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February 21, 1992


The opinion of the court was delivered by: VAUGHN R. WALKER

 This litigation arises out of the initial public offering of common stock of VeriFone, Inc. on March 13, 1990.

 The offering was underwritten on a firm commitment basis at $ 16 per share by Morgan Stanley & Co., Robertson, Stephens & Co. ("Robertson"), and Dean Witter Reynolds, Inc. ("Dean Witter"). As frequently happens, *fn1" the price of VeriFone stock jumped up on the first day of trading to substantially more than the initial offering price, closing at $ 19 1/4. *fn2" The stock price continued to climb during the spring and early summer of 1990, reaching a high of $ 25 1/4 on July 11, and then slid down during August and September, until the fourteenth of that month, a Friday, when it closed at $ 14 7/8.

 The following Monday, September 17, 1990, VeriFone issued a press release stating that its revenue growth in the second half of 1990 had fallen short of "internal expectations" and "current estimates by Wall Street analysts who have been following the Company." Declaration of Jordan Eth in Support of Defendant Verifone's Motion to Dismiss, filed April 12, 1991 ("Eth Decl."), Exh. I. The press release quoted VeriFone's CEO as stating that business in the company's "core financial market and in our rapidly expanding International markets continues to exceed our expectations, but not sufficiently to offset the shortfalls in other areas." Id. The press release announced that VeriFone had implemented cost containment measures and expansion controls in anticipation of slower revenue growth.

 On that day, the stock price declined 13.4% to close at $ 12 7/8. The stock price then dropped to $ 7 5/8 on the following day, a further decline of 40.8%. Since September 1990, the stock has made a steady recovery. During the week of June 3, 1991, the stock reached $ 19 3/4, and closed at $ 18 1/2 on June 6, 1991.

 On September 20, 1990, three days after VeriFone's press release, this litigation was initiated by the filing of a class action brought by eight of the leading law firms which specialize in securities practice, *fn3" on behalf of plaintiffs Minichino, Steen, Marchesi, and the Steinbergs. The next day, two other leading firms, *fn4" filed a class action on behalf of plaintiff Halkin. On November 8, 1990, the cases were reassigned to the undersigned. An amended consolidated complaint was filed on March 22, 1991 by all of these law firms on behalf of all plaintiffs in the Minichino and Halkin actions.

 The amended complaint alleges seven causes of action under sections 11 and 12(2) of the Securities Act, section 10(b) of the Exchange Act and Rule 10b-5 promulgated thereunder, section 20A of the Exchange Act as amended, California Corporations Code section 1507, and state law torts of fraud and negligent misrepresentation. VeriFone and some or all of ten individual officers and directors of VeriFone (collectively, "the VeriFone defendants") are named in all of the seven causes of action. Plaintiffs also name Morgan Stanley, Robertson and Dean Witter (collectively, "the underwriter defendants"), as representatives of a class of underwriters participating in the VeriFone public offering. The underwriter defendants are also named in all of the causes of action, but the underwriter class is named only in the causes of action arising under sections 11 and 12(2) of the Securities Act and section 1507 of the California Corporations Code.

 The complaint alleges that defendants are responsible for misleading statements in and omissions from (1) VeriFone's March 13, 1990 registration statement and prospectus; (2) VeriFone's Forms 10-Q for the first and second quarters of 1990, filed with the SEC in May and August 1990; (3) press releases issued by VeriFone in April and July 1990 announcing the company's first and second quarter 1990 earnings; and (4) stock analysts' reports issued by some of the underwriter defendants in April, May and July 1990. Defendants have provided the court with all of the documents in which the allegedly false and misleading statements are contained. Eth Decl., Exh. A - I.

 Finally, the complaint alleges that over 717,900 of the 3.9 million shares of VeriFone common stock in the IPO were sold by officers and directors of VeriFone while in possession of material nonpublic information, and that defendant Caufield on August 20, 1990 sold nearly 500,000 shares while in possession of material nonpublic information.

 Defendants have moved to dismiss all counts of the complaint.


 VeriFone designs and manufactures products used by retail merchants and others to automate a variety of transactions, such as authorizing credit card purchases. First Amended Consolidated Class Action Complaint ("Compl."), P5. Since its founding, VeriFone has been financially successful, earning profits in each year from 1985 to 1989. Compl., P18. For example, in the two years prior to the IPO VeriFone's revenue had grown by 65.2% (in 1988) and 68.2% (in 1989). Compl., P36.

