McMahan & Co. v. Wherehouse Entertainment, Inc.

• Decision Date: 10 April 1990
• Docket Number: D,No. 399,399
• Citation: 900 F.2d 576
• Parties: , Fed. Sec. L. Rep. P 95,267 McMAHAN & COMPANY, Froley, Revy Investment Co., Inc. and Wechsler & Krumholz, Inc., Plaintiffs-Appellants, v. WHEREHOUSE ENTERTAINMENT, INC., Louis A. Kwiker, George A. Smith, Michael T. O'Kane, Lawrence K. Harris, Donald E. Martin, Joel D. Tauber, Furman Selz Mager Dietz & Birney, Inc., Wei Acquisition Corp., Wei Holdings, Inc., Adler & Shaykin, and Chemical Bank, Defendants-Appellees. ocket 89-7664.
• Court: U.S. Court of Appeals — Second Circuit

Page 576

900 F.2d 576

58 USLW 2636, Fed. Sec. L. Rep. P 95,267

McMAHAN & COMPANY, Froley, Revy Investment Co., Inc. and Wechsler & Krumholz, Inc., Plaintiffs-Appellants, v. WHEREHOUSE ENTERTAINMENT, INC., Louis A. Kwiker, George A.

Smith, Michael T. O'Kane, Lawrence K. Harris, Donald E.

Martin, Joel D. Tauber, Furman Selz Mager Dietz & Birney,

Inc., Wei Acquisition Corp., Wei Holdings, Inc., Adler &

Shaykin, and Chemical Bank, Defendants-Appellees.

No. 399, Docket 89-7664.

United States Court of Appeals, Second Circuit.

Argued Dec. 19, 1989.

Decided April 10, 1990.

Philip K. Howard, New York City (Howard, Darby & Levin, Warren G. Caywood, Jr., Bonnie Blacklock, of counsel), for appellant McMahan.

Dennis J. Block, New York City (Weil, Gotshal & Manges, H. Adam Prussin, Richard B. Friedman, Miranda S. Schiller, of counsel), for appellee Wherehouse.

Before OAKES, PRATT, Circuit Judges, and SAND, District Judge for the S.D.N.Y., sitting by designation.

GEORGE C. PRATT, Circuit Judge:

Plaintiffs appeal from a judgment of the United States District Court for the Southern District of New York, Mary Johnson Lowe, Judge, dismissing their complaint that defendants made material misrepresentations and omissions in a debenture offering in violation of Sec. 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. Sec. 78j; Sec. 11 of the Securities Act of 1933, 15 U.S.C. Sec. 77k; and Sec. 12(2) of the Securities Act of 1933, 15 U.S.C. Sec. 77l. Finding that the complaint "fail[ed] to allege any omission or misstatement of fact--material or otherwise--within the meaning of the securities laws", the district court granted summary judgment to defendants. The court also dismissed plaintiffs' state-law claims for lack of pendent jurisdiction. Since we conclude that plaintiffs presented sufficient evidence to create a genuine issue as to whether the offering was materially misleading, we reverse the summary judgment and remand the case for further proceedings.

BACKGROUND

Defendant Wherehouse Entertainment, Inc. offered 6 1/4% convertible subordinated debentures whose key selling feature was a right of holders to tender the debentures to Wherehouse in the case of certain triggering events which might endanger the value of the debentures. The tender right was to arise if:

(a) A person or group * * * shall attain the beneficial ownership * * * of an equity interest representing at least 80% of the voting power * * * unless such attainment has been approved by a majority of the Independent Directors;

(b) The Company * * * consolidates or merges * * * unless approved by a majority of the Independent Directors;

(c) The Company * * * incurs * * * any Debt * * * excluding * * * Debt which is authorized or ratified by a majority of the Independent Directors, immediately after the incurrence of which the ratio of the Company's Consolidated Total Debt to its Consolidated Capitalization exceeds .65 to 1.0.

Indenture Sec. 5.02, 11-12 (June 15, 1986); see also Prospectus Summary, "Optional Tender", 3 (July 10, 1986); id. Description of Debentures, "Optional Debenture Tender", 25-26.

The offering materials defined an "Independent Director" as "a director of the Company" who was not a recent employee but who was a member of the board of directors on the date of the offering or who was subsequently elected to the board by the then-Independent Directors. Indenture, Sec. 5.02, 12; Prospectus Description of Debentures, "Optional Debenture Tender", 26. The reason offered for this unusual right to tender was that it would be a protection against certain forms of take-over attempts, including leveraged buy-outs. Prospectus Description of Debentures, "Effect on Certain Takeovers", 27. At the heart of this appeal is the meaning of the limitation placed on the right to tender by the role of "Independent Directors".

