Shaw v. Digital Equipment Corp., s. 95-1995

• Decision Date: 08 February 1996
• Docket Number: Nos. 95-1995,95-1996,s. 95-1995
• Citation: 82 F.3d 1194
• Parties: Fed. Sec. L. Rep. P 99,217 Merry Lou SHAW, et al., Plaintiffs, Appellants, v. DIGITAL EQUIPMENT CORP., et al., Defendants, Appellees. Leonard WILENSKY, et al., Plaintiffs, Appellants, v. DIGITAL EQUIPMENT CORP., et al., Defendants, Appellees. . Heard
• Court: U.S. Court of Appeals — First Circuit

Page 1194

82 F.3d 1194

Fed. Sec. L. Rep. P 99,217

Merry Lou SHAW, et al., Plaintiffs, Appellants, v. DIGITAL EQUIPMENT CORP., et al., Defendants, Appellees.

Leonard WILENSKY, et al., Plaintiffs, Appellants, v. DIGITAL EQUIPMENT CORP., et al., Defendants, Appellees.

Nos. 95-1995, 95-1996.

United States Court of Appeals, First Circuit.

Heard Feb. 8, 1996.

Decided May 7, 1996.

Appeals from the United States District Court for the District of Massachusetts [Hon. Joseph L. Tauro, U.S. District Judge].

Sanford P. Dumain, with whom David J. Bershad, James P. Bonner, Milberg, Weiss, Bershad, Hynes & Lerach, New York City, Glen DeValerio, Kathleen Donovan-Maher, Berman, DeValerio & Pease, Boston, MA, Richard Schiffrin, Schiffrin & Craig, Ltd., Buffalo Grove, IL, Joseph D. Ament, and Much, Shelist, Freed, Denenberg, Ament, Bell & Rubenstein, P.C., Chicago, IL, were on brief, for Shaw appellants.

Thomas G. Shapiro, with whom Edward F. Haber, Shapiro, Grace, Haber & Urmy, Boston, MA, Glen DeValerio, Kathleen Donovan-Maher, Berman, DeValerio & Pease, Boston, MA, Fred Taylor Isquith, Peter C. Harrar, Wolf, Haldenstein, Adler, Freeman & Herz, L.L.P., New York City, Richard Bemporad, and Lowey, Dannenberg, Bemporad & Selinger, P.C., New York City, were on brief, for Wilensky appellants.

Edmund C. Case, with whom Jordan D. Hershman, Deborah S. Birnbach, Testa, Hurwitz & Thibeault, Boston, MA, John D. Donovan, Jr., Randall W. Bodner, Daniel J. Klau, and Ropes & Gray, Boston, MA, were on brief, for Shaw appellees.

Edmund C. Case, with whom Jordan D. Hershman, Deborah S. Birnbach, Testa, Hurwitz & Thibeault, Boston, MA, John D. Donovan, Jr., Randall W. Bodner, Daniel J. Klau, Ropes & Gray, Boston, MA, Gerald F. Rath, Robert A. Buhlman, Bingham, Dana & Gould, Boston, MA, Michael J. Chepiga, Daniel A. Shacknai and Simpson, Thacher & Bartlett, New York City, were on brief, for Wilensky appellees.

TORRUELLA, Chief Judge, CYR and LYNCH, Circuit Judges.

LYNCH, Circuit Judge.

Plaintiffs, purchasers of the securities of Digital Equipment Corp., appeal from the district court's dismissal of two consolidated class actions alleging violations of the federal securities laws. Both complaints assert that there were misleading statements and nondisclosures in the registration statement and prospectus prepared in connection with a public offering of stock. That offering commenced on March 21, 1994, just 11 days prior to the close of the quarter then in progress, and about three weeks prior to the company's announcement of an unexpectedly negative earnings report for that quarter. One of the complaints further alleges that defendants made fraudulently optimistic statements to the public in the period leading up to the offering. The district court found that neither complaint identified any statements or omissions actionable under the securities laws and dismissed both for failure to state a claim. We agree that many of the alleged misstatements and omissions do not provide a legally cognizable basis for the plaintiffs' claims, but we also conclude that a limited set of allegations in both complaints relating to the registration statement and prospectus for the March 1994 offering does state a claim. We further find that the surviving portions of the complaints satisfy the pleading requirements of Fed.R.Civ.P. 9(b). Accordingly, we affirm the district court's decision in part, reverse in part, and remand for further proceedings.

I. Background

Digital Equipment Corporation ("DEC") is one of the world's largest suppliers of computer hardware, software and services. Founded in 1957, it first became a publicly held company in 1966. By the early 1990's, the company's success had burgeoned into $14 billion in yearly revenues. The company's success story, however, would not last forever. By 1992, the company had fallen on hard times. In January 1992 it reported its first-ever quarterly operating loss of $138.3 million. Faced in the ensuing months with operating losses in the range of $30 million to $311 million per quarter, the company decided to engage in radical surgery, cutting loose some 35,000 employees over the course of 15 months in the process, including its founder and CEO. To cover the costs of these actions, the company accumulated "restructuring" charges totalling close to $3.2 billion in fiscal years 1990-1992 combined.

