Shaw v. Digital Equipment Corp.

United States Court of Appeals
For the First Circuit

No. 95-1995

MERRY LOU SHAW, ET AL.,

Plaintiffs, Appellants,

v.

DIGITAL EQUIPMENT CORP., ET AL.,

Defendants, Appellees.

No. 95-1996

LEONARD WILENSKY, ET AL.,

Plaintiffs, Appellants,

v.

DIGITAL EQUIPMENT CORP., ET AL.,

Defendants, Appellees.

APPEALS FROM THE UNITED STATES DISTRICT COURT

FOR THE DISTRICT OF MASSACHUSETTS

[Hon. Joseph L. Tauro, U.S. District Judge]

Before

Torruella, Chief Judge,

Cyr and Lynch, Circuit Judges.

Sanford P. Dumain, with whom David J. Bershad, James P.

Bonner, Milberg, Weiss, Bershad, Hynes & Lerach, Glen DeValerio,

Kathleen Donovan-Maher, Berman, DeValerio & Pease, Richard

Schiffrin, Schiffrin & Craig, Ltd., Joseph D. Ament, and Much,

Shelist, Freed, Denenberg, Ament, Bell & Rubenstein, P.C., were

on brief, for the Shaw appellants.

Thomas G. Shapiro, with whom Edward F. Haber, Shapiro,

Grace, Haber & Urmy, Glen DeValerio, Kathleen Donovan-Maher,

Berman, DeValerio & Pease, Fred Taylor Isquith, Peter C. Harrar,

Wolf, Haldenstein, Adler, Freeman & Herz, L.L.P., Richard

Bemporad, and Lowey, Dannenberg, Bemporad & Selinger, P.C., were

on brief, for the Wilensky appellants.

Edmund C. Case, with whom Jordan D. Hershman, Deborah S.

Birnbach, Testa, Hurwitz & Thibeault, John D. Donovan, Jr.,

Randall W. Bodner, Daniel J. Klau, and Ropes & Gray were on

brief, for the Shaw appellees.

Edmund C. Case, with whom Jordan D. Hershman, Deborah S.

Birnbach, Testa, Hurwitz & Thibeault, John D. Donovan, Jr.,

Randall W. Bodner, Daniel J. Klau, Ropes & Gray, Gerald F. Rath,

Robert A. Buhlman, Bingham, Dana & Gould, Michael J. Chepiga,

Daniel A. Shacknai, and Simpson, Thacher & Bartlett were on

brief, for the Wilensky appellees.

May 7, 1996

LYNCH, Circuit Judge. Plaintiffs, purchasers of the

securities of Digital Equipment Corp., appeal from the district

court's dismissal of two consolidated class actions alleging

violations of the federal securities laws. Both complaints

assert that there were misleading statements and nondisclosures

in the registration statement and prospectus prepared in

connection with a public offering of stock. That offering

commenced on March 21, 1994, just 11 days prior to the close of

the quarter then in progress, and about three weeks prior to

the company's announcement of an unexpectedly negative earnings

report for that quarter. One of the complaints further alleges

that defendants made fraudulently optimistic statements to the

public in the period leading up to the offering. The district

court found that neither complaint identified any statements or

omissions actionable under the securities laws and dismissed

both for failure to state a claim. We agree that many of the

alleged misstatements and omissions do not provide a legally

cognizable basis for the plaintiffs' claims, but we also

conclude that a limited set of allegations in both complaints

relating to the registration statement and prospectus for the

March 1994 offering does state a claim. We further find that

the surviving portions of the complaints satisfy the pleading

requirements of Fed. R. Civ. P. 9(b). Accordingly, we affirm

the district court's decision in part, reverse in part, and

remand for further proceedings.

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I.

Background

Digital Equipment Corporation ("DEC") is one of the

world's largest suppliers of computer hardware, software and

services. Founded in 1957, it first became a publicly held

company in 1966. By the early 1990's, the company's success

had burgeoned into $14 billion in yearly revenues. The

company's success story, however, would not last forever. By

1992, the company had fallen on hard times. In January 1992 it

reported its first-ever quarterly operating loss of $138.3

million. Faced in the ensuing months with operating losses in

the range of $30 million to $311 million per quarter, the

company decided to engage in radical surgery, cutting loose

some 35,000 employees over the course of 15 months in the

process, including its founder and CEO. To cover the costs of

these actions, the company accumulated "restructuring" charges

totalling close to $3.2 billion in fiscal years 1990-1992

combined.

In the midst of its financial woes, however, the company

took some steps to restore its health. In February 1992, DEC

had introduced a new product, the "Alpha" chip. The Alpha chip

was hailed as a technological advance that could potentially

restore the company's fortunes. In mid-1992, the company

installed a new CEO, Robert B. Palmer. He took the helm in the

fall of that year, as the company continued to implement

strategies to help its Alpha technology gain acceptance in the

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marketplace and to bring the company back to financial

vitality. At the time Palmer took over, the company had

absorbed over $3 billion in losses for the prior three years

and had been losing money at the rate of approximately $3

million per day. Under the new management, it appeared that

the company's financial hemorrhaging had finally begun to slow.

On January 14, 1993, DEC reported a loss for the second

quarter of fiscal year 1993 that was far smaller than had been

anticipated by analysts. That promising result was followed by

another quarter of losses, but within Wall Street's

expectations. Then, on July 28, 1993, the company announced

its first profitable quarter since before the 1992 fiscal year,

reporting a net profit of $113.2 million for the fourth quarter

of fiscal year 1993. That result was slightly below analysts'

expectations, but a stark improvement over the operating loss

of $188.1 million (and overall loss of $2 billion) reported for

the comparable quarter in the prior year.

Still, on October 20, 1993, DEC announced a loss of

$83.1 million for the first quarter of 1994, an improvement

over the $260.5 million loss for the same quarter the prior

year, but worse than analysts had been predicting. On January

19, 1994, the company announced another setback, reporting

losses for the second quarter of fiscal year 1994, ending

January 1, 1994, of $72 million. The loss was worse than

analysts had expected and was virtually identical to the losses

for that period the prior year.

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It was against this backdrop that DEC, on January 21,

1994, filed with the SEC a "shelf" registration statement

giving the company the option to issue up to $1 billion in

various classes of debt and equity securities. Two months

later, DEC through its underwriters conducted an offering of

$400 million in depositary shares of preferred stock, pursuant

to the "shelf" registration, a prospectus dated March 11, 1994,

and a prospectus supplement dated March 21, 1994. The offering

commenced on the date of the prospectus supplement and closed

one week later on March 28, 1994, four days before the end of

the third fiscal quarter. All 16 million depositary shares of

preferred stock were sold, at an offering price of $25. DEC

raised a badly needed $387.4 million.1

Less than three weeks later, on April 15, 1994, DEC

announced an operating loss of over $183 million for the

quarter that had ended on April 2, 1994. This third quarter

loss was far greater than analysts had been expecting, and the

largest that the company had reported since the first quarter

of fiscal 1993. It bucked the positive trend of reduced losses

under the company's new management. The announcement sent the

price of the newly distributed preferred stock tumbling from

the offering price of $25 to $20.875 by the close of trading on

April 15. The common stock fell from $28.875 to $23 during the

1. Because the offering was conducted pursuant to a "firm
commitment" underwriting arrangement, DEC sold all of the
offered shares to the underwriters at a discount, who then in
turn sold the shares to the public. Thus, DEC's proceeds were
less than the total offering amount.

