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Filed: September 29, 1999
UNITED STATES COURT OF APPEALS
FOR THE FOURTH CIRCUIT
No. 98-2572
(CA-98-487-A)
Lionel Phillips, etc.,
Plaintiff - Appellant,
versus
LCI International, Incorporated, et al,
Defendants - Appellees.
O R D E R
The court amends its opinion filed September 15, 1999, as follows:
On page 21, first full paragraph, line 3 -- the number "32" is deleted from the text.
For the Court - By Direction
/s/ Patricia S. Connor
PUBLISHED
Clerk
UNITED STATES COURT OF APPEALS
FOR THE FOURTH CIRCUIT
LIONEL PHILLIPS, on behalf of
himself and all others similarly
situated,
Plaintiff-Appellant,
v.
No. 98-2572
LCI INTERNATIONAL, INCORPORATED;
H. BRIAN THOMPSON,
Defendants-Appellees,
SECURITIES & EXCHANGE COMMISSION,
Amicus Curiae.
Appeal from the United States District Court
for the Eastern District of Virginia, at Alexandria.
Claude M. Hilton, Chief District Judge.
(CA-98-487-A)
Argued: June 7, 1999
Decided: September 15, 1999
Before WIDENER and MOTZ, Circuit Judges, and
HOWARD, United States District Judge for the
Eastern District of North Carolina, sitting by designation.
_________________________________________________________________
Affirmed by published opinion. Judge Motz wrote the opinion, in
which Judge Widener and Judge Howard joined.
_________________________________________________________________
COUNSEL
ARGUED: Douglas Michael Palais, MEZZULLO & MCCAND-
LISH, P.C., Richmond, Virginia, for Appellant. Walter Estes Dellin-
ger, III, O'MELVENY & MYERS, L.L.P., Washington, D.C., for
Appellees. ON BRIEF: Frederic S. Fox, Christine M. Comas,
KAPLAN, KILSHEIMER & FOX, L.L.P., New York, New York;
Andrew N. Friedman, Lyn M. Rahilly, COHEN, MILSTEIN, HAUS-
FELD & TOLL, P.L.L.C., Washington, D.C., for Appellant. Martin
Glenn, Achilles M. Perry, O'MELVENY & MYERS, L.L.P., New
York, New York; Michael J. Chepiga, David B. Smallman, Felecia L.
Stern, SIMPSON, THACHER & BARTLETT, New York, New
York, for Appellees. Harvey J. Goldschmid, General Counsel, David
M. Becker, Deputy General Counsel, Eric Summergrad, Principal
Assistant General Counsel, Nathan A. Forrester, Attorney Fellow,
SECURITIES & EXCHANGE COMMISSION, Washington, D.C.,
for Amicus Curiae.
_________________________________________________________________
OPINION
DIANA GRIBBON MOTZ, Circuit Judge:
As of February, 1998, LCI International was the nation's seventh
largest long-distance telecommunications company, providing voice
and data transmission services to residential and business customers.
LCI had a major customer base, operating system, and sales force, but
lacked a substantial transmission network. Qwest, a rival telecommu-
nications company, had built an extensive fiber optic network, but
lacked a commensurate base of customers, systems, and sales force.
By March, 1998, the two companies agreed that a merger would ben-
efit both and announced that Qwest would acquire LCI in a stock for
stock merger valued at over $ 4.4 billion, making the merged com-
pany the fourth largest long-distance company in the United States.
The question presented here is whether a public statement by LCI's
chief executive that "[w]e're not a company that's for sale," made less
than a month before Qwest acquired LCI, violated federal securities
laws. Because we find that, in context, the statement was not a mate-
rial misstatement made with the intent to defraud, we affirm the dis-
trict court's dismissal of this action brought by dissatisfied former
LCI stockholders.
2
I.
Relying on the proxy statement issued to LCI shareholders in con-
nection with the merger and certain press statements, the complaint
alleges the following facts.
In October, 1997, Joseph P. Nacchio, President and CEO of Qwest,
approached H. Brian Thompson, Chairman of the Board and CEO of
LCI, at an industry trade convention and proposed that Thompson
consider a merger of the two companies. During October and Novem-
ber, Phillip F. Anschutz, Chairman of the Qwest Board, discussed
with Thompson the concept of a merger between the two companies.
Starting at the end of October, officers from the two companies
began meeting to further discuss a possible merger. On November 27,
Anschutz proposed to Thompson that Qwest and LCI begin reciprocal
due diligence and begin negotiating a merger of the two companies
in which Qwest would acquire LCI in a stock for stock merger. Even
though LCI was larger than Qwest, the market value of Qwest was
substantially higher than LCI.
On December 8, LCI Executive Vice President of LCI Joseph Law-
rence met with officers of Qwest and investment bankers representing
each party. On December 11, Nacchio sent a letter to Thompson, stat-
ing that Qwest "was prepared to begin its due diligence investigation
immediately in order to be in a position to sign a definitive merger
agreement within two weeks." This letter also stated that Qwest
would be prepared to offer each shareholder, subject to due diligence
and satisfactory negotiation of a merger agreement, $36 worth of
Qwest stock for each share of LCI stock.
The LCI Board met on December 15 to discuss the offer and con-
cluded that Qwest's offer did not merit a substantive response. On
December 16, LCI's Lawrence sent Qwest's Nacchio a letter advising
him the LCI Board had considered the offer but that "LCI was not for
sale." The letter further indicated that in order for the LCI Board to
consider a sale of LCI, an offer would have to be substantially higher
than $36 per share.
3
On February 17, 1998, LCI publicly reported its fiscal fourth quar-
ter earnings. LCI's Thompson was interviewed by the Dow Jones
News Service in connection with the earnings announcement. Thomp-
son is quoted as stating that "[w]e're not a company that's for sale."
The article also states that "[Thompson] said[that LCI] was more of
a buyer than a seller in a telecommunications industry that is rapidly
consolidating."
