Semerenko v. Cendant Corp. , 223 F.3d 165 ( 2000 )

Opinions of the United
2000 Decisions States Court of Appeals
for the Third Circuit
6-16-2000
Semerenko v. Cendant Corp
Precedential or Non-Precedential:
Docket 99-5355
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Filed June 16, 2000
UNITED STATES COURT OF APPEALS
FOR THE THIRD CIRCUIT
No. 99-5355
GEORGE SEMERENKO
v.
CENDANT CORP.; WALTER A. FORBES; E. KIRK
SHELTON; COSMO CORIGLIANO; CHRISTOPHER K.
MCLEOD; ERNST & YOUNG LLP
George Semerenko, individually and on behalf of all
others similarly situated.
Appellant
(D.C. Civil No. 98-05384)
No. 99-5356
P. SCHOENFELD ASSET MANAGEMENT LLC,
on behalf of itself and all others similarly situated,
Appellant
v.
CENDANT CORP.; WALTER A. FORBES;
E. KIRK SHELTON; COSMO CORIGLIANO;
CHRISTOPHER K. MCLEOD; ERNST & YOUNG LLP
(D.C. Civil No. 98-04734)
On Appeal from the United States District Court
for the District of New Jersey
District Judge: Honorable William H. Walls
Argued March 21, 2000
BEFORE: MANSMANN and GREENBERG, Circuit Judges
and ALARCON, Senior Circuit Judge*
(Opinion Filed: June 16, 2000)
Arthur N. Abbey [Argued]
Jill S. Abrams
Stephen J. Fearon, Jr.
Nancy Kaboolian
Abbey, Gardy & Squitieri, LLP
212 East 39th Street
New York, NY 10016
Allyn Z. Lite
Joseph J. DePalma
Mary Jean Pizza
Lite DePalma Greenberg &
Rivas, LLC
Two Gateway Center - 12th Floor
Newark, NJ 07102-5003
Andrew Barroway
David Kessler
Schiffrin & Barroway
Three Bala Plaza East - Suite 400
Bala Cynwyd, PA 19004
Attorneys for Appellants
George Semerenko and
P. Schoenfeld Management, LLC
_________________________________________________________________
* The Honorable Arthur L. Alarcon, Senior Judge of the United States
Court of Appeals for the Ninth Circuit, sitting by designation.
2
Jonathan J. Lerner
Samuel Kadet [Argued]
Skadden, Arps, Slate, Meagher &
Flom LLP
Four Times Square
New York, NY 10036
Michael M. Rosenbaum
Carl Greenberg
Budd Larner Gross Rosenbaum
Greenberg & Sade, P.C.
150 John F. Kennedy Parkway
CN 1000
Short Hills, NJ 07078-0999
Attorneys for Appellee
Cendant Corporation
James M. Hirschhorn
Steven S. Radin
Sills Cummis Radin Tischman
Epstein & Gross, P.A.
One Riverfront Plaza
Newark, NJ 07102-5400
Dennis J. Block [Argued]
Howard R. Hawkins, Jr.
Cadwalader, Wickersham & Taft
100 Maiden Lane
New York, NY 10038
Greg A. Danilow
Timothy E. Hoeffner
Weil, Gotshal & Manges LLP
767 Fifth Avenue
New York, NY 10153
Attorney for Appellees
Walter Forbes and Christopher
McLeod
3
Richard Schaeffer [Argued]
Bruce Handler
Dornbush Mensch Mandelstam &
Schaeffer, LLP
747 Third Avenue
New York, NY 10017
Attorneys for Appellee
E. Kirk Shelton
Gary P. Naftalis
Kramer, Levin, Naftalis & Frankel
919 Third Avenue
New York, NY 10022
Attorney for Appellee
Cosmo Corigliano
Alan N. Salpeter
Michele Odorizzi
Mayer, Brown & Platt
190 South LaSalle Street
Chicago, IL 60603
William P. Hammer, Jr.
J. Andrew Heaton [Agrued]
Ernst & Young LLP
1225 Connecticut Avenue, NW
Washington, D.C. 20036
Douglas S. Eakeley
Lowenstein Sandler
65 Livingston Avenue
Roseland, NJ 07068
Attorneys for Ernst & Young LLP
4
Harvey J. Goldschmid
General Counsel
Jacob H. Stillman
Solicitor
Eric Summergrad
Deputy Solicitor
Hope Hall Augustini
Special Counsel
Securities & Exchange Commission
450 Fifth Street, N.W.
Washington, D.C. 20549-0606
Attorneys for Amicus-Appellant
Securities and Exchange
Commission
OPINION OF THE COURT
ALARCON, Senior Circuit Judge.
I
The P. Schoenfeld Asset Management LLC and the class
of similarly situated investors (collectively, the"Class")
appeal from the order of the district court dismissing their
claims for securities fraud pursuant to Rule 12(b)(6) of the
Federal Rules of Civil Procedure. The Class's complaint was
filed under S 10(b) of the Securities Exchange Act of 1934
(the "Exchange Act") and Rule 10b-5. The complaint also
alleged that the individual defendants were liable for the
underlying violations of S 10(b) and Rule 10b-5 as control
persons under S 20(a) of the Exchange Act.
We conclude that the complaint alleges sufficient facts to
establish the elements of reliance and loss causation, and
that the district court applied the incorrect analysis for
determining whether the complaint alleges that the
purported misrepresentations were made "in connection
with" the purchase or the sale of a security. Because the
standard that we have articulated for the "in connection
5
with" requirement is different from the one applied by the
district court, we vacate the judgment below and remand
the matter for further proceedings. Given that we do not
resolve whether the dismissal was proper under S 10(b) and
Rule 10b-5, we do not address the dismissal of the Class's
claim under S 20(a).
II
The Class filed this action against the Cendant
Corporation ("Cendant"),1 its former officers and directors
Walter A. Forbes, E. Kirk Shelton, Christopher K. McLeod,
and Cosmo Corigliano (the "individual defendants"), and its
accountant Ernst & Young LLP ("Ernst & Young")
(collectively, the "defendants"). The Class alleges that the
defendants violated S 10(b) and Rule 10b-5 by making
certain misrepresentations about Cendant during a tender
offer for shares of American Bankers Insurance Group, Inc.
("ABI") common stock. The Class consists of persons who
purchased shares of ABI common stock during the course
of the tender offer. The class period runs from January 27,
1998 to October 13, 1998. The complaint does not allege
that any member of the Class purchased securities issued
by Cendant, or that any member of the Class tendered
shares of ABI common stock to Cendant. Instead, it alleges
that the defendants made certain misrepresentations about
Cendant that artificially inflated the price at which the
Class purchased their shares of ABI common stock, and
that the Class suffered a corresponding loss when those
misrepresentations were disclosed to the public and the
merger agreement was terminated. In light of the
procedural posture of this case, we must assume the truth
of the facts alleged in the complaint. See In re Burlington
Coat Factory Sec. Litig., 114 F.3d 1410, 1420 (3d Cir.
1997).
On December 22, 1997, the American International
Group, Inc. ("AIG") announced that it would acquire one
_________________________________________________________________
1. Cendant was formed on December 17, 1997 as the surviving entity in
a merger between HFS Inc. and CUC International, Inc. In the interests
of simplicity, and because the merger predates the class period, we refer
to Cendant as including its predecessor organizations.
6
hundred percent of the outstanding shares of ABI common
stock for $47 per share. On January 27, 1998, Cendant
made a competing tender offer to purchase the same shares
at a price of $58 per share, or a total price of approximately
$2.7 billion. In conjunction with its tender offer, Cendant
filed with the Securities and Exchange Commission (the
"SEC") a Schedule 14D-1 that overstated its income during
prior financial reporting periods.
On March 3, 1998, AIG matched Cendant's bid and
offered to pay ABI shareholders $58 for each share of
outstanding ABI common stock. Cendant eventually raised
its bid price to $67 per share. It then executed an
agreement to purchase ABI for approximately $3.1 billion,
payable in part cash and in part shares of Cendant
common stock. Cendant filed an amendment to its
Schedule 14D-1 on March 23, 1998 reporting the terms of
the merger agreement. Eight days later, Cendantfiled a
Form 10-K reporting its financial results for the 1997 fiscal
year.
