S.E.C. v. MacDonald, s. 81-1356

• Decision Date: 01 February 1983
• Docket Number: 81-1513 and 81-1514,Nos. 81-1356,s. 81-1356
• Citation: 699 F.2d 47
• Parties: Fed. Sec. L. Rep. P 99,078, 12 Fed. R. Evid. Serv. 1085 SECURITIES AND EXCHANGE COMMISSION, Plaintiff, Appellee, v. James E. MacDONALD, Jr., Defendant, Appellant.
• Court: U.S. Court of Appeals — First Circuit

Page 47

699 F.2d 47

Fed. Sec. L. Rep. P 99,078, 12 Fed. R. Evid. Serv. 1085

SECURITIES AND EXCHANGE COMMISSION, Plaintiff, Appellee, v. James E. MacDONALD, Jr., Defendant, Appellant.

Nos. 81-1356, 81-1513 and 81-1514.

United States Court of Appeals,

First Circuit.

Argued Oct. 4, 1982.

Decided Feb. 1, 1983.

Thomas D. Gidley, Providence, R.I., with whom Paul V. Curcio, and Hinckley, Allen, Salisbury & Parsons, Providence, R.I., were on brief, for appellant before panel. ^*

Harlan W. Penn, S.E.C., Washington, D.C., with whom Paul Gonson, Sol., Edward F. Greene, Gen. Counsel, Michael K. Wolensky, Associate Gen. Counsel, and John P. Sweeney, Asst. Gen. Counsel, Washington, D.C., were on brief, for appellee. ^* Before COFFIN, Chief Judge, ALDRICH, CAMPBELL, BOWNES and BREYER, Circuit Judges.

OPINION EN BANC ¹

BAILEY ALDRICH, Senior Circuit Judge.

In this proceeding brought by the Securities Exchange Commission (SEC), defendant James E. MacDonald, Jr. was ordered by the district court to disgorge profits of $53,012 realized on the purchase and subsequent sale of 9,600 shares of Realty Income Trust (RIT) stock. The court, sitting without jury, found that defendant violated the antifraud provisions of the Securities Exchange Act of 1934, section 10(b), 15 U.S.C. Sec. 78j(b), and SEC Rule 10b-5 promulgated thereunder, 17 C.F.R. Sec. 240.10b-5, by making the purchases without disclosing certain material inside information learned in his capacity as chairman of RIT's board of trustees. Defendant appeals, contending that the court erred in its findings of materiality and scienter; in excluding certain evidence, and in its measurement of the profits to be disgorged. We affirm, except as to the amount.

RIT is a real estate investment trust whose stock is traded on the American Stock Exchange. The present controversy revolves around defendant's knowledge of RIT's acquisition of the Kroger Building, a twenty-five story office building in Cincinnati, Ohio, and its likely negotiation of a profitable long-term lease of vacant space therein to Kenner Products. The basic facts, as found by the court, expressly and impliedly, are briefly as follows.

The land under the Kroger Building had been owned by RIT since 1962. Until December 1975, the building was owned and managed by City Center Development Company. Both the land and the building were subject to a first mortgage to Prudential Insurance Company. Under the terms of its ground lease, City Center was obligated to pay ground rent to RIT and mortgage payments to Prudential, but in 1975 it defaulted on both accounts. To protect its investment and avoid foreclosure, RIT advanced mortgage payments to Prudential, and then, on December 2, 1975, filed suit against City Center seeking reimbursement and the appointment of a receiver. The suit was publicly announced on December 4. On December 12, the case was settled by City Center's surrendering to RIT ownership of the Kroger Building. The news of the settlement was reported in a local Cincinnati paper but was not otherwise made available to the investing public. That day, however, RIT did release its quarterly financial report, which, basically, contained nothing but bad news.

Meanwhile, Kenner Products had been looking for a new home, its previous one having been acquired by the city. A tentative decision was made to move into the Kroger Building, and negotiations between City Center and Kenner ensued. After its acquisition of the building, RIT took over the negotiations. A report on the proposed terms of the lease was made to the trustees, including defendant, on December 15. The next day his wife, acting in his behalf, ² put in an order with her broker for the purchase of up to 20,000 shares of RIT stock at a price of 4 1/4. One hundred shares were purchased at that price. On December 23, defendant went personally to the broker's office and raised the purchase limit to $5 per share. This resulted in the purchase of 9,500 shares that day at 4 5/8.

