Appeal from a judgment of the United States District Court for the Eastern District of New York, Mark A. Costantino, Judge, granting defendants' motion for summary judgment dismissing plaintiffs' complaint alleging violations of § 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b) (1982), on the ground that plaintiffs adduced no facts that could support a finding of scienter.
Feinberg, Chief Judge, and Van Graafeiland and Kearse, Circuit Judges.
Class action plaintiffs Stuart M. Wechsler and Eric Rosenfeld appeal from a judgment of the United States District Court for the Eastern District of New York, Mark A. Costantino, Judge, dismissing their complaint charging defendants Leasco Data Processing Equipment Corp. ("Leasco"), certain of its officers and directors, and its auditors, Touche, Ross, Baily & Smart ("Touche Ross"), with having omitted or approved the omission of certain information from Leasco annual reports, in violation of § 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b) (1982). The court granted defendants' motion for summary judgment on the ground that plaintiffs asserted no facts that could support a finding that defendants had acted with scienter. Plaintiffs contend that since there was a pretrial ruling that the materiality of the information omitted was an issue of fact, since defendants admitted that they knew the information and knew it had been omitted from the annual reports, and since there was circumstantial evidence from which scienter could be inferred, the court erred in ruling as a matter of law that there was not scienter. We agree.
In July 1968, Leasco sought to acquire control of Reliance Insurance Company ("Reliance") by means of an exchange offer in which 63,462 shares of Reliance Class A common stock and 164,430 shares of Reliance common stock would be exchanged for 799,050 units of Leasco securitites ("Units"); each Unit consisted of one share of Leasco Series B convertible perferred stock and one half of a warrant to purchase one share of Leasco common stock. Under the terms of the exchange offer, Leasco arranged for the Reliance shareholders simultaneously to sell all of the Leasco Units they received in the exchange to institutional buyers (the "Institutional Buyers" or "Buyers") at the price of $72 per Unit, for a total purchase price of $57,531,600. At the same time, Leasco agreed to arrange for the resale of the Units by the Institutional Buyers within one year of the date of purchase, and it guaranteed that in the resale the Buyers would receive no less than their cost of $72 per Unit. In addition, Leasco agreed to pay the Institutional Buyers 75 cents per Unit for each month that the Buyers held the Units ("75-Cent Carrying Charge"). Both the exchange offer and the sale to the Institutional Buyers were consummated on September 19, 1968.
On December 20, 1968, Leasco issued its annual report for the fiscal year ended September 30, 1968 ("1968 annual report"). This report contained Leasco's financial statements for the year, as to which Touche Ross issued an unqualified opinion. The only reference in those financial statements to the transaction between Leasco and the Institutional Buyers was in note 13, entitled "Post Balance Sheet Events," which stated in relevant part as follows:
In connection with the acquisition of Reliance, Leasco entered into an arrangement with certain holders of Reliance stock whereby Leasco would exchange shares of Leasco Series B preferred stock and warrants for such Reliance stock and concurrently sell such securities to a group of buyers. Leasco agreed to arrange for the resale of the Leasco securities prior to September 20, 1969 and guaranteed that the buyers of the Leasco securities would receive not less thatn $72 for each unit, consisting of one share of preferred stock and 1/2 warrant, plus $.75 for each month that the unit is owned by the buyer. The agreement further provided that Leasco would receive a portion of the proceeds above such guarantee. If such sale had occurred on December 20, 1968 at then prevailing market prices, Leasco's participation in the proceeds of such arrangement would have been approximately $18,000,000.
Note 13 did not disclose the possibility that if Leasco decided to repurchase the Units, it would be required, under the terms of the guaranty, to pay the Institutional Buyers some $57,000,000. Moreover, this figure could not be computed from information contained in the 1968 annual report because the total number of Units to which the guaranty applied was nowhere revealed in the report.
Nor did note 12 to the financial statements, entitled "Commitments and Contingent Liabilities," refer to the transaction with the banks, notwithstanding Leasco's contingent obligation under the guaranty. In addition, neither note 12 nor note 13 revealed that the effect of the 75-Cent Carrying Charge would be to aggregate an expense to Leasco of more than $7,000,000 each year that the Buyers held the Units; this figure also could not be computed from reading the 1968 annual report because the report did not reveal the total number of Units involved in the transaction.
In December 1969, Leasco issued its annual report for the fiscal year ended September 30, 1969 ("1969 annual report)", as to whose financial statements Touche Ross issued an unqualified opinion. Once again, no reference to Leasco's guaranty to the Buyers was included in the note to the financial statements entitled "Commitments and Contingent Liabilities." The only reference to the arrangement appeared in note 11, entitled "Additional Paid-In Capital," which stated as follows:
In connection with the acquisition of Reliance, Leasco entered into an arrangement with certain holders of Reliance stock whereby Leasco exchanged shares of Leasco series B preferred stock and warrants for such Reliance stock and such holders concurrently sold such securities to a group of buyers. Leasco agreed to arrange for the resale of the Leasco securities prior to September 19, 1969, and guaranteed that the buyers of the Leasco securities would receive not less that $72 for each unit, consisting of one share of preferred stock and 1 1/4 warrants plus $.75 for each month that the unit was owned by the buyer. The agreement further provided that Leasco would receive a portion of the proceeds if any above such guarantee. In July 1969 Leasco entered into an amendment with owners of 75% of the units providing for the extension, with some modification, of the agreement until October 1, 1970. In September 1969, the balance of the units were placed with a new group of buyers on substantially the same terms. In connection with these arrangements Leasco paid the holders $7,272,000 representing $.75 for each month the units had been held, which amount has been charged to additional paid-in capital. If all the units had been sold on December 10, 1969 at their prevailing market prices, Leasco would have been required to pay an additional amount of approximately $16,000,000.
Like note 13 in the 1968 annual report, this note failed to disclose the total number of Units held by the Buyers, and the full extent of Leasco's contingent liability thus could not be computed from information contained in the 1969 annual report. In addition, this note charged the 75-Cent Carrying Charge to additional paid-in capital instead of to ...