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same period, and to $21.125 by the close of the next trading

day.

In its April 15 announcement, the company also disclosed

that it had decided to "accelerate [its] on-going restructuring

efforts" and "also consider further restructuring." This was

despite a representation in the March 21 prospectus supplement

that "[t]he Corporation believes that the remaining

restructuring reserve of $443 million is adequate to cover

presently planned restructuring actions." Eventually,

following the close of fiscal year 1994, DEC announced on July

14, 1994 that it would cut almost one-fourth of its remaining

workforce and take an additional charge of $1.2 billion for

fiscal year 1994 (beyond the $443 million remaining in reserve

as of March 21) to cover the costs of additional restructuring

activities.

II.

Description of the Actions

These two lawsuits were filed on Tuesday, April 19,

1994, two business days after the company's announcement of

April 15, 1994. One, the Wilensky action, brought on behalf of

all persons who purchased shares in the March 1994 public

offering, asserts claims under Sections 11, 12(2), and 15 of

the Securities Act of 1933 ("Securities Act") against DEC, its

Chief Executive Officer (Robert B. Palmer), its Chief Financial

Officer (William Steul), and seven underwriting or investment

banking firms, representing a purported defendant class of 65

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underwriters who participated in the offering. The second, the

Shaw action, advances claims under Sections 10(b) and 20(a) of

the Securities Exchange Act of 1934 ("Exchange Act") and Rule

10b-5, and a pendent claim of common law negligent

misrepresentation, on behalf of all purchasers of DEC common

stock between January 19 and April 15, 1994 (the "Class

Period").

At the heart of both complaints are two sets of claims.

First, plaintiffs assert that DEC management had knowledge of

material facts concerning the large losses developing during

the third fiscal quarter of 1994, and that the defendants were

under a duty to disclose such material information to the

market in connection with the public offering conducted on

March 21, 1994. Second, both the Wilensky and Shaw plaintiffs

contend that the representation made in the March 21 prospectus

supplement concerning the "adequacy" of the then-remaining

"restructuring reserve" was materially misleading. The Shaw

plaintiffs allege, additionally, that throughout the Class

Period, the defendants made fraudulently optimistic statements

to the public concerning DEC's future prospects in order

artificially to inflate the market value of DEC shares, and

that these statements were actionably false or misleading.

The defendants filed motions to dismiss under Fed. R.

Civ. P. 9(b) and 12(b)(6). The district court consolidated the

cases, stayed all discovery, and then dismissed both actions.

The district court ruled, inter alia, that defendants had

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violated no duty to disclose and that the defendants'

statements were not misleading, bespoke caution, or were

otherwise not actionable as a matter of law. The court granted

the defendants' motions to dismiss under Rule 12(b)(6), without

reaching whether the complaints satisfied the pleading

requirements of Rule 9(b). These appeals followed. We affirm

in part and reverse in part. For clarity, we discuss each of

the two actions in turn.

III.

The Section 11 and 12(2) Claims

(Wilensky Action)

Sections 11 and 12(2) are enforcement mechanisms for the

mandatory disclosure requirements of the Securities Act of

1933. Section 11 imposes liability on signers of a

registration statement, and on underwriters, if the

registration statement "contained an untrue statement of a

material fact or omitted to state a material fact required to

be stated therein or necessary to make the statements therein

not misleading." 15 U.S.C. 77k. Section 12(2) provides that

any person who "offers or sells" a security by means of a

prospectus or oral communication containing a materially false

statement or that "omits to state a material fact necessary to

make the statements, in the light of the circumstances under

which they were made, not misleading," shall be liable to any

"person purchasing such security from him." 15 U.S.C.

77l(2).

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The Wilensky plaintiffs assert claims under Sections 11,

12(2), and 15,2 alleging that the registration statement and

prospectus filed in connection with the March 1994 public

offering contained materially false statements and omitted to

state material information required to be provided therein.

The thrust of the Wilensky complaint is that defendants knew as

of the March 21 date of the 1994 public offering, of material

facts portending the unexpectedly large losses for the third

quarter of fiscal 1994 that were announced later, and that

failure to disclose these material facts in the registration

statement and prospectus violated Section 11. Additionally,

the Wilensky plaintiffs contend that the statement in the

registration statement and prospectus characterizing as

"adequate" the company's then-remaining "restructuring reserve"

of $443 million was materially false and misleading, in

violation of both Sections 11 and 12.

The defendants parry by attempting to reduce plaintiffs'

claims to an argument that the company was required to disclose

its internal forecasts about the outcome of the third quarter.

They argue that the plaintiffs' position is untenable because

the securities laws impose no duty upon a company to disclose

internal projections, estimates of quarterly results, or other

forward-looking information. They also say that the statement

concerning the adequacy of the company's restructuring reserves

2. Section 15 imposes derivative liability upon persons who
"control" those liable under Section 11 or 12. See 15 U.S.C.

77o.

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is not actionably misleading when considered in context.

Finally, defendants contend that the complaint fails to allege

sufficient facts establishing that DEC and the underwriter

defendants were statutory "sellers" subject to liability under

Section 12(2). We evaluate each set of arguments separately.

A. Actionability of Alleged Nondisclosures Under Section 11

The proposition that silence, absent a duty to disclose,

cannot be actionably misleading, is a fixture in federal

securities law. See, e.g., Backman v. Polaroid Corp., 910 F.2d

10, 13 (1st Cir. 1990) (en banc). Equally settled is that

accurate reports of past successes do not themselves give rise

to a duty to inform the market whenever present circumstances

suggest that the future may bring a turn for the worse. See

Serabian v. Amoskeag Bank Shares, Inc., 24 F.3d 357, 361 (1st

Cir. 1994); Capri Optics Profit Sharing v. Digital Equip.

Corp., 950 F.2d 5, 7-8 (1st Cir. 1991). In short, the mere

possession of material nonpublic information does not create a

duty to disclose it. See Roeder v. Alpha Indus., Inc., 814

F.2d 22, 26 (1st Cir. 1987) (citing Chiarella v. United States,

445 U.S. 222, 235 (1980)).

To focus here on a duty to disclose in the abstract,

however, would be to miss the obvious in favor of the obscure.

This action arises out of an allegedly defective registration

statement and prospectus filed in connection with a public

stock offering. The obligations that attend the preparation of

those filings embody nothing if not an affirmative duty to

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disclose a broad range of material information. Cf. Herman &

MacLean v. Huddleston, 459 U.S. 375, 381-82 (1983). Indeed, in

the context of a public offering, there is a strong affirmative

duty of disclosure.3 See Ernst & Ernst v. Hochfelder, 425

U.S. 185, 195 (1976) (the Securities Act "was designed to

provide investors with full disclosure of material information

concerning public offerings").

The question here is not whether defendants were under

an abstract duty to disclose information -- clearly, they were.

The issue, rather, is whether the defendants had a specific

obligation to disclose information of the type that the

plaintiffs complain was omitted from the registration statement

and prospectus. The task of deciding whether particular

information is subject to mandatory disclosure is not easily

separable from normative judgments about the kinds of

information that the securities laws should require to be

disclosed, which depend, in essence, on conceptions of

materiality. See generally Victor Brudney, A Note On

3. In Roeder, this court alluded to three situations that

could give rise to a duty to disclose material facts: (i) when
an insider trades in the company's securities on the basis of
material nonpublic information; (ii) when a statute or
regulation requires disclosure; and (iii) when the company has
previously made a statement of material fact that is false,
inaccurate, incomplete, or misleading in light of the
undisclosed information. Roeder, 814 F.2d at 27; see also In

re Time Warner, Inc. Sec. Litig., 9 F.3d 259, 267 (2d Cir.