The following day, December 24, RIT issued a press release, publicly announcing for the first time the acquisition of the Kroger Building, and referring to Kenner, that

"the Trust expects to sign a lease almost immediately for 105,000 square feet of space in the building with a major new tenant. The lease will bring occupancy in the building up to 95%, which would indicate a market value of the building of approximately $8,500,000 which is approximately $2,000,000 more than the existing first mortgage and RIT's investment in the property."

The price of RIT stock then jumped from 4 5/8 to 5 1/2 in two days of trading--a rise of 19%--and closed the year at 5 3/4. Defendant held on to the stock until 1977 when it was sold at an average price of over $10 per share.

Materiality

Defendant first asserts that the court applied an erroneous legal standard in determining the materiality of the insider information. The proper standard for determining whether an omitted fact was material in a Rule 10b-5 case is the same as that formulated by the Supreme Court in TSC Industries, Inc. v. Northway, Inc., 1976, 426 U.S. 438, 96 S.Ct. 2126, 48 L.Ed.2d 757, a proxy-dispute case, namely, whether there is "a substantial likelihood that, under all the circumstances, the omitted fact would have assumed actual significance in the deliberations of a reasonable shareholder." Id. at 449, 96 S.Ct. at 2132; Harkavy v. Apparel Industries, Inc., 2 Cir., 1978, 571 F.2d 737, 741 & n. 5; Holmes v. Bateson, 1 Cir., 1978, 583 F.2d 542, 558 & n. 20. This is the precise standard applied by the district court, which found that the inside information "would have assumed actual significance in the deliberations of a reasonable shareholder." Defendant nevertheless claims error based on the court's stating, later in its oral opinion, that "any shareholder who did not have the insider information ... would be suffering from some kind of a feeling of depression, as far as that stock was concerned, and that that depression, might be substantially altered by the information that was available ...." (Emphasis added). This isolated statement in no manner suggests that the court applied the wrong legal standard. While the Court in TSC Industries, ante, stressed that materiality depends upon what a reasonable shareholder would, not might, consider important, at the same time it noted that it is not necessary to show that the undisclosed information would have been sufficient to alter the shareholder's decision; it is enough to show "a substantial likelihood that a reasonable shareholder would consider it important ...." 426 U.S., ante, at 449, 96 S.Ct., at 2132. The district court specifically so found, and it was not error for it further to find that the insider information might have been sufficient actually to reverse a shareholder's bearish feelings about the stock. It is not to be forgotten that the stockholders' most recent news was the gloomy report of December 12. At the time of the disputed stock purchase, the last news to the general public was that RIT was suing to recover over $500,000 owed it by City Center, the owner of the Kroger Building, for rent due, and for mortgage payments advanced by RIT on City Center's behalf; that RIT's quarterly earnings were down over 60%; and that it was "not currently earning a satisfactory rate of return on any of its foreclosure properties."

At the same time, defendant knew not only of RIT's acquisition of the Kroger Building, but also of at least a strong probability that Kenner would lease therein approximately 100,000 square feet of previously vacant space at an annual rental of roughly $500,000. The combined value to RIT of these two transactions as reflected by its December 24 press release, to which a trustee subscribed at trial, was approximately $2,000,000. Thus the court could find that the inside information known to defendant gave him reason to believe that in all likelihood the trust was going to be approximately $2,000,000 better off than a reasonable investor would expect. Since there were only 1,500,000 shares of RIT stock outstanding, the court could warrantably conclude that when the inside information became public, other things being equal, the stock would likely rise by more than a dollar per share.

This in fact happened. As already stated, on December 23, the day before the press release was issued, RIT stock closed at 4 5/8, and by December 31 it had risen to 5 3/4, a gain of 1 1/8 per share. It was not clear error for the court to attribute the rise to the public disclosure of information pertaining to the Kroger Building and the Kenner lease. Nor can the court be faulted for holding that under all the circumstances, a reasonable RIT shareholder would consider this information, which pointed towards a 20% increase in the value of his stock, important in deciding whether or not to sell it.

Defendant argues that since, according to his witness, real estate trusts, generally, rose about 20% in early 1977, RIT's increase was attributable to general market conditions, and not the Kenner lease. This was a matter for the district court, not for us. We merely repeat that in light of the stockholders' report of December 12, the court could well have found that, without Kroger, RIT might not have followed the market. We are equally unimpressed with defendant's argument that because the successful negotiation of the Kenner lease was not "definite" at the time of the stock purchases, his inside information was not material as matter of law. In light of defendant's statements and the December 24 press release, the court could conclude that at the time of the stock purchases the lease was close enough to a sure thing as hardly to be considered a contingency at all. But even if not, investors regularly deal in probabilities and expectations, rather than certainties. The materiality of facts regarding a contingent future event is simply a function of the anticipated...