Two days later on February 19, LCI received another letter from
Anschutz at Qwest indicating that his company was prepared to offer
$40 worth of Qwest stock for each share of LCI stock, subject to a
due diligence investigation. As in December, Qwest stated that "it
was prepared to begin its due diligence investigation immediately in
order to sign a definitive merger agreement within two weeks." On
February 23, LCI's Board of Directors, assisted by legal counsel and
investment bankers convened via conference call to discuss the Qwest
letter. At that meeting, the LCI board directed its legal counsel to
negotiate a confidentiality agreement with Qwest pursuant to which
each party would conduct due diligence of the other; that agreement
was signed on February 26, 1998. During the next two weeks, repre-
sentatives of LCI and Qwest undertook due diligence and negotiated
the terms of the agreement.
On March 8, both Boards approved the final merger agreement.
That agreement provided that Qwest would acquire LCI in a stock for
stock merger, with LCI shareholders receiving as consideration $42
worth of Qwest stock for every share of LCI stock exchanged. At the
LCI Board meeting, Thompson voted against the merger because he
"believed that LCI could continue to prosper as an independent com-
pany under its current management." Thompson later announced that
he wished to vote in favor of the merger, and consequently changed
his vote.
After the Boards of LCI and Qwest approved the merger, the com-
panies informed the public of the agreement. On March 9, Thompson
and Qwest President Nacchio were interviewed on the Cavuto Busi-
ness Report. The executives were asked "What got the talks going?"
Nacchio stated that "We started talking a couple of months ago . . .
on a sincere basis and I guess it accelerated about three weeks ago."
Thompson immediately responded "Yes." On the same day, on CNN
4
Moneyline with Lou Dobbs, the host questioned "You have been talk-
ing to each other for how long?" Thompson replied, "Talking to each
other? It goes way back, but really in earnest for the last three or four
weeks."
On April 3, 1998, Lionel Phillips and others (collectively, the
stockholders) purportedly representing the class of LCI shareholders
that sold their stock after Thompson's February 17 statement but
before the public announcement of the merger on March 9, filed this
action against LCI and Thompson. The stockholders allege that when
on February 17, Thompson stated that LCI was "not a company that's
for sale," LCI was in fact in ongoing negotiations to be acquired by
Qwest. They maintain Thompson's statement constituted a material
misrepresentation designed to defraud the market by artificially
depressing the value of LCI stock. As proof of the falsity of Thomp-
son's statement and his intent to defraud, the stockholders cite the
post-merger interviews in which Thompson and Nacchio admitted
that the parties had been "talking" on a "sincere basis" for three or
four weeks prior to the March 9 interview. (Thompson made the state-
ment in question on February 17, exactly three weeks before the
March 9 interview.) Finally, they allege that Thompson's statement
had the effect he desired--artificially depressing the price of LCI
stock--in violation of § 10(b) of the Securities Exchange Act, 15
U.S.C.A. § 78(j)(b) (West 1997), and Rule 10b-5, 17 C.F.R.
§ 240.10b-5 (1998), and that the stockholders, based on the publicly
available information that LCI was not for sale, sold their stock at the
artificially depressed price.
The district court dismissed the stockholders' original complaint on
July 20, 1998, and their amended complaint on September 30, 1998.
The stockholders appeal.
II.
In order to prevail on a § 10(b) and a Rule 10b-5 claim, the plaintiff
carries the burden of proving:
(1) the defendant made a false statement or omission of
material fact (2) with scienter (3) upon which the plaintiff
5
justifiably relied (4) that proximately caused the plaintiff's
damages.
Hillson Partners Ltd. Partnership v. Adage, Inc. , 42 F.3d 204, 208
(4th Cir. 1994). If a reasonable investor, exercising due care, would
gather a false impression from a statement, which would influence an
investment decision, then the statement satisfies the initial element of
a § 10(b) claim. See SEC v. Texas Gulf Sulphur Co. , 401 F.2d 833,
862 (2d Cir. 1968) (en banc).
The district court held that the stockholders' complaint failed to
meet this initial requirement. First, the court concluded that Thomp-
son's statement was not false because the "merger" of LCI and Qwest
did not constitute a "sale." The court explained that a sale "is gener-
ally considered to occur when cash is tendered to shareholders in
exchange for their shares in order for one company to assume control
over the other," while a merger is "the combination of two corpora-
tions after which one of the corporations carries on the combined
business and the other ceases to exist in separate form." Because
Thompson never stated that LCI was "not due to be acquired through
a merger," the district court concluded that his statement was not
false.
In so doing, the district court looked to the definitions of sales and
mergers made in a corporate treatise. See 1 Byron E. Fox & Eleanor
M. Fox, Corporate Acquisitions and Mergers § 2.02 [3] (Supp. 1988).
Because Qwest had tendered no cash to LCI, the district court found
Qwest's acquisition of LCI for stock did not constitute a sale. There-
fore, even assuming Thompson knew LCI was actively engaged in
merger negotiations, his statement that LCI was "not for sale" was
held not to be false.
We do not believe that a violation of the securities laws should rest
on such a technical and narrow definition of "sale," particularly in
view of the stockholders' well founded allegations that LCI manage-
ment itself used "sale" as a synonym for "merger." Both the proxy
statement issued to LCI shareholders and the press reports of the
merger relating statements by LCI officers interchangeably use the
terms "sale" and "acquired by merger." Moreover, the Supreme Court
has expressly held that, for the purpose of § 10(b)'s requirement that
6
statements be made "in connection with a purchase or sale ," the term
"sale" includes an exchange of one company's stock for that of
another in the course of a merger or exchange. See SEC v. National
Sec., Inc. , 393 U.S. 453, 467-68 (1969). Indeed, a narrow definition
of "sale" would seem to run counter to the intent of the securities laws
--to protect a "reasonable investor" from fraud. See Basic v.
