Ninth circuit holds statements were material misrepresentation notwithstanding literal truth

By Cydney Posner

Miller v. Thane is a recent 9th circuit case that warrants the attention of those of us who help prepare and review disclosure documents. In Miller, the court held that, even though statements in a prospectus were literally true, they nevertheless were material misrepresentations, and the district court clearly erred in finding otherwise. So here's a case to keep in mind when reviewing language that may be true in one sense but may not accurately convey the whole story in light of all the circumstances. (And also, here's a reminder to include the forward-looking statements qualifications under the Private Securities Litigation Reform Act, which didn't seem to be raised in this case, perhaps because no legend was included.)

The case involved a public/private merger, with shares of Thane, the public company, to be issued in the merger and registered under an S-4 registration statement. The question before the court was whether Thane misrepresented to investors that it would list its shares on the Nasdaq National Market and, if so, whether those misrepresentations were material. Prior to the merger, shares of Thane were traded on the OTCBB, but Thane agreed in the merger to use commercially reasonable efforts to cause its shares, immediately after the merger, to be approved for quotation on Nasdaq. Nasdaq quotation was described in the initial filing as a condition to the merger (although that representation was omitted in the final). In April 2002, Nasdaq notified Thane that it had approved Thane’s listing application. Subsequent amendments to the S-4 stated (i) that Thane shares had been approved for quotation on Nasdaq upon completion of the merger, subject to Thane’s compliance with the minimum bid price requirements of $5.00 per share and (ii) that Thane was "expected to" satisfy the Nasdaq listing requirement and, as a result, Nasdaq listing would be one of the benefits of the merger because the stockholders would have greater liquidity for their shares. However, in April 2002, Thane’s investment bankers advised the Thane board that stockholder value would be maximized if Thane did not list its common stock on Nasdaq immediately after the merger, but instead waited until after completion of a follow-on offering, expected to be completed as early as mid-July, approximately six weeks after the merger was consummated. The merger was approved and consummated in May and, following the advice of its bankers, Thane delayed listing on Nasdaq even though its share price following the merger exceeded $5.00. But, of course (or there would be no movie here, would there?), after a scant several weeks, Thane suffered terrible reverses, started (and continued) to trade well below the $5.00 Nasdaq threshold, never listed on Nasdaq and, in 2004, went private at $0.35 per share.

The plaintiff class filed an action in the district court, alleging violations of Section 12(a)(2) of the Exchange Act for misrepresentation in connection with a securities offering, as well as control person liability against individual defendants. The district court found that the statements in the final prospectus regarding Nasdaq listing were not false or misleading because they were "literally true": they did not promise that Thane shares would actually be listed on Nasdaq, but rather represented only that the shares would be or already had been approved or qualified for Nasdaq listing, subject to satisfying the threshold price per share. The district court also found relevant the history of prior versions of the prospectus, which initially cited Nasdaq listing as a condition, but ultimately did not (with the elimination of the condition giving rise to a reasonable inference that there was no promise to list). The district court did not find the statements to be material in any event, because there was little depreciation in the share price immediately following the failure to timely list.

Under Section 12(a)(2), a successful plaintiff must demonstrate (1) an offer or sale of a security, (2) by the use of a means or instrumentality of interstate commerce, (3) by means of a prospectus or oral communication, (4) that includes an untrue statement of material fact or omits to state a material fact that is necessary to make the statement, in the light of the circumstances under which it was made, not misleading. However, a plaintiff is not required to show scienter or reliance. Recognizing that the "clear error standard" presented a "high bar," the court of appeals nevertheless held that, while the disputed statements were literally true, "literal truth is not the standard for determining whether statements in a prospectus are misleading." Instead, the court looked to the "fair and reasonable implication an ordinary investor would derive" from all the representations regarding listing and concluded that an ordinary investor could fairly and reasonably infer that, after approval, the shares would be listed on Nasdaq once the $5.00 threshold was met. The appellate court also rejected the lower court's argument that the "drafting history" should have led investors to connect the dots, concluding that investors are not required to seek out prior versions: "investors are not generally required to look beyond a given document to discover what is true and what is not." Thus, the lower court erred in imputing to investors knowledge of the earlier versions. In addition, the court emphasized the "context and manner of presentation" of the six references to Nasdaq listing, which, read in context, suggested "nothing short of actual listing on the NASDAQ." Finally, the court held that the district court erred when it considered the movement (or lack thereof) in share price of a stock that was traded on an inefficient market (like the OTCBB) to determine materiality and, therefore, its conclusion that Thane’s misrepresentations were immaterial was held to be clear error.