After the close of trading on April 15, 1998, Cendant
announced that it had discovered potential accounting
irregularities, and that its Audit Committee had engaged
Willkie, Farr & Gallagher and Arthur Andersen LLP to
perform an independent investigation. Cendant also
announced that it had retained Deloitte & Touche LLP to
reaudit its financial statements, and that "[i]n accordance
with [Statement of Accounting Standards] No. 1, the
Company's previously issued financial statements and
auditors' reports should not be relied upon." Nevertheless,
the April 15, 1998 announcement reported that the
irregularities occurred in a single business unit that
"accounted for less than one third" of Cendant's net
income, and it indicated that Cendant would restate its
annual and quarterly earnings for the 1997 fiscal year by
$0.11 to $0.13 per share. Immediately after Cendant
disclosed the accounting irregularities, the price of ABI
common stock dropped from $64-7/8 to $57-3/4,
representing an eleven percent decrease from the price at
which the shares had been trading.
Following the April 15 announcement, Cendant made
several pubic statements in which it represented that it was
7
committed to completing the merger with ABI
notwithstanding the discovery of the accounting
irregularities. On April 27, 1998, Walter A. Forbes, the
chairman of the board of directors of Cendant, and Henry
R. Silverman, the president and the chief executive officer
of Cendant, issued a letter to Cendant shareholders, which
was published in the financial press. That letter states:
We are outraged that the apparent misdeeds of a small
number of individuals within a limited part of our
company has adversely affected the value of your
investment -- and ours -- in Cendant. We are working
together diligently to clear this matter up as soon as
possible. We fully support the Audit Committee's
investigation and continue to believe that the strategic
rationale and industrial logic of the HFS/CUC merger
that created Cendant is as compelling as ever.
Cendant is strong, highly liquid, and extremely
profitable. The vast majority of Cendant's operating
businesses and earnings are unaffected and the
prospects for the Company's future growth and success
are excellent.
We have reaffirmed our commitment to completing all
pending acquisitions: American Bankers, National
Parking Corporation and Providian Insurance.
In a press release issued on May 5, 1998, Cendant stated
that "over eighty percent of the Company's net income for
the first quarter of 1998 came from Cendant business units
not impacted by the potential accounting irregularities."
On July 14, 1998, Cendant revealed that the April 15,
1998 announcement anticipating the restatement of its
financial results for the 1997 fiscal year was inaccurate,
and that the actual reduction in income would be twice as
much as previously announced. Cendant further
acknowledged that its investigation had uncovered several
accounting irregularities that had not previously been
disclosed, and that those accounting irregularities affected
additional Cendant business units and other fiscal years.
Cendant estimated that earnings would be reduced by as
much as $0.28 per share in 1997. After the July 14, 1998
disclosure, the price of ABI common stock dropped until
8
Cendant issued several public statements indicating that it
intended to continue the tender offer and that it was
"contractually committed" to completing the ABI merger.
Thereafter, the market price of ABI common stock was
"buoyed" by Cendant's repeated statements that it was
committed to completing the merger.
On August 13, 1998, Cendant issued a press release
announcing that its investigation into the accounting
irregularities was complete. The release stated that Cendant
would restate its earnings by $0.28 per share in 1997, by
$0.19 per share in 1996, and by $0.14 per share in 1995.
On August 27, 1998, Cendant issued a statement that the
board of directors had adopted the audit report. The audit
report was publicly filed with the SEC on August 28, 1998,
and a copy was forwarded to the United States Attorney for
the District of New Jersey. The report includedfindings that
"fraudulent financial reporting" and other"errors" inflated
Cendant's pretax income by approximately $500 million
from 1995 to 1997, and that Forbes and Shelton were
"among those who must bear responsibility." After the audit
report was filed with the SEC, the price of ABI common
stock closed at $53-1/2 per share on August 28, 1998 and
fell further to a closing price of $51-7/8 per share on
August 31, 1998, the first day of trading following the
disclosure.
On September 29, 1998, Cendant filed an amended Form
10-K for the 1997 fiscal year announcing that Cendant had
actually lost $217.2 million in 1997 rather than earning
$55.5 million, as previously reported. That announcement
caused the price of ABI common stock to drop further to
$43 per share by the close of trading. On October 13, 1998,
Cendant and ABI announced that they were terminating
the merger agreement, and that Cendant would pay ABI a
$400 million dollar break up fee, despite the fact that it was
not contractually bound to do so. The termination
agreement, which was executed the same day, provided
that the termination of the merger would not result in
liability on the part of Cendant or ABI, or on the part of any
of their directors, officers, employees, agents, legal and
financial advisors, or shareholders. In response to the
disclosure, the price of ABI common stock dropped to
$35-1/2 per share by the end of the day.
9
On October 14, 1998, the day after Cendant and ABI
disclosed the termination of the planned merger, the Class
filed a complaint in the United States District Court for the
District of New Jersey alleging that Cendant and the
individual defendants violated S 10(b) and Rule 10b-5 by
making fraudulent misrepresentations concerning
Cendant's financial condition, its willingness to complete
the tender offer, and its willingness to complete the
proposed merger. The complaint also alleged that the
individual defendants were liable for those violations as
control persons under S 20(a). The Class subsequently
amended its complaint to expand the class period and to
name Ernst & Young as an additional defendant in its
claims under S 10(b) and Rule 10(b)(5).2
The defendants filed a motion to dismiss the Class's
complaint pursuant to Rule 12(b)(6) and Rule 9(b) of the
Federal Rules of Civil Procedure. The district court granted
the motion and entered an order dismissing the complaint
under Rule 12(b)(6). In explaining its dismissal order, the
district court stated that the complaint failed to establish
that the alleged misrepresentations were made "in
connection with" the Class's purchases of ABI common
stock, that the Class reasonably relied on the purported
misrepresentations, and that the Class suffered a loss as
the proximate result of the purported misrepresentations.
The order also dismissed the Class's S 20(a) claim against
the individual defendants on the basis that a claim for
control person liability cannot be maintained in the
absence of an underlying violation of the Exchange Act. In
light of its decision to dismiss the complaint pursuant to
Rule 12(b)(6), the district court declined to consider
whether the Class's complaint also failed to satisfy the
heightened pleading requirements of Rule 9(b).
_________________________________________________________________
2. We note that the Class also alleged in its amended complaint that
Cendant and the individual defendants violated S 14(e) of the Williams
Act by making purported misrepresentations in connection with the
tender offer. See 15 U.S.C. S 78n(e). We do not discuss that claim,
however, because the Class has chosen to abandon it on appeal.
10
III
Before we address the merits of the Class's arguments,
we must first resolve an important question that concerns
our jurisdiction to hear this appeal pursuant to 28 U.S.C.
S 1291. In reviewing this matter, it came to our attention
that the district court did not indicate whether it intended
to dismiss all of the Class's claims with or without
prejudice. In fact, the order denying the Class's motion for
leave to amend suggests that the dismissal was without
prejudice inasmuch as it did not foreclose the Class from
submitting a second motion for leave to amend with a
proposed complaint attached. The order states:
Plaintiffs have requested leave to amend their
complaints if any or all of their claims are dismissed.
However, plaintiffs have not detailed the substance of
any amendment or presented to the Court a proposed
amended complaint. Although plaintiffs no longer have
the right to amend their complaints as a matter of
course after those complaints have been dismissed, the
Court may still permit amendment as a matter of
discretion. Kauffman v. Moss, 420 F.2d 1270, 1276 (3d
Cir.) cert. denied, 400 U.S. 846, 91 S. Ct. 93, 27 L.
Ed.2d 84 (1970). However, the Court will not consider
plaintiffs' requests until they submit the sought
amendment for the Court's review. The present
complaints lack legal vitality. Without scrutiny of the
proposed amendment, the Court cannot determine
whether it, the amendment, would be resuscitable or
futile. Plaintiffs' motion for leave to amend is denied.
This court has held that a dismissal without prejudice is
not a final and appealable order under S 1291, unless the
plaintiff can no longer amend the complaint or unless the
plaintiff declares an intention to stand on the complaint as
dismissed. See Nyhuis v. Reno, 204 F.3d 65, 68 n.2 (3d Cir.
2000); In re Westinghouse Sec. Litig., 90 F.3d 696, 705 (3d
Cir. 1996); Borelli v. City of Reading, 532 F.2d 950, 951-52
(3d Cir. 1976) (per curiam). The Class did not advise the
district court that it could no longer amend its pleadings, or
that it had elected to stand on the complaint. Instead, it
filed a notice of appeal with this court. In its opening brief,
the Class represented that "[t]his court has jurisdiction over
11
this appeal under 28 U.S.C. S 1291 because the district
court's opinion and order dismissed of all claims with
respect to all parties without leave to replead."
On March 1, 2000, this court ordered the parties to
submit further briefing on the question whether the district
court had entered a final, appealable order. In its
supplemental brief, the Class indicated that it intended to
stand on its complaint for the purposes of our review of
whether the dismissal was proper under Rule 12(b)(6), but
not for the purposes of our independent review of whether
the complaint complied with Rule 9(b). In effect, the Class
took the position that it could stand on its complaint to
satisfy the final judgment rule and, at the same time, avoid
a de novo review of whether the complaint pleads the
element of scienter with sufficient particularity.