Plaintiffs are financial institutions that purchased 34% of the convertible debentures. Eighteen months after the purchase, Wherehouse entered into a merger agreement with defendants WEI Holdings, Inc. and its subsidiary WEI Acquisition Corp. The practical effect of the merger, accomplished through a leveraged buy-out, left Wherehouse with a debt approaching 90% of its capitalization and left plaintiffs' debentures valued at only approximately 50% of par. Plaintiffs attempted to exercise their right to tender, but the company refused to redeem the debentures on the ground that the "board of directors" had approved the merger.

Plaintiffs then commenced this suit for damages and an injunction to prevent the merger. Named as defendants were Wherehouse, various officers of Wherehouse, the underwriter of the debentures, WEI Holdings, Inc., WEI Acquisition Corp., and the bank that was financing the tender offer. Plaintiffs claimed that the descriptions of the debentures in the registration materials, as well as representations made during conversations, were materially misleading. Specifically, they claimed that, even though the defendants knew that the right to tender was illusory, their representations of the right as valuable and protected had misled investors into buying the debentures and therefore violated federal securities laws. In the alternative, claiming that the representations created a right to tender under the contract, plaintiffs asserted state-law claims of breach of contract, interference with contract, breach of implied duty of good faith, and fraudulent conveyance.

Defendants argued that all the relevant provisions were clear and unambiguous and that no false statements were made; thus the offering was not materially misleading or in violation of the securities laws.

The district court found nothing misleading. It granted summary judgment to defendants and dismissed plaintiffs' state-law claims for lack of pendent jurisdiction. The district court held that defendants were not required to speculate about the likelihood of a waiver of debentureholders' rights by the Independent Directors and that, even if the right were worthless, defendants were not required to use pejorative terms describing it as such. Moreover, it found the tender option was not illusory, because it (was possible that it) might provide a benefit to debentureholders in the case of a takeover hostile to shareholders which management chose to fight. Finally, according to the district court, the definition of "Independent Directors" was adequate because further description of their role, the extent of their discretion, their interests, or their intent would constitute mere legal conclusions, characterizations, or descriptions of underlying motives and were not required disclosures. Thus, the district court found that the descriptions of the right were not misstatements, and that the alleged omissions were not required to be disclosed under the securities laws.

We disagree with the district court's atomistic consideration of the presentation of the debentureholders' right to tender. The district court concluded that defendants had not misled plaintiffs because the information they included in the written and oral representations was "literally true". We think, however, that when read as a whole, the defendants' representations connoted a richer message than that conveyed by a literal reading of the statements. The central issue on all three claims is not whether the particular statements, taken separately, were literally true, but whether defendants' representations, taken together and in context, would have mislead a reasonable investor about the nature of the debentures.

Some statements, although literally accurate, can become, through their context and manner of presentation, devices which mislead investors. For that reason, the disclosure required by the securities laws is measured not by literal truth, but by the ability of the material to accurately inform rather than mislead prospective buyers. Greenapple v. Detroit Edison Co., 618 F.2d 198, 205 (2d Cir.1980) (where method of presentation or "gloss" placed on information obscures or distorts significance of material facts, it is misleading). Even " 'a statement which is literally true, if susceptible to quite another interpretation by the reasonable investor * * * may properly * * * be considered a material misrepresentation.' " Beecher v. Able, 374 F.Supp. 341, 347 (S.D.N.Y.1974) quoting SEC v. First American Bank & Trust Co., 481 F.2d 673 (8th Cir.1973).

We hold that the district court erred in granting summary judgment to the defendants because plaintiffs have raised a triable issue as to whether the written and oral representations about the right to tender these debentures were materially misleading to a reasonable investor in violation of Sec. 11 and Sec. 12 of the 1933 Securities Act and also of Sec. 10(b) of the 1934 Securities Exchange Act. Since the analysis for all three securities claims is similar, we will first consider it in some detail under Sec. 11, and then review it only briefly under Secs. 12 and 10(b).

A. Section 11 of the Securities Act of 1933

Section 11 states that any signer, officer of the issuer, and underwriter may be held liable for a registration statement which "contained an untrue statement of a material fact or omitted to state a material fact * * * necessary to make the statements therein not misleading". Plaintiffs claim that these offering materials misstated the right to tender and omitted important information about it in violation of Sec. 11. They argue that a reasonable investor would have believed that the right to tender was valuable because it was presented as a right to be exercised at the holder's option and as a protection against takeovers that might affect the security of the debentures. In truth, however, the right to tender was illusory, they argue, because it was designed to be exercised only at the option of management and therefore was intended to protect the interests of shareholders, not of debentureholders.

Plaintiffs are...