 VeriFone's March 13, 1990 registration statement and prospectus described the company's past growth trends in revenues and earnings, included a list of its well-known customers, described markets for potential future growth, and listed other well-known companies that were evaluating VeriFone's products. The prospectus also contained a detailed discussion of "risk factors" associated with purchase of the stock. Eth Decl., Exh. A at 6-8.

 Plaintiffs contend that the risk factor discussion was uninformative boilerplate which did not disclose with sufficient detail the risks faced by holders of VeriFone stock. In particular, plaintiffs claim that the company's historic revenue growth trends had ceased and that the company was "facing a brick wall" both in the company's existing markets and in the company's attempt to finish new products and open new markets. Opposition to VeriFone's Motion to Dismiss ("Opp.") at 2.

 Plaintiffs do not allege that any statement in the prospectus is literally untrue. Instead, plaintiffs' claim is that the omission of facts known to defendants, and only to defendants, at the time of the IPO, made the true statements in the prospectus materially misleading.

 In paragraphs 21 and 41 of the complaint, plaintiffs present a most unfavorable description of VeriFone's business prospects at the time of the March 13, 1990 public offering. According to the complaint, some of VeriFone's target markets were growing slower than in the previous years; historic sales channels and core markets were showing little future potential; future growth was dependent on new markets in which VeriFone had little marketing expertise, no customers and no reasonable expectation of success; near-term future sales and growth figures would be inflated by atypically large one-time sales; and the introduction of new products was suffering from delays in development and weak customer interest. Compl., PP21, 41. In short, plaintiffs allege that VeriFone's future was to be as dim as its past had been bright.

 Plaintiffs further claim that defendants' effort to mislead the market in the manner described above continued for the six months after the March 13 IPO. In addition to the matters omitted from the prospectus, plaintiffs find the same allegedly misleading omissions, and others, in VeriFone's press releases, in VeriFone's quarterly reports filed with the SEC, and in analysts' reports prepared by Morgan Stanley and Dean Witter.

 On April 16, 1990, VeriFone issued a press release announcing its results for the quarter ending March 30, 1990. The document reported revenue and income growth, of 49% and 20% respectively, over the same period in the prior year. The press release further announced that the company was "pleased" with the continued growth and discussed the new products introduced during the quarter. Compl., P45; Eth Decl., Exh. C. However, the press release again failed to disclose the adverse information which plaintiffs assert should have been present in the March 13 prospectus. Furthermore, the press release did not explain that, according to plaintiffs, VeriFone's first quarter results were atypically "boosted" by large one-time orders. Nor did the press release provide detail showing that certain of VeriFone's markets were experiencing "flat" sales growth. Compl., P46. Not surprisingly, plaintiffs find similar fault with VeriFone's Form 10-Q for the quarter ending March 30, 1990, filed on May 14, 1990. Compl., P51; Eth Decl., Exh. E.

 VeriFone's July 17, 1990 press release, announcing results for the quarter ending June 29, 1990, also described a successful quarter. Again, revenue and net income grew in comparison to the same period in the previous year (this time, by 37% and 33%, respectively). Combining first and second quarter results, the July 17 press release calculated first-half revenue growth of 42% and income growth of 29%. Defendant Tyabji is quoted in the press release as being "pleased with the continued growth," and he discussed VeriFone's second quarter success in reaching new markets. Eth Decl., Exh. F. The content of the July 17 press release is repeated in VeriFone's Form 10-Q for the second quarter, filed August 7, 1990. Eth Decl., Exh. H.

 Again, plaintiffs find fault. Compl., PP53, 58. Neither the press release nor the Form 10-Q reported any of the information plaintiffs claim is also missing from earlier VeriFone disclosures. In addition, by this time, say plaintiffs, orders for VeriFone products had slowed, so that future revenue and income figures would be far lower than the past trend would indicate. But VeriFone did not report this decrease in new business, nor did the company project declining future earnings.

 Dean Witter issued two reports on Verifone. In May, Dean Witter made earnings growth estimates "identical to those made by Morgan Stanley," and projected earnings growth for certain of VeriFone's target markets and for the transaction automation industry as a whole. Compl., P47. This report opined that current holders of VeriFone common stock should continue to hold the stock, but cautioned potential new investors that the post-IPO "price surge" made the stock an unattractive new investment. Eth Decl., Exh. D. Dean Witter issued a further report in July, "reaffirming its earlier earnings estimates and projected growth rates, but touting even greater upside potential." Compl., P54 (emphasis in original). The July report contained the same "hold" recommendation as the May report. Eth Decl., Exh. G. Plaintiff complain that nowhere in either the May or July reports did Dean Witter discuss the information also omitted by VeriFone in its disclosures, nor did Dean Witter disclose certain technical problems experienced by VeriFone in new product development. Compl., PP49, 56. Plaintiffs further assert that Dean Witter had "no reasonable basis" for its projections. Id.