Our own research indicates that the Class's position is
consistent with the law of this circuit. In Shapiro v. UJB
Financial Corp., 964 F.2d 272 (3d Cir. 1992), this court
recognized that a plaintiff may amend a complaint to
comply with the particularity requirements of Rule 9(b) even
after the plaintiff stands on the complaint to invoke the
court's appellate jurisdiction under 28 U.S.C. S 1291. In
that case, the district court dismissed all of the plaintiffs'
claims for securities fraud under Rule 12(b)(6) and,
alternatively, dismissed a number of the plaintiffs' claims
for failing to plead scienter with the particularity required
by Rule 9(b). The district court also granted the plaintiffs
leave to file an amended complaint to cure some of the
defects identified in its order. See id. at 277-78. Rather
than filing an amended complaint, however, the plaintiffs
formally announced that they would stand on their
complaint. See id. at 278. On review, this court concluded
that the district court incorrectly dismissed several of the
plaintiffs' claims pursuant to Rule 12(b)(6). See id. at 280-
284. Despite the fact that the plaintiffs had elected to stand
on their complaint as dismissed, this court declined to
affirm the dismissal under Rule 9(b). See id. at 285 & n.14.
Instead, it remanded the matter to the district court to
grant the plaintiffs leave to amend those claims which were
properly dismissed pursuant to Rule 9(b) and to evaluate
whether the remaining claims satisfied the rule's
heightened pleading requirements. See id.12
In this matter, the district court did not consider the
sufficiency of the allegations under Rule 9(b)."[B]ecause we
are hesitant to preclude the prosecution of a possibly
meritorious claim because of defects in the pleadings," the
Class should be "afforded an additional, albeitfinal
opportunity, to conform the pleadings" in the event that its
complaint fails to comply with Rule 9(b).3 In re Burlington
Coat Factory Sec. Litig., 114 F.3d at 1435 (quoting Ross v.
A.H. Robins Co., 607 F.2d 545, 547 (2d Cir. 1979)). We
leave it to the district court, however, to determine, in the
first instance, whether such an amendment is required. See
Shapiro, 964 F.2d at 285 n.14. We hold, consistent with the
law of this circuit, that we have jurisdiction to hear the
merits of this appeal pursuant to S 1291. See Shapiro, 964
F.2d at 278. Our review is limited to the question whether
the dismissal was proper under Rule 12(b)(6).
IV
Our review of a district court's decision to grant a motion
to dismiss is plenary. See Weiner v. Quaker Oats Co., 129
F.3d 310, 315 (3d Cir. 1997). "A motion to dismiss
pursuant to Rule 12(b)(6) may be granted only if, accepting
all well pleaded allegations in the complaint as true, and
viewing them in the light most favorable to [the] plaintiff,
[the] plaintiff is not entitled to relief. The issue is not
whether a plaintiff will ultimately prevail but whether the
claimant is entitled to offer evidence to support the claims."
In re Burlington Coat Factory Sec. Litig., 114 F.3d at 1420(quotations and citations omitted). In this case, we may
affirm only if it appears that the Class could prove no set
of facts that would entitle it to relief. See Weiner, 129 F.3d
at 315.
Section 10(b) prohibits the "use or employ, in connection
with the purchase or sale of any security, . . .[of] any
manipulative or deceptive device or contrivance in
contravention of such rules and regulations as the
Commission may prescribe." 15 U.S.C. S 78j(b). Rule 10b-5,
which was promulgated under S 10(b), makes it unlawful
_________________________________________________________________
3. We note that the Class is not free to add new factual allegations to
comply with Rule 12(b)(6). See Shapiro, 964 F.2d at 284.
13
for any person "[t]o make any untrue statement of a
material fact or to omit to state a material fact necessary to
make the statements made in the light of the
circumstances under which they were made, not
misleading. . . in connection with the purchase or sale of
any security." 17 C.F.R. S 240.10b-5(b). To state a valid
claim under Rule 10b-5, a plaintiff must show that the
defendant (1) made a misstatement or an omission of a
material fact (2) with scienter (3) in connection with the
purchase or the sale of a security (4) upon which the
plaintiff reasonably relied and (5) that the plaintiff 's
reliance was the proximate cause of his or her injury. See
Weiner, 129 F.3d at 315; In re Burlington Coat Factory Sec.
Litig., 114 F.3d at 1417.
In the present case, the defendants make numerous
arguments to support the dismissal of the Class's
complaint pursuant to Rule 12(b)(6). They contend that the
district court correctly concluded that the alleged
misrepresentations were not made "in connection with" the
purchase or the sale of a security. They also suggest that
the Class could not have reasonably relied on any of the
alleged misrepresentations, and that the alleged
misstatements were not the proximate cause of the Class's
loss. We address each argument, below, under a separate
heading.
A.
We must first decide whether the Class's complaint
pleads sufficient facts to satisfy the "in connection with"
requirement of S 10(b) and Rule 10b-5. The parties have
expressed much disagreement over the standard that this
court applies in determining whether an alleged
misrepresentation was made "in connection with" the
purchase or the sale of a security. The defendants, in
varying respects, contend that the alleged
misrepresentations must speak directly to the investment
value of the security that is bought or sold, and that they
must have been made with the specific purpose or objective
of influencing an investor's decision. In contrast, the Class
and the SEC, as amicus curiae, argue that the "in
connection with" requirement is satisfied whenever a
14
misrepresentation is made in a manner that is reasonably
calculated to influence the investment decisions of market
participants. Recognizing that "the ``in connection with'
phrase is not the least difficult aspect of the 10b-5 complex
to tie down," we take this opportunity to clarify the
standard that governs this matter. Chemical Bank v. Arthur
Anderson & Co., 726 F.2d 930, 942 (2d Cir. 1984) (noting
the difficulty in establishing a test for the"in connection
with" requirement) (quotations and citations omitted).
In Ketchum v. Green, 557 F.2d 1022 (1977), this court
considered the question whether certain misrepresentations
arising out of an internal contest for the control of a closely
held corporation were made "in connection with" the
subsequent forced redemption of the losing parties' stock.
There, a group of minority shareholders secretly conspired
to remove the two majority shareholders from their
respective positions as the chairman of the board of
directors and as the president of the corporation. See
Ketchum, 557 F.2d at 1023-24. By misrepresenting their
intentions concerning the election of corporate officers, the
minority shareholders were able to persuade the majority
shareholders to elect them to a majority of the seats on the
board of directors. See id. After gaining control of the board
of directors, the minority shareholders immediately voted to
remove the two majority shareholders from their
officerships. See id. To entrench themselves, they also
passed resolutions terminating the majority shareholders'
employment and authorizing the mandatory repurchase of
the majority shareholders' stock pursuant to a stock
retirement agreement. The majority shareholders brought
an action pursuant to S 10(b) and Rule 10b-5 to enjoin
their ouster from the corporation and to obtain damages.
See id. at 1024. On review, this court held that the majority
shareholders failed to establish that the complained of
misrepresentations were made "in connection with" the
purchase or the sale of a security. See id. at 1027-29. In
addition to noting that the case fell within an"internal
corporate mismanagement" exception to S 10(b) and Rule
10b-5, the court reasoned that the degree of proximity
between the claimed fraud and the securities transaction
was simply too attenuated for the case to fall within the
scope of the federal securities laws. See id. at 1028-29
15
This court again considered the contours of the"in
connection with" requirement in Angelastro v. Prudential-
Bache-Sec., Inc., 764 F.2d 939 (3d Cir. 1985), when it
addressed the question whether a brokerage firm could be
held liable under S 10(b) and Rule 10b-5 for making
misrepresentations concerning the terms of its margin
accounts. In that case, a class of investors sued a national
brokerage firm for misrepresenting both the specific interest
rates that it would charge in connection with a margin
purchase and the formula that it would apply in calculating
those rates. See Angelastro, 764 F.2d at 941. The district
court dismissed the investors' complaint on the basis that
the alleged misrepresentations were not made "in
connection with" the purchase or the sale of a security. See
id. This court reversed, holding that the investors could
pursue their claims under S 10(b) and Rule 10b-5. The
court reasoned that the requisite causal connection was
satisfied by the brokerage firm's fraudulent course of
dealing, notwithstanding the fact that the alleged
misrepresentations did not relate to the merits of a
security. See id. at 944-45. In holding in favor of the class,
the court specifically noted that "Rule 10b-5 also
encompasses misrepresentations beyond those implicating
the investment value of a particular security." Id.While the decisions in Ketchum and Angelastro are
illustrative of the point that the "in connection with"
language requires a causal connection between the claimed
fraud and the purchase or the sale of a security, and that
the misrepresentations need not refer to a particular
security, they are not helpful in applying the standard to
the facts of this case. This case does not present a claim
based on allegations of internal corporate misconduct
arising from a contest for the control of a closely held
corporation. See Ketchum, 557 F.2d at 1028. Nor does it
concern a fraudulent course of dealing by a brokerage firm.
