UNITED STATES DISTRICT COURT, SOUTHERN DISTRICT OF NEW YORK
November 17, 1978
Arnold B. ELKIND, Plaintiff,
LIGGETT & MYERS, INC., Defendant
The opinion of the court was delivered by: MOTLEY
Findings of Fact and Conclusions of Law
Plaintiff Arnold Elkind purchased 100 shares of Liggett & Myers, Inc. (Liggett) common stock on July 12, 1972 at $ 633/8 per share on the New York Stock Exchange. He sold these shares on December 27, 1972 at $ 381/8. He brought this class action against Liggett alleging violations of Section 10(b) of the Securities Exchange Act of 1934 (Act) (15 U.S.C. § 78j) and Rule 10b-5 (17 C.F.R. § 10b-5). Elkind is a citizen of New Jersey and Liggett is a Delaware corporation with its principal place of business in North Carolina. Liggett is one of the largest manufacturers of cigarettes. However, its business is now diversified and includes pet foods (such as Alpo), liquor, cereal, rugs and other products. This court issued an opinion on December 14, 1977 certifying as a class all those who bought Liggett stock from June 19 to July 18, 1972. As stated in that opinion, plaintiff voluntarily dismissed his complaint against the individual defendants at trial.
During the relevant time, Ralph P. Moore was Vice President and Chief Financial Officer and Daniel Provost was Director of Corporate Communications and Assistant Director of Corporate Marketing. In conjunction with its expanded business interests, Liggett employed a public relations firm, Edward Gottlieb & Associates, to help Liggett communicate with securities analysts.
In 1971 Liggett's diversified interests produced a record year. However, in 1972 Liggett's earnings dropped dramatically. In July 1972 Liggett issued a press release stating that its preliminary earnings figures for the second quarter showed a decline from the year before. The dispute in this case centers around events in June and July 1972 leading up to the issuance of the press release. The court makes the following findings of fact and conclusions of law.
Plaintiff alleges that Liggett violated Rule 10b-5 by failing to disclose the lowered earnings in June and by tipping this information. Plaintiff also contends that Liggett breached its duty not to make misleading statements by 1) failing to correct the earnings projections of financial analysts which it knew to be far too high; 2) making statements which, in light of the analysts' projections, Liggett knew would be misinterpreted; and 3) failing to issue a press release in June when it had the preliminary earning figures for April and May rather than waiting until it had preliminary figures for all of the second quarter in July. Plaintiff contends that Liggett officials acted with Scienter and that these acts caused him harm for which Liggett is liable. The court finds that plaintiff has failed to carry his burden of proving these claims by a fair preponderance of the credible evidence.
Plaintiff's second cause of action is for tipping. The court finds that plaintiff has carried his burden in this respect. He has proved that Liggett officials tipped material inside information to financial analysts. Plaintiff therefore is entitled to recover under this cause of action.
In 1971 Liggett had earnings per share of $ 4.22. This was a record high with net earnings up to 18% Over restated 1970 earnings.
In January 1972 Liggett's Board of Directors established a budget for that year which projected earnings of $ 4.30 a share. During the first half of 1972 financial analysts issued very favorable reports on Liggett's prospects for 1972. Many analysts projected a 10% Increase in earnings. Liggett's own internal budget projections showed only a 2% Increase in earnings. Many analysts submitted their reports to Liggett for review. At meeting with financial analysts, Liggett generally represented that it would have what it termed a "good year".
In March Liggett issued a press release stating that the first two months of 1972 had been good months for the company. In April Liggett offered a $ 50 million debenture issue.
On May 3, 1972, Liggett announced its figures for the first quarter of 1971, that is January through March. For this quarter, net earnings, before extraordinary credits and charges, had increased by 17% Over the first quarter of 1971. Net earnings per share, after the credits, were $ 1.00 as compared to $ .81 for the first quarter of 1971.
On May 15, the Liggett board of directors received preliminary figures for April which showed a sharp drop in earnings per share. April 1972 earnings were $ .03 per share compared to April 1971 earnings which were $ .30. Liggett issued no statement at this time. Its stock was selling at 683/4.