In the midst of its financial woes, however, the company took some steps to restore its health. In February 1992, DEC had introduced a new product, the "Alpha" chip. The Alpha chip was hailed as a technological advance that could potentially restore the company's fortunes. In mid-1992, the company installed a new CEO, Robert B. Palmer. He took the helm in the fall of that year, as the company continued to implement strategies to help its Alpha technology gain acceptance in the marketplace and to bring the company back to financial vitality. At the time Palmer took over, the company had absorbed over $3 billion in losses for the prior three years and had been losing money at the rate of approximately $3 million per day. Under the new management, it appeared that the company's financial hemorrhaging had finally begun to slow.

On January 14, 1993, DEC reported a loss for the second quarter of fiscal year 1993 that was far smaller than had been anticipated by analysts. That promising result was followed by another quarter of losses, but within Wall Street's expectations. Then, on July 28, 1993, the company announced its first profitable quarter since before the 1992 fiscal year, reporting a net profit of $113.2 million for the fourth quarter of fiscal year 1993. That result was slightly below analysts' expectations, but a stark improvement over the operating loss of $188.1 million (and overall loss of $2 billion) reported for the comparable quarter in the prior year.

Still, on October 20, 1993, DEC announced a loss of $83.1 million for the first quarter of 1994, an improvement over the $260.5 million loss for the same quarter the prior year, but worse than analysts had been predicting. On January 19, 1994, the company announced another setback, reporting losses for the second quarter of fiscal year 1994, ending January 1, 1994, of $72 million. The loss was worse than analysts had expected and was virtually identical to the losses for that period the prior year.

It was against this backdrop that DEC, on January 21, 1994, filed with the SEC a "shelf" registration statement giving the company the option to issue up to $1 billion in various classes of debt and equity securities. Two months later, DEC through its underwriters conducted an offering of $400 million in depositary shares of preferred stock, pursuant to the "shelf" registration, a prospectus dated March 11, 1994, and a prospectus supplement dated March 21, 1994. The offering commenced on the date of the prospectus supplement and closed one week later on March 28, 1994, four days before the end of the third fiscal quarter. All 16 million depositary shares of preferred stock were sold, at an offering price of $25. DEC raised a badly needed $387.4 million. ¹

Less than three weeks later, on April 15, 1994, DEC announced an operating loss of over $183 million for the quarter that had ended on April 2, 1994. This third quarter loss was far greater than analysts had been expecting, and the largest that the company had reported since the first quarter of fiscal 1993. It bucked the positive trend of reduced losses under the company's new management. The announcement sent the price of the newly distributed preferred stock tumbling from the offering price of $25 to $20.875 by the close of trading on April 15. The common stock fell from $28.875 to $23 during the same period, and to $21.125 by the close of the next trading day.

In its April 15 announcement, the company also disclosed that it had decided to "accelerate [its] on-going restructuring efforts" and "also consider further restructuring." This was despite a representation in the March 21 prospectus supplement that "[t]he Corporation believes that the remaining restructuring reserve of $443 million is adequate to cover presently planned restructuring actions." Eventually, following the close of fiscal year 1994, DEC announced on July 14, 1994 that it would cut almost one-fourth of its remaining workforce and take an additional charge of $1.2 billion for fiscal year 1994 (beyond the $443 million remaining in reserve as of March 21) to cover the costs of additional restructuring activities.

II. Description of the Actions

These two lawsuits were filed on Tuesday, April 19, 1994, two business days after the company's announcement of April 15, 1994. One, the Wilensky action, brought on behalf of all persons who purchased shares in the March 1994 public offering, asserts claims under Sections 11, 12(2), and 15 of the Securities Act of 1933 ("Securities Act") against DEC, its Chief Executive Officer (Robert B. Palmer), its Chief Financial Officer (William Steul), and seven underwriting or investment banking firms, representing a purported defendant class of 65 underwriters who participated in the offering. The second, the Shaw action, advances claims under Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 ("Exchange Act") and Rule 10b-5, and a pendent claim of common law negligent misrepresentation, on behalf of all purchasers of DEC common stock between January 19 and April 15, 1994 (the "Class Period").

At the heart of both complaints are two sets of claims. First, plaintiffs assert that DEC management had knowledge of material facts concerning the large losses developing during the third fiscal quarter of 1994, and that the defendants were under a duty to disclose such material information to the market in connection with the public offering conducted on March 21, 1994. Second, both the Wilensky and Shaw plaintiffs contend that the representation made in the March 21 prospectus supplement...