See Angelastro, 764 F.2d at 944. Rather, it involves the
public dissemination of allegedly misleading information
into an efficient securities market. In light of the law of this
circuit that the scope of the "in connection with"
requirement must be determined on a case-by-case basis,
we are compelled to look elsewhere in deciding the standard
16
that governs this matter.4 See Ketchum, 557 F.2d at 1027;
Angelastro, 764 F.2d at 942-43, 945.
In resolving the issue before us, we are persuaded by
recent decisions in the Second Circuit and the Ninth Circuit
that have addressed the scope of the "in connection with"
requirement when the alleged fraud involves the public
dissemination of false and misleading information. See In re
Ames Dep't Stores Inc. Stock Litig., 991 F.2d 953, 956, 965-
66 (2d Cir. 1993) (involving the public dissemination of
false information in publicly filed offering documents, press
releases, and research reports); McGann v. Ernst & Young,
102 F.3d 390, 392-93 (9th Cir. 1996) (involving the public
dissemination of false information in a publiclyfiled annual
report). Those courts have generally adopted the standard
articulated in Securities & Exch. Comm'n v. Texas Gulf
Sulphur Co., 401 F.2d 833, 862 (2d Cir. 1968) (in banc),
and applied an objective analysis that considers the alleged
misrepresentation in the context in which it was made.5
They have held that, where the fraud alleged involves the
public dissemination of information in a medium upon
which an investor would presumably rely, the "in
connection with" element may be established by proof of
_________________________________________________________________
4. Despite the arguments of the defendants, we do not find the Second
Circuit's decision in Chemical Bank instructive in the present inquiry. In
that case, a corporation misrepresented its financial status to a
commercial lender when it pledged the securities of a subsidiary as
collateral for a loan. See Chemical Bank, 726 F.2d at 944-45. The court
held that the misrepresentations were "merely an incident in a
transaction not otherwise involving the purchase or sale of securities"
and dismissed the lender's action under S 10(b). Id. at 944 n.24. As this
court has previously pointed out, the "Second Circuit was concerned
that every bank loan partially secured by the pledge of stock might fall
within the scope of [S] 10(b)." Angelastro, 764 F.2d at 946. That concern
is not present here, where the alleged fraud involves the public
dissemination of allegedly false and misleading statements into an
efficient securities market.
5. Contrary to the suggestions of the individual defendants, this court
has adopted the standards articulated in Texas Gulf Sulphur Co. for
determining whether the statutory requirements ofS 10(b) and Rule 10b-
5 are satisfied. See Gottlieb v. Sandia American Corp., 452 F.2d 510,
515-16 (3d Cir. 1971) (adopting the Texas Gulf Sulphur Co. test as the
statutory test for actions arising under S 10(b)).
17
the materiality of the misrepresentation and the means of
its dissemination. See In re Ames Dep't Stores Inc. Stock
Litig., 991 F.2d at 963, 965; Securities & Exch. Comm'n v.
Rana Research, Inc., 8 F.3d 1358, 1362 (9th Cir. 1993); In
re Leslie Fay Cos. Sec. Litig., 871 F. Supp. 686, 697
(S.D.N.Y. 1995). Under that standard, it is irrelevant that
the misrepresentations were not made for the purpose or
the object of influencing the investment decisions of market
participants. See In re Ames Dep't Stores Inc. Stock Litig.,
991 F.2d at 965 (holding that an investor's reliance need
not be envisioned to give rise to liability underS 10(b) and
Rule 10b-5).
We conclude that the materiality and public
dissemination approach should apply in this case. The
purpose underlying S 10(b) and Rule 10b-5 is to ensure that
investors obtain fair and full disclosure of material facts in
connection with their decisions to purchase or sell
securities. See Angelastro, 764 F.2d at 942. That purpose is
best satisfied by a rule that recognizes the realistic causal
effect that material misrepresentations, which raise the
public's interest in particular securities, tend to have on the
investment decisions of market participants who trade in
those securities. See In re Ames Dep't Stores Inc. Stock
Litig., 991 F.2d at 966. We therefore adopt the reasoning of
the Second Circuit and the Ninth Circuit and hold that the
Class may establish the "in connection with" element
simply by showing that the misrepresentations in question
were material, and that they were disseminated to the
public in a medium upon which a reasonable investor
would rely. We also point out that, under the standard
which we adopt, the Class is not required to establish that
the defendants actually envisioned that members of the
Class would rely upon the alleged misrepresentations when
making their investment decisions. See In re Ames Dep't
Stores Inc. Stock Litig., 991 F.2d at 965; In re Leslie Fay
Cos. Sec. Litig., 871 F. Supp. at 697-98. Rather, it must
only show that the alleged misrepresentations were
reckless. See In re Advanta Corp. Sec. Litig. , 180 F.3d 525,
535 (3d Cir. 1999) (reaffirming that S 10(b) and Rule 10b-5
cover reckless misrepresentations).
We also emphasize that it is no defense that the alleged
misrepresentations were made in the context of a tender
18
offer and a proposed merger, or that they did not
specifically refer to the investment value of the security that
was bought or sold. It is well established that information
concerning a tender offer or a proposed merger may be
material to persons who trade in the securities of the target
company, despite the highly contingent nature of both
types of transactions. See Basic Inc. v. Levinson, 485 U.S.
224, 238-39 (1988) (holding that preliminary merger
discussions may be material even before an agreement-in-
principle is reached); Securities & Exch. Comm'n v. Materia,
745 F.2d 197, 199 (2d Cir. 1984) (stating that "even a hint
of an upcoming tender offer may send the price of the
target company's stock soaring"); Securities & Exch.
Comm'n v. Maio, 51 F.3d 623, 637 (7th Cir. 1995) (holding
that undisclosed information concerning a tender offer was
sufficiently material to give rise to liability for insider
trading under Rule 10b-5 and Rule 14e-3); Securities &
Exch. Comm'n v. Mayhew, 916 F. Supp. 123, 131 (D. Conn.
1995) (holding that undisclosed information concerning a
pending merger was sufficiently material to give rise to
liability for insider trading under S 10(b)). It is also settled
that S 10(b) and Rule 10b-5 encompass misrepresentations
beyond those concerning the investment value of a
particular security. See Angelastro, 764 F.2d at 942-44(holding that a brokerage firm may be liable for
misrepresenting the terms of a margin account); cf.
Deutschman v. Beneficial Corp., 841 F.2d 502, 508 (3d Cir.
1988) (holding that the purchaser of an option contract
has standing to seek damages under S 10(b) for
misrepresentations concerning the underlying securities).
So long as the alleged misrepresentation were material, the
"in connection with" requirement may be satisfied simply by
showing that they were publicly disseminated in a medium
upon which investors tend to rely.
We do not resolve, however, whether the "in connection
with" is satisfied in the present case. Because the standard
that we have set forth is different from the one applied by
the district court, and because the parties have not been
afforded a full opportunity to brief the issues of materiality
and public dissemination, we will remand this matter to
allow the district court to consider, in the first instance, the
question whether the Class's complaint pleads sufficient
19
facts to satisfy the requirements of Rule 12(b)(6). 6 We note,
however, that the issue of materiality typically presents a
mixed question of law and fact, and that the delicate
assessment of inferences is generally best left to the trier of
fact. See Shapiro, 964 F.2d at 281 n.11. The district court
should decide the issue of materiality as a matter of law
only if the alleged misrepresentations are so clearly and
obviously unimportant that reasonable minds could not
differ in their answers to the question. See Weiner, 129
F.3d at 317; In re Craftmatic Sec. Litig., 890 F.2d 628, 641
(3d Cir. 1990).
B.
