S.E.C. v. Bausch & Lomb Inc.

• Decision Date: 30 September 1977
• Docket Number: D,No. 11,11
• Citation: 565 F.2d 8
• Parties: Fed. Sec. L. Rep. P 96,186 SECURITIES AND EXCHANGE COMMISSION, Plaintiff-Appellant, v. BAUSCH & LOMB INCORPORATED and Daniel G. Schuman, Defendants-Appellees. ocket 76-6189.
• Court: U.S. Court of Appeals — Second Circuit

Page 8

565 F.2d 8

Fed. Sec. L. Rep. P 96,186

SECURITIES AND EXCHANGE COMMISSION, Plaintiff-Appellant, v. BAUSCH & LOMB INCORPORATED and Daniel G. Schuman,

Defendants-Appellees.

No. 11, Docket 76-6189.

United States Court of Appeals, Second Circuit.

Argued Sept. 1, 1977.

Decided Sept. 30, 1977.

Harvey L. Pitt, SEC, Washington, D. C. (Paul Gonson, Kathryn B. McGrath, John M. Mahoney, Edward B. Horahan, III, SEC, Washington, D. C.), for plaintiff-appellant SEC.

William H. Morris, Rochester, N. Y. (John Stuart Smith and Nixon, Hargrave, Devans & Doyle, Rochester, N. Y.), for defendant-appellee Bausch & Lomb Inc.

Arthur L. Liman, New York City (Lewis A. Kaplan, Adele R. Wailand, and Paul Weiss, Rifkind, Wharton & Garrison, New York City), for defendant-appellee Daniel G. Schuman.

Before KAUFMAN, Chief Judge, OAKES and MESKILL, Circuit Judges.

IRVING R. KAUFMAN, Chief Judge:

Many a corporate executive, conscious of the antifraud provisions of the Securities Acts, may analogize an encounter with a financial analyst to a fencing match conducted on a tightrope; he is compelled to parry often incisive questioning while teetering on the fine line between data properly conveyed and material inside information that may not be revealed without simultaneously disclosing it to the public. Exhorted by the Securities and Exchange Commission and the various stock exchanges ¹ to divulge tidbits of nonpublic, "non-material" information, which may assume heightened significance when woven by the skilled analyst into the matrix of knowledge obtained elsewhere, the corporate representative will incur severe consequences if he discusses areas which are later deemed material. But, since the importance of a particular piece of information depends on the context in which it is given, materiality has become one of the most unpredictable and elusive concepts of the federal securities laws. The SEC itself has despaired of providing written guidelines to advise wary corporate management of the distinctions between material and non-material information, and instead has chosen to rely on an after-the-fact, case-by-case approach, seeking injunctive relief when it believes that the appropriate boundaries have been breached. ²

In the instant case, it is clear that the appellee, Daniel G. Schuman, Chairman of the Board and the principal financial spokesman of Bausch & Lomb, Inc., violated the sanctum of materiality by divulging the corporation's first quarter earnings forecast to an analyst on March 16, 1972. Nevertheless, we agree wholeheartedly with the conclusion of the able district judge, reached after an extensive hearing during which he observed the witnesses and adjudicated their credibility, that the SEC has failed to establish the essential predicate of injunctive relief that there exists a reasonable likelihood of future wrongdoing by the appellees. Accordingly, we affirm the district court's order refusing to enjoin future violations of the securities laws.

I. THE FACTS

A. Bausch & Lomb Introduces Soflens

The fortunes of Bausch & Lomb, Inc. ("B & L"), one of the nation's leading optical manufacturers, changed dramatically in March 1971, when it secured the Food and Drug Administration's approval to market the first hydrophilic ³ soft contact lens in the United States. Because the new product, trade named "Soflens", was more comfortable than the conventional hard contact lens, it was eagerly received by ophthalmic practitioners in a nationwide series of introductory symposia sponsored by B & L between May and November 1971. Soflens sales soon significantly increased B & L's profits. Annual earnings grew 50 percent in 1971 compared to the previous year, and earnings in the last quarter of 1971 rose to $1.02 per share, almost triple those of the same quarter in 1970. The increment was almost completely attributable to Soflens.

As earnings skyrocketed, the value of B & L's stock soared on the New York and Pacific stock exchanges. The price of a B & L share jumped from $46 in March 1971 to a peak of $194.75 on January 28, 1972, and B & L was dubbed a "glamor" stock. But, like any infatuation, the investment community's love affair with B & L faded swiftly as Soflens' imperfections became increasingly apparent during the first quarter of 1972.