Levinson , 485 U.S. 224, 231 (1988). For a court to look only to a cor-
porate treatise to define an element of an allegedly fraudulent state-
ment would transform the "reasonable investor" standard to that of a
"reasonable corporate lawyer."
Nor do we find persuasive the district court's reasoning as to mate-
riality. The court held that Thompson's statement was not material as
a matter of law because "[e]very investor knows or should know that
at the right price, and under certain circumstances, any publicly-held
company can be for `sale.' Thompson's statement was not a guarantee
that LCI was not for sale." This conclusion seems to us to be a varia-
tion on the infamous statement in Flamm v. Eberstadt , 814 F.2d 1169
(7th Cir. 1987). There the court held that misstatements about merger
negotiations were immaterial as a matter of law because "[a]t the right
price, any corporation is for sale." Id. at 1179. Basic substantially
undercuts the force of such aphorisms. Although in Basic the
Supreme Court did not expressly disapprove of such rationales, it did
clearly state that the materiality of statements involving merger nego-
tiations required a "fact-specific" inquiry that "depends on the signifi-
cance the reasonable investor would place on the . .. misrepresented
information," and explicitly rejected the view adopted by the Flamm
court that merger discussions do not become material until the merger
partners have agreed in principle as to price and structure. Basic , 485
U.S. at 233-41.
Basic directs that materiality of statements as to mergers be
assessed by evaluating the probability of the merger reaching fruition
and the magnitude of the proposed merger. Id . at 238. Probability is
to be ascertained by examining "indicia of interest in the transaction
at the highest corporate levels"; magnitude is to be assessed by con-
sidering "the size of the two corporate entities and of the potential
premiums over market value." Id. at 239-40. Here the stockholders
allege high-level negotiations between named managers and directors
from both companies, involvement of investment bankers by both
7
parties, and an earlier offer by Qwest to acquire LCI for $36 per
share. Moreover, the merger resulted in a $4.4 billion merged com-
pany. Thus, it appears that allegations similar to these could, in the
appropriate case, satisfy the materiality requirement.
In sum, we do not believe the district court's rationale for dismiss-
ing this complaint withstands scrutiny.
III.
Nevertheless, we agree with the district court that the stockholders'
complaint fails to allege a misrepresentation of material fact. The
complaint rests on mischaracterizations of the public record, exagger-
ation of a single statement, and isolation of that statement from its
context and from the wealth of other information publicly available
when it was made. Of course, factual allegations must be true to pro-
vide the basis for a cause of action, see generally In re Verifone Sec.
Litig. , 11 F.3d 865, 868 (9th Cir. 1993); hyperbole and speculation
cannot give rise to a claim of securities fraud. See Biechele v. Cedar
Point, Inc. , 747 F.2d 209, 216 (6th Cir. 1984) ("Mere speculation may
not be the basis of section 10(b) liability."). Moreover, the Supreme
Court has repeatedly cautioned that allegedly fraudulent corporate
statements must be examined in context and in light of the "total mix"
of information made available to investors. Basic , 485 U.S. at 231 -32;
TSC Indus., Inc. v. Northway, Inc. , 426 U.S. 438, 449 (1976). If what
Thompson actually said here is examined in the context of all of the
information publicly available, we believe that a reasonable factfinder
could not conclude that the contested statement constitutes a material
misrepresentation.
The stockholders' essential claim, as alleged in their complaint, is
that Thompson "unequivocally and publicly stated that LCI was not
for sale," while in fact "LCI was, at the time of the statement, engaged
in serious merger negotiations with Qwest Communications Interna-
tional, and had been for some time." The allegations that the stock-
holders make to support that claim are not based on any confidential
or private information. Rather, they avow exclusive reliance on the
public record. Unfortunately, perhaps because facts in the public
record often undercut their fraud claim, they occasionally mischarac-
terize those facts.
8
The stockholders do recognize and allege that according to the
proxy statement filed with the SEC and provided to LCI stockholders
in December 1997 (two months before Thompson's assertedly fraudu-
lent February statement), LCI in fact rejected Qwest's merger offer
after some months of tentative negotiations, stating that "LCI was not
for sale." This rejection, in language identical to the February state-
ment, seems to undermine the stockholders' allegation of continuing
negotiations between LCI and Qwest. Perhaps anticipating this, the
stockholders further allege that "according to the Proxy Statement" in
the letter in which LCI rejected Qwest's December merger offer, LCI
told Qwest that "LCI would definitely consider a higher proposal
given the strategic benefits of the proposed deal." In fact the proxy
statement actually says:
. . . by letter dated December 16, 1997, Mr. Lawrence [of
LCI] advised Mr. Nacchio [of Qwest] that the LCI Board
had given careful consideration to the December 11th Let-
ter, but that LCI was not for sale. Mr. Lawrence's letter fur-
ther indicated that in order for the LCI Board to consider a
sale of LCI, an offer would have to be substantially in
excess of the value indicated in the December 11th Letter in
order to reflect LCI's long-term value. Mr. Lawrence also
noted that the December 11th Letter was vague or silent
with respect to a number of material terms, and that the LCI
Board did not believe it was in the interest of the LCI Stock-
holders to comment further at that time.
Thus, contrary to the allegations in the complaint, according to the
proxy statement, LCI's rejection letter does not mention the "strategic
benefits" of a merger with Qwest or that LCI"would definitely con-
sider a higher proposal" from Qwest.