We next turn to the question whether the Class's
complaint alleges sufficient facts to establish the element of
reliance. It is axiomatic that a private action for securities
fraud must be dismissed when a plaintiff fails to plead that
he or she reasonably and justifiably relied on an alleged
misrepresentation. See Weiner, 129 F.3d at 315 (setting
forth reliance as an element of a private right of action
under S 10(b) and Rule 10-5); In re Burlington Coat Factory
Sec. Litig., 114 F.3d at 1417 (same). The defendants claim
that the complaint fails to establish the element of reliance,
because it alleges that the defendants' misrepresentations
were made in the context of a tender offer and a proposed
merger, that AIG made a competing tender offer to
purchase shares of ABI common stock at $58 per share,
and that Cendant issued a press release on April 15, 1998
_________________________________________________________________
6. The parties' briefs consider whether it was reasonable for the Class to
rely on some of the defendants' statements. On remand, the parties are
bound by our holding with respect to those statements inasmuch as it
addresses the issue of materiality. See In re Trump Casino Sec. Litig., 7
F.3d 357, 371 (3d Cir. 1993) (applying the bespeaks caution doctrine in
the context of materiality). They are otherwise free to renew their
motions and make any other arguments concerning the question of
materiality as they see fit. See In re Phillips Petroleum Sec. Litig., 881
F.2d 1236, 1248 n.16 (3d Cir. 1989). We note that, in the context of an
efficient market, "the concept of materiality translates into information
that alters the price of the firm's stock." In re Burlington Coat Factory
Sec. Litig., 114 F.3d at 1425.
20
warning investors not to rely on its prior representations
concerning its financial condition.
Traditionally, purchasers and sellers of securities were
required to establish that they were aware of, and directly
misled by, an alleged misrepresentation to state a claim for
securities fraud under S 10(b) and Rule 10b-5. See Peil v.
Speiser, 806 F.2d 1154, 1160 (3d Cir. 1986) (discussing
theories of reliance). Recognizing that the requirement of
showing direct reliance presents an unreasonable
evidentiary burden in a securities market where face-to-face
transactions are rare and where lawsuits are brought by
classes of investors, however, this court has adopted a rule
that creates a presumption of reliance in certain cases. See
id. Under the fraud on the market theory, a plaintiff in a
securities action is generally entitled to a rebuttable
presumption of reliance if he or she purchased or sold
securities in an efficient market. See In re Burlington Coat
Factory Sec. Litig., 114 F.3d at 1419 n.8 (holding that a
purchaser of securities in an open and developed market is
entitled to a presumption of reliance).
The fraud on the market theory of reliance is, in essence,
a theory of indirect actual reliance under which a plaintiff
is entitled to three separate presumptions in attempting to
establish the element of direct reliance. See Zlotnick v. Tie
Communications, 836 F.2d 818, 822 (3d Cir. 1988). Under
the fraud on the market theory of reliance, the court
presumes (1) that the market price of the security actually
incorporated the alleged misrepresentations, (2) that the
plaintiff actually relied on the market price of the security
as an indicator of its value, and (3) that the plaintiff acted
reasonably in relying on the market price of the security.
See id. The fraud on the market theory of reliance, however,
creates only a presumption, which a defendant may rebut
by raising any defense to actual reliance. See Basic, Inc.,
485 U.S. at 248-49. This court has pointed out that
the presumption of reliance may be rebutted by showing
that the market did not respond to the alleged
misrepresentations, or that the plaintiff did not actually
rely on the market price when making his or her
investment decision.7 See Zlotnik, 836 F.2d at 822; Peil, 806
_________________________________________________________________
7. To rebut the presumption of reliance, a defendant may show that the
misrepresentations were immaterial, that the market was aware that the
21
F.2d at 1161. This court has also held that a defendant
may defeat the presumption of reliance by showing that the
plaintiff 's reliance on the market price was actually
unreasonable.8 See Zlotnik , 836 F.2d at 822; Peil, 806 F.2d
at 1161.
In the present case, we are persuaded that the Class has
sufficiently pleaded the element of reliance to withstand a
challenge under Rule 12(b)(6) with respect to at least some
of the alleged misrepresentations. The complaint alleges
that ABI common stock traded in an open and developed
market throughout the class period, that the market price
of ABI common stock incorporated the alleged
misrepresentations,9 and that the Class members
_________________________________________________________________
misrepresentations were false, or that the misrepresentations were
otherwise not assimilated into the price of the security. Of course, the
defendant may also rebut the presumption by showing that the investor
would have purchased or sold the securities at that price even with full
knowledge of the misrepresentation, that the investor traded in the
securities based on an actual belief that the market price was
inaccurate, or that the investor's decision to trade was based on some
factor other than the market price. See Basic, Inc., 485 U.S. at 248;
Zlotnik, 836 F.2d at 822; Peil, 806 F.2d at 1161.
8. To establish that an investor's reliance was unreasonable, a defendant
may show that the investor knew, or had reason to know, that the
misrepresentations were in fact false. See Zlotnik, 836 F.2d at 822; Peil,
806 F.2d at 1161.
9. The market assimilates information concerning the possibility of a
tender offer or a merger, and the amount of consideration that will be
received, into the price of the securities of a target corporation. See
Frank L. Easterbrook & Daniel R. Fischel, The Proper Role of a Target's
Management in Responding to a Tender Offer, 94 Harv. L. Rev. 1161,
1164 (1981) (stating that "[t]he value of any stock can be understood as
the sum of two components: the price that will prevail in the market if
there is no successful offer (multiplied by the likelihood that there will
be
none) and the price that will be paid in a future tender offer (multiplied
by the likelihood that some offer will succeed)"). In this case, the
defendants' misrepresentations were incorporated into the price of ABI
common stock inasmuch as they spoke to the likelihood that the tender
offer and the proposed merger would be successful, or to the extent that
they related to the investment value of the Cendant shares that members
of the Class were to receive in consideration for tendering their shares
of
ABI common stock.
22
purchased shares of ABI common stock in reliance on that
price. The complaint also states that the Class was directly
misled by the alleged misrepresentations. Those allegations,
if true, are sufficient to establish direct reliance and to
create a presumption of indirect actual reliance so long as
the Class's reliance on the purported misrepresentations or
the market price of ABI common stock was not
unreasonable as a matter of law.
We conclude that it was reasonable for the Class
members who purchased shares prior to March 3, 1998 to
rely on the alleged misrepresentations occurring prior to
that date. The defendants have not provided us with a
legitimate reason for us to conclude to the contrary. Their
arguments concern only the reasonableness of the reliance
of the Class members who purchased shares of ABI
common stock after March 3, 1998. They have no bearing
on the investment decisions of persons who purchased
shares of ABI common stock prior to that date, because the
reasonableness of reliance is determined at the time of the
transaction in question. See Hayes v. Gross, 982 F.2d 104,
107 (3d Cir. 1992) (requiring an investor to rely on an
alleged misrepresentation at the time of the purchase or the
sale of securities); Zlotnik, 836 F.2d at 823 (same); Gannon
v. Continental Ins. Co., 920 F. Supp. 566, 578 (D.N.J. 1996)
(holding that an investor cannot rely on statements that are
made subsequent to the purchase of securities).
To the extent that the defendant's arguments suggest
that it is unreasonable as a matter of law to rely on
information concerning a tender offer or a merger before the
transaction is finalized, we disagree. The Supreme Court
has cautioned that "[n]o particular event or factor short of
closing the transaction need be either necessary or
sufficient by itself to render merger discussions material."
Basic, Inc., 485 U.S. at 239. And, other courts have
similarly held that information concerning a tender offer
may be material while the transaction is still in the
planning stage. Maio, 51 F.3d at 637; Mayhew, 916 F.
Supp. at 131. If it may be reasonable for an investor to find
information concerning a tentative tender offer or a merger
important when making an investment decision, we see no
reason why the conditional nature of those transactions
23
should necessarily prevent the investor from reasonably
relying on that information as well. See 2 Thomas Lee
Hazen, The Law of Securities RegulationS 13.5B, at 527 (3d
ed. 1995) (stating that "[t]he reliance requirement is a
corollary of materiality").
We are also persuaded that the Class members who
purchased shares of ABI common stock between March 3,
1998 and April 15, 1998 alleged sufficient facts to satisfy
the element of reliance. With respect to those purchasers,
the defendants maintain that AIG's $58 tender offer
provided an independent valuation of ABI common stock
upon which the Class members directly or indirectly relied.
In effect, the defendants suggest that the market did not
incorporate the alleged misrepresentations into the price of
ABI common stock during the competing tender offer, and
that the Class members would have purchased shares of
ABI common stock to tender to AIG even if they had known
the truth about Cendant. See Basic, Inc., 485 U.S. at 249(noting that the presumption of indirect actual reliance may
be rebutted by showing that the plaintiff would have
completed the transaction regardless of the alleged
misrepresentations); Zlotnik, 836 F.2d at 822 (stating that
the presumption of indirect actual reliance may be rebutted
by showing that the market price was not affected by the
alleged misrepresentations). While those arguments are
facially appealing, we do not find them persuasive given the
procedural posture of this case.