1993), cert. denied, 114 S. Ct. 1397 (1994); Backman, 910 F.2d

at 12-13; Greenfield v. Heublein, Inc., 742 F.2d 751, 758 (3d

Cir. 1984), cert. denied, 469 U.S. 1215 (1985). We do not

decide here whether these three situations are the only ones
that could trigger a duty of disclosure, or whether they
necessarily would do so in every case.

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Materiality and Soft Information Under the Federal Securities

Laws, 75 Va. L. Rev. 723, 728 (1989). For our purposes, it

suffices to say that the determination of whether the alleged

nondisclosures in this case provide a legally sufficient basis

for the plaintiffs' claims cannot be severed from consideration

of the basic policies underlying the disclosure obligations of

the applicable statutes and regulations.

We conclude that we cannot say that DEC was not required

to disclose material information concerning its performance in

the quarter in progress at the time of the March 21, 1994

public offering. Nor can we conclude, as a matter of law and

on these pleadings, that DEC was not in possession of such

material nonpublic information at the time of the offering.

1. The Insider Trading Analogy

In understanding the nature of the disclosure

requirements attending a public offering of stock, it is

helpful to conceptualize DEC (the corporate issuer) as an

individual insider transacting in the company's securities, and

to examine the disclosure obligations that would then arise.

There is no doubt that an individual corporate insider

in possession of material nonpublic information is prohibited

by the federal securities laws from trading on that information

unless he makes public disclosure. He must disclose or abstain

from trading. See SEC v. Texas Gulf Sulphur Co., 401 F.2d 833,

848 (2d Cir. 1968) (en banc), cert. denied, 394 U.S. 976

(1969); see also SEC v. MacDonald, 699 F.2d 47, 50 (1st Cir.

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1983) (en banc). A central justification for the "disclose or

abstain" rule is to deny corporate insiders the opportunity to

profit from the inherent trading advantage they have over the

rest of the contemporaneously trading market by reason of their

superior access to information. See Shapiro v. Merrill Lynch,

Pierce, Fenner & Smith, Inc., 495 F.2d 228, 235 (2d Cir. 1974);

SEC v. Texas Gulf Sulphur Co., 401 F.2d 833, 848 (2d Cir. 1968)

(en banc).4 The rule eliminates both the incentives that

insiders would otherwise have to delay the disclosure of

material information, and minimizes any efficiency losses

associated with the diversion of resources by insiders to

"beating the market." See Robert C. Clark, Corporate Law

8.2, at 273-75 (1986); Frank H. Easterbrook & Daniel R.

Fischel, The Economic Structure of Corporate Law 288 (1991)

("The lure of trading profits may induce people to spend a lot

of effort and other resources "beating the market"; . . . [T]he

prompt disclosure of information by the affected firm will

extinguish the trading opportunity. When everyone knows the

truth, no one can speculate on it."5).

4. See also Brudney, supra, at 735 (noting that the other

major justification for requiring trading insiders to disclose
is to increase the quality and quantity of information
available to investors, thereby facilitating efficiency in the
allocation of capital).

5. Judge Easterbrook and Professor Fischel ultimately reject
this beating-the-market concern as a justification for
mandatory disclosure. They argue that companies normally will

voluntarily disclose material bad news, because, among other
reasons, if a company consistently fails to make such
disclosure, the market will discount the value of the company's
securities by the increased probability that it is in

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The policy rationale for the "disclose or abstain" rule

carries over to contexts where a corporate issuer, as opposed

to an individual, is the party contemplating a stock

transaction. Courts, including this one, have treated a

corporation trading in its own securities as an "insider" for

purposes of the "disclose or abstain" rule. See, e.g.,

McCormick v. Fund American Cos., Inc., 26 F.3d 869, 876 (9th

Cir. 1994) (collecting cases) ("[T]he corporate issuer in

possession of material nonpublic information, must, like other

insiders in the same situation, disclose that information to

its shareholders or refrain from trading with them."); Rogen v.

Ilikon Corp., 361 F.2d 260, 268 (1st Cir. 1966); Kohler v.

Kohler Co., 319 F.2d 634, 638 (7th Cir. 1963); Green v.

Hamilton Int'l Corp., 437 F. Supp. 723, 728-29 (S.D.N.Y. 1977);

VII Louis Loss & Joel Seligman, Securities Regulation 1505 (3d

ed. 1991) ("When the issuer itself wants to buy or sell its own

securities, it has a choice: desist or disclose."); 18 Donald

C. Langevoort, Insider Trading: Regulation, Enforcement &

Prevention 3.02[1][d], at 5 (3d rel. 1994) ("Issuers

themselves may buy or sell their own securities, and have long

possession of undisclosed material negative information,
thereby increasing the company's long-run costs of raising
capital. Id. at 288-89. However, as the authors also

recognize, the argument for voluntary disclosure becomes
considerably weaker in contexts where the short-term interests
of the company's managers differ from its long-term interests,
for example, where management is under pressure to engineer a
rapid turnaround in the company's financial performance. See

id. at 169 (discussing the "agency" problem in the context of

tender offers).

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been held to an obligation of full disclosure . . . .

Conceptually, extending the insider trading prohibition to

instances of issuer insider trading makes perfect sense.").

Just as an individual insider with material nonpublic

information about pending merger or license negotiations could

not purchase his company's securities without making

disclosure, the company itself may not engage in such a

purchase of its own stock, if it is in possession of such

undisclosed information. See, e.g., Rogen, 361 F.2d at 268.

By extension, a comparable rule should apply to issuers engaged

in a stock offering. Otherwise, a corporate issuer selling its

own securities would be left free to exploit its informational

trading advantage, at the expense of investors, by delaying

disclosure of material nonpublic negative news until after

completion of the offering. Cf. Ian Ayres, Back to Basics:

Regulating How Corporations Speak to the Market, 77 Va. L. Rev.

945, 959-60 (1991) (describing the argument that securities

laws impose needed discipline, because companies do not always

internalize the costs of failing to provide the market with

accurate information that would lower stock prices).

2. The Statutory and Regulatory Scheme

Analogizing a corporate issuer to an individual insider

subject to the "disclose or abstain" rule of insider trading

law illustrates the policy reasons supporting a comparably

strong disclosure mechanism in the context of a public

offering. We look to the explicit statutory and regulatory

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framework to determine whether the Securities Act provides such

a mechanism, and whether the Wilensky complaint states a

legally cognizable claim for nondisclosure under Section 11.

Section 11 by its terms provides for the imposition of

liability if a registration statement, as of its effective

date: (1) "contained an untrue statement of material fact"; (2)

"omitted to state a material fact required to be stated

therein"; or (3) omitted to state a material fact "necessary to

make the statements therein not misleading." 15 U.S.C.

77k(a). The plaintiffs' claim of nondisclosure relies on the

second of these three bases of liability. That predicate is

unique to Section 11; neither Section 12(2) of the Securities

Act nor Section 10(b) or Rule 10b-5 under the Exchange Act

contains comparable language. It is intended to ensure that

issuers, under pain of civil liability, not cut corners in

preparing registration statements and that they disclose all

material information required by the applicable statutes and

regulations. See Huddleston, 459 U.S. at 381-82; Harold S.