On June 19, the board of directors received the preliminary figures for May which showed earnings per share of $ .23, a significant revival from April's figure of $ .03 a share, but a decline from the earnings per share in May 1971 which were $ .27 a share. Earnings to that date were $ 1.26, below the earnings for the same period in 1971 of $ 1.38, but ahead of the budgeted earnings for 1972. At this time Liggett's stock sold for $ 641/2.
By July 14, Liggett stock was selling at $ 60. During the time between June 21 and July 18, the New York Stock Exchange commenced a stock watch investigation of Liggett stock. On July 17, the board of directors received the preliminary figures for June, the final month of the second quarter. Earnings for June were $ .20 a share. Earnings for the first six months of 1972 stood at $ 1.46, down from $ 1.82 for the same period in 1971. On that day, the board of directors decided to issue a press release stating the preliminary earning figures even though Liggett had never done so before. The final figures would not be available for another two weeks.
On July 18, at 2:15 p.m., Liggett issued its press release stating that earnings per share would be down from 1971. The press release explained this decline in terms of a decline in earnings of Liggett's international cigarette operations, a decline in J. & B. scotch sales during the second quarter as a result of heavy trade sales in the first quarter in anticipation of an April price increase, a decline in pet food earnings because of higher raw material prices, manufacturing start-up costs, higher costs and lower volume and losses in another subsidiary due to high recall and compliance expenses to meet F.T.C. flammability standards.
After the July 18 press release the price of Liggett stock continued to fall from approximately $ 52 a share until it bottomed out at approximately $ 40 a share on August 7. In August the price rose briefly and then declined again. Earnings for 1973 and 1974 remained depressed.
I. Failure to Correct Analyst's Projections
In the first half of 1972 financial analysts were projecting that Liggett's earnings would increase by ten per cent in 1972. At this time Liggett's internal budget projections showed that Liggett expected only a two per cent increase in earnings in 1972. It was the practice of many of these analysts to submit their reports to Liggett for review before publishing them. Liggett corrected any factual errors in the reports but refused to comment in any way on the earnings projections. Liggett stated that its policy was not to comment on incorrect opinions or projections based on correct factual data.
Plaintiff's expert witness testified that it was the custom and practice in the industry to correct analysts' earnings projections that were incorrect by a significant margin. There can be no doubt that the analysts' projections for Liggett were widely off target. Plaintiff contends that Liggett was under a legal duty to correct these projections which came to its attention. However, the Second Circuit has ruled otherwise.
In Electronic Specialty Co. v. Int'l Controls Corp., 409 F.2d 937 (2d Cir. 1969), the Second Circuit rejected the plaintiff's claim that the defendant corporation had a duty to correct erroneous factual statements appearing in a Wall Street Journal article about the defendant. It was clear that the defendant had knowledge of the article. Defendant was involved in a tender offer battle with the plaintiff which was being covered by the Wall Street Journal. The article overstated both the extent of the defendant's holdings in the plaintiff's company and the price which defendant was likely to offer for shares in plaintiff's company.
The Second Circuit stated, at 949,
"While a company may choose to correct a misstatement in the press not attributable to it, cf, SEC v. Texas Gulf Sulphur Co., 401 F.2d 833, 857-64, 866-69 (concurring opinion) (2 Cir. 1968), we find nothing in the securities legislation requiring it to do so."
In Electronic Security, supra, the Second Circuit was ruling on a claim under § 14 of the Act. The court finds the Second Circuit's reasoning in that case equally applicable to a claim under § 10(b). Hutto v. Texas Income Properties Corp., 416 F. Supp. 478, 482 (S.D.Tex.1976); Milberg v. Western Pacific Railroad Co., 51 F.R.D. 280, 282 (S.D.N.Y.1970) (no likelihood of success on similar 10b-5 claim); Zucker v. Sable, 426 F. Supp. 658, 662 (S.D.N.Y.1976) (" . . . defendants had no obligation under the securities law to correct the (press) error.") (dictum). This is not a case in which Liggett failed to correct false statements made by its underwriter, Cf. Green v. Jonhop, Inc., 358 F. Supp. 413, 420 (D.Ore.1973), or someone else closely allied with the corporation, Cf. Brennan v. United States Life Insurance Co., 417 F.2d 147 (7th Cir. 1969).