In the paragraph immediately following this mischaracterization
and immediately prior to the description of Thompson's allegedly
fraudulent February statement, the complaint alleges that, again
"[a]ccording to the Proxy Statement, Qwest, through Anschutz,
advised LCI, in response to LCI's concern that Qwest's original offer
was too low, that Qwest was prepared to raise its $36 offer by at least
$4 to a minimum of $40 per share of LCI common stock." The stock-
holders' placement of this information in their complaint leads a
9
reader to infer that the offer to raise the share price occurred
chronologically between the initial negotiations and the February
statement; however, this inference is without support in the public
record. Rather, the proxy statement actually relates that "[b]y letter
dated February 19, 1998 [two days after issuance of the allegedly
fraudulent statement]," Qwest advised the LCI Board of Qwest's will-
ingness to up the offer to $40 per share.
Furthermore, Thompson's statement itself belies the stockholders'
contention that Thompson "publicly denied any negotiations were
ongoing," and for this reason, the statements and "facts in Basic bear
a striking resemblance to those here." Brief of Appellant at 23 and 21
n.11. The sole asserted basis for the claim of securities fraud in this
case is the purportedly fraudulent statement that: "[w]e're not a com-
pany that's for sale." That statement does not "publicly deny any
ongoing negotiations." Nor does it "resemble" the Basic statements.
In Basic , the defendant corporation issued three statements, which
said (1) the corporate officers "knew no reason for the stock's activity
and that no negotiations were underway with any company for a
merger;" (2) "management is unaware of any present or pending com-
pany development that would result in the abnormally heavy trading
activity and price fluctuation;" and (3) "we remain unaware of any
present or pending developments that would account for the high vol-
ume of trading and price fluctuations in recent months." Basic , 485
U.S. at 227 n.4. Thus in Basic , the company flatly denied any "aware-
ness" of any "developments"--present or pending--that would affect
the price or volatility of the company's stock and specifically denied
that the merger "negotiations were underway."
Similarly, in the only other case that the stockholders cite in which
shareholders of a publicly-held corporation were found to have stated
a securities fraud claim solely on the basis of asserted misrepresenta-
tions about merger negotiations, corporate officers had repeatedly
"denied the existence of any merger negotiations" and stated that they
"were not currently engaged in any" such efforts. In re Columbia Sec.
Litig. , 747 F. Supp. 237, 240 (S.D.N.Y. 1990). Thompson's "[w]e're
not a company that's for sale" statement contains no equivalent blan-
ket denial of awareness of any merger negotiations, let alone, any
explicit assertion that the company was not presently engaged in such
negotiations.
10
Nor do the remarks Thompson made in the post-merger interviews
on March 9 provide support for the stockholders' assertion that his
February "not for sale" statement was materially false like the state-
ments in Basic and Columbia . During the interviews, Thompson
acknowledged that Qwest and LCI "started talking a couple months
ago . . . on a sincere basis," which "accelerated about three weeks
ago." That account tells us nothing about the truth or materiality of
the "not for sale" statement. Although the post-merger remarks could
be consistent with a hiatus in negotiations after the December rejec-
tion and renewal of them with announcement of LCI's strong fourth
quarter earnings, if interpreted in the light most favorable to the stock-
holders, the remarks certainly could support their allegation that
merger negotiations were "ongoing" when Thompson issued his Feb-
ruary "not for sale" statement. But that is all the post-merger remarks
could do and thus they add nothing to the stockholders' case because,
for purposes of evaluating the complaint, we assume that the stock-
holders' allegation as to "ongoing" negotiations is true. The post-
merger remarks simply do not transform Thompson's February state-
ment into a flat denial of any merger negotiations like those in Basic
and Columbia .
Indeed, the stockholders themselves actually seem to recognize that
the situation here differs markedly from that in Basic and Columbia .
First, they acknowledge in their complaint that at the time of Thomp-
son's statement "the transaction had not yet been finalized and
Thompson did not and could not have known whether Qwest would
acquire LCI in exchange for cash, or Qwest common stock, or
whether the transaction would take some other form"--or, one might
add, in view of the December rejection and the yet to be performed
due diligence inquiry, whether it would go forward at all. Second, in
their reply brief, the stockholders concede that the "[w]e're not a
company that's for sale" statement was, as LCI maintains, equivalent
to stating that the company was not "in play." See Reply Brief at 1
(stating that LCI "chose to speak about whether LCI was `in play'").
A corporate officer's statement that the company was not "for sale"
or "in play" is a good deal different from that officer's express denial
of any merger negotiations.
Having stripped the stockholders' allegations of mischaracteriza-
tions and exaggeration, we focus on whether the exact statement in
11
its true context constitutes a material representation. In arguing that
it is, the stockholders do not assert that they actually relied on the
statement, but rather they maintain that it had an artificial depressive
effect on the market of LCI stock, and therefore was a fraud on the
market. See Basic , 485 U.S. at 243 -44.
Although this fraud-on-the-market theory primarily impacts
§ 10(b)'s reliance element--by eliminating any need to prove individ-
ual reliance on an assertedly false statement--the rationale behind
this theory also affects the materiality element--by "shift[ing] the
critical focus of the materiality inquiry." Shaw v. Digital Equip.
Corp. , 82 F.3d 1194, 1218 (1st Cir. 1996). Because in a fraud-on-the-
market case the "reasonable investor" for materiality purposes is not
an individual plaintiff, but the market itself, a statement cannot be
material if the hypothetical reasonable investor--that is, the market--
would not regard the statement, in context, as significant. The market
may well take a more jaundiced view of corporate statements--both
optimistic puffery and "holding pattern" statements like the one at
hand--than an individual investor. See, e.g. , id. ; Raab v. General
Physics Corp. , 4 F.3d 286, 289-90 (4th Cir. 1993) ("[T]he market
price of a share is not inflated by vague statements predicting growth
. . . . Analysts and arbitrageurs rely on facts in determining the value
of security, not mere expressions of optimism."); Glazer v. Formica
Corp. , 964 F.2d 149, 155 (2d Cir. 1992) ("The mere fact that a com-
pany has received an acquisition overture or that some discussion has
occurred will not necessarily be material.").
