Marx v. Computer Sciences Corp.

• Decision Date: 22 November 1974
• Docket Number: No. 73-1548,73-1548
• Citation: 507 F.2d 485
• Parties: Fed. Sec. L. Rep. P 94,904 William H. MARX and Florence Marx, his wife, Plaintiffs-Appellants, v. COMPUTER SCIENCES CORPORATION, Defendant-Appellee.
• Court: U.S. Court of Appeals — Ninth Circuit

Page 485

507 F.2d 485

Fed. Sec. L. Rep. P 94,904

William H. MARX and Florence Marx, his wife, Plaintiffs-Appellants, v. COMPUTER SCIENCES CORPORATION, Defendant-Appellee.

No. 73-1548.

United States Court of Appeals, Ninth Circuit.

Nov. 22, 1974.

George M. Hartung, Jr. (argued), of LeSourd, Patten, Fleming & Hartung, Seattle, Wash., for plaintiffs-appellants.

Don Paul Badgley (argued), of Bogle, Gates, Dobrin, Wakefield & Long, Seattle, Wash, for defendant-appellee.

Before MERRILL and KOELSCH, Circuit Judges, and JAMESON, ^* District judge.

OPINION

KOELSCH, Circuit Judge:

The plaintiffs (hereinafter Marx) appeal from a summary judgment for defendant Computer Sciences Corporation (CSC) on plaintiffs' claim for damages allegedly resulting from the violation of Section 10(b) of the Securities and Exchange Act of 1934 (15 U.S.C. 78j(b)) and Rule 10b-- 5 of the Securities and Exchange Commission and from the denial of plaintiffs' cross-motion for partial summary judgement on the issue of liability. ¹

Marx predicates his claim upon an earnings forecast made by CSC. His contention in substance is that the forecast was not in accordance with the requirements of 10(b) of the Act and Rele 10b-- 5, in that it was both 'untrue' and omitted material facts required to make it 'not misleading.' ²

'Summary judgment of course is proper only where there is no genuine issue of any material fact or where viewing the evidence and the inferences which may be drawn therefrom in the light most favorable to the adverse party, the movant is clearly entitled to prevail as a matter of law.' Stansifer v. Chrysler Motors Corporation, 487 F.2d 59, 63 (9th Cir. 1973). We thus turn to the record to ascertain from the 'pleadings, depositions, answers to interrogatories, and admissions on file, together with the affidavits' whether the ruling of the district court was correct.

In brief, the following 'facts' appear:

Marx is a knowledgeable and experienced private investor. For some time prior to January 23, 1970, he had been closely studying various financial reports concerning CSC, a company whose business consisted principally of the development and merchandising of computer-related services, known as proprietary systems, one of which, 'Computicket' (CT), was currently being developed. CSC's general accounting practice was to initially capitalize development expenses, rather than to treat them as charges against current income. And when a system became fully operational-- defined as generating revenue in excess of expenses-- CSC would then change its accounting treatment and begin to charge off the accumulated development expenses against income. CSC's current registration statement, filed with the Securities and Exchange Commission in April, 1969, and which Marx had studied, contained the statement that CSC expected to begin expensing CT on October 1 of that year; the statement in the ensuing prospectus was to the same effect:

'It is CSC's policy to capitalize all costs applicable to developing proprietary programs and systems and to amortize such costs over estimated total revenues from the sale of such programs and systems over a specified time period. At July 25, 1969, $17,580,000 relating to the costs incurred in developing proprietary systems were capitalized. This figure includes $6,800,000 of expenditures incurred in connection with the developing and marketing of COMPUTICKET. The company plans to treat all such additional costs incurred for development of COMPUTICKET after October 1, 1969 as expenses and to charge them against revenues.' ³

On January 23, 1970, William R. Hoover, then a vice president and director of CSC, delvered a carefully prepared speech at a meeting in New York of the New York Seciety of Security Analysts. In it he stated:

'In concluding my remarks, I would like to briefly discuss a few aspects of CSC's financial performance. Approximately three years ago, Fletcher Jones, chairman of CSC, forecast revenues for the current CSC fiscal year of $100 million with a net income of 10% Of revenue. While it will not be the policy of the company to forecast yearly earnings in the future, since it is so near the closing of our fiscal year (March 27) it is appropriate to compare our performance with Mr. Jones' forecast. I am pleased to say that CSC expects to exceed the revenue and profit forecast with a total revenue of approximately $105 million and a net income of approximately $1.00 per share on 12.8 million shares outstanding.' ⁴