The Second Circuit's ruling in Electronic Specialty, supra, has been criticized by commentators who would place a greater duty on corporations to correct press errors. A. S. Jacobs, What is a Misleading Statement or Omission under Rule 10b-5? 42 Fordham L.Rev. 243, 259 (1973). However, this court finds itself bound by the Second Circuit ruling in Electronic Specialty, supra. Therefore, the Court finds that plaintiff has not stated a cause of action against Liggett for failure to correct speculation about its earnings.
II. Liggett's Statements as Misleading
At trial plaintiff dismissed his claim of false representations and relied solely on his claim of nondisclosure. Plaintiff also stipulated at trial that Liggett officials never stated in so many words that earnings would increase in 1972. Trial Transcript (Tr.) 493. However, in his post-trial briefs plaintiff appears to be raising this issue again.
Plaintiff contends that Liggett's statements, while not affirmatively misleading, were misleading because Liggett knew that its audience of financial analysts had predicted a 10 per cent increase in earnings for 1972. Liggett officials made only general statements that 1972 would be a "good year". Plaintiff's expert witness testified that such a statement would mean to him that Liggett expected to continue to increase earnings at the rate that it had done over the last six years. However, the court finds that this argument is, in essence, a restatement of plaintiff's claim that Liggett was under a duty to correct the analysts' earning projections. Plaintiff does not contest that Liggett officials thought that earnings would increase by 2 per cent in 1972 when they stated that 1972 would be a good year. The court finds that plaintiff has failed to prove that Liggett made misrepresentations about its financial condition. Therefore, plaintiff's claim on this ground is denied.
III. Failure to Issue a Press Release in June
Plaintiff contends that, as a matter of law, on June 19, 1972 when Liggett received the April and May preliminary earnings figures, it was under a duty to issue a press release revealing the drop in earnings. Plaintiff contends that it was deceptive of Liggett to wait until July 18 to issue a press release. Plaintiff contends that Liggett acted with Scienter in keeping silent.
The court finds that Liggett did not have a duty to disclose the April and May preliminary figures because it was reasonable of Liggett, at the time, to view the drop in earnings as only temporary and not a significant change in Liggett's condition which would require a press release. SEC v. Texas Gulf Sulphur, 401 F.2d 833 (2d Cir. 1968), Cert. denied, sub nom. Coates v. SEC, 394 U.S. 976, 89 S. Ct. 1454, 22 L. Ed. 2d 756 (1969); Financial Indus. Fund, Inc. v. McDonnell Douglas Corp., 474 F.2d 514 (10th Cir.), Cert. denied, 414 U.S. 874, 94 S. Ct. 155, 38 L. Ed. 2d 114 (1973).
It is clear that projected earnings reports would be material information to an investor. It is also clear that Liggett had reports in its possession which it did not disclose. The question for this court is whether the reports indicated, at the time, that there was such a significant decline in earnings that Liggett was under a legal duty to disclose this to investors.
Earnings for April 1972 were reported at $ .03 a share. This was a dramatic drop from the year before when April's earnings had been $ .30 a share. This was also below the budget which projected earnings of $ .24 a share. Plaintiff does not contend that Liggett was under a duty to disclose the April figures when it received them. As Liggett points out, the company had experienced earnings of only $ .01 a share in December 1971, and 1971 had been a record year for earnings.
Earnings for May 1972 were $ .23 a share. This was a significant revival from the April earnings figure at $ .03. It is true that the May 1972 figures were somewhat below the earnings reported in May 1971 of $ .27 a share. Plaintiff contends that even though the May figures showed a revival, that Liggett should have realized in June that 1972 earnings as a whole would be below 1971 earnings.
The court finds that it was reasonable for Liggett in June to believe that the May figures indicated that the earnings had rallied and that the June figures would show a continued rally from the April drop, just as Liggett had recovered from the low December, 1971 earnings per share. In June, earnings to date stood at $ 1.26 compared to a figure of $ 1.38 for the same period in 1971. However, due to Liggett's high first quarter earnings in 1972, which were up 17 per cent over 1971's first quarter, Liggett's preliminary earnings were still ahead of its budgeted earnings for the period.
