The opinion of the court was delivered by: BRIEANT
By motion filed October 14, 1983 and fully submitted for decision on November 22, 1983, defendants in this class action, brought under § 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b), Rule 10b-5 of the Securities and Exchange Commission, 17 C.F.R. § 240.10b-5, and state common law, seek summary judgment in their favor on the ground that the undisputed facts establish that no material misstatements or omissions were made, and that defendants acted without scienter. Plaintiff opposes the motion for the reasons stated below. Familiarity with all prior proceedings in this matter is assumed. The facts relevant to the instant motion are as set forth below.
According to the Amended Class Action Complaint, filed July 16, 1982, defendant Four-Phase Systems, Inc. ("Four-Phase") is the issuer of common stock which was, at the relevant time, listed and traded on the New York Stock Exchange ("NYSE"). The individual defendants are former officers and/or directors of Four-Phase. Plaintiff is suing as the representative of a class which includes all persons other than defendants who owned Four-Phase stock immediately prior to the December 2, 1981 public announcement by the issuer quoted below, and who sold the stock at any time prior to a later announcement on December 10, 1981, of a proposed merger by the issuer with Motorola ("Motorola"). (See Memorandum and Order dated Nov. 10, 1982, at 2 and 8).
On December 2, 1982 the defendants issued an announcement (the "Hodder Statement"), disseminated to the public over the Dow-Jones wire, which read as follows:
"R. Frederick Hodder, Treasurer of Four-Phase Systems said the Company is not aware of any corporate developments which would affect the market of its stock."
This statement was released following several calls to Four-Phase from Veronica Dever, a marketing representative of the NYSE, regarding a steep and sudden rise in the market price and concurrent increase in the trading volume of Four-Phase common stock. It is undisputed that on November 27, November 30 and December 1, 1981, the three trading days before December 2, 1981, Four-Phase closed on the NYSE at prices of $28, $27 5/8ths and $28 3/4ths on share volume of 27,500, 18,000 and 39,800 shares, respectively. On December 2, 1981, the price rose to $34 1/2 with a volume of 302,000 shares.
Plaintiff claims that the Hodder Statement was false and also that it contained a material omission. In essence, plaintiff seeks to establish at trial that word of then on-going merger negotiations between Four-Phase and Motorola had leaked, causing the substantial change in the volume of shares sold and the market price experienced on December 2, 1981, prior to release of the Hodder Statement, and that the market subsequently reacted adversely to Four-Phase stock and its price dropped as a result of the Hodder Statement. It is conceded that on December 8, 1981, when the NYSE halted trading, the stock closed at $32 7/8ths with a volume of 103,200 shares. On December 10, 1982, while trading was halted, Four-Phase announded that it had entered into a merger agreement with Motorola, whereby Motorola would acquire all Four-Phase stock for Motorola stock in an exchange valued at $45 per share. On December 11, 1981, when trading resumed, the closing price of Four-Phase stock was $39 1/2 with a volume of 527,900 shares.
Plaintiff pleads that the December 2nd statement was materially false and misleading, that defendants knew that a merger was under discussion with Motorola, and that they also knew that the possibility of such a merger was a favorable corporate development which could and did in fact affect the market in the stock once news of the merger negotiations leaked. Except with relation to the merger negotiations, they knew of nothing else which could have produced the market reaction. Accordingly, they knew that the Hodder Statement was false and misleading as to a meterial fact.
It is alleged further that the Hodder Statement artificially depressed the market price of Four-Phase, thus affecting the "integrity" of the market, and that in reliance on the Hodder Statement and/or the integrity of the market, plaintiff and those similarly situated sold their stock during the class period, suffering damages or a lost benefit which would have been enjoyed had they awaited the merger.
Defendants contend that in light of the information known to Four-Phase and the individual defendants on December 2, 1981, the Hodder Statement was neither a material misstatement nor a material omission, and they assert further that the same undisputed facts establish that they acted without the requisite fraudulent intent. Additionally, they argue that scienter is lacking because Four-Phase issued the release on the "advice of counsel." For these reasons, they urge that summary judgment is appropriate under Reiss v. Pan American World Airways, Inc., 711 F.2d 11 (2d Cir. 1983). A review of the events preceding the December 2nd announcement follows.
In February 1981 Four-Phase, through its president and chairman, Lee Boysel, vice-president of finance, Glen McLaughlin, and a director, Neil Brownstein, met with Frederick Frank, a managing director of Lehman Brothers Kuhn Loeb ("Lebman"), Four-Phase's investment banker, to discuss the prospects of a merger of Four-Phase into some other company as a means of financing the company's long-term capital requirements for future operations and expansion and to investigate Lehman's qualifications for representing Four-Phase in any merger investigations and negotiations. A further meeting with Lehman was held on February 20, 1981 at which Lehman presented a list of selected merger candidates, Lehman's fee arrangement was discussed, a strategy for contracting only three potential merger candidates at any one time was adopted, and a code name, "Project Sherwood," was selected for the joint effort to acquire a merger partner. Subsequent to this meeting, Four-Phase directed Lehman to proceed with Project Sherwood, a fee arrangement was agreed upon, and Lehman was engaged as the exclusive agent for the purpose of finding a purchaser or merger partner for the company.
In the Spring of 1981, lehman first contacted Motorola in connection with Project Sherwood. Written materials about Four-Phase were forwarded to Motorola, and Motorola informed Lehman that such an acquisition might be consistent with its own growth strategies. In the months that followed, Lehman also approached two other potential partners, General Dynamics and McDonnell Douglas, each of which also expressed an interest in acquiring Four-Phase. However, all acquisition plans were delayed while Four-Phase prepared for a public offering of debentures which became effective in June 1981 and it was not until August 28, 1981 that representatives of Four-Phase and Motorola met to discuss a possible merger.
At that time, Motorola presented its notice of the necessary event or stages precedent to an agreement to purchase Four-Phase. These included a thorough investigation of the company's management, a detailed evaluation of the company's business, and a careful pricing analysis of any proposed transaction. Several additional meetings among various representatives of Motorola and Four-Phase took place in September, October and November, 1981, at which the structure of the acquisition and its pricing were discussed.Also during this period, Lehman slowed down its activities with respect to the other two merger candidates, and "increasingly detailed information regarding Four-Phase, its products, its current operations, its finances, and its business projections" was provided to Motorola. (See Affidavit of Glen McLaughlin, sworn to October 13, 1983, at P5). ...