 Plaintiffs allege that the Morgan Stanley and Dean Witter reports were based on information provided by VeriFone. Compl., PP43, 48, 55. The complaint also alleges that defendants were in contact with stock market professionals, analysts, money managers, and similar members of the investment community. Compl., P60. Finally, plaintiffs allege that from March 13 to September 19, analysts, including employees of the underwriter defendants, made projections of VeriFone's financial prospects based on information from the defendants and confirmed those projections with VeriFone before publication. Compl., P61.

 Plaintiffs allege that the "truth" about VeriFone only became known after VeriFone released the September 17 press release. That disclosure, and the market's quick and negative reaction, form the basis for most of plaintiffs' causes of action.


 A. The Fraud-On-The-Market Theory.

 Defendants' liability is predicated on the "fraud-on-the-market" theory seemingly approved in principle by four justices of the Supreme Court in Basic Inc. v. Levinson, 485 U.S. 224, 99 L. Ed. 2d 194 , 108 S. Ct. 978 (1988). This theory posits that information regarding a corporation's expected future value is quickly and accurately incorporated into the price at which the corporation's securities trade in public markets. *fn6" Defendants are therefore held liable for any material misrepresentation which is proved to have caused the price of a security traded on an open and developed securities market to deviate from the security's efficient price which, under the theory, is presumed to reflect the price at which the security would have traded in the absence of the misleading information. *fn7" Id. at 246. Persons who purchase or sell the security during the period of the price deviation, and who are injured as a result, are entitled to recover from the responsible defendants without regard to whether the persons trading knew of the misrepresentation or misleading omission which caused the price deviation. In this way, the fraud-on-the-market theory dispenses with the traditional requirement of individual reliance in securities fraud cases.

 The fraud-on-the-market theory recognizes that average investors in a developed securities market do not personally need access to the elaborate disclosure of documents and accounting data required by our securities laws. *fn8" Market professionals obtain information from myriad sources, including the issuer, market analysts, and the financial and trade press. The professional traders analyze information about securities, and the trading activity of these knowledgeable investors pushes the price of the security toward a value which reflects all publicly available information. In this way, securities prices on the national exchanges reflect (albeit not perfectly) the expected future cash flows from the security. An investor making trades who has not relied on particular disclosures is presumed under the fraud-on-the-market theory to rely on the integrity of information reflected in the market price of the security. Basic Inc., 485 U.S. at 247. In this way, an investor who has never seen or heard of a fraudulent disclosure is no less a victim than one who pored over its details. *fn9"

 The fraud-on-the-market theory thus shifts the inquiry from whether an individual investor was fooled to whether the market as a whole was fooled. *fn10" Hence, the theory not so much eliminates the reliance requirement as subsumes it in the fraud-on-the-market analysis. In the same way, the theory also subsumes the inquiry into materiality, causation and damages. For if a misleading or fraudulent disclosure or omission could have had no effect on the security's market price, the information cannot have been material. Similarly, if a misstatement or omission had no effect on the market price (because, for example, the market already had the correct information from other sources) then there could be no causation and no damages. The case at bar calls upon the court to explore materiality in this context.

 The class alleged in the complaint are persons who purchased VeriFone common stock in the initial public offering on March 13, 1990 through September 18, 1990, the day following the press release. For there to be recoverable damages under the fraud-on-the-market theory, plaintiffs must allege that the prices paid by them were inflated by the difference between the efficient price of the common stock and the higher amount the class members actually paid for the stock. Of course, if defendants' alleged fraud did not inflate the price of the stock purchased by plaintiffs over that which would have prevailed had defendants fully complied with their obligations under the securities laws, then plaintiffs were not damaged and cannot recover.

 The starting point for analyzing a pleading under the fraud-on-the-market theory, therefore, is to identify the false statement or misleading omission which could have caused the stock price to deviate from its efficient price. In this case, the starting point lies in the September 17 press release. According to plaintiffs, that release disclosed to the market the true facts which, in turn, had the effect of reducing the price of VeriFone common stock from its artificially high price to its efficient price.