In reviewing a motion to dismiss under Rule 12(b)(6), we
must accept the allegations of the complaint as true and
draw all reasonable inferences in the light most favorable to
the plaintiffs. See Wiener, 129 F.3d at 315. In this case, the
Class's complaint alleges that the market price of ABI
common stock was inflated due to the alleged
misrepresentations, and it states that the Class purchased
"ABI shares believing they would receive $58 per share . . .
in a combination of cash and Cendant stock." Though we
agree with the defendants that the market price of ABI
common stock incorporated information concerning AIG's
$58 tender offer, we may not assume for the present
purposes that it did not also incorporate information
concerning a potential acquisition by Cendant, or that
24
Cendant's tender offer did not have an actual effect on the
Class. Indeed, it is likely that the shares of ABI common
stock traded at a relative premium during the competing
tender offer based on the fact that two purportedly willing
and able suitors sought to acquire the company. It is also
possible that members of the Class would not have
purchased shares of ABI common stock had they been
unable to exchange them for shares of Cendant. Because
we must assume the truth of the allegations of the
complaint, and resolve all competing allegations and
inferences in favor of the Class, we agree that the existence
of a competing tender offer did not effect the Class's
reliance on the defendants' alleged misrepresentations. See
In re Burlington Coat Factory Sec. Litig., 114 F.3d at 1420(stating that a court must credit the allegations of the
complaint and not the defendant's responses when
resolving conflicting allegations on a motion to dismiss). We
also note that the effect of the $58 tender offer would have
been limited to those members of the Class who purchased
shares from March 3, 1998, when the tender offer was
made, and March 17, 1998, when Cendant raised its bid
price to $67 per share.
We agree that the Class has failed to demonstrate that it
was reasonable for its members to rely on the defendants'
prior financial statements and auditors' reports following
the April 15, 1998 disclosure of the accounting
irregularities. The complaint states that Cendant disclosed
on April 15, 1998 that it had uncovered accounting
irregularities, and that it warned investors not to rely on its
prior financial statements and auditor's reports when
making an investment decision.10 The complaint further
alleges that the common stock of both Cendant and ABI
traded in an efficient market, and that the market price of
each stock instantly dropped after Cendant issued the
_________________________________________________________________
10. The April 15, 1998 announcement, which wasfiled as an exhibit to
an amendment to Cendant's Schedule 14D-1, warned:
In accordance with SAS No. 1, the Company's previously issued
financial statements and auditors' reports should not be relied
upon. Revised financial statements and auditors' reports will be
issued upon completion of the investigations.
25
warning.11 In light of the curative nature of the warning
statement, and given the instantaneous decline in the
market price of both companies' common stock, we
conclude that the announcement immediately rendered the
prior misrepresentations concerning Cendant's financial
condition thereafter immaterial as a matter of law. See
Weiner, 129 F.3d at 321 (holding that a public statement
curing the misleading effect of a prior misrepresentation
renders the prior misrepresentation immaterial); In re
Burlington Coat Factory Sec. Litig., 114 F.3d at 1425(stating that an efficient market immediately incorporates
information into the price of a security); Teamsters Local
282 Pension Trust Fund v. Angelos, 762 F.2d 522, 530 (7th
Cir. 1985) (dicta) (stating that an investor may not ask a
court to focus on a misrepresentation and ignore
information that has already been disseminated). Thus,
neither the market nor the Class members could have
reasonably relied upon Cendant's prior financial statements
or its audit reports after April 15, 1998. Because it made
no misrepresentations after the curative statement was
issued, Ernst & Young may not be held liable to members
of the Class who purchased shares of ABI common stock
after April 15, 1998.
Nevertheless, we do not accept the defendants' contention
that the Class could not have reasonably relied on the
alleged misrepresentations that were included in the April
15, 1998 announcement. The Class claims that the April
15, 1998 announcement misrepresented Cendant's
financial condition by stating that the company expected to
restate its 1997 earnings by $0.11 to $0.13 per share and
to reduce its net income prior to restructuring and unusual
charges by approximately $100 to $115 million. The
defendants claim that the Class was not entitled to rely on
those statements or on any subsequent statements,
because the announcement warned that the
representations were subject to "known and unknown risks
_________________________________________________________________
11. The complaint states that the market price of ABI common stock
dropped eleven percent, from $64-7/8 to $57-3/4, following the
disclosure of the accounting irregularities, and that the market price of
Cendant common stock plummeted forty-six percent, from $35-10/16 to
$19-1/16, following the disclosure.
26
and uncertainties including, but not limited to, the outcome
of the Audit Committee's investigation."12 Their argument is
based upon both the bespeaks caution doctrine, which
renders alleged misrepresentations immaterial, and the
common sense principle that investors do not act
reasonably in relying on statements that are accompanied
by meaningful cautionary language.
The parties disagree as to whether the bespeaks caution
doctrine applies to the statements made in the April 15,
1998 announcement that predicted the amount by which
Cendant would restate its results for the 1997 year. The
Class and the SEC maintain that the "bespeaks caution"
doctrine is inapplicable, because the statements related to
present and historical facts that were capable of verification
and, as such, not forward-looking. See Grossman v. Novell,
Inc., 120 F.3d 1112, 1123 (10th Cir. 1997) (holding that the
bespeaks caution doctrine applies only to forward-looking
information). The defendants, in contrast, characterize the
statements concerning the restatement as forward-looking,
and thus subject to the bespeaks caution doctrine, because
Cendant had not completed a reaudit when it disclosed the
amount of the anticipated restatement. See Harris v. Ivax
Corp., 182 F.3d 799, 802-3 (11th Cir. 1999) (holding that
statements made on the last day of a quarter concerning
the results for the quarter are forward-looking).
We need not decide whether the alleged
misrepresentations in the April 15, 1998 announcement
were forward-looking statements, however, because we
conclude that the accompanying warnings were not
sufficiently cautionary to warn against the danger of relying
_________________________________________________________________
12. We note that the Private Securities Litigation Reform Act's safeharbor
for forward-looking statements does not apply in this case. See 15 U.S.C.
S 78u-5(i)(A)-(B). The alleged misrepresentations were made in
conjunction with a tender offer and were attached as exhibits to
Cendant's Schedule 14D-1 and the amendments thereto. The safeharbor
expressly states that it is inapplicable to statements made in connection
with a tender offer, except "to the extent otherwise specifically provided
by rule, regulation, or order of the [SEC]." Id. Because the SEC has yet
to extend the safeharbor to tender offers by rule, regulation, or order,
we
do not discuss the defendants' contentions that their statements were
also protected under the safeharbor.
27
on the specific numbers identified in the announcement. In
In re Trump Casino Sec. Litig., 7 F.3d 357, 369 (3d Cir.
1993), this court instructed that cautionary language must
be "extensive yet specific" to prevent a reasonable investor
from relying on specific projections. There, the court
explained:
a vague or blanket (boilerplate) disclaimer which
merely warns the reader that the investment has risks
will ordinarily be inadequate to prevent misinformation.
To suffice, the cautionary statements must be
substantive and tailored to the specific future
projections, estimates or opinions in the prospectus
which the plaintiffs challenge.
Id. at 371-72. In Kline v. First Western Gov't Sec., Inc., 24
F.3d 480, 489 (3d Cir. 1994), this court clarified that
"Trump requires that the language bespeaking caution
relate directly to that by which plaintiffs claim to have been
misled."
In the present case, the cautionary language set forth in
the April 15, 1998 announcement generally pertains only to
the risk that the results of operations could vary in future
fiscal years.13 In fact, the only risk factor that is apparently
_________________________________________________________________
13. The cautionary language states, in relevant part:
Certain matters discussed in the news release are forward-looking
statements, as defined in the Private Securities Litigation Reform
Act
of 1995. Such forward-looking statements are subject to a number
of known and unknown risks and uncertainties including, but not
limited to, the outcome of the Audit Committee's investigation;
uncertainty as to the Company's future profitability; the Company's
ability to develop and implement operational andfinancial systems
to
manage rapidly growing operations; competition in the Company's
existing and potential future lines of businesses ; the Company's
ability to integrate and operate successfully acquired businesses
and
the risks associated with such businesses; the Company's growth
strategy and for the Company to operate within the limitations
imposed by financing arrangements; uncertainty as to the future
profitability of acquired businesses; and other factors. Other
factors
and assumptions not identified above were also involved in the
derivation of these forward-looking statements, and the failure of
such other assumptions to be realized as well as other factors may
also cause actual results to differ materially from those
projected.
(emphasis added).
28
applicable to the restatement of Cendant's results for the
1997 fiscal year relates to the risk that the announcement's
calculations might differ from those made by the Audit
Committee. We are not persuaded that such a general
statement of risk is sufficiently substantive and tailored to
satisfy the requirements of the bespeaks caution doctrine.
