Weiner v. Quaker Oats Co.

129 F.3d 310 (3rd Cir. 1997)
  • Opinion Date: November 6, 1997

SECURITIES; DISCLOSURE—When a company publicizes that it will maintain certain material financial ratios and then does not publicize that it has materially deviated from those ratios, it may be liable to investors under the Securities Exchange Act.

Shareholders sued a company under the Securities Exchange Act of 1934 alleging that the company disseminated false and misleading information in violation of Securities and Exchange Commission Rule 10b-5 and Sections 10(b) and 20(a) of the Act. The shareholders alleged that management, in order to make the company a less attractive takeover candidate, resolved to increase the company’s debt by acquiring another company. On numerous occasions prior to the acquisition, the company publicly announced its intention to maintain a debt-to-equity ratio in the upper-60% range. The day the acquisition was announced, shares of the corporation fell 10%, the company’s debt nearly tripled, and the debt-to-equity ratio increased to 80%. The shareholders alleged that the company knew the impending purchase would increase the company’s debt-to-equity ratio, but nevertheless failed to adjust its public projections. This failure artificially inflated the price of the company’s stock and prevented the company from being taken over. Furthermore, those shareholders who believed the company’s representations prior to the acquisition experienced a 10% loss in the value of their stock. The District Court dismissed the claim, holding that the company’s statements concerning debt-to-equity ratio were immaterial.

The Third Circuit began by citing numerous cases where the Supreme Court held that the fundamental purpose of the Act was to replace a policy of caveat emptor with a policy of full disclosure. Santa Fe Industries, Inc. v. Green, 430 U.S. 462 (1977). To establish a claim of fraud under Rule 10b-5, it must be proven that: (1) material misstatements or omissions of material facts were made in connection with the purchase or sale of securities, (2) with knowledge of the omissions or of the falsity of the statements, (3) the misstatements or omissions were relied on, and (4) such reliance was the proximate cause of the injury. Specifically, the shareholders of the company alleged that they purchased shares in reliance on statements made by the company concerning the guideline for the ratio of debt-to-equity. Since the statements by the company and the purchases of stock by the investors were made during the time the company was in active pursuit of its acquisition target, the shareholders claimed that the company must have known its projections were no longer a realistic possibility. The company claimed that the debt-to-equity figure was not material. The Court recited the standard of materiality set forth in TSC Industries, Inc. v. Northway, Inc., 426 U.S. 438 (1976) which states that an omitted fact is material if there is a substantial likelihood that a reasonable shareholder would consider it important in deciding how to proceed. There must be a substantial likelihood that disclosure of the omitted fact would have been viewed by the reasonable investor as having significantly altered the total mix of information available. More specifically, the Third Circuit has held that “materiality is a question of law and fact…only if the misrepresentation or omission is so obviously unimportant to an investor that reasonable minds cannot differ on the question of materiality, is it appropriate to rule that the allegations are not actionable as a matter of law.” Shapiro v. UJB Financial Corp., 964 F.2d 272 (3rd Cir. 1992). Applying the standard in Shapiro, the Court found that the ratio guideline was listed numerous times in numerous documents, and may have created a reasonable understanding among investors that the ratio guideline was a number to which the company attached considerable significance. Therefore, this ratio guideline could have induced a reasonable investor to expect that the ratio would remain the same, or that the company would announce any anticipated significant change. Since the prior ratio rise had been predicted in a previous annual report, it was reasonable for an investor to expect that the company would make another such prediction if it expected the ratio to change significantly in the ensuing year. In other words, the Court concluded it was entirely reasonable for an investor to assume that if the company believed its debt-to-equity ratio would soon change significantly, it would have said so in the annual report issued a month before the acquisition was announced. The Court stated that at the time of the alleged false and misleading statements, regardless of exactly what stage of acquisition talks the company was in, the company knew that the acquisition would result in a much higher debt-to-equity ratio.

The Court concluded that the shareholders’ complaint set forth sufficient facts in support of a claim that would entitle them to relief, since a reasonable fact finder could determine that the company’s statements regarding its debt-to-equity ratio would have been material to a reasonable investor. Since the company had a duty to update such statements when they became unreliable, dismissal was inappropriate. The Court remanded the case for further proceedings.