With this understanding in mind, we examine the other information
that was publicly available to reasonable investors at the time Thomp-
son made his February statement. We undertake this examination
because "even lies are not actionable" when an investor "possesses
information sufficient to call the [mis]representation into question."
Teamster Local 282 Pension Trust Fund v. Angelos , 762 F.2d 522,
529 (7th Cir. 1985). After all, the securities laws impose liability only
when there is a "substantial likelihood" that an alleged misrepresenta-
tion "significantly altered `the total mix' of information" a reasonable
investor (the market) possesses. TSC Indus. , 426 U.S. at 449 .
The Dow Jones article in which Thompson's "not for sale" state-
ment is reported contains a summary of much of this information. We
12
note that although the stockholders failed to attach that article to their
complaint (LCI attached it to its motion to dismiss), a court may con-
sider it in determining whether to dismiss the complaint because it
was integral to and explicitly relied on in the complaint and because
the plaintiffs do not challenge its authenticity. See Parrino v. FHP,
Inc. , 146 F.3d 699, 705-06 (9th Cir. 1998); Shaw , 82 F.3d at 1220;
Cortec Indus., Inc. v. Sum Holding L.P. , 949 F.2d 42, 48 (2nd Cir.
1991). The short article reads, in its entirety:
LCI 4Q Rev. Up 30%; Chairman Says Co. Not For Sale
--LCI
by Shaw Young
NEW YORK (Dow Jones)--After reporting fourth-
quarter earnings in line with Wall Street expectations on
revenue growth of 30%, H. Brian Thompson, Chairman and
chief executive of LCI International Inc. (LCI) on Tuesday
said his company isn't looking to grow by being bought out.
"We're not a company that's for sale," Thompson told
Dow Jones. He said the McLean, Va., long-distance com-
pany is more of a buyer than a seller in a telecommunica-
tions industry that is rapidly consolidating.
At the end of December, LCI, the nation's seventh-
biggest long-distance carrier, closed a $331.8 million
merger with USLD Communications Corp.
Including charges from the merger and other nonrecurring
items, LCI reported a pro forma fourth-quarter loss of $37
million, or 39 cents a share, on revenue of $446 million.
Year-ago pro forma earnings were $23 million, or 23 cents
a share, on revenue of $344 million.
Excluding one-time items, the company earned 26 cents
a share. On a stand alone basis, earnings were 27 cents, as
analysts surveyed by First Call Corp. had expected.
Thompson said he couldn't yet comment on analysts' pre-
dictions for upcoming quarters because those estimates
don't yet reflect the merger.
13
Goldman, Sachs & Co. analyst Richard Klugman said in
a report earlier Tuesday that he sees the company "posting
a sustainable internal growth rate of roughly 25%, a rate that
could be augmented by further EPS-accretive acquisitions,
similar to the USLD deal."
Thompson said he is very pleased with the company's
revenue growth and the 31% increase in calling traffic it
registered in the fourth quarter.
Investors, apparently satisfied with the results, boosted
the company's NYSE-listed shares 1 1/8, or 4%, to 29 1/8,
on volume of 730,000 shares. Average daily volume is
616,400 shares. The stock is just below the 52-week high of
31 7/16 set Dec. 30.
Hence the article demonstrates that reasonable investors would
know that: (1) LCI had excellent fourth quarter earnings; (2) the com-
pany was trading at very near its year high of 31 7/16 per share; (3)
the telecommunications industry was "rapidly consolidating;" (4) LCI
had closed a $ 331.8 million merger with another telecommunications
company less than two months earlier; and (5) an analyst believed
LCI's continued revenue growth was "sustainable" and could be "aug-
mented" by further acquisitions. Furthermore, reasonable stockhold-
ers would learn from this article that the author regarded Thompson's
"[w]e're not a company that's for sale statement" as an indication that
the company "wasn't looking to grow by being bought out." They
would also learn, however, that Thompson was not foreclosing further
mergers-- although he believed the company was"more a buyer than
a seller."
In none of the cases on which the parties rely, or any other case
that we have found, has a statement like that at issue here, made in
a context at all similar to this, been found to be a misstatement of
material fact. Most of the cases cited by the parties involve claims
that the corporation made statements that too optimistically reported
on corporate earnings, profits, growth, or other developments. In
those cases, the asserted misrepresentation caused the plaintiff share-
holders to buy stock at an inflated price and resulted in an immediate
loss to them when the too rosy forecasts failed to materialize and the
14
stock's price plummetted. See, e.g. , Hillson , 42 F.3d at 207; Raab , 4
F.3d at 286.
That scenario presents rather different concerns than the case at
hand in which the stockholders claim that a corporate statement artifi-
cially depressed the value of publicly traded stock. On the one hand,
"depressive" statements cannot be dismissed as mere "puffery"; on the
other hand, the effect of such statements on the market may be more
difficult to quantify than statements that are too optimistic, because,
in themselves, "depressive" statements may cause no actual gain or
loss. For example, here the stockholders make no claim the statement
caused any actual loss to them or gain to others. And although the
complaint does not reveal the price the plaintiff stockholders paid for
LCI stock, it does disclose that they sold it in late February and early
March 1998 at prices ranging from $33 5/16 to $30 per share. The
fact that the stock's 52-week high was $31 7/16 a share as of Febru-
ary 17, 1998, strongly suggests that no plaintiff lost money on the sale
of LCI stock. (The stockholders' theory apparently is that they did not
realize as much profit as they would have absent the asserted misrep-
resentation.)
Of the more than 80 cases cited by the parties only seven concern
allegations like those at issue here, that corporate statements or omis-
sions artificially depressed a stock's value. None of these cases assist
us because all involve vastly different facts, i.e., corporations flatly
denying any merger possibility, see Basic and Columbia ; or corporate
insiders allegedly conspiring to drive down the price in order to
obtain over $30 million in benefits for themselves, see Pittiglio v.