See In re Trump Casino Sec. Litig., 7 F.3d at 371-72. Nor
are we persuaded that it is adequate to give investors
reasonable notice that the projected restatement of
Cendant's financial statements should not be trusted so as
to make any reliance unreasonable as a matter of law. In
our opinion, a reasonable investor may be willing to rely on
the announcement's specific calculations concerning the
restatement in the absence of a more detailed explanation
of the reasons that the calculations might be incorrect and
of the effect of any error. The announcement's blanket
warning--that the amount of the restatement could later
turn out to be wrong--was simply not sufficient to caution
reasonable investors against relying on the defendants'
representations. See Kline, 24 F.3d at 489-90 (holding that
cautionary statements in an opinion letter were not
sufficiently cautionary to preclude reliance where they
suggested nothing more than the possibility that the
speaker "might have gotten the law wrong or incorrectly
assessed the risk that the IRS would deny deductions");
see, e.g., Harris, 182 F.3d at 810, 813-14 (setting forth
meaningful and specific cautionary language as an
appendix to the opinion). Because we conclude that the
alleged misrepresentations concerning the restatement of
Cendant's 1997 financial information did not include
sufficient cautionary language, we agree that the Class
could reasonably rely on the anticipated restatement in the
April 15, 1998 announcement. For the same reason, we
conclude that the Class members were not necessarily
prevented from reasonably relying on the defendants'
subsequent statements concerning Cendant's intent to
merge with ABI.
The Class was not entitled, however, to rely indefinitely
upon the April 15, 1998 misrepresentations. Cendant
announced on July 14, 1998 that it had revised the
restatement of its 1997 income, and it disseminated the
formal results of the Audit Committee's investigation one
29
month later. We think that it is possible that either, if not
both, of those announcements might have cured the effect
of the alleged misrepresentations in the April 15, 1998
announcement and rendered the disclosure thereafter
unreliable. However, in light of our decision to remand this
case, and given that the parties have not discussed the
issue, we leave it for the district court to decide in the first
instance the point at which the particular
misrepresentations could no longer be trusted.
C.
Finally, we must decide whether the Class's complaint
adequately pleads the element of loss causation. The
defendants contend that the complaint failed to allege
sufficient facts to support an inference that the alleged
misrepresentations were the proximate cause of the Class's
loss. They maintain that the complaint shows that several
intervening events, and not the alleged misrepresentations,
led first to the artificial inflation and then to the decline in
the market price of ABI common stock. In particular, they
assert that the price of ABI common stock was inflated by
AIG's $58 tender offer and by the approval of the merger
agreement by the board of directors of ABI. They also
suggest that the Class's loss was actually caused by the
mutual termination of the merger agreement by the board
of directors of both ABI and Cendant. We disagree.
In Scattergood v. Perelman, 945 F.2d 618, 624 (3d Cir.
1991), this court held that a plaintiff may establish the
element of loss causation simply by showing that he or she
purchased a security at a market price that was artificially
inflated due to a fraudulent misrepresentation. Id. In that
case, the defendants issued a press release stating that
they were considering acquiring the outstanding shares of
another company at the prevailing market price. See id. at
623. The press release also warned that the defendants had
"not yet determined to proceed with such transaction," and
it cautioned that there could "be no assurance that [the
defendants] will ultimately decide to make such an offer or
that the [board of directors of the target corporation] would
recommend such an offer to the stockholders." Id. Some of
the plaintiffs purchased shares of the target company's
30
stock at price below the tender offer price expecting that
the stock would be acquired at the tender offer price in the
near future. See id. at 624. The defendants moved to
dismiss the complaint pursuant to Rule 12(b)(6), because
the complaint lacked an assertion that "the plaintiffs
experienced an economic loss as a proximate result of the
alleged Rule 10b-5 violation." Id. The district court granted
the motion to dismiss, and this court reversed. This court
held that "the fair inference of the complaint, if one
assumes--as we must--the truth of its allegations, is that
the market price paid by the plaintiffs exceeded the value of
the stock at the time of purchase based on the facts." Id. It
reasoned that the dismissal was improper, because the
complaint suggested that the price paid exceeded the value
that the market would have established for the target
company's shares had the truth been known. See id. The
court expressed no opinion concerning the proper method
for measuring the plaintiff 's injury. See id. at 624 n.2.
This court reached a similar conclusion in Hayes v.
Gross, 982 F.2d 104, 107 (3d Cir. 1992). There, an investor
filed a class action lawsuit against the directors and officers
of a savings and loan association pursuant to S 10(b) and
Rule 10b-5 claiming that the class members were injured
when they purchased the association's stock at an inflated
price. See id. at 105. At the urging of the directors, the
officers, and the Resolution Trust Company, the district
court dismissed the action for failure to state a claim. See
id. at 105. This court reversed the dismissal and remanded
the matter for further proceedings. It concluded that the
class had established the element of reliance, and it
expressly found "no merit" in the Resolution Trust
Company's contention that the complaint failed to allege
the element of loss causation. See id. at 107 & n.2. In
holding that the complaint stated a claim underS 10(b) and
Rule 10b-5, the court explained:
Plaintiff alleges that defendants knowingly or recklessly
made material misrepresentations which inflated the
market price for Bell stock, and that he relied on the
market price as reflecting Bell's true value. As a result,
plaintiff claims to have suffered injury as a stock
purchaser.
31
Id. at 107.
We interpret Scattergood and Hayes as holding that,
where the claimed loss involves the purchase of a security
at a price that is inflated due to an alleged
misrepresentation, there is a sufficient causal nexus
between the loss and the alleged misrepresentation to
satisfy the loss causation requirement. Cf. Sowell v. Butcher
& Singer, Inc., 926 F.2d 289, 297 (3d Cir. 1991) (stating
that the difference between the purchase price and the
"true value" of the security at the time of the purchase is
the "proper measure of damages to reflect the loss
proximately caused by the defendants' deceit") (quoting
Huddleston v. Herman & MacClean, 640 F.2d 534, 555 (5th
Cir. 1981) modified on other grounds, 459 U.S. 375 (1983)).
We note, however, that those decisions assume that the
artificial inflation was actually "lost" due to the alleged
fraud. Where the value of the security does not actually
decline as a result of a misrepresentation, it cannot be said
that there is in fact an economic loss attributable to that
alleged misrepresentation. In the absence of a correction in
the market price, the cost of the alleged misrepresentation
is still incorporated into the value of the security and may
be recovered at any time simply by reselling the security at
the inflated price. See Green v. Occidental Petroleum Corp.,
541 F.2d 1335, 1345 (9th Cir. 1976) (Sneed, J., concurring)
(stating that an investor's proximate losses are limited to
those amounts that are attributable to the unrecovered
inflation in the purchase price). Because a plaintiff in an
action under S 10(b) and Rule 10b-5 must prove that he or
she suffered an actual economic loss, we are persuaded
that an investor must also establish that the alleged
misrepresentations proximately caused the decline in the
security's value to satisfy the element of loss causation.
We find the Eleventh Circuit's decision in Robbins v.
Koger Properties, Inc., 116 F.3d 1441, 1448 (11th Cir.
1997), instructive of this point. In that case, a group of
investors filed a class action lawsuit against Kroger
Properties, Inc. ("KPI"), its officers, and its independent
accountant pursuant to S 10(b) and Rule 10b-5 when the
price of KPI stock dropped following a dividend cut. See id.
at 1445. Only the suit against the independent accountant
32
proceeded to trial. See id. At trial, the investors presented
evidence that the independent accounting firm made
fraudulent statements which inflated the price at which
they purchased KPI stock. See id. at 1445-46. It was also
shown, however, that the dividend cut and the drop in the
price of KPI stock occurred more than one year before the
fraud was uncovered, and that the board of directors cut
the dividend for reasons unrelated to the alleged fraud. See
id. at 1445, 1448. The independent accountant moved for
judgment as a matter of law, contending that the investors
had failed to prove the essential element of loss causation.
See id. at 1446. The district court denied the accountant's
motion, and the Eleventh Circuit reversed. See id. at 1446,
1449. The Eleventh Circuit held that the investors had
failed to satisfy the loss causation requirement, because
they did not present evidence that the artificial inflation
was removed from the market price of KPI stock, thereby
causing a loss. See id. at 1446. In entering judgment in
favor of the accountant, the court noted that the
misrepresentations were not discovered until more than one
year after the drop in the stock price, and that the investors
had not presented any evidence that the cut in dividends,
which led to the drop in price, was related to the alleged
misrepresentations. See id. at 1446-47.