Bloomenthal et al., Securities Law Handbook 14.08, at 663

(1996 ed.) ("Congress . . . devised Section 11 of the

Securities Act as an in terrorem remedy that would . . .

encourage careful preparation of the registration statement and

prospectus.").

The information "required to be stated" in a

registration statement is spelled out both in Schedule A to

Section 7(a)of the Securities Act, 15 U.S.C. 77g(a), 77aa,

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and in various regulations promulgated by the SEC pursuant to

its statutory authority.6 Those rules and regulations are no

less essential to the statutory scheme than the general

outlines of the statute itself. Cf. Touche Ross & Co. v. SEC,

609 F.2d 570, 580 (2d Cir. 1979).

In this case, DEC conducted its March 1994 public

offering pursuant to a registration statement on SEC Form S-3.

Item 11(a) of the instructions to Form S-37 requires that the

issuer (registrant) describe in the portion of the registration

statement comprising the prospectus:

any and all material changes in the registrant's

affairs which have occurred since the end of the

latest fiscal year for which certified financial
statements were included in the latest annual
report to security holders and which have not
been described in a report on Form 10-Q or Form
8-K filed under the Exchange Act.

Instructions to Form S-3, Item 11(a) (emphasis added).

To understand the scope of the "material changes"

disclosure requirement, it is helpful to understand the nature

6. Section 7(a) of the Securities Act provides that the
"registration statement shall contain such other information,
and be accompanied by such other documents, as the Commission
may by rules or regulations require as being necessary or
appropriate in the public interest or for the protection of
investors." 15 U.S.C. 77g(a); see also 15 U.S.C. 77j(d)

(granting SEC similar authority with respect to prospectuses);
15 U.S.C. 77s(a) (granting SEC broad authority to "make,
amend, and rescind such rules and regulations as may be
necessary to carry out the provisions of this [Act], including
rules and regulations governing registration statements and
prospectuses").

7. The provisions of the registration forms prescribed by the
SEC constitute an integral part of the regulatory disclosure
framework. See 17 C.F.R. 230.400, 230.401, 239.0-1 et seq.

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of Form S-3. Form S-3 is a streamlined registration form

available only to certain well-capitalized and widely followed

issuers about which a significant amount of public information

is already available.8 A registrant on Form S-3 accomplishes

disclosure in part by incorporating in the prospectus by

reference its most recent Form 10-K and Forms 10-Q filed

pursuant to the Exchange Act. See Instructions to Form S-3,

Item 12(a). Unlike registrants on more broadly available forms

(such as S-1), a Form S-3 registrant is not required separately

to furnish in the prospectus the information required by Item

303(a) of Regulation S-K, 17 C.F.R. 229.303(a) ("Management's

discussion and analysis of financial condition and results of

operations"),9 because that information is presumed to be

contained in the Exchange Act filings that Form S-3

incorporates by reference, which are themselves subject to the

requirements of Regulation S-K.10 The primary purpose of the

8. To be eligible to register on Form S-3, an issuer must have
been subject to public reporting requirements for at least one
year, filed all reports required under the Exchange Act (such
as Forms 10-Q and 10-K) timely during the past year, and must
meet certain other requirements relating to financial strength
and stability. See 17 C.F.R. 239.13; see also Bloomenthal et

al., supra, 5.05[1][b], at 212-13.

9. Item 303(a) requires the disclosure, among other
information, of "any known trends or uncertainties that have
had or that the registrant reasonably expects will have a
material favorable or unfavorable impact on net sales or
revenues or income from continuing operations." 17 C.F.R.
229.303(a)(3)(ii).

10. By contrast, a registrant on Form S-1 (which does not
permit incorporation by reference) must independently furnish
in the prospectus the information required by Item 303 of
Regulation S-K. See Instructions to Form S-1, Item 11(h).

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"material changes" disclosure requirement of Item 11(a), then,

is to ensure that the prospectus provides investors with an

update of the information required to be disclosed in the

incorporated Exchange Act filings, including the information

provided in those filings concerning "known trends and

uncertainties" with respect to "net sales or revenues or income

from continuing operations." 17 C.F.R. 229.303(a)(3)(ii).

In this case, the date of the final prospectus for the

March 1994 offering and the effective date of the registration

statement was March 21, 1994.11 Prior to that date, the end

of DEC's latest fiscal year was July 3, 1993 (fiscal year

1993), and the last Form 10-Q filed by the company was for the

quarter that had ended on January 1, 1994 (DEC's second fiscal

quarter). The question, then, is whether the complaint

contains sufficient allegations that defendants failed to

disclose in the registration statement any information

regarding "material changes" in DEC's "affairs" as of March 21,

1994, that had occurred since July 3, 1993 and had not been

reported in the Form 10-Q filed for the second quarter of

fiscal year 1994. If the Wilensky complaint adequately so

alleges, then the complaint sets forth a cognizable claim of

nondisclosure under Section 11, namely, that defendants failed

11. The effective date of the registration statement for
purposes of Securities Act liability is the "speaking date" of
the final prospectus. See Bloomenthal et al., supra,

5.05[2][f] at 216. The parties do not dispute that March 21,
1994 was the effective date of the registration statement.

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to include in the registration statement information "required

to be stated therein."

3. The Alleged Nondisclosures

Plaintiffs argue that defendants failed to comply with

Item 11(a) by omitting three categories of information from the

registration statement and prospectus. First, plaintiffs

contend that defendants failed to disclose that DEC had

embarked on a risky marketing strategy that involved slashing

prices and sacrificing profit margins in the hopes of

increasing "market penetration" of the company's Alpha chip

products. Second, plaintiffs assert that defendants failed to

disclose that under the company's compensation scheme, its

sales representatives were being paid "double commissions,"

again to the detriment of the company's profit margins. Third,

and most centrally, plaintiffs allege that, by the date of the

March 21 offering, defendants were in possession of, yet failed

to disclose, material knowledge of facts indicating that the

third fiscal quarter would be an unexpectedly disastrous one.

We dispose of the first two claims of nondisclosure, and then

focus our discussion on the third.

a. Marketing Strategy

The defendants provide a decisive rejoinder to the

plaintiffs' claim of nondisclosure concerning the "marketing

strategy": the relevant aspects and consequences of the

strategy were in fact prominently disclosed, both in the text

-21-

of the prospectus and in documents incorporated by

reference.12 For example, in its Form 10-Q filing for the

quarter ending October 2, 1993 (the first quarter of fiscal

year 1994), the company explained its reported decline in gross

profit margins as follows:13

The decline in product gross margin resulted from
the decrease in product sales, a continued shift
in the mix of product sales toward low-end
systems which typically carry lower margins,
competitive pricing pressures and unfavorable
currency fluctuations, partially offset by
manufacturing cost efficiencies.

The Corporation has adopted an aggressive,
competitive price structure for its Alpha AXP
systems. Given this pricing, as well as the
factors described in the preceding paragraph, the
Corporation expects to experience continued
downward pressure on product gross margins.

This statement, in conjunction with related disclosures found

elsewhere in the prospectus and incorporated filings relating

to "competitive pricing pressures," declining gross profit

margins, "competitive pricing actions taken by the

Corporation," an "industry trend toward lower product gross

12. As required by Item 12 of the instructions to Form S-3,
the March 11, 1994 prospectus specifically incorporated by
reference the company's Form 10-K filing for fiscal year 1993
(as amended by Form 10-K/A dated March 11, 1994), and its Form
10-Q filings for the quarterly periods that ended on October 2,
1993 and January 1, 1994.