Michigan Nat'l Corp. , 906 F. Supp. 1145, 1152 (E.D. Mich. 1995);
or judicial rejection of the plaintiffs' claim because merger negotia-
tions were too tentative, see Glazer , 964 F.2d at 149; Taylor v. First
Union Corp. , 857 F.2d 240 (4th Cir. 1988); Connelly v. General Med.
Corp. , 880 F. Supp. 1100 (E.D. Va. 1995); or dismissal on other
grounds, see Goodwin v. Elkins & Co. , 730 F.2d 99 (3d Cir. 1984).
We are therefore left without any clear precedent on point. Hence,
the strength of the complaint must be resolved simply by analyzing
the contested statement in light of the relevant general legal principles
set forth above. That analysis requires the conclusion that the "[w]e're
not a company that's for sale" statement in the context in which it was
15
made--a report of high fourth quarter earnings and an almost record
price for the stock--and in view of the mix of other information avail-
able to reasonable investors--including the "rapidly consolidating"
nature of the industry and LCI's very recent merger with another
company and an analyst's opinion that LCI revenues could be aug-
mented by further acquisitions--was not a misrepresentation of mate-
rial fact.
We recognize that this is a close question. But we cannot conclude
that there is a "substantial likelihood that" this statement "signifi-
cantly altered" the "total mix" of information available to the market
as a whole. TSC Indus. , 426 U.S. at 449 . We find important the fact
that in making the statement Thompson did not deny present or future
merger negotiations as did management in Basic and Columbia .
Rather, although he maintained LCI was not "in play"--"[w]e're not
a company that's for sale"--Thompson actually indicated that there
would be mergers in the company's future; to be sure he said, accord-
ing to a reporter, that LCI was "more a buyer than a seller," but
Thompson did not foreclose the latter possibility. In an industry
known to be "rapidly consolidating," there is no substantial likelihood
that the statement, taken in its entirety, significantly altered the total
mix of information available to reasonable investors.
For these reasons, the district court correctly held that the chal-
lenged statement did not constitute a misstatement of material fact.
IV.
In addition to failing to allege a material misstatement, we believe
that the stockholders have failed to allege facts that adequately plead
scienter.
In 1995, Congress enacted the Private Securities Litigation Reform
Act (PSLRA) of 1995, Pub. L. No. 104-67 (1995) , which amended
the Securities Exchange Acts of 1933, 15 U.S.C.A. §§ 77a-77bbbb
(West 1997), and 1934, 15 U.S.C.A. §§ 78a-78lll (West 1997). The
PSLRA did not change the standard of proof a plaintiff must meet or
the kind of evidence a plaintiff must adduce to demonstrate scienter
at trial in a securities fraud case. See In re Comshare, Inc. Sec. Litig. ,
No. 97-2098, 1999 WL 460917, at *5 (6th Cir. July 8, 1999). Thus,
16
to establish scienter, a plaintiff must still prove that the defendant
acted intentionally, which may perhaps be shown by recklessness. See
Malone v. Microdyne Corp. , 26 F.3d 471 (4th Cir. 1994). But in order
to "prevent abusive and meritless lawsuits," H.R. Conf. Rep. No. 104-
369, at 31 (1995), the PSLRA does seek to heighten the standard for
pleading scienter, and so "chang[es] what a plaintiff must plead in his
complaint in order to survive a motion to dismiss." In re Comshare ,
1999 WL 460917, at *5.
The PSLRA directs that a complaint must, "with respect to each act
or omission alleged to violate the chapter, state with particularity facts
giving rise to a strong inference that defendant acted with the required
state of mind." 15 U.S.C.A. § 78u-4(b)(2). Nowhere does the PSLRA
define this "required state of mind." See In re Baesa Sec. Litig. , 969
F. Supp. 238, 240 (S.D.N.Y. 1997). Hence, although the new statute
indisputably seeks to make pleading scienter more difficult for plain-
tiffs, see Press v. Chemical Inv. Servs. Corp. , 166 F.3d 529, 537 (2d
Cir. 1999); In re FAC Realty Sec. Litig. , 990 F. Supp. 416, 421
(E.D.N.C. 1997), there is "widespread disagreement among courts as
to the proper interpretation of the PSLRA's heightened pleading
requirement." In re Silicon Graphics Inc. Sec. Litig. , Nos. 97-16204,
97-16240, 1999 WL 595194, at *1 (9th Cir. Aug. 4, 1999).
The legislative history of the PSLRA refers to the Second Circuit
standard. See H.R. Conf. Rep. No. 104-369, at 41 ("The Conference
Committee language is based in part on the pleading standard of the
Second Circuit."). That standard recognized that a plaintiff may plead
scienter by alleging specific facts that either (1) constitute circumstan-
tial evidence of conscious or reckless behavior or (2) establish a
motive to commit fraud and an opportunity to do so. See In re Time
Warner Inc. Sec. Litig. , 9 F.3d 259, 268-69 (2d Cir. 1993). Some
courts have held that the PSLRA adopted the Second Circuit's test for
pleading scienter. See Press , 100 F.3d at 537 ("The [PSLRA] height-
ened the requirement for pleading scienter to the level used by the
Second Circuit."); In re Advanta Corp. Sec. Litig. , 180 F.3d 525, 534
(3d Cir. 1999).
Other courts, however, relying on further discussion in the
PSLRA'S legislative history have interpreted the PSLRA as institut-
ing an even more stringent standard. See H.R. Conf. Rep. No. 104-
17
369, at 41 ("Because the Conference Committee intends to strengthen
existing pleading requirements, it does not intend to codify the Sec-
ond Circuit's case law interpreting the pleading standard."). For
example, in In re Comshare , the Sixth Circuit held that establishing
motive and opportunity was insufficient to satisfy PSLRA's pleading
requirement, but concluded that a plaintiff could survive a motion to
dismiss if he "alleges facts giving rise to a strong inference of reck-
lessness." 1999 WL 595194, at *5; see also In re Stratosphere Corp.