Following delivery of the speech, printed copies were distributed and Hoover responded to questions from the audience. With respect to Computicket and Infonet, another CSC system, he did state that 'neither . . . have yet reached full operational stage, neither one will begin to write down appreciable costs in this year'; however, no such intelligence was contained in the prepared speech, and the 'broad tape' which disseminated the news of the forecast throughout financial circles simply carried the earnings forecast and made no mention of Computicket. Marx either saw or was advised of this news report the day it appeared. Having neither knowledge that CSC had not begun expensing CT on October 1, as indicated in the prospectus, nor any other information concerning CT's status and condition, he purchased 2,000 shares of CSC stock at a price of about $30.

The forecast did not prove correct. At the close of the fiscal year, earnings were only 41 cents (and CSC stock had dropped to about $10). The difference between that amount and the 'approximately $1.00' forecasted was largely, if not wholly, the result of the 'write-off' of the entire accumulated development cost (in excess of $10,000,000) of CT, which CSC abandoned shortly after the Hoover speech. Just when CSC arrived at this decision is not clear. But it does appear that CT troubles had been of long standing. From its inception, CT had not met internal projections or market capture expected of it. It was financed by loans from CSC, which in turn was dependent on the availability of short-term capital. It had experienced problems getting equipment installed, it had been running deficits of one-half a million dollars or more per month for several months before the time of the speech, and it had lost, one of its contracts with the First National City Bank of New York for an outlet. Moreover, CSC had attempted, without success, to sell the CT proprietary package to various prospects for differing amounts and during October and November, 1969, had gone so far as to discuss CT's abandonment, althought it then made no decision in that regard. In short, the inference is plain that the likelihood of CT's commercial success became progressively more doubtful with the passage of time.

After duly considering these facts, we conclude that the district court should not have granted summary judgment in favor of CSC.

I. Potential Liability for Making an 'untrue Statement of a Materail Fact.'

That a forecast, essentially a prediction, may be regarded as a 'fact' within the meaning of the Rule is settled by G & M, Inc. v. Newbern,488 F.2d 742 (9th Cir. 1973). In that case this court rejected a defendant's argument that his representations as to future earnings of a corporation were not actionable under Rule 10b-- 5 because mere opinion. We said:

'Under the securities law a reasoned and justified statement of opinion, one with a sound factual or historical basis, is not actionable. Here, however, considering the gross disparity between prediction and fact, and also considering Newbern's other misrepresentations and failures to disclose, which were relevant to the accuracy of his prediction, we have no difficulty in finding this 'prediction' to be actionable. See, e.g., 1 Bromberg, supra, 5.3 at 97; 7.2(1) at 147-48; and cases cited therein.' 488 F.2d at 745-46. ⁵

Nor can there be doubt that the forecast of earnings was a 'material' fact. The applicable test of materiality is essentially objective (see 2 Bromberg, Securities Law: Fraud 8.3, at 201 (1973): '. . . whether 'a reasonable man would attach importance (to the fact misrepresented) in determining his choice of action in the transaction in question." List v. Fashion Park, Inc., 340 F.2d 457, 462 (2d Cir. 1965). ⁶ And generally earnings projections of a company constitute a prime factor in estimating the worth of its stock, especially when made close to the end of the fiscal year:

'While investors probably attach more significance to future earnings than to any other single factor, they tend to take predictions with a grain of salt because of their inherent uncertainties. But the uncertainty of a projection for a given period declines as the end of the period approaches.' 2 Bromberg, supra, 7.2(1) at 149.

Kripke, The SEC, The Accountants, Some Myths and Some Realities, 45 N.Y.U.L.Rev. 1151, 1197 (1970).

The next question is, was the forecast an 'untrue' statement. Of course in hindsight it turned out to be wrong. But at least in the case of a prediction as to the future, that in itself does not make the statement untrue when made. However, the forecast may be regarded as a representation that on January 23, 1970, CSC's informed and reasonable belief was that at the end of the coming period, earnings would be approximately $1.00. That is what a reasonable investor would take the statement to mean, and we believe it would be 'untrue' when made if CSC did not then believe earnings would be in that amount or knew that there was reason to believe they would not be. In addition, because such a statement implies a reasonable method of preparation and a valid basis, we believe also that it would be 'untrue' absent such preparation or basis.

In short, we are clear that the determination of untruthfulness vel non of a statement is inextricably linked with the so-called 'scienter' requirement of a private 10b-- 5 action and involves an inquiry into the circumstances underlying the...