Turning to the complaint at issue in this case, we are
persuaded that the Class has alleged sufficient facts to
show that the alleged misrepresentations proximately
caused the claimed loss. The Class contends that it
purchased shares of ABI common stock at a price that was
inflated due to the alleged misrepresentations, and that it
suffered a loss when the truth was made known and the
price of ABI common stock returned to its true value. The
complaint states, in relevant part:
94. As a result of the Cendant Defendants'
fraudulent conduct as alleged herein, the prices at
which ABI securities traded were artificially inflated
throughout the Class Period. When plaintiff and the
other members of the Class purchased their ABI
securities, the true value of such securities was
substantially lower than the prices paid by plaintiff and
the other members of the Class. The market price of
33
ABI common stock declined sharply from its March 23,
1998, $64-7/16 per share closing price, to its
September 29, 1998, $43 per share closing price. By
October 13, 1998, ABI's closing price dropped to
$35-1/2. In ignorance of the materially false and
misleading nature of the statements and documents
complained of herein, as well as of the adverse,
undisclosed information known to defendants, plaintiff
and the other members of the Class relied, to their
detriment on such statements and documents, and/or
on the integrity of the market, in purchasing their ABI
common stock at artificially inflated prices during the
Class Period. Had plaintiff and the other members of
the Class known the truth, they would not have taken
such action.
95. At all relevant times, the misrepresentations
and omissions particularized in this Amended
Complaint directly or proximately caused, or were a
substantial contributing cause of, the damages
sustained by plaintiff and the other members of the
Class. The misstatements and omissions complained of
herein had the effect of creating in the market an
unrealistically positive assessment of Cendant, as well
as of its financial condition, causing ABI's common
stock to be overvalued and artificially inflated at all
relevant times. Defendants' false portrayal, during the
Class Period, of the Company's operations and
prospects, as well as of Cendant's financial condition,
resulted in purchases of ABI securities by plaintiff and
by the other members of the Class at artificially
inflated prices measured by the difference between the
market prices and the actual value of such securities
at the time of purchase, thus causing the damages
complained of herein.
* * *
97. As a direct and proximate result of defendants'
aforesaid wrongful conduct during the Class Period,
plaintiff and other members of the Class have suffered
substantial damages in connection with their
purchases of ABI common stock.
34
The complaint further indicates that the price of ABI
common stock was "buoyed" by the defendants alleged
misrepresentations, and that it dropped in response to
disclosure of the alleged misrepresentations and the
termination of the merger agreement. Assuming the truth of
those allegations, and taking all reasonable inferences in
the light most favorable to the Class, we agree that the
Class is entitled to offer evidence to support its claim.
Notwithstanding the allegations of the complaint,
however, the defendants maintain that the price of ABI
common stock was inflated, not by the alleged
misrepresentations, but rather by AIG's $58 tender offer
and by the approval of the merger agreement by the board
of directors of ABI. We do not agree. The Class period
covers persons who purchased shares of ABI common stock
prior to both events. For those purchasers, neither the
competing tender offer nor the board approval of the merger
agreement could have provided an independent valuation
that would have inflated the price of ABI common stock.
Nor can we say, for the Class members who purchased
shares of ABI common stock after that time, that the
announcement of AIG's $58 bid and the approval of the
merger agreement were sufficient to destroy the causal
connection between the alleged misrepresentations and the
artificial inflation in the price of ABI common stock. It is
well established that not every intervening event is
sufficient to break the chain of causation. See Rankow v.
First Chicago Corp., 870 F.2d 356, 367 (7th Cir. 1989)
(stating that to allow any intervening change in market
conditions not directly caused by the defendant to break
the chain of causation and exempt the defendant from
liability would eviscerate Rule 10b-5); W. Page Keeton et al.,
Prosser & Keeton on the Law of Torts S 44 (5th ed. 1984)
(explaining that proximate causation is not destroyed by
every intervening event). So long as the alleged
misrepresentations were a substantial cause of the inflation
in the price of a security and in its subsequent decline in
value, other contributing forces will not bar recovery. See
Robbins, 116 F.3d at 1447 n.5. While we are mindful that
the defendants may disprove that the Class suffered a loss
as a result of the alleged misrepresentations by showing
35
that the misrepresentations were not a substantial factor in
setting the price of ABI common stock during the Class
period, we disagree that the defendants may do so at this
stage of the proceedings. See In re Burlington Coat Factory
Sec. Litig., 114 F.3d at 1420 (setting forth the standard for
reviewing a motion to dismiss). It is possible that one
portion of the inflation was attributable to both the
competing tender offer and the board approval of the
merger agreement, and that the remaining portion of the
inflation was attributable to the alleged misrepresentations.
It is equally reasonable to infer that the alleged
misrepresentations played a substantial role in the decision
of the board of directors of ABI to approve the merger
agreement, especially considering the fact that ABI
shareholders were to receive Cendant common stock in
exchange for their shares of ABI common stock.
We also disagree with the defendants' contention that the
mutual termination of the merger agreement was an
intervening event that caused the Class's loss. The
complaint alleges that the market price of the common
stock of both ABI and Cendant declined in response to the
alleged fraud. From that allegation, it is reasonable to
conclude that the disclosure of the falsity of the alleged
misrepresentations played a substantial factor in the
termination of the merger agreement. Indeed, it is possible
that the board of directors of ABI no longer found it
beneficial for its shareholders to exchange shares of ABI
common stock for shares of Cendant common stock
following the discovery of Cendant's true financial
condition. In light of the sharp decline in the price of
Cendant common stock, it is also reasonable to infer that
the board of directors of Cendant sought to cancel the
merger to avoid diluting the shares of its existing
shareholders. We therefore agree with the contentions of
the Class and conclude that the complaint alleges sufficient
facts to establish the element of loss causation.
CONCLUSION
In sum, we conclude that the complaint alleges sufficient
facts to establish the elements of reliance and loss
causation. We do not resolve, however, whether the
36
complaint also satisfies the "in connection with"
requirement; nor do we consider whether the complaint
complies with the heightened pleading requirements of Rule
9(b). Rather, we vacate the judgment of the district court
and remand this matter so that the district court may
determine, in the first instance, whether the alleged
misrepresentations were material and publicly disseminated
in a reliable medium and, if so, whether the complaint
nevertheless should be dismissed for a failure to plead
scienter with particularity.14 Because we do not resolve
whether the dismissal was proper under S 10(b) and Rule
_________________________________________________________________
14. We find no merit in the defendants' claim that the dismissal should
be affirmed on the alternative ground that the complaint fails to allege
that the defendants shared a "fiduciary or other similar relation of trust
and confidence" with the Class members. The complaint does not allege
that the defendants failed to disclose material facts. See, e.g., Dirks v.
Securities & Exch. Comm'n, 463 U.S. 646, 6611983) (considering whether
a tippee was under a duty to disclose inside information or to abstain
from trading); Chiarella v. United States, 445 U.S. 222, 228 (1980)
(considering whether a financial printer was under a duty to disclose
information to shareholders of a corporation for whom he did not work
or to abstain from trading in the corporation's securities); Gordon v.
Diagnostek, Inc., 812 F. Supp. 57, 60 (E.D. Pa. 1993) (considering
whether an acquiring corporation was under a duty to disclose certain
financial information to the shareholders of a target corporation); Lerner
v. FNB Rochester Corp., 841 F. Supp. 97, 99, 103 (W.D.N.Y. 1993)
(considering whether a potential acquirer was under a duty to disclose
material information to the shareholders of a target corporation);
Gershon v. Wal-Mart Stores, Inc., 901 F. Supp. 128, 129-31 (S.D.N.Y.
1995) (considering whether a corporation was under a duty to disclose
to the shareholders of another corporation that it intended to terminate
a contract for the sale of goods); Lindlom v. Mobile Telecomm.
Technologies Corp., 985 F. Supp. 161, 163 (D.D.C. 1997) (considering
whether a subsidiary whose securities were not traded owed a duty to
disclose certain information to the shareholders of the parent
corporation). Rather, it alleges that the defendants made affirmative
misrepresentations. Though defendants who are neither fiduciaries nor
insiders generally are not under a duty to disclose material information,
they subject themselves to liability under S 10(b) and Rule 10b-5 when
they make affirmative misrepresentations. See Deutschman v. Beneficial
Corp., 841 F.2d 502, 506 (3d Cir. 1988) (stating that nothing in the law
of this circuit "can be construed to require afiduciary relationship
between a section 10(b) defendant and the victim of that defendant's
affirmative misrepresentation").
37
10b-5, we do not address the merits of the dismissal of the
Class's claim under S 20(a).
A True Copy:
Teste:
Clerk of the United States Court of Appeals
for the Third Circuit
38