Folger Adam Co. v. PMI Industries, Inc.

Citation938 F.2d 1529
Decision Date15 July 1991
Docket NumberD,No. 1083,1083
Parties, 60 USLW 2140, Fed. Sec. L. Rep. P 96,131 FOLGER ADAM COMPANY, Plaintiff-Appellant, v. PMI INDUSTRIES, INC., Control Systems Corporation, WEDGE Group, Inc., and Salomon Brothers Inc., Defendants-Appellees. ocket 90-7798.
CourtUnited States Courts of Appeals. United States Court of Appeals (2nd Circuit)

Steven B. Feirson, New York City (George G. O'Brien, Judy L. Popper, Marshall J. Walthew, Michael F.R. Harris, Robert Cohen, Howard S. Schrader, Dechert Price & Rhoads, of counsel), for plaintiff-appellant.

Melvyn L. Cantor, New York City (Mary Elizabeth McGarry, John R. Menz, Daniel J. Sullivan, Nicholas Even, Simpson Thacher & Bartlett, of counsel), for defendants-appellees PMI Industries, Inc., Control Systems Corp. and WEDGE Group, Inc.

Robert B. Mazur, New York City (Warren R. Stern, David Gruenstein, George T. Conway III, Wachtell, Lipton, Rosen & Katz, of counsel), for defendant-appellee Salomon Bros. Inc.

Before OAKES, Chief Judge, and CARDAMONE and MAHONEY, Circuit Judges.

OAKES, Chief Judge:

Folger Adam Company ("Folger Adam") appeals from a judgment following a jury trial of the United States District Court for the Southern District of New York, Whitman Knapp, Judge, dismissing its claims under federal and state securities laws against PMI Industries, Inc., WEDGE Group, Inc., Control Systems Corporation (collectively "PMI") and Salomon Brothers Inc. ("Salomon"). Because we find that

the district court erroneously instructed the jury regarding the meaning of the materiality requirement of the federal securities laws, and that a properly instructed jury could find that appellees committed omissions or misstatements of material fact in violation of those laws, we reverse and remand for a new trial.

BACKGROUND

In early 1986, PMI, a diversified holding company, began negotiating to sell Stewart Decatur Security Systems and the William Bayley Company (collectively "Stewart/Bayley"), two of its subsidiaries that manufacture detention and security equipment, to Folger Adam. Toward this end, PMI retained Salomon, an investment banking firm, to evaluate Stewart/Bayley's net worth and to prepare an offering memorandum on the two companies. In April 1986, Salomon requested various financial documents from Stewart/Bayley, including any internal earnings projections that had been prepared on the two companies. In response, Stewart/Bayley's management sent financial forecasts to Salomon that predicted that Stewart/Bayley's earnings would fall from $4.8 million in 1986 to $2.9 million in 1987, and would stay approximately at that level through 1990 (the "April projections").

After PMI learned of the pessimistic April projections, it asked Salomon not to include them in the offering memorandum on Stewart/Bayley. According to Folger Adam, PMI was afraid that if the projections were included in the offering memorandum, the sale price for the two companies would substantially decrease. PMI vigorously refutes this interpretation, and argues that it sought to exclude the April projections from the offering memorandum because the projections were "conservative" estimates of Stewart/Bayley's earnings potential that did not accurately reflect the two companies' future prospects. The parties do agree, however, that, although the April projections were included in an early version of the offering memorandum, they were omitted from the final version, which instead stated that "management believes that net sales and net income for fiscal year 1986 should increase over 1985 levels and remain strong in the future."

After receiving the final offering memorandum, Folger Adam asserts that it contacted PMI and Salomon in order to obtain any earnings projections that had been performed on Stewart/Bayley, but was informed by both appellees that no such forecasts had ever been prepared. Folger Adam also contends that Salomon stated that, although no formal earnings projections had been performed, Stewart/Bayley's earnings were estimated to remain around $5 million a year for the foreseeable future. PMI and Salomon flatly reject these allegations.