13. Since the complaint alleges nondisclosures in the
registration statement and prospectus, the court may look to
the text of those materials and the incorporated SEC filings to
determine whether the plaintiffs' allegations are well founded.
See Kramer v. Time Warner, Inc., 937 F.2d 767, 774 (2d Cir.

1991). We discuss more fully later the circumstances in which
a court may look outside the four corners of a complaint in
deciding a motion to dismiss.

-22-

margins," and "persistent intense pricing competition,"

together obviate the plaintiffs' claim that defendants failed

to disclose the company's adoption of a price-cutting strategy

to boost the "market penetration" of its Alpha-based systems.

b. "Double Commissions"

The plaintiffs' claim of a failure to disclose "double

commissions" also fails to make out a Section 11 violation. To

the extent that the claim comprises allegations of

mismanagement,14 it is not cognizable under the securities

laws. See Santa Fe Indus., Inc. v. Green, 430 U.S. 462, 477-80

(1977); In re Craftmatic Sec. Litig., 890 F.2d 628, 638-39 (3d

Cir. 1989) (stating that plaintiffs cannot circumvent Santa Fe

by simply pleading a mismanagement claim as a failure to

disclose management practices); see also Hayes v. Gross, 982

F.2d 104, 106 (3d Cir. 1992). Otherwise, the claim fails for

lack of any allegations establishing a plausible theory of

materiality.

The complaint does not allege that "double commissions"

have some intrinsic significance to investors. Plaintiffs

complain, rather, that DEC failed to tell the market that the

commission-based compensation scheme, instead of boosting sales

as it was supposed to do, was contributing to the company's

losses. This argument is problematic. As the complaint itself

acknowledges, DEC publicly announced the switch from a salary-

14. The complaint's assertion that "DEC implemented its
commission program and set sales quotas without careful
evaluation" is an example of such an allegation.

-23-

based compensation scheme to the incentive-based model that

produced the double commissions. Furthermore, according to the

complaint, the switch was made not during the third fiscal

quarter of 1994, but some two years earlier, in 1992. The

plaintiffs do not allege that any material changes to the

compensation scheme were implemented after that time. Whatever

the bearing of DEC's incentive-based compensation scheme on the

company's expenses in relation to its revenues, the investing

public had at least a year's worth of hard financial data

(through the second quarter of fiscal 1994) to evaluate whether

the commission system was working to increase gross

margins,15 or instead, as plaintiffs allege, to shrink them.

Plaintiffs do not allege that there were any material changes

in the payment of commissions between the time of the March

public offering and the last prior Form 10-Q filed by the

company (for the second fiscal quarter of 1994), and so on

their own theory the claim that DEC failed to disclose the

payment of "double commissions" amounts to naught.

c. Operating Results Prior to End of Quarter

We turn to the complaint's central, overarching claim

that defendants failed, in connection with the March public

offering, to disclose material factual developments foreboding

disastrous quarter-end results. In evaluating this claim, we

15. The payments made to sales representatives constituted a
component of the company's quarterly expenses, and the
aggregate effect of such payments could have been determined by
examining the company's quarterly earnings data, as disclosed
in the required SEC filings.

-24-

accept arguendo the complaint's allegations16 that DEC had in

its possession as of the March 21 offering date nonpublic

information concerning the company's ongoing quarter-to-date

performance, indicating that the company would suffer

unexpectedly large losses for that quarter. We ask, then,

whether there was a duty to disclose such information in the

registration statement and prospectus under the rubric of

"material changes" under Item 11(a) of Form S-3. We focus upon

the defendants' primary legal arguments on this point: that DEC

was under no duty to disclose "intra-quarterly" results or any

other information concerning its third quarter performance

until after the quarter ended; and that defendants had no duty

as of March 21, 1994 to disclose any internal projections or

predictions concerning the expected outcome of the quarter.

A central goal underlying the disclosure provisions of

the securities laws is to promote fairness and efficiency in

the securities markets. See Central Bank of Denver, N.A. v.

First Interstate Bank of Denver, N.A., 114 S. Ct. 1439, 1445

(1994) ("Together, the Acts embrace a fundamental purpose . . .

to substitute a philosophy of full disclosure for the

philosophy of caveat emptor." (internal quotation omitted)); In

re LTV Sec. Litig., 88 F.R.D. 134, 145 (N.D. Tex. 1980). The

disclosure of accurate firm-specific information enables

16. As discussed below, based on the character of the
allegations in the Wilensky complaint, the plaintiffs' claims

under the Securities Act are not subject to the pleading
requirements of Fed. R. Civ. P. 9(b).

-25-

investors to compare the prospects of investing in one firm

versus another, and enables capital to flow to its most

valuable uses. LHLC Corp. v. Cluett, Peabody & Co., 842 F.2d

928, 931 (7th Cir.), cert. denied, 488 U.S. 926 (1988); cf.

Acme Propane, Inc. v. Tenexco, Inc., 844 F.2d 1317, 1323 (7th

Cir. 1988) (securities laws aim at ensuring the availability to

the investing public of information not otherwise in the public

domain). The availability of reliable firm-specific

information is also essential to the market's ability to align

stock price with a security's "fundamental value." See Marcel

Kahan, Securities Laws and the Social Costs of "Inaccurate"

Stock Prices, 41 Duke L. J. 977, 988-89 (1992).

The need for issuers to disclose material information is

crucial in the context of a public offering, where investors

typically must rely (unless the offering is "at the market") on

an offering price determined by the issuer and/or the

underwriters of the offering. See Kahan, supra, at 1014-15

(explaining the heightened need to target disclosure

requirements to companies engaged in public offerings).

Accordingly, the disclosure requirements associated with a

stock offering are more stringent than, for example, the

regular periodic disclosures called for in the company's annual

Form 10-K or quarterly Form 10-Q filings under the Exchange

Act. See id. at 1014-15 & n.163.

The need for complete and prompt disclosure is

particularly keen when a corporation issues stock pursuant to a

-26-

"shelf registration" under SEC Rule 415(a), as DEC did in its

public offering of March 1994. See 17 C.F.R. 230.415(a)

(permitting registration of securities to be issued on a

"continuous" or "delayed" basis). The shelf registration rule

permits a company to file a single registration statement

covering a certain quantity of securities (register securities

"for the shelf"), and then over a period of up to two

years,17 with the appropriate updates of information,18

issue installments of securities under that registration

statement (take the securities "down from the shelf") almost

instantly, in amounts and at times the company and its

underwriters deem most propitious. See Clark, supra, at 751

(explaining that the shelf registration process enables firms

to pinpoint the timing of offerings to the issuer's advantage);

see generally Jeffrey N. Gordon & Lewis A. Kornhauser,

Efficient Markets, Costly Information, and Securities Research,

60 N.Y.U. L. Rev. 761, 819-20 (1985).

17. A shelf registration under Rule 415 may only cover an
amount of securities that "is reasonably expected to be offered
and sold within two years from the initial effective date of
the registration." 17 C.F.R. 230.415(a)(2).

18. For example, Rule 415(a)(3) requires that a shelf
registrant comply with Item 512(a) of Regulation S-K, 17 C.F.R.
229.512(a)(ii), which requires that a registrant file a post-
effective amendment to an initial registration statement "[t]o
reflect in the prospectus any facts or events arising after the
effective date of the registration statement . . . which,
individually or in the aggregate, represent a fundamental
change in the information set forth in the registration
statement."

