The opinion of the court was delivered by: WARD
Plaintiff Securities and Exchange Commission ("SEC" or "Commission") seeks to permanently enjoin defendants Bausch & Lomb, Inc. ("BOL") and Daniel G. Schuman ("Schuman") from violating § 10(b) of the Securities Exchange Act of 1934 ("the 1934 Act"), (15 U.S.C. § 78j(b)), and Rule 10b-5 promulgated thereunder (17 CFR § 240.10b-5).
The broad anti-fraud provisions, § 10(b) of the 1934 Act and Rule 10b-5, are an essential part of American securities law. Section 10 declares it "unlawful for any person . . . (b) [to] use or employ, in connection with the purchase or sale of any security . . . any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the Commission may prescribe as necessary or appropriate in the public interest or for the protection of investors." 15 U.S.C. § 78j. Pursuant to this grant of authority, the Commission in 1942 promulgated Rule 10b-5, which reads:
"Employment of manipulative and deceptive devices.
"It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce, or of the mails, or of any facility of any national securities exchange,
"(1) To employ any device, scheme, or artifice to defraud,
"(2) To make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading, or
"(3) To engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person, in connection with the purchase or sale of any security."
Both § 10(b) and Rule 10b-5 are designed to protect the unwary from the unscrupulous. In addition, they attempt to insure that even the most sophisticated investor is not duped simply because he is not privy to information made available only to a favored few. These enactments effectuate the goals which underlie our national system of securities regulation: full disclosure and prevention of unfair practices. Speaking for the draftsmen of § 10(b), Thomas G. Corcoran stated:
"Subsection (c) [§ 9(c) of H.R. 7852 -- later § 10(b)] says, 'Thou shalt not devise any other cunning devices'. . .
"Of course subsection (c) is a catch-all clause to prevent manipulative devices. I do not think there is any objection to that kind of clause. The Commission should have the authority to deal with new manipulative devices."
Hearings on H.R. 7852 and H.R. 8720 before the House Comm. on Interstate and Foreign Commerce 73d Cong., 2d Sess., 115 (1934).
Over the course of time, these provisions have generated a great deal of litigation, and a substantial body of law has developed around them. Yet their essential nature must not be lost sight of. In a recent 10b-5 opinion, Green v. Santa Fe Industries, Inc., 533 F.2d 1283 (2d Cir. 1976), Judge Medina noted that, "[since] the time to which the memory of man runneth not to the contrary the human animal has been full of cunning and guile." Id. at 1287. Exceptional if not unique among 10b-5 cases, the instant matter involves a defendant who cannot fairly be described as a man "full of cunning and guile."
This man, nevertheless, is accused of "tipping" i.e., disclosing material inside information in violation of Rule 10b-5.
BOL, one of the country's leading manufacturers of optical products, is a publicly held corporation with its principal place of business in Rochester, New York. At the time of the events complained of and to date its stock has been traded on the New York Stock Exchange and the Pacific Coast Stock Exchange. BOL's business is divided into four product categories: Soflens; Opthalmic Products; Scientific Instruments; and Consumer Products.
Since May 1971 Schuman has been Chairman of the Board of Directors of BOL. Between 1967 and 1971 he served as Executive Vice President for finance and administration. In that position, one of his responsibilities was the firm's relations with the financial community, including securities analysts.
BOL attracted the attention of many investors in 1971 because of the commercial introduction of an exciting new product, "Soflens," a soft contact lens. After the receipt of approval of their marketing from the United States Food and Drug Administration ("FDA"), the lenses were first sold to practitioners (ophthalmologists, optometrists, and opticians) in kits each holding 72 lenses; the practitioners could later purchase more lenses in whatever quantity they chose. BOL held a series of symposia in cities throughout the country between May and November 1971 at which the Soflens was introduced to the potential professional customers.
Substantial numbers of kits were sold in 1971, and this fact was reflected in BOL's earnings for that year. The company's earnings per share of common stock by quarter in 1970 and 1971 (before earnings from a 1971 acquisition and before extraordinary income) and for the first quarter of 1972 are set forth in the following table.
