___________
_____________________________

the

pleading

The defendants' primary challenge to

the Shaw complaint under

____

the sufficiency of

Rule 9(b) is that it

fails to allege

-68-

specific facts

defendants

that would

had

financial results

prior to

knowledge

permit a reasonable

of

information

for the third

the quarter's end.

quarter of

We limit

inference that

foretelling

fiscal year

our analysis to

the

1994

those

allegations in the Shaw complaint that state a cognizable claim

____

for securities fraud.

have

March

The issue is thus whether the plaintiffs

sufficiently pleaded

that

21, 1994 that indicated

defendants knew

the third quarter

turn out as it did, and that the company would

announce

further

restructuring

additional restructuring charge for

the question

is close, we

actions

facts as

was going to

soon thereafter

necessitating

the fiscal year.

think that

of

an

Although

the complaint

survives

"especially rigorous" in

applying

Rule 9(b) scrutiny.

This court

has been

Rule 9(b) in securities

fraud actions "to minimize the

chance

'that

a plaintiff with a largely groundless claim will bring a

suit

and conduct extensive discovery in the hopes of obtaining

an

increased settlement,

process will

878

286,

in the

reveal relevant evidence.'"

hopes that

Romani,
______

the

929 F.2d at

(quoting New England Data Servs., Inc. v. Becher, 829 F.2d

_____________________________
______

288

(1st

Cir. 1987)).

particularity requirement

general

averment that

turned out badly."

(1st Cir. 1992).

by

rather than

hindsight.'"

We

have

emphasized that

cannot be avoided "simply

defendants

'knew'

the

through a

earlier what

later

Greenstone v. Cambex Corp., 975 F.2d 22, 25

__________
____________

A securities plaintiff cannot

Id. (quoting
___

Denny v. Barber,
_____
______

-69-

plead "'fraud

576 F.2d 465,

470

(2d Cir.

1978)).

This

means that

a plaintiff

may not

simply contrast a defendant's past optimism with less favorable

actual results, and then "contend[] that the difference must be

attributable

to fraud."

627 (7th Cir.),

Rule

that

cert. denied,
_____ ______

9(b) requires

facts that make

975

that the

498 U.S. 941

was

F.2d

25

Rather,

forth specific

believe that defendant

materially

at

(1990).

complaint "set[]

it reasonable to

statement

Greenstone,
__________

DiLeo v. Ernst & Young, 901 F.2d 624,

_____
_____________

false

(collecting

or

knew

misleading."

cases);

see also
_________

Serabian, 24 F.3d at 361 (quoting Greenstone).

________
__________

Here,

the complaint cannot

fairly be

characterized as

resting on conclusory allegations of the defendants' knowledge.

The plaintiffs provide a series of factual allegations relating

to

a combination of

failing product

developments known to

pricing strategies,

products, wayward compensation

downsizing

knowledge

the company (e.g.,

____

market resistance

policies, failure to

to new

implement

plans) that could have provided a basis for advance

of the

information disclosed

on April

15, 1994.38

____________________

38.

In asserting that defendants had direct knowledge of DEC's

third quarter operating

allege that "[m]ore so
DEC's

management,

virtually
information"

developed, plaintiffs

than the management of

including

immediately
by

results as they

the Individual

cognizant

virtue of

the

of

the

company's use

most companies,
Defendants,
Company's
of

was

sales

"a highly-

efficient reporting system which

sales and

cost information

sales are

made."

should

to senior management

The defendants argue

virtually as

that these allegations

be viewed with skepticism and as the product of nothing

more than

"pure speculation."

that

plaintiffs'

the

reporting
might

allows the Company to forward

Speculation

allegations

system" may speak to the

have known

what they

of

or not,

we think

"highly-efficient

question of how defendants

___

allegedly

knew, but

absent some

indication of the specific factual content of any single report

_______

-70-

These factual

allegations, together with other

aspects of the

complaint

discussed below,

provide a

basis for

a reasonable

inference

that defendants

knew facts

by March

21 indicating

that the

third fiscal

accelerated

quarter would

restructuring

restructuring charge

efforts

were likely

be disastrous, and

requiring

to follow.39

that

further

Cf. Serabian,
___ ________

24 F.3d at 365; In re Wells Fargo, 12 F.3d at 931.

_________________

In

additional

defendants' knowledge,

the

company, neither

stockholdings

during

company's treasurer,

support

their

allegations

plaintiffs assert that two

of whom

the

is a

third

sold 1,625

total holdings) on February

manager and

of

shares (68% of

11, 1994.

vice president of the

insiders of

defendant here,

fiscal quarter.

The other,

of

sold DEC

One,

the

the officer's

the general

company's personal computer

business,

sold 2,000 shares (20% of his position) on March 22,

1994.

____________________

generated by the alleged reporting system, do not independently

provide a factual basis

for inferring any such knowledge.

On

balance, we do not think that generalized allegations regarding

the existence of

an internal "reporting system"

substantially

assist a securities fraud complaint in overcoming the hurdle of

Rule 9(b).
(D.S.C.

See
___

Pitten v.
______

Jacobs, 903
______

1995); cf. Arazie v.

___ ______

F. Supp.

Mullane, 2 F.3d
_______

1456, 1467 (7th

Cir. 1993) (refusing to credit "scanty" allegations

internal

documents, absent

projected

figures,

when

indication
they

of

937, 949-50

concerning

"who prepared

were prepared,

how

firm

the

the

numbers were, or which . . . officers reviewed them").

39.

We

reject defendants' argument

adequately

to

defendants

in the purported fraud.

367-68.

particularize

the

that the
roles

of

complaint fails
the

individual

Cf. Serabian,
___ ________

24 F.3d at

-71-

Of

course,

occurred does not

v.