-27-

The social benefit of the shelf registration rule is

that it can enable an issuer to decrease its costs of raising

capital. See Clark, supra, at 751. The concomitant risk is

that, by permitting securities to be offered on a "delayed"

basis, the rule may adversely affect the quality and timeliness

of the disclosures made in connection with the actual issuance

of securities. See Shelf Registration, SEC Release Nos. 33-

6499, 34-20384, 35-23122, 1983 WL 35832 (SEC), *2 ("Shelf Reg.

Rel."); see also I Loss & Seligman, supra, at 355 ("The

rationale for limiting the time during which registered

securities may be sold is that investors need current

information when considering an offering. To permit

'registration for the shelf' runs the risk that investors

subsequently will be offered securities on the basis of

outdated or stale information."). In response to these

concerns, the SEC, in adopting Rule 415 in its current form,

assured that "[p]ost-effective amendments [to the initial

registration statement] and prospectus supplements [would]

serve to ensure that investors are provided with complete,

accurate and current information at the time of the offering or

sale of securities." Shelf Reg. Rel., supra, 1983 WL 35832

(SEC), *9. The SEC explained that registrants would not be

permitted "to use the shelf registration rule as a basis for

omitting required information from their registration

statements when they become effective." Id., 1983 WL 35832

(SEC), *10.

-28-

Based on concerns about Rule 415's effect on the

adequacy and timeliness of disclosure, the SEC chose to limit

the availability of the rule, in the context of primary stock

offerings, to the widely-followed companies (like DEC) that are

eligible to register securities on SEC Form S-3.19 See 17

C.F.R. 230.415(a)(1)(x); SEC Rel. No. 33-6499, 1983 WL 35832

(SEC) at *5; I Loss & Seligman, supra, at 361 & n.90. The

theory was that the concerns about adequacy of disclosure were

less prominent in the case of "S-3" registrants, because those

companies are precisely the ones that in the ordinary course of

their businesses "provide a steady stream of high quality

corporate information to the marketplace and whose corporate

information is broadly disseminated[] . . . and is constantly

digested and synthesized by financial analysts." Shelf Reg.

Rel., supra, 1983 WL 35832 (SEC), *5.

Defendants assert here that the disclosure requirements

of the Securities Act and regulations, including Item 11(a) of

Form S-3, should be interpreted so that they would never

mandate the provision of current information about a company's

performance in the quarter in progress at the time of a public

offering, so long as the company satisfies its quarterly and

annual periodic disclosure obligations under the Exchange Act.

That argument cuts severely against the very reason the shelf

19. As an exception to the Form S-3 limitation, the SEC also
made the shelf registration rule available in certain other
limited circumstances not relevant here. See 17 C.F.R.

230.415(a)(1)(i)-(ix); Bloomenthal et al., supra, 5.12[1]

at 235-36; I Loss & Seligman, supra, at 362-63.

-29-

registration rule was made available to issuers like DEC: that

"S-3" companies would provide the market with a continuous

stream of high quality corporate information. The rule permits

offerings to be made on a "continuous" or "delayed" basis

because it envisions "continuous" disclosure. It would be

inconsistent with this rationale to permit an issuer to take

refuge in its periodically-filed Forms 10-Q or 10-K to avoid

the obligation to disclose current material facts in its shelf

offering prospectus.

Absent some mechanism requiring a registrant to disclose

internally known, material nonpublic information pertaining to

a quarter in progress, the shelf registration procedure, by

enabling the issuer to pinpoint the timing of its offering,

would give a company anticipating a negative earnings

announcement the ability to time its offerings of securities

from the shelf to be completed prior to the public release of

the known negative news. This would allow companies to exploit

what amounts to a naked informational trading advantage. Cf.

Gordon & Kornhauser, supra, at 819-20. Item 11(a) of Form S-3,

by requiring the issuer to disclose current information

concerning "material changes" from previously reported data,

provides a mechanism -- comparable in effect to the "disclose

or abstain" rule governing insider trading -- to prevent such

strategic behavior.20

20. Of course, if the issuer desires not to disclose the
information prior to quarter's end, then the flexibility of the
shelf registration procedure permits the issuer to "delay" a

-30-

In the face of these concerns, DEC argues that the

plaintiffs' claims of nondisclosure are without merit, because

they seek to impose liability upon DEC for a failure to

disclose its internal projections about the outcome of the

third quarter of fiscal 1994. The federal securities laws

impose no obligation upon an issuer to disclose forward-looking

information such as internal projections, estimates of future

performance, forecasts, budgets, and similar data. See, e.g.,

In re Verifone Sec. Litig., 11 F.3d 865, 869 (9th Cir. 1993);

In re Convergent Technologies Sec. Litig., 948 F.2d 507, 516

(9th Cir. 1991). Plaintiffs, however, insist that their

Section 11 claim is concerned not with the nondisclosure of

projections, but of current information that DEC allegedly had

in its possession as of March 21, 1994 about "losses" the

company was incurring in the ongoing quarter. Defendants

respond, in turn, that under a system of quarterly reporting,

"losses" cannot be realized until a quarter has ended, and that

because the quarter in question did not end until April 2,

1994, whatever information DEC had as of March 21 concerning

that quarter necessarily must have been forward-looking, in the

nature of a projection or forecast, which it had no obligation

to disclose.

DEC's argument elevates form over substance. DEC's

assertion that companies do not realize "losses" as such until

planned offering until after the quarter is completed and the
results from the quarter are publicly reported.

-31-

a quarter has ended is, of course, largely unexceptionable.

But it does not follow that DEC's only information concerning

the ongoing quarter as of March 21 must have been forward-

looking. That contention relies on two faulty components.

First, it assumes that plaintiffs could not adduce adequate

evidence that defendants were actually in possession of

material information about the ongoing quarter at the relevant

time. Second, it assumes that the potential unreliability of

inferences that could be drawn from current information about

operating results as of eleven days before the end of a quarter

absolutely protects that information from mandatory disclosure.

The first premise is inconsistent with the standards governing

a Rule 12(b)(6) motion to dismiss. The second confuses the

issue of materiality with the duty to disclose.

Defendants posit, in essence, that there can never be a

duty to disclose internally known, pre-end-of-quarter financial

information, because any inferences about the quarter that

might be drawn from such information could be rendered

unreliable by later developments in the same quarter, such as a

sudden surge of profitable sales. This position does not

withstand scrutiny. Present, known information that strongly

implies an important future outcome is not immune from

mandatory disclosure merely because it does not foreordain any

particular outcome. The question whether such present

information must be disclosed (assuming the existence of a

duty), poses a classic materiality issue: given that at any

-32-

point in a quarter, the remainder of the period may not mirror

the quarter-to-date, is there a sufficient probability that

unexpectedly disastrous quarter-to-date performance will carry

forward to the end of the quarter, such that a reasonable

investor would likely consider the interim performance

important to the overall mix of information available?

As desirable as bright-line rules may be, this question

cannot be answered by reference to such a rule. To try to do

so would be contrary to Basic, Inc. v. Levinson, 485 U.S. 224

(1988). The Supreme Court there refused to adopt a bright-line

approach to determine at what stage preliminary merger

discussions create a sufficient probability of actual

consummation to become material. See id. at 237-39 (rejecting

"agreement-in-principle" test). So here. We decline to adopt,

as defendants would have us do, a hard and fast rule that

current information concerning a company's operating experience

is never subject to disclosure until after the end of the

quarter to which the information pertains. Rather, the

question is whether the nondisclosure of interim facts rendered

the prospectus materially incomplete. An issuer's compliance

with the periodic disclosure requirements of the Exchange Act

does not per se preclude such undisclosed facts from being

material.

