The First Circuit Court of Appeals recently affirmed that Section 11 of the Securities Act of 1993 (the "1933 Act") does not impose a "specific obligation" on a company to disclose in its registration statement or prospectus the material fact that, at the time of its initial public offering ("IPO"), its Chief Executive Officer and the majority of its Board of Directors held divergent views on the strategic direction the company should take. According to the Court, such omission did not render any of the company's registration statements misleading.
Individual, Inc. ("Individual") is a provider of electronic customized information services, and generates its revenue primarily through subscriptions paid by users of its services. In January 1996, Individual filed a registration statement with the Securities and Exchange Commission for its IPO, which was declared effective as of March 15, 1996. The "business model" section of the prospectus stated that Individual's future business objective was "to build the industry's leading 'open information exchange' . . . by enhanc[ing] its knowledge of processing systems and expanding its base of participants." The "use of proceeds" section of the prospectus further stated that a portion of the net proceeds from the IPO would be used for "general corporate purposes" as well as "the acquisition of businesses, services and technologies that are complementary to those of the Company."
The price of Individual's stock rose rapidly from $14 to $20 per share in the period after the IPO due to the Company's announcements of strategic alliances with Microsoft and Toshiba, as well as first quarter operating results that reflected a 233% increased in its user base. On July 24, 1996, however, Individual announced that its CEO had resigned due to a conflict he had with the Board over the Company's future business objectives. Individual's stock immediately fell 36%.
Thereafter, six common stock purchasers brought suit under Sections 11 and 15 of the 1933 Act against Individual, Inc. ("Individual"), its board members, and the underwriters who participated in Individual's March 15, 1996 IPO. Plaintiffs alleged that defendants omitted material facts in Individual's registration statement and prospectus for the IPO concerning the future objectives of the company by failing to disclose that the conflict between the CEO and the Board that was reported in July 1996 existed at the time the IPO became effective in March 1996. Specifically, the plaintiffs alleged that the registration documents revealed only the position of the majority of Individual's Board, who preferred a strategy for more moderate, organic growth by developing the company's core business, and not that of the CEO, who wanted to pursue an aggressive acquisition strategy. The United States District Court for the District of Massachusetts dismissed the complaint, finding that while the board conflict existed at the time the IPO became effective and was a material fact, the defendants had no duty to disclose it in the registration statement or prospectus.
On appeal, the First Circuit affirmed. The First Circuit initially addressed whether the uncontested fact that a board-level dispute existed in July 1996 could support the inference that the conflict existed in March 1996, when the IPO became effective. According to the Court, such a conclusion could be viewed as a "fact" for pleading purposes where "the suggested inference rises to what experience indicates is an acceptable level of probability." "Our 'experience indicates,'" the Court explained, "that Board-level conflicts, like the one that existed in July 1996, 'do not arise or disappear overnight.'" Accordingly, the Court held that a board-level conflict in March 1996 properly could be inferred from the undisputed conflict that existed in July 1996.
Next, the First Circuit affirmed that the conflict between Individual's CEO and the majority of its Board was a "material" fact. As the Court noted, the conflict could not be characterized as "obviously unimportant to a reasonable investor." Rather, the Court found that "investors would consider the existence of a board-level dispute over the strategic direction of the company important to their investment decision.
Even though the plaintiffs had identified a material omission for the purposes of surviving a motion to dismiss, the First Circuit determined that the defendants had no duty to disclose the conflict. The Court noted that although there is a "strong affirmative duty of disclosure" in the context of a public offering, "it is clear that an issuer of securities owes no absolute duty to disclose all material information." Rather, the issue is "whether the securities laws impose on defendants a 'specific obligation' to disclose information of the type that plaintiffs claim was omitted."
In this regard, the First Circuit rejected plaintiffs' contention that Section 11 imposed a "specific obligation" on the defendants to disclose the board-level conflict in order to make other statements in the "business model" and "use of proceeds" sections of the registration statements not misleading. According to the Court, disclosure of the "business model" supported by the majority of the board "did not obligate defendants also to disclose information about the extent to which each individual Board member supported that model." This was particularly true with respect to Individual's CEO, the Court noted, because he represented a "distinct minority of a multi-member board."
Similarly, the Court found that disclosure in the "use of proceeds" section of the majority's intention to use IPO proceeds for complementary acquisitions did not obligate defendants also to disclose the CEO's different views concerning the types of acquisitions Individual should pursue. The Court further observed that the Company subsequently adhered to the purpose stated in the "use of proceeds" section by following the direction of the majority of the Board.
Since the "business model" and "use of proceeds" sections were "complete and accurate" as stated, the First Circuit concluded that the omission of the board-level conflict did not render the registration statements misleading. Thus, the Court found that there was no duty to disclose the dispute under Section 11. Finally, the court upheld the District Court's dismissal of plaintiffs' Section 15 claim because there was no primary violation under Section 11. *
Cooperman v. Individual, Inc., -- F.3d. --, 1999 WL 145527 (1st Cir. Mar. 22, 1999).