 It is at this point in the analysis -- the very beginning -- that plaintiffs' theory of the case begins to break down.

 B. The Duty to Disclose Forward-Looking Information.

 Plaintiffs do not allege that any of the factual statements made by the defendants are false. Instead, plaintiffs claim that the defendants omitted to disclose the information, discussed above, which would be necessary for investors to properly value VeriFone common stock. In the absence of the omitted information, say plaintiffs, the information provided by defendants to the market was misleading and caused, as the fraud-on-the-market theory suggests, a deviation between the market price of VeriFone stock and its efficient price. Plaintiffs argue, that because financial analysts measure the value of a share of stock by "the reasonable estimated future earnings" of the issuer, VeriFone and other issuers of securities perpetrate a fraud on the market when they disclose only a portion of the information which investors would find necessary to estimate future earnings. Opp. at 11.

 Contrary to plaintiffs' argument, the securities laws do not require an issuer of stock to disclose every bit of information that has some bearing on the issuer's future earnings. *fn11" As a matter of law, silence is not misleading in the absence of a duty to disclose. Basic Inc., 485 U.S. at 239 n.17. Thus, for plaintiffs to prevail on a claim that the literally truthful information provided by defendants was insufficient to prevent a fraud on the market, plaintiffs must show not only that a particular piece of information would have been helpful to investors, but also, as a threshold matter, that the information was of a kind which the defendants had a legally cognizable duty to disclose. Id. ; Alfus v. Pyramid Technology Corp., 764 F. Supp. 598, 601 (N.D. Cal. 1991) ("Alfus II").

 Plaintiffs point to three sources of a duty placed upon defendants to disclose the omitted information described in the complaint. First, plaintiffs argue that under Sections 11, 12(2), 10(b), and Rule 10b-5, defendants have a duty to reveal all information necessary to insure that statements actually made are not misleading. 15 U.S.C. § 77k, 711(2), 78j. 17 C.F.R. § 240.10b-5. Second, plaintiffs point to Regulation S-K, which the SEC promulgated to govern the drafting of registration statements, annual reports and certain other filings required by the Securities and Exchange Acts. 17 C.F.R. § 229.10(a). Item 303 of Regulation S-K requires that issuers of securities disclose trends, demands, commitments, events or uncertainties known to the issuer that are likely to affect the corporation's liquidity, net sales or revenues. 17 C.F.R. § 229.303(a)(1)-(3). Finally, plaintiffs point to the reporting and disclosure requirements which govern members of the New York Stock Exchange, the American Stock Exchange and the National Association of Securities Dealers.

 Plaintiffs assert that the failure of the defendants to disclose the adverse information identified in the complaint is actionable on the grounds that this information was necessary to prevent the literally truthful information from misleading the market. Plaintiffs describe defendants' disclosures as "half truths," Opp. at 10, which, under the guise of accurate historical] reporting, served only to mislead investors about VeriFone's likely future. Compl., P22.

 At the time of the hearing, defendants relied upon Alfus v. Pyramid Tech. Corp., 745 F. Supp. 1511 (N.D. Cal. 1990) ("Alfus I "), in which the court determined that accurate historical reporting and general statements of optimism do not imply a misleading projection of future results. Id. at 1516. Subsequent to argument, the Ninth Circuit handed down In re Convergent Technologies Securities Litigation, 948 F.2d 507, 513 (9th Cir. 1991), which, in essence, adopted Alfus I as the law of this Circuit. *fn12" See also In re Apple Computer Securities Litigation, 886 F.2d 1109, 1118-19 (9th Cir. 1989) (generally optimistic statements regarding the future are not actionable absent evidence that the corporation did not believe the statements at the time they were made). The Convergent Technologies court further held that an issuer's internal projections need not be disclosed, even if those internal projections contain more detailed information than the data publicly disclosed. 948 F.2d at 516.

 Although the Ninth Circuit did not spell out any reasoning for its holding in Convergent Technologies, the result reached is sound. Shareholders and potential investors are most in need of "hard" information, such as sales and profit data, because such information is in the exclusive control of the corporation. *fn13" Indeed, the corporation is not merely the "least cost provider" of this information, it is probably the only source of it. This information, when accurately reported, is rarely subject to misinterpretation, even if the disclosure is accompanied by generally optimistic statements about the future by corporate officers. *fn14" professional investors, and most amateur investors ...

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