By the same token, we reject any bright-line rule that

an issuer engaging in a public offering is obligated to

disclose interim operating results for the quarter in progress

-33-

whenever it perceives a possibility that the quarter's results

may disappoint the market. Far from it. Reasonable investors

understand that businesses fluctuate, and that past success is

not a guarantee of more of the same. There is always some risk

that the quarter in progress at the time of an investment will

turn out for the issuer to be worse than anticipated. The

market takes this risk of variability into account in

evaluating the company's prospects based on the available facts

concerning the issuer's past historical performance, its

current financial condition, present trends and future

uncertainties. But, strong-form efficient market theories

aside, the ability of market observers to evaluate a company

depends upon the information publicly available to them. If,

as plaintiffs allege here, the issuer is in possession of

nonpublic information indicating that the quarter in progress

at the time of the public offering will be an extreme departure

from the range of results which could be anticipated based on

currently available information, it is consistent with the

basic statutory policies favoring disclosure to require

inclusion of that information in the registration statement.

We do not mean to imply, however, that nondisclosure

claims similar to those asserted by plaintiffs here can never

be disposed of as a matter of law. In many circumstances, the

relationship between the nonpublic information that plaintiffs

claim should have been disclosed and the actual results or

events that the undisclosed information supposedly would have

-34-

presaged will be so attenuated that the undisclosed information

may be deemed immaterial as a matter of law. Cf. Verifone, 11

F.3d at 867-70 (affirming dismissal of claim that registration

statement allegedly failed to disclose information concerning

development that came to light six months later); Krim v.

BancTexas Group, Inc., 989 F.2d 1435, 1439, 1449-50 (5th Cir.

1993) (affirming summary judgment disallowing claim that

prospectus failed to disclose information of developments that

matured four months later); Convergent, 948 F.2d at 509-11,

515-16 (same, where prospectuses in March and August 1983

allegedly failed to disclose negative developments announced in

February 1984); Zucker v. Quasha, 891 F. Supp. 1010, 1012, 1018

(D.N.J. 1995) (dismissing complaint based on alleged

nondisclosure in March 31 registration statement of information

relating to results of period ending July 2), aff'd, F.3d

(3d Cir. 1996) (table, No. 95-5428). In such circumstances,

where the allegedly undisclosed information is sufficiently

remote in time or causation from the ultimate events of which

it purportedly forewarned, the plaintiff's claim of

nondisclosure may be indistinguishable from a claim that the

issuer should have divulged its internal predictions about what

would come of the undisclosed information. Cf. Verifone, 11

F.3d at 869 (characterizing plaintiffs' claims of nondisclosure

of "adverse material facts and trends" as of March 13 as claims

that defendants failed to disclose forecasts of news actually

released to public on September 17).

-35-

Here, however, the prospectus in question was filed 11

days prior to the end of the quarter in progress. The results

for that quarter turned out to be, by all accounts, the product

of more than a minor business fluctuation. Accepting, as we

must, the plaintiffs' allegation that DEC, by March 21, 1994,

was in possession of information about the company's quarter-

to-date performance (e.g., operating results) indicating some

substantial likelihood that the quarter would turn out to be an

extreme departure from publicly known trends and uncertainties,

we cannot conclude as a matter of law and at this early stage

of the litigation that such information was not subject to

mandatory disclosure under the rubric of "material changes" in

Item 11(a) of Form S-3. We conclude, accordingly, that the

Wilensky plaintiffs' complaint as to this theory states a

legally cognizableclaim under Section11 of theSecurities Act.21

21. It bears reemphasizing that the plaintiffs' claim is
sustainable only to the extent it relates to the nondisclosure
of "hard" material information, as opposed to "soft"
information in the nature of projections. See In re Verifone

Sec. Litig., 784 F. Supp. 1471, 1482 (N.D. Cal. 1992), aff'd,

11 F.3d 865 (9th Cir. 1993); see generally 2 Loss & Seligman,

supra, at 622 n.66. Although DEC had no obligation to disclose

a forecast of results for the quarter in progress at the time
of the offering, it was permitted to do so. If it had chosen
to disclose such a forward-looking projection, and if the
projection was made with reasonable basis and in good faith, it
would have been protected by the SEC's safe harbor provision.
See SEC Rule 175, 17 C.F.R. 230.175; see also Arazie v.

Mullane, 2 F.3d 1456, 1468 (7th Cir. 1993); Searls v. Glasser,

64 F.3d 1061, 1066 (7th Cir. 1995); cf. Private Securities

Litigation Reform Act of 1995, Pub. L. No. 104-67, 102, 109
Stat. 737, 749-55 (creating expanded statutory protection for
forward-looking statements). Furthermore, had DEC chosen to
disclose projected results, such a disclosure (if reasonable)
could very well have rendered the "hard" interim information
underlying the projection immaterial as a matter of fact or of

-36-

B. Actionability of Statement Concerning Restructuring

Reserves

The Wilensky plaintiffs also allege that the

registration statement and prospectus for the March 21 offering

contained a materially false and misleading statement

actionable under both Sections 11 and 12(2). They contend that

the statement of DEC's "belie[f]" as to the "adequacy" of the

then-remaining $443 million restructuring reserve "to cover

presently planned restructuring actions" was false and

misleading, in light of information contemporaneously known to

the company.

1. Background

The "restructuring reserve" referred to in the

prospectus supplement originated as a $1.5 billion charge taken

by DEC at the close of its fiscal year 1992 (ended June 27,

1992) as part of the company's ongoing efforts to streamline

the company "to achieve a competitive cost structure." The

reserve was intended to cover the anticipated costs of employee

separations, facilities consolidations, asset retirements,

relocations, and related expenses. The company had absorbed

similar restructuring charges of $1.1 billion and $550 million

in fiscal years 1991 and 1990, respectively.

law, unless the market would have had some reason to discredit
the projection, thereby creating a substantial likelihood that
a reasonable investor might still have found the underlying
information important to the total mix of information
available.

-37-

During fiscal year 1993, DEC took a number of actions

consistent with the $1.5 billion dollar reserve recorded at the

end of fiscal year 1992. By the end of the fiscal year (July

3, 1993), the remaining reserve was reported to be

approximately $739 million. During the first two quarters of

the next fiscal year, the company continued to draw from the

reserve, so that by the end of the second quarter (January 1,

1994), the reserve stood at approximately $443 million. In its

Form 10-Q for that quarter, dated February 4, 1994 (and

incorporated by reference into the registration statement and

prospectus at issue here), DEC stated its belief that the $443

million reserve was "adequate" to cover restructuring

activities planned at that time. This statement was repeated

in the prospectus supplement dated March 21, 1994. The full

statement, with its immediately surrounding context, was as

follows:

While spending for R&E [research & engineering]
and SG&A [selling, general & administrative] is
declining, the Corporation believes its cost and
expense levels are still too high for the level
and mix of total operating revenues. The
Corporation is reducing expenses by streamlining
its product offerings and selling and
administrative practices, resulting in reductions
in employee population, closing and consolidation
of facilities and reductions in discretionary
spending. The Corporation believes that the
remaining restructuring reserve of $443 million
is adequate to cover presently planned
restructuring actions. The Corporation will
continue to take actions necessary to achieve a
level of costs appropriate for its revenues and
competitive for its business.