Sec. Litig. , 1 F. Supp. 2d 1096, 1106 (D. Nev. 1998); In re Baesa , 969
F. Supp. 238. The Ninth Circuit has interpreted the PSLRA still more
restrictively. In In re Silicon Graphics , the court held that in order to
plead scienter adequately a plaintiff must allege facts "that constitute
circumstantial evidence of deliberately reckless or conscious miscon-
duct." 1999 WL 446521, at *1. The court distinguished "deliberate"
recklessness from the "simple" recklessness required under the Sec-
ond Circuit test, describing the former as "facts that come closer to
demonstrating intent." Id.
We have not yet determined which pleading standard best effectu-
ates Congress's intent. Nor need we do so here because the stockhold-
ers have failed to allege facts sufficient to meet even the most lenient
standard possible under the PSLRA, the two-pronged Second Circuit
test.
First, they have failed to allege specific facts demonstrating that
Thompson's statement gave rise to a "strong inference" that LCI acted
with a reckless or conscious effort to defraud. The securities laws
generally define recklessness as an act "so highly unreasonable and
such an extreme departure from the standard of ordinary care as to
present a danger of misleading the plaintiff to the extent that the dan-
ger was either known to the defendant or so obvious that the defen-
dant must have been aware of it." Hoffman v. Estabrook & Co. , 587
F.2d 509, 517 (1st Cir. 1978) (quoting Sanders v. John Nuveen & Co. ,
554 F.2d 790, 793 (7th Cir. 1977). Mere negligence is not sufficient
to support liability. See Ernst & Ernst v. Hochfelder , 425 U.S. 185 ,
215 (1976). The "allegations of scienter must be based on a substan-
tial factual basis in order to create a `strong inference' that the defen-
dant acted with the required state of mind." Zeid v. Kimberley , 973
F. Supp. 910, 918 (N.D. Cal. 1997). When, as here, a court deter-
mines that the complaint "fails adequately to allege that defendants'
18
statements were [materially] false (affirmatively or through omis-
sions), the [c]omplaint obviously fails to allege facts constituting cir-
cumstantial evidence of reckless or conscious misbehavior on the part
of defendants in making statements." San Leandro Emergency Med.
Group Profit Sharing Plans v. Philip Morris Co., 75 F.3d 801, 813
(2d Cir. 1996); see also Zeid , 973 F. Supp. at 924 (holding that
because plaintiff failed to prove the alleged misstatements were false,
plaintiff cannot demonstrate any facts "to create an inference that
Defendants knew the statements were false").
Nor does the complaint allege sufficient specific facts of "motive
and opportunity" to defraud. Undeniably, Thompson, as Chairman
and CEO of LCI, had the opportunity to cause an artificial depression
in the price of the stock, see In re Time Warner , 9 F.3d at 269, but
his or the company's motive to make such a statement is far more
problematic. In order to demonstrate motive, a plaintiff must show
"concrete benefits that could be realized by one or more of the false
statements and wrongful nondisclosures alleged." Shields v. Citytrust
Bancorp. Inc. , 25 F.3d 1124, 1130 (2d Cir. 1994). Merely alleging
facts that lead to a "strained and tenuous inference" of motive is insuf-
ficient to satisfy the pleading requirement. Zeid , 973 F. Supp. at 923.
The stockholders allegations of Thompson's motive, as stated in
the complaint, are as follows:
Thompson has a motive to materially misrepresent the exis-
tence of negotiations with Qwest to be certain the deal
would go through. Thompson's statement served to keep
LCI's stock price depressed to ensure that in the midst of
serious merger negotiations, Qwest would not be discour-
aged from acquiring LCI. Indeed, Thompson's subsequent
single vote against the deal, which he later changed prior to
the public announcement, enabled him to bargain further
with Qwest. Qwest wanted to announce that the LCI-Qwest
deal has the unanimous approval of both companies' boards
of directors, so Thompson held back his vote in favor of the
LCI-Qwest deal until Qwest agreed to terms more favorable
to him -- such as a position for Thompson on Qwest's
board of directors, or a higher share price that would inure
to his benefit.
19
These allegations present multiple problems. First, the stockholders
have, in several respects, apparently alleged facts that misstate the
vote on the merger. They assert that Thompson cast the "single vote"
against the merger as a bargaining chip to obtain some personal bene-
fit, which Qwest gave to him to persuade him to change his vote prior
to public announcement of the merger, so that it could be announced
that the LCI board unanimously approved the merger. The proxy
statement tells a different story. (Although it was not attached to the
complaint, we can consider the proxy statement for the same reasons
we have considered the Dow Jones Article. See supra at 13.) Accord-
ing to the proxy statement, both Thompson and another director ini-
tially voted against the merger, making the board vote seven to two.
The proxy statement further reveals that only after the March 9
announcement of the merger did Thompson and the other director
change their votes. That two directors voted against the merger and
that neither changed his vote in time for the public announcement of
it would, of course, undermine the stockholders' allegation that
Thompson's vote was so vital to Qwest that he could use it to extort
some benefit for himself.
Looking beyond the stockholders' possible mischaracterizations,
the stockholders claim that Thompson's motive in issuing the chal-
lenged statement was to depress the price of LCI stock to assure the
success of the merger. This contention is, of course, totally at odds
with Thompson's initial vote against the merger. Why would Thomp-
son commit fraud to facilitate a merger to which he was opposed?
Moreover, even if we assume that Thompson's initial vote was a sub-
terfuge, designed to serve his self-interest, as the stockholders con-
tend, their allegations as to Thompson's motive for depressing the
stock--to retain a position on the corporation's board and obtain a
higher price for his stock--do not constitute or imply an adequate
motive to commit securities fraud.