It is true that in March, 1972 Liggett issued a generally worded statement that the first two months of 1972 had been good months for the company. At that point Liggett was reporting on the continuation of a trend. All the information available to Liggett at that time clearly indicated that 1972 would be a good year. In June the information available to Liggett did not point to any clear trend. Therefore, Liggett did not issue a press release until July when there was sufficient information to show that earnings were going to be down. The fact that Liggett issued a generally worded statement in March on what at that time were continuing trends did not place a legal duty on Liggett to issue specific earnings figures in June.
In July when Liggett received the June figures which showed that the June earnings had dropped back to $ .20 a share, a figure below the May rally of $ .23 a share, rather than continuing to rise, Liggett issued a press release the next day. Liggett based this release on the preliminary figures available to it rather than waiting for the final figures as it had always done in the past.
The court finds that Liggett was under no duty to disclose its April and May preliminary earnings figures in June. The court finds that Liggett's disclosure in July of preliminary figures for the second quarter satisfied any duty to disclose its financial condition to investors. Texas Gulf Sulphur, supra; Financial Indus. Fund, Inc. v. McDonnell Douglas, supra. Therefore, the court finds that plaintiff has failed to prove his claim of non-disclosure against Liggett.
Although Liggett was under no duty to disclose its preliminary earnings figures for April and May in June, tipping of such information would be a disclosure of inside material information which would violate Rule 10b-5. As the Second Circuit stated in SEC v. Texas Gulf Sulphur Co., supra, at 848,
"(T)he Rule (against tipping) is based in policy on the justifiable expectation of the securities marketplace that all investors trading on impersonal exchanges have relatively equal access to material information."
The court finds that plaintiff has proved that Liggett officials tipped material inside information, that sales of Liggett stock resulted from these tips, and that plaintiff is entitled to recover damages. Liggett is liable even though its officials were tippers who did not trade in Liggett stock themselves. Shapiro v. Merrill Lynch, Pierce, Fenner & Smith, 495 F.2d 228 (2d Cir. 1974).
The court finds that on July 10, 1972, Provost, an officer of Liggett, told Peter Barry, a financial analyst with Kuhn, Loeb, that there was trouble in various Liggett divisions and that Liggett would be taking the unprecedented step of issuing a press release about its earnings in a week or so. From this, Barry inferred that there would be an announcement of a significant decline in earnings. Barry Deposition at 34-37. Barry then sent a wire incorporating this information to Kuhn, Loeb's offices. John Sadler, a salesperson in the Chicago office, received the wire and, based on the wire, contacted several of his clients to recommend that they sell their Liggett stock.
One of Kuhn, Loeb's clients, Richard Schroeder, then sold 100 shares of Liggett stock after having been called by Sadler. There can be no doubt that the information that Liggett would issue a press release for the first time in its history outside of its regular reporting, and that Liggett was in trouble, was material information to an investor. This was not information available to the public. The court finds that this was an illegal tip of material inside information in violation of Rule 10b-5.
The court finds that on July 17, 1972, Moore, an officer of Liggett, told Robert Cummins, an analyst with Loeb, Rhodes & Co., that there was a good possibility that Liggett would show a decline in earnings for the second quarter but that such information was "confidential" until there was a public report. Cummins Deposition, at 17 Et seq. Moore did not tell Cummins that there would be a press release the next day. On the same day, July 17, Cummins sent a wire containing this information. Cummins also spoke directly with Bruce Davies, a stockbroker with Benjamin Bartlett & Co. (Bartlett) in Cincinnati, and told him that Liggett's second quarter earnings would be down. Bartlett immediately sold 1,800 shares of Liggett stock for its customers. The court finds that this was a tip of material inside information in violation of Rule 10b-5.