1970 1971 1972
First Quarter $.36 $.27 $.68
Second Quarter $.43 $.45
Third Quarter $.39 $.61
Fourth Quarter $.35 $1.02
In the article entitled "Bausch & Lomb Estimates '71 Net Soared Higher Than Anticipated Due to Soft Lens" which appeared in the Wall Street Journal of January 19, 1972, Staff Reporter David Brand wrote what purported to be the substance of an interview with Schuman. Prior to publication the article was not seen by Schuman or any other BOL official. Brand wrote:
From Mr. Schuman's comments, it can be deduced that the lens contributed between 82 cents and $1 a share to the year's earnings; and that fourth quarter operating net rose sharply to $1.02 a share from an indicated 35 cents a year ago.
Things are going to get even better for Bausch & Lomb, Mr. Schuman hinted. Earnings for the first quarter, he predicted, "should be pretty good," when compared with the 1971 fourth quarter. And for all of 1972, "the range (of earnings) is very considerable."
The earnings impact of the soft lens in 1972, "should be very substantial," according to Mr. Schuman. This can already be seen from the effect on the second half of 1971. In the fourth quarter, the earnings impact of the lens "was more than twice that of the impact of the lens in the third quarter," Mr. Schuman said.
Schuman was unhappy with Brand's account of his "predictions" of 1972 first quarter earnings. At trial, he testified that he made no comparisons to the previous year but simply said the first quarter earnings "'should be pretty good,' period."
Analysts and the company anticipated a drop in Soflens sales in the first quarter of 1972. The symposia had concluded late in the preceding year, initial orders had been taken, and the products were being shipped. Subsequent sales would be replacements or new orders from presumably less interested practitioners who had not responded to the promotional campaign. Consumer acceptance was still a matter of speculation. Lewis A. Sanders ("Sanders"), an analyst with Sanford C. Bernstein & Co. ("Bernstein"), stated in a memorandum dated January 24, 1972, "we estimate that domestic inventory kit shipments will fall considerably in the first quarter . . . ."
A wave of adverse publicity developed about the Soflens in late 1971 and became more intense in the first quarter of 1972. Articles circulated in the press suggesting that soft contact lenses were liable to become contaminated and pose a health threat to their users. Other stories raised the spectre of FDA inquiries and the possibility of competition from other manufacturers. This "flak" reflected on the fortunes of BOL. The New York Stock Exchange ("NYSE") price of BOL dropped from $194.75 on January 28, 1972 to $145 on March 10 of that year.
On February 29, 1972, the firm of Smith, Barney & Co. withdrew its "buy" recommendation on BOL stock, citing three reasons for this action:
1. Recurrent negative publicity which questions both the safety and efficacy of soft contact lenses.
2. Periodic concern that the Food and Drug Administration (FDA) may impose restrictive regulatory controls.
3. The possibility of competition.
In the midst of the rumors about contamination, a press release was issued by BOL on March 1, 1972 stating that Soflens shipments had been halted temporarily because of a leakage problem in the shipping vials but that they would resume the following day. In fact, shipments of Soflens began again on March 10, the delay occasioned because BOL was awaiting certain test results.
BOL's own confidence in its performance waned as the year progressed. The company internally predicted earnings of $1.04 in January but lowered them to $.95 in February and again to $.74 on March 9. This last revised internal earnings forecast was received by Schuman on March 13.
Schuman had been away on vacation in Mexico during the period February 23 to March 12, 1972. During his absence, securities analysts had requested appointments to speak with him and his secretary, who did not ordinarily schedule engagements without his knowledge, had set up several interviews.
Although he had misgivings about the meetings, Schuman decided to go ahead with them rather than appear to be "ducking" the analysts and their anticipated discussions of the decline in his company's stock. Additionally, he was interested in learning what the analysts were thinking and hoped that speaking with them would help to prepare him for a planned meeting with Dan Dorfman ("Dorfman"), Dow Jones staff reporter and Wall Street Journal columnist.