In August 1986, Folger Adam signed a letter of intent to purchase Stewart/Bayley, and began to perform its own program of due diligence on the two companies. As part of this investigation, Folger Adam requested that PMI analyze Stewart/Bayley's 1987 earnings potential. This request was considered at an October 1, 1986 meeting of Stewart/Bayley's Board of Directors. According to Folger Adam, Stewart/Bayley's managers suggested at the meeting that 1987 earnings be projected at $2.4 million (the "October projections"), but PMI's president refused such an "unacceptable" figure, and instead insisted that Folger Adam be told that 1987 earnings would be between $3.8 and $4.2 million. PMI concedes that the $2.4 million figure was mentioned at the meeting, but argues that it was simply an arbitrary figure meant to initiate discussion, and that the entire board at the end of the meeting agreed that a more accurate projection was between $3 and $4 million.

Thereafter, PMI informed Folger Adam that the 1987 earnings were projected to be approximately $4 million. Folger Adam contends that upon receiving the information, it became concerned because the figure was significantly less than 1986 earnings. Folger Adam alleges that to quell this concern, PMI informed it that the $4 million figure was a product of management's conservatism, and that a more realistic In December 1986, after PMI gave Folger Adam written confirmation of the $4 million forecast, Folger Adam closed on its purchase of Stewart/Bayley for $28.5 million. Immediately thereafter, Folger Adam discovered that Stewart/Bayley's earnings were declining. In fact, the actual operating income for the two companies for 1987 was approximately $500,000, nearly one-eighth of the $4 million projection that PMI had provided to Folger Adam before the deal was consummated. Although appellees disclaim any responsibility for this precipitous decline in Stewart/Bayley's earnings, they do concede that Folger Adam did not learn of the pessimistic April 1986 projections until July 1987, approximately seven months after the sale had been consummated.

projection for 1987 earnings would be approximately $5 million. PMI disagrees that it ever made any such statement.

After Folger Adam discovered the April and October projections, it initiated this suit on the ground that appellees had offered and sold Stewart/Bayley by means of oral misrepresentations and a misleading offering memorandum, in violation of section 12(2) of the Securities Act of 1933, 15 U.S.C. Sec. 77 l(2), section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. Sec. 78j; and Rule 10b-5 promulgated thereunder, 17 C.F.R. Sec. 240.10b-5. 1

The central issue at trial was whether the April and October projections constituted material facts that had to be disclosed under the federal securities laws. After seven weeks of testimony, the district court instructed the jury on the law, including the law on materiality, 2 and directed them to answer several interrogatories, the first of which asked whether appellees had misstated or omitted any material facts in connection with the sale of Stewart/Bayley. Because the jury found that appellees had not made any material misstatements or omissions, the court instructed the jury to stop deliberating, and entered judgment in favor of appellees.

Folger Adam appeals the district court's judgment on the ground that the court misinstructed the jury regarding on the issue of materiality. Appellees respond that the materiality instruction was proper and that, in any event, their conduct was not actionable as a matter of law.

DISCUSSION

The Supreme Court has alternatively defined a material fact as that which a reasonable investor would view "as having significantly altered the 'total mix' of information made available" or that which there is a substantial likelihood that a reasonable investor "would consider ... important in deciding how to vote." TSC Indus. Inc. v. Northway, Inc., 426 U.S. 438, 449, 96 S.Ct. 2126, 2132, 48 L.Ed.2d 757 (1976). No matter how stated, however, it is well-established that a material fact need not be outcome-determinative; that is, it need not be important enough that it "would have caused the reasonable investor to change his vote." Id. Rather, the information need only be important enough that it "would have assumed actual significance in the deliberations of the reasonable shareholder." Id.

In this case, the district court's four-paragraph materiality charge did not adequately inform the jury of the proper meaning of materiality, and, in fact, may have affirmatively misled the jury on the correct standard. First, although the charge repeatedly stated that a material fact is one that would alter the total mix of available information, see supra note 2, it never mentioned, much less highlighted, the critical distinction between facts that are important enough to assume actual significance in a reasonable investor's deliberations, and facts that are so important that they would change an investor's decision whether to consummate the transaction. 3 In our view, it is doubtful that the jury, which is presumed to be unfamiliar with legal jargon and probably has little or no experience in the securities industry, would comprehend that a fact that would significantly alter the total mix of available information is simply a fact that would "have assumed actual significance in the deliberations of the reasonable shareholder." TSC, 426 U.S. at 449, 96 S.Ct. at 2132. Rather, we think that the jury would take the "total mix" formulation to mean that a material fact is one that would cause a reasonable investor to change her decision on whether to consummate a transaction. As a result, the jury may erroneously have believed that appellees' conduct could constitute...

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