The court finds that the other alleged tips to analysts such as Karekin Sahagian, Lawrence Smith, Arthur Baer, the firm of Newberger & Berman and Jeffrey Weingarten were not proved by plaintiff to have involved tips of material inside information. SEC v. Bausch & Lomb, Inc., 420 F. Supp. 1226 (S.D.N.Y.1976), aff'd, 565 F.2d 8 (2d Cir. 1977). Plaintiff failed to prove that any sales resulted from the alleged tips on July 18, the day of the issuance of the press release. SEC v. Texas Gulf Sulphur, supra; SEC v. Lum's, Inc., 365 F. Supp. 1046 (S.D.N.Y.1973). Therefore, plaintiff cannot recover based on these alleged tips.
The court finds that Liggett is liable to the plaintiff class from July 11, 1972, when inside information was tipped, to July 18, 1972, when this situation was cured by public release of the same information.
As the Second Circuit stated in Shapiro v. Merrill Lynch, Pierce, Fenner & Smith, 495 F.2d 228, 237 (2d Cir. 1974),
"We hold that defendants owed a duty for the breach of which they may be held liable in this private action for damages not only to the purchasers of the actual shares sold by defendants (in the unlikely event they can be identified) but to all persons who during the same period purchased Douglas stock in the open market without knowledge of the material inside information which was in the possession of defendants."
The measure of damages is the difference between the price actually paid for Liggett stock by each member of the plaintiff class and the price at which Liggett stock would have sold if the tipped information had been publically disclosed. Texas Gulf Sulphur, supra. Plaintiff chose to use the "value" line method of damages by which a value line is calculated showing the price at which Liggett stock would have sold for each day of the damages period.
Plaintiff's expert witness, John B. Torkelsen, calculated that the price of Liggett stock would have dropped dramatically at the time of disclosure and then slowly declined until it bottomed out. Thus the value line would show a sharp drop and then a gentle downward slope. Torkelsen took into account the fluctuation of the overall market by dividing the price for Liggett common stock on the New York Stock Exchange by the Standard & Poor 500 index for each day. Torkelson calculated that if disclosure had been made on July 11 that the price of Liggett stock would have dropped from its selling price for that day, which was $ 623/4, to $ 42.77. Torkelson then testified that the price would have declined to $ 41.38 on July 18. On that day Liggett stock actually sold for $ 55. Liggett stock actually declined to $ 41 on August 7, which plaintiff contends was the "bottom-out" price. The stock continued to decline to $ 381/8 on December 27, 1972, the day on which Elkind sold his stock. See Plaintiff's Ex. 152, attached as an Appendix. Plaintiff's method of computing damages yields smaller damages that the method of using the "bottom-out" price of $ 41 as the actual value of Liggett stock of disclosure had been made. Thus, plaintiff's method of calculating damages is fairly conservative. See Green v. Occidental Petroleum Corp., 541 F.2d 1335, 1334-6 (9th Cir. 1976) (concurring opinion), for a discussion of the "value line" method of damages.
Defendants have criticized the plaintiff's calculations, but did not propose any alternate method of formulating damages. The court holds that it will award damages based on the formula proposed by plaintiff. Feit v. Leasco Data Processing Equipment Corp., 332 F. Supp. 544 (E.D.N.Y.1971).
All members of the class who purchased Liggett stock during the period July 11 to July 18, 1972 will be entitled to recover from Liggett the difference between the amount they paid for their Liggett stock, less commissions, taxes and sales charges, and the amount for which Liggett stock would have sold if Liggett had disclosed the information it tipped to analysts, as calculated by plaintiff's expert witness and embodied in Plaintiff's Exhibit 152, Appendix.
Based on the daily volume of Liggett shares sold on the New York Stock Exchange from July 11 to July 18, 1972, it can be estimated that the amount of damages recoverable by the class is approximately $ 791,000.
The court further finds that the plaintiff is entitled to prejudgment interest in order to fully compensate the class in view of the long delay since this action was commenced and the fact that the class will have to bear the cost of its attorney's fees, discovery costs and the fee of the expert witness. Chris-Craft Industries, Inc. v. Piper Aircraft Corp., 516 F.2d 172, 191 (2d Cir. 1975), rev'd on other grounds, 423 U.S. 944, 96 S. Ct. 353, 46 L. Ed. 2d 276 (1977).
The court will refer this case to a magistrate to supervise the awarding of damages to members of the class. Submit Order on notice.
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