Inasmuch as the events which followed form the predicate of this action, further recitation of the facts is deferred. The major incidents out of which liability is said to arise will be analyzed later in this opinion in light of the applicable law.
Corporate Communications with Securities Analysts
At the heart of this controversy is a question of the permissible scope of communications between a corporate officer and securities analysts. Analysts provide a needed service in culling and sifting available data, viewing it in light of their own knowledge of a particular industry and ultimately furnishing a distilled product in the form of reports. These analyses can then be used by both the ordinary investor and by the professional investment adviser as a basis for the decision to buy or sell a given stock. The data available to the analyst -- his raw material -- comes in part from published sources but must also come from communication with management.
Both the NYSE and the SEC have encouraged publicly traded companies to maintain an "open door" policy toward securities analysts.
In an administrative proceeding, Matter of Investors Management Co., Inc., Securities and Exchange Act Release No. 9267 (July 29, 1971) (1970-1971 Transfer Binder), CCH FED. SEC. L. REP. para. 78,163 (" Investors Management "), the Commission acknowledged the role of analysts and the potential benefit of meetings between them and corporate officials.
We appreciate the concerns that have been expressed about the need to facilitate the free flow of information throughout the financial community. We have consistently required or encouraged the broadest possible disclosure of corporate information so as to provide public investors and their professional financial advisers with the most accurate and complete factual basis upon which to make investment decisions. We also recognize that discussions between corporate management and groups of analysts which provide a forum for filling interstices in analysis, for forming a direct impression of the quality of management, or for testing the meaning of public information may be of value.
In a footnote, it also dealt with the proper way to proceed should an inadvertent leak take place.
See also Haack, Corporate Responsibility to the Investing Public, CCH FED. SEC. L. REP. para. 77,554 at 83,173: "If during the course of discussion, some important information is divulged that has not yet been published -- information which could affect the holdings or investment decision of any stockholder -- that information should be made the subject of an immediate and comprehensive news release." Id. at 80,521, n. 27.
Statements regarding the appropriate scope of conversations between securities analysts and corporate insiders had also been issued by staff and members of the SEC. Such statements were, of course, prefaced by the standard disclaimer to the effect that the Commission's policy is to abjure responsibility for private publications by its employees and that opinions so expressed are solely those of the individual authors. In the absence of official pronouncements on a topic of considerable concern, however, it ill behooves the Commission which often rightly seeks to impose liability on agency principles, to assert that remarks made by its "insiders" will not bear on how individuals attempt to conform their conduct to the law.
The available guidance, scanty as it was, suggested that corporate officials should conduct themselves reasonably and that this standard would permit general discussion out of which a skilled analyst could extract pieces of a jigsaw puzzle which would not be significant to the ordinary investor but which the analyst could add to his own fund of knowledge and use toward constructing his ultimate judgment. Discussions with analysts regarding earnings prospects, trends in products, operating conditions, and the implications on earnings of a particular volume of business were approved. Responses to "ball park" estimates were deemed proper. This, of course, assumed management was, "not trying to give their stock a little jiggle," and did not "go overboard."
This Court's jurisdiction is predicated upon § 27 of the 1934 Act (15 U.S.C. § 78aa). As an "instrumentality of interstate commerce" was used by defendants, Myzel v. Fields, 386 F.2d 718, 727 (8th Cir. 1967), cert. denied, 390 U.S. 951, 19 L. Ed. 2d 1143, 88 S. Ct. 1043 (1968), the jurisdictional reach of Rule 10b-5 is satisfied.
For purposes of an SEC enforcement proceeding seeking injunctive relief, the elements of a Rule 10b-5 violation include disclosure of material, non-public corporate information and a connection between this disclosure and the purchase or sale of a security. See SEC v. Lum's, Inc., 365 F. Supp. 1046, 1060-61 (S.D.N.Y. 1973) (" Lum's "). The level of ...