Egan,
____

allegations

suspicious

and

141

the

mere

fact

stock

suffice to establish scienter.

F.R.D. 370,

of "insider

373

(D.

trading in

times" may permit

by further

that insider

inference, the

Mass.

See Tapogna
___ _______

1992).

However,

suspicious amounts

an inference that

company --

sales

or at

the trader --

possessed material

nonpublic information at the time.

26 (citing

See Greenstone, 975 F.2d at

___ __________

In re Apple Computer,
____________________

Rubinstein,
__________

20

F.3d

at 169-70

886 F.2d at 1117);

(characterizing

see also
________

sufficiently

suspicious trading as "presumptively probative of bad faith and

scienter").

alleged

Here,

insider

the level

stock

occurred more than a

(March

might

21, 1994);

be

holdings

of

plaintiffs'

are

at least

is

and the

second sale,

"suspicious"

stock.

consistent with their

sale

date of concern

here

though made

at what

involved a

of the

Nonetheless,

allegations of insider

the

the

first

time,

insignificant) percentage

DEC

warranted by

marginal:

month prior to the

considered a

(albeit not

sales

of suspicion

we

insider's total

think

trading, inasmuch

theory of

small

that

the

as they

fraud, provide

some support

against the

defendants' motion to

dismiss under

Rule 9(b).

Finally,

in testing

the allegations

of

the complaint

against Rule 9(b), we need not turn a blind eye to the obvious:

the

proximity

of

the

date

of

the

allegedly

fraudulent

statements and omissions to both the end of the quarter then in

progress

and the date on which disclosure was eventually made.

-72-

While

the short

statement or

information

time

frame between

omission and

does

a later disclosure

not, standing

factual grounding to satisfy

1467-68,

there

consideration

is

of

Fecht,
_____

70 F.3d at

alone,

in

such temporal

Rule

of inconsistent

provide

On

9(b)

proximity

the complaint's

1083-84.

quarter

(and the

as a

circumstantial

the facts as

to

precludes

circumstance

be taken

See
___

alleged in this

the allegedly

of the ongoing

eventual disclosure)

factual support

F.3d at

claims of fraud.

and omissions to the end

date of

a sufficient

that

case, we think that the proximity of the date of

misleading statements

fraudulent

Rule 9(b), see Arazie, 2

___ ______

nothing

potentially bolstering

an allegedly

provides some

into account

in

determining whether the complaint

pleads an adequate basis for

inferring defendants' culpable knowledge.

We

mandate of

have no

intention

Rule 9(b).

complaint under

that

here of

But in

diluting

the stringent

determining the adequacy

rule, we

cannot

hold plaintiffs

of a

to

standard that would effectively require them, pre-discovery, to

plead evidence.

Rule 9(b) proscribes the pleading of "fraud by

hindsight," Denny, 576 F.2d at

_____

be

that

470, but neither can plaintiffs

expected to plead fraud with complete insight.

the

12(b)(6)

portions of

the

Shaw complaint
____

scrutiny also satisfy

of Rule 9(b).

VI.

that

We conclude

survive Rule

the particularity requirements

Conclusion
__________

-73-

The district court erred

in dismissing the Wilensky and

________

Shaw complaints in their entirety.

____

Portions of both complaints

survive Rule 12(b)(6), but only to the extent that they allege:
____

(i) that

the registration

statement filed in

connection with

the public

offering

of March

21,

material information in DEC's

would have alerted the

quarterly

results;

1994, failed

disclose

possession as of that date

market to the likelihood

and

to

(ii)

that

the

that

of disastrous

statement

in

the

prospectus supplement as to the "adequacy" of the restructuring

reserve

remaining as of March 21, 1994 was materially false or

misleading.40

fails

We hold,

to state a claim

Act as to DEC

however, that the

Wilensky complaint
________

under Section 12(2)

of the Securities

and the individual defendants.

light of the limited basis

to

who

go forward, only the

purchased

reinstated,

and

DEC

the

Furthermore, in

on which we permit the Shaw

____

claims of the

shares

after

allegations

single named plaintiff

March

in

action

21,

the

1994

Shaw
____

may

be

complaint

pertaining to the scope of the putative plaintiff class must be

modified

Civ.

accordingly.

P. 9(b)

do

Finally, the

not

apply

currently

pleaded,

and

complaint

does satisfy

the

to

requirements of

the

Wilensky
________

surviving portion

Rule 9(b).

On

Fed. R.

complaint

of

remand,

the

as

Shaw
____

the district

____________________

40.

The district

court did not state

any independent reasons

for dismissing the Wilensky plaintiffs' derivative claims under

________

Section 15 of the Securities Act or the Shaw plaintiffs' claims

____
under

Section 20(a)

of the

negligent misrepresentation.

Exchange Act
Those claims

and for

common law

should, therefore,

be reinstated and permitted to proceed to the extent consistent

with this opinion.

-74-

court

may

choose to

require

the plaintiffs

to

amend their

complaints in accordance with these conclusions.

In

closing,

we

note

that

although

the

issues

of

materiality and knowledge raised by the two complaints preclude

terminating this

here is

litigation on

intended to foreclose

other issues,

after discovery

the pleadings, nothing

the possibility that

and an opportunity

development, might be susceptible

summary judgment.

we say

those and

for factual

to resolution on motions for

To borrow wise words

from one of our prior

decisions:

"Despite

our conclusion

that

certain allegations

survive threshold consideration, we note that plaintiffs remain

great distance from actually proving"

federal securities laws.

any violations of the

Serabian, 24 F.3d at 365-66.

________

Affirmed in part, reversed in part, and remanded.

No
________________________________________________________
costs are awarded.
__________________

-75-