80). Plaintiffs allege that at the time of White's statement, the bidding was far from smooth. As of the date of Mr. White's statement, GTE, Bell Atlantic and Southwestern Bell had indicated that they would not bid for all of Centel; NYNEX and BellSouth had demonstrated weak interest; PacTel, Ameritech and U.S. West had expressed interest only in limited Centel properties. (Id. P63(a)-(h), 69). Centel's positive statement at a time when the targeted bidders expressed weak interest supports an inference that the defendants' favorable opinion was without basis in fact.
To establish a valid claim under § 10b of the Securities Exchange Act of 1934 or Rule 10b-5 a plaintiff must allege that the defendant acted with the intent to deceive, manipulate or defraud. See Ernst & Ernst, 425 U.S. at 193. The Seventh Circuit expanded the scienter requirement for a claim pursuant to § 10b or Rule 10b-5 to include reckless disregard for the truth. Rowe v. Maremont Corp., 850 F.2d 1226, 1238 (7th Cir. 1988)(citing Sundstrand Corp. v. Sun Chemical Corp., 553 F.2d 1033, 1043-45 (7th Cir. 1977), cert. denied, Meers v. Sundstrand Corp., 434 U.S. 875, 54 L. Ed. 2d 155, 98 S. Ct. 224, 98 S. Ct. 225 (1977).
The defendants argue that the pleadings fail to allege a rational theory of scienter. The Second Amended Complaint alleges two distinct theories of motive to deceive, manipulate or defraud: (1) the defendants drove up the value of Centel stock to protect their lucrative positions with the company (Second Amended Complaint P 100); and (2) the defendants artificially inflated the market price of Centel stock to gain leverage in their negotiations with potential bidders (Id. PP 46, 50, 96). The defendants argue that plaintiffs' theories of scienter rest on contradictory and conclusory allegations which fail to prove motive.
The defendants persuasively highlight the flaw in the plaintiffs' first theory. If the defendants wanted to protect their lucrative positions with Centel, then they would not have sold the company, thereby, putting their jobs in jeopardy. Incidentally, plaintiffs' appear to have abandoned the first theory since their brief discusses only the "leverage theory" as support for the motive requirement (Plaintiffs' Brief at 32-33).
The defendants make a strong argument in the reply brief that the pleadings fail to support the plaintiffs' "leverage theory" as well. Plaintiffs allege in their complaint that the defendants inflated the share price of Centel to gain leverage in negotiations with potential bidders. (Second Amended Complaint P 96). This type of conclusory statement does not meet the standard of Rule 9(b), which requires pleadings with particularity concerning any circumstances constituting fraud. The Second Amended Complaint fails to indicate how inflated prices would give Centel leverage over the bidders and what each defendant would derive from the alleged scheme.
Although the pleadings fail adequately to allege motive, the plaintiffs do allege, in satisfaction of the scienter requirement, that the defendants recklessly failed to disclose material information. Under the recklessness standard established by this Circuit, "the danger of misleading buyers must be actually known or so obvious that any reasonable man would be legally bound as knowing, and the omission must derive from something more egregious than even 'white heart/empty head' good faith." Sundstrand Corp., 553 F.2d at 1045.
In the instant case, the defendants argue that they were under no duty to disclose information about the progress of the auction because much of the "negative information" was already public and that information which remained private would not render misleading the defendants' prior statements. (Reply Br. at 15). The Second Circuit held in Time Warner that a duty to disclose arises whenever private material facts render prior public statements substantially misleading, and not just when that information fully negates the public statements. In Re: Time Warner Inc. Securities Litigation, 9 F.3d 259, 1993 U.S. App. LEXIS 31173, at *24-25 (2nd Cir. 1993), cert. denied, 128 L. Ed. 2d 70 (1974). "[A] corporation is not required to disclose a fact merely because a reasonable investor would very much like to know that fact. Rather, an omission is actionable under the securities laws only when the corporation is subject to a duty to disclose the omitted facts." Id. at *21.
The United States Supreme Court examined in Basic Inc. v. Levinson whether information concerning the existence and status of preliminary merger discussions constitutes material information and requires disclosure. 485 U.S. at 235. The Supreme Court held that "materiality depends on the significance the reasonable investor would place on the withheld or misrepresented information." 485 U.S. at 240. The Supreme Court in Basic Inc. concluded that materiality is a factual inquiry to be determined on a case-by-case basis. Id. at 239-40.