B. B & L Stock Prices Plummet in Response to Adverse Publicity

Both analysts and B & L itself anticipated a decrease in sales of a 72-Soflens kit for practitioners after the final introductory symposium. Subsequent sales would consist primarily of replacement lenses. But, during the early months of 1972, Soflens faced less predictable, and more serious, difficulties. A primary source of concern among investors and within B & L itself was a spate of adverse publicity ("flak") generated by broad coverage accorded medical studies indicating that soft contact lenses were not as safe and effective as conventional vision aids. The financial press reported that medical researchers had discovered substantial bacterial contamination of the Griffin lens, a soft contact lens manufactured by Frigitonics Inc. for the Canadian market, and that the American Optometric Association was questioning the sterility of Soflens itself. Rumors abounded that the FDA was contemplating withdrawal of its approval of Soflens, further prompting many analysts to predict weakened consumer acceptance of the product.

The possibility of competition for Soflens proved even more damaging to B & L's stature among investors. On February 23rd and 24th, 1972 the price of B & L shares dropped a total of 191/8 points, 113/8 of these on the 23rd alone, after the Wall Street Journal announced that E. I. du Pont de Nemours & Co. would enter the soft contact lens business. By the end of the month, B & L's prospects had again darkened. On February 29th, Smith Barney & Co. analyst J. Gary Burkhead withdrew his "buy" recommendation on B & L. The next day, March 1st, B & L issued a press release stating that Soflens shipments had been halted by contamination in the shipping vials, and on that day alone B & L stock prices fell 171/2 points. During the three weeks preceding the week of March 13th, B & L plummeted a precipitous 40 points on the New York Stock Exchange. And, as that week began, reports that the Senate planned to investigate B & L's monopolistic hold on the soft contact lens market circulated in the financial community.

C. March 15, 1972

Amid mounting investor concern about Soflens, Daniel G. Schuman, Chairman of B & L, embarked upon a series of interviews with financial analysts on March 15th. Although Schuman was reputed among analysts to be a poor source of information because of his extreme caution in discussing financial matters, intense interest in the impact of recent developments on B & L's fate led several analysts to seek appointments with Schuman. Despite misgivings about the proposed meetings which had been arranged without his knowledge while he was vacationing, Schuman determined to proceed rather than appear to evade inquiries concerning the company's declining fortunes. Not surprisingly, Schuman maintained his customary circumspect style during these sessions only three of which need be discussed in detail.

1. The Sanders interview

On the afternoon of March 15th, Schuman spoke with Lewis A. Sanders, an analyst with Sanford C. Bernstein & Co. Sanders proffered his earnings estimates of $5 for the year, and $.75 for the quarter, seeking Schuman's appraisal. Schuman declined to comment, however, even though B & L's own earnings projection for the first quarter, which he had received on March 13th, was $.74, strikingly close to Sanders's. The conversation turned to the effect of the "flak" on Soflens sales and Schuman informed Sanders that the number of warranty cards received from customers had ceased to increase in the last two weeks, indicating that sales of Soflens had "flattened out". But, he cautioned that reliable forecasting was impossible on the basis of two weeks of data, especially since the flow of returning cards depended on the whims of Soflens customers. Schuman continued that, contrary to earlier hopes, B & L did not expect to introduce the aphakic lens, a hydrophilic lens for cataract patients, and the "minikit", a 38-lens package designed to attract the practitioner unwilling to invest in the larger 72-lens kit, in the first quarter. This "disclosure" conformed with the information B & L's Marketing Division had disseminated to inquiring Soflens customers. Indeed, the SEC does not contend that any liability arises from the Sanders-Schuman interview. The session is noteworthy primarily for the effect it produced following his meeting with Schuman, Sanders reconfirmed his existing "buy" recommendation on B & L, and Sanford C. Bernstein & Co. purchased 850 B & L shares for its discretionary accounts.

2. The Brokaw interview

Late in the afternoon of March 15 Schuman met with Byron R. Wien and Richard J. Clancy, of the firm of Brokaw, Schaenen, Wien, Clancy & Co. ("Brokaw"). The day had been inauspicious for B & L stock, which had suffered a decline of 81/8 points on the New York Stock Exchange. The Brokaw analysts entered Schuman's office as Sanders was leaving and began their interview by asking Schuman to reveal Sanders's prediction of B & L's annual earnings. Without commenting on its accuracy, Schuman informed them of Sanders's $5 prediction. He then delivered a lengthy soliloquy indicating he understood analysts disagreed widely in their forecasts of B & L's earnings, and that B & L itself had no idea how Soflens would fare. Schuman further opined that analysts' predictions were placing a great deal of unnecessary pressure on the stock and magnifying the widespread publicity concerning Soflens contamination. He concluded with a heartfelt plea that analysts display more circumspection in their predictions and discussions.

After suffering through this gratuitous lecture, Wien and Clancy...