Allegations that "merely charge that executives aim to prolong the
benefits they hold" are, standing alone, insufficient to demonstrate the
necessary strong inference of scienter. See Shields , 25 F.3d at 1130.
For this reason assertions that a corporate officer or director commit-
ted fraud in order to retain an executive position, or retain such a posi-
tion with the merged company, simply do not, in themselves,
adequately plead motive. See Leventhal v. Tow , 48 F. Supp. 2d 104,
20
115 (D. Conn. 1999) (allegations that "defendants artificially inflated"
stock price "to protect and enhance their executive positions and
negotiate as favorable a deal as possible in a pending employment
contract also fail to give rise to a strong inference of scienter") (inter-
nal quotation marks omitted). Similarly insufficient are allegations
that corporate officers "were motivated to defraud the public because
an inflated stock price would increase their compensation." Acito v.
IMCERA Group, Inc. , 47 F.3d 47, 54 (2d Cir. 1995); see also Melder
v. Morris , 27 F.3d 1097, 1102 (5th Cir. 1994) (accepting such allega-
tions as proof of scienter "would effectively eliminate the state of
mind requirement as to all corporate officers and defendants"). To
support a claim of motive based on the benefit a defendant derives
from an increase in the value of his holdings, a plaintiff must demon-
strate some sale of "personally-held stock" or"insider trading" by the
defendant. See Marksman Partners, L.P. v. Chantal Pharm. Corp. ,
927 F. Supp. 1297, 1312 (C.D. Cal. 1996); see also Stevelman v. Alias
Research Inc. , 174 F.3d 79, 85 (2d Cir. 1999) (holding that allega-
tions of insider trading, in combination with the timing of misrepre-
sentations, satisfied the scienter requirement); Shields , 25 F.3d at
1130. The stockholders make no allegations that Thompson engaged
in any such activity.
The rationale underlying these holdings is straightforward. Similar
situations arise in every merger; thus, allowing a plaintiff to prove a
motive to defraud by simply alleging a corporate defendant's
desire to retain his position with its attendant salary, or realize gains
on company stock, would force the directors of virtually every com-
pany to defend securities fraud actions, see Acito , 47 F.3d at 54, every
time that company effected a merger or acquisition. See Leventhal , 48
F. Supp. 2d at 115 ("This motive has been rejected routinely.").
Because the stockholders' allegations pertain to motivations common
to every corporate merger, those allegations cannot demonstrate
scienter.
Moreover, the allegations that Thompson gained some personal
benefit by depressing the price of LCI stock seems totally without
logical basis. To be sure, in certain circumstances management may
benefit from low share prices. For instance, if management is contem-
plating a leveraged buy out, see Taylor , 857 F.2d 240, or if manage-
ment is hoping to close off shareholder dissent by instituting a self-
21
tender to attract a white knight, see Pittiglio , 906 F. Supp. 1145, then
driving the price of the stock down may further their interests. But the
stockholders make no similar allegations in this case.
We recognize that Thompson could have been motivated as the
stockholders allege. A corporate officer, who owned two million
shares of stock in a corporation involved in merger negotiations,
could issue a fraudulent statement artificially depressing the stock's
price, with the hope that by doing so he could ultimately obtain a
higher price when the merger was complete. By the same token, that
officer, believing that an acquiring corporation wished to have the
unanimous support of the acquired company's board, could temporar-
ily withhold his approval of the merger in order to extort an executive
position from the acquirer, even though his vote was neither the sole
vote against the merger nor changed in time for the public announce-
ment of the merger. However, we are not called on to decide whether
the defendants' actions demonstrate a theoretically possible motive.
Rather, the PSLRA requires us to "curtail the filing of meritless law-
suits," H.R. Conf. Rep. 104-369, at 41, by allowing only those suits
which demonstrate "a strong inference of scienter" to survive a
motion to dismiss. In re Advanta , 180 F.3d at 541 (holding that plain-
tiffs' allegations "[did] not permit a strong inference of scienter"); see
also Epstein v. Itron, Inc. , 993 F. Supp. 1314, 1323 (E.D. Wash.
1998) (recognizing that the PSLRA "indicates Congress intended to
heighten . . . the quantum of the inference necessary as to defendants'
unlawful state of mind").
In determining whether the stockholders have established this req-
uisite inference, we may not accept claims of fraud based on "specu-
lation." See O'Brien v. National Property Analysts Partners , 936 F.2d
674, 676 (2d Cir. 1991) (citing Wexner v. First Manhattan Co. , 902
F.2d 169, 172 (2d Cir. 1990)). Moreover, "[o]ne who believes that
another has behaved irrationally has to make a strong case ." DiLeo
v. Ernst & Young , 901 F.2d 624, 629 (7th Cir. 1990) (emphasis
added). We are unwilling to piece together speculative inferences to
conclude that Thompson had a true motive to commit fraud. Assum-
ing, as we must, see Shields , 25 F.3d at 1130, that Thompson sought
to further his own professional and economic interests, issuing a state-
ment designed to artificially depress the value of LCI stock was not
the way any rational person, who owned two million shares of LCI,
22
would further those interests. Cf . In re Health Management, Inc. Sec.
Litig. , 970 F. Supp. 192, 204 (E.D.N.Y. 1977) (plaintiffs fail to
explain "how the desire to conclude various acquisitions by using
inflated value of the stock as consideration for mergers . . . is in the
informed economic self interest of" individual corporate officers).
Irrespective of the actual reasons for Thompson's voting behavior on
the merger, the stockholders' allegations, although hypothetically
possible, do not provide the requisite "strong inference" of fraudulent
intent required under the securities laws. See 15 U.S.C.A. § 78u-
4(b)(2). Accordingly, the complaint fails to allege specific facts suffi-
cient to demonstrate scienter.
V.
In sum, because the challenged statement, in context, does not con-
stitute a material misstatement with intent to defraud, the judgment of
the district court is
AFFIRMED .
23