The plaintiffs have pled sufficient facts to survive a motion to dismiss as to the defendants' alleged recklessness in failing to correct the alleged misimpression left by the Centel spokesman's March 26, 1992 statement. Mr. White of Centel stated on March 26, 1992 that the bidding process was progressing "very smoothly" (Second Amended Complaint P 77). As discussed earlier in this opinion, plaintiffs alleged sufficient facts to suggest that White's statement may have been misleading when it was made. Since White's statement, Centel learned that two more of the targeted bidders were unlikely to bid on the entire company. BellSouth informed one of Centel's investment bankers on March 27, 1992 that BellSouth was unlikely to submit a competitive bid on "a large group of assets." (Id. P 79). U.S. West privately informed Centel that it would not submit a cash bid on April 8, 1992. (Id. P 80). By then, the defendants were aware that six (Ameritech, U.S. West, PacTel, GTE, Bell Atlantic and Southwestern Bell) of the eight originally targeted bidders would not bid for the entire company. (Id. PP 63c, 63f, 69, 77). Of the remaining two targeted companies, NYNEX earlier had expressed privately a "lack of enthusiasm" for a transaction (Id. P 63a); and, subsequently, BellSouth indicated that bidding on limited Centel properties was problematic. (Id. P 79). These facts could suggest that the defendants were aware that Centel's stock was worth significantly less than the value the defendants had touted to the market. A jury could find these undisclosed facts material that the defendants had a duty to disclose this information.
Defendants aver that the pleadings fail to allege with specificity actual reliance on the purported misstatements as required by Federal Rule of Civil Procedure 9(b). Rule 9(b) requires that all averments to fraud must be alleged with particularity. Defendants argue that plaintiffs' pleadings are facially deficient because they allege the plaintiffs' reliance upon misstatements rather than upon the integrity of the market and they allege reliance in conclusory terms. The plaintiffs respond by arguing that when fraud on the market is alleged, reliance is presumed.
The United States Supreme Court has long held that reliance is an element of a Rule 10(b)-5 cause of action. Basic Inc., 485 U.S. at 243. The Supreme Court held that "reliance provides the requisite causal connection between a defendant's misrepresentation and a plaintiff's injury" but there is more than one way to demonstrate this link. Id. The Supreme Court in Affiliated Ute Citizens v. United States relaxed the reliance requirement in nondisclosure cases. 406 U.S. 128, 92 S. Ct. 1456, 31 L. Ed. 2d 741 (1972), reh'g. denied, 407 U.S. 916 (1972), and reh'g. denied, 408 U.S. 931 (1972). The Supreme Court held there that positive proof of actual reliance is not necessary for recovery when a defendant fails to abide by its obligation to disclose material facts which a reasonable investor would have considered in making a decision. Id. at 153-54. In Basic Inc., the Supreme Court held that reliance may be presumed in Rule 10b-5 litigation because in well developed markets, the market price reflects publicly available information. 485 U.S. at 246-47. The Supreme Court also held that a defendant may rebut this presumption at trial with a showing that severs the link between the alleged misrepresentation and the stock price paid or received by the plaintiff or plaintiff's decision to trade at a fair market price. Id. at 248, see also n. 29.
The plaintiffs allege that the defendants knowingly or recklessly misled them as to the progress of the auction. (Second Amended Complaint PP 95-103) The Second Amended Complaint contrasts the negative information about which the defendants were aware with the optimistic public statements that the defendants made to prospective bidders. (Id. PP 63, 69, 71-72, 78-80, 84-86, 88-89). As discussed earlier in this opinion, a jury could find material the facts that the defendants failed to disclose. Since the plaintiffs have pled fraud on the market, then reliance may be presumed, subject to rebuttal at trial.
Since this court finds that the plaintiffs state a claim under federal securities laws as to Count I, this court has supplemental jurisdiction to entertain Count II, the common law fraud claim, pursuant to 28 U.S.C. § 1367. For these reasons, this court denies the defendants' motion to dismiss.
BRIAN BARNETT DUFF, JUDGE
UNITED STATES DISTRICT COURT
June 7, 1994
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