-38-

As events turned out, additional restructuring charges

were in fact taken later in fiscal year 1994. At the time of

the company's announcement on April 15, 1994 of the $183

million loss for the third fiscal quarter of 1994, defendant

Palmer stated that he had already instructed management to

"accelerate [the company's] on-going restructuring efforts" and

that the company would "consider further restructuring to

achieve [its] goals." In line with these statements, the

company announced on July 20, 1994 (just after the close of

fiscal year 1994) that it had decided to take an additional

restructuring charge of $1.2 billion in fiscal year 1994 (ended

June 30, 1994).

2. Whether the Statement Was Misleading

Although defendants were required to disclose the size

of the remaining restructuring reserve in the registration

statement and prospectus as affecting the company's liquidity

and capital resources,22 the characterization of the reserve

as adequate was arguably voluntary. But whether voluntary or

not, DEC's description of its belief as of March 21, 1994 that

the remaining $443 million reserve was "adequate" carried with

it an obligation to ensure that the representation was not

22. Item 303(a) of Regulation S-K requires the registrant to
include in its Exchange Act filings (e.g., Forms 10-Q and 10-

K), which in turn are incorporated by reference into
registration statements on Form S-3, a description of "trends
or any known demands, commitments, events or uncertainties"
affecting the registrant's liquidity, and of the registrant's
"material commitments for capital expenditures." 17 C.F.R.
229.303(a)(1)-(2).

-39-

misleading. See Roeder, 814 F.2d at 26; cf. Serabian v.

Amoskeag Bank Shares, Inc., 24 F.3d 357, 365 (1st Cir. 1994)

("[I]f a defendant characterizes . . . reserves as 'adequate'

or 'solid' even though it knows they are inadequate or

unstable, it exposes itself to possible liability [under the

securities laws]." (quoting Shapiro v. UJB Financial Corp., 964

F.2d 272, 282 (3d Cir.), cert. denied, 506 U.S. 934 (1992)));

cf. also In re Wells Fargo Sec. Litig., 12 F.3d 922, 930 (9th

Cir. 1993), cert. denied, 115 S. Ct. 295 (1994). Plaintiffs

assert that defendants failed to meet that obligation.

The undeniable purport of the "adequacy" statement is

that DEC had no plans as of the date of the prospectus

supplement to engage in actions that would require the taking

of a restructuring charge beyond the $443 million then

remaining in "reserve." This was false or misleading,

plaintiffs say, because DEC knew as of March 21, 1994 that

further restructuring actions would be necessary to put the

company back on the right track after its impending third

quarter setback, and that these actions would deplete the

remaining reserve and require further restructuring charges to

be taken. Defendants reply, as the district court noted, that

whatever the natural implication of the "adequacy" statement,

its context sufficiently "bespeaks caution" to render any

misleading inference from the statement immaterial as a matter

of law. We do not agree.

-40-

The "bespeaks caution" doctrine "is essentially

shorthand for the well-established principle that a statement

or omission must be considered in context." In re Donald J.

Trump Casino Sec. Litig., 7 F.3d 357, 364 (3d Cir. 1993), cert.

denied, 114 S. Ct. 1219 (1994); see also Rubinstein v. Collins,

20 F.3d 160, 167 (5th Cir. 1994). It embodies the principle

that when statements of "soft" information such as forecasts,

estimates, opinions, or projections are accompanied by

cautionary disclosures that adequately warn of the possibility

that actual results or events may turn out differently, the

"soft" statements may not be materially misleading under the

securities laws.23 See Romani v. Shearson Lehman Hutton, 929

F.2d 875, 879 (1st Cir. 1991); see also Harden v.

Raffensperger, Hughes & Co., 65 F.3d 1392, 1404 (7th Cir.

1995); In re Worlds of Wonder Sec. Litig., 35 F.3d 1407, 1413-

14 (9th Cir. 1994) (collecting cases), cert. denied, 116 S. Ct.

185 (1995); Rubinstein, 20 F.3d at 166-68; In re Trump, 7 F.3d

at 371-72; I. Meyer Pincus & Assocs. v. Oppenheimer & Co., 936

F.2d 759, 763 (2d Cir. 1991). In short, if a statement is

couched in or accompanied by prominent cautionary language that

clearly disclaims or discounts the drawing of a particular

inference, any claim that the statement was materially

misleading because it gave rise to that very inference may fail

as a matter of law. In re Trump, 7 F.3d at 364.

23. The doctrine has been codified in the Securities
Litigation Reform Act, supra, Pub. L. No. 104-67, 102, 109

Stat. at 750.

-41-

Here, however, the bespeaks caution doctrine does not

preclude a claim that the reserve "adequacy" statement was

materially misleading. The "adequacy" statement has both a

forward-looking aspect and an aspect that encompasses a

representation of present fact. In its forward-looking aspect,

the statement suggests that DEC would take no further

restructuring charges in the near-term future. In its present-

oriented aspect, it represents that as of March 21, 1994, DEC

had no current intent to undertake activities that would

require any such further restructuring charges to be taken. To

the extent that plaintiffs allege that the reserve "adequacy"

statement encompasses the latter representation of present

fact, and that such a representation was false or misleading

when made, the surrounding cautionary language could not have

rendered the statement immaterial as a matter of law. See

Harden, 65 F.3d at 1405-06 (explaining that the bespeaks

caution doctrine cannot render misrepresentations of "hard"

fact nonactionable).24

Furthermore, to the extent that plaintiffs allege that

the "adequacy" statement implies a hiatus on new restructuring

charges for the near future, we do not think that the

surrounding context warns against such an implication with

sufficient clarity to be thought to bespeak caution. See Fecht

24. Cf. also Securities Litigation Reform Act, supra, Pub. L.

No. 104-67, 102, 109 Stat. at 750 (providing safe harbor to
statements couched in cautionary language only if the
statements are identified as forward-looking).

-42-

v. Price Co., 70 F.3d 1078, 1082 (9th Cir. 1995), cert. denied,

64 U.S.L.W. 3688 (1996). The prospectus supplement does state

that DEC will "continue to take actions," but it is at best

ambiguous whether those "actions" refer to any restructuring

activities other than those "presently planned." Thus, one

might easily interpret the purportedly cautionary statement,

especially in light of the "adequacy" characterization, to mean

that the company's ongoing "actions" will continue to be

covered by the existing restructuring reserve. If it was true,

as plaintiffs allege, that defendants knew as of March 21, 1994

that DEC's performance in the third quarter would precipitate

actions on a scale and schedule that would necessitate the

taking of additional restructuring charges, the "adequacy"

statement may well have been materially misleading.

We cannot conclude, as a matter of law and on these

pleadings, that the actionability of the "reserve adequacy"

statement is precluded by a context that bespeaks caution. The

cautionary statements to which defendants point did not provide

an unambiguous warning of the possibility that DEC might take

additional restructuring charges in the near future -- as it

turned out, a charge of $1.2 billion in the fiscal year then in

progress. See id. at 1082 (bespeaks caution doctrine provides

basis for dismissal as matter of law "only when reasonable

minds could not disagree as to whether the mix of information

in the [allegedly actionable] document is misleading" (emphasis

in original)); Rubinstein, 20 F.3d at 167-68 (stating that

-43-

questions of whether disclosures were sufficiently cautionary

may not always be resolved as a matter of law). Accordingly,

we hold that the district court erred in concluding that the

plaintiffs' allegations pertaining to the prospectus

supplement's description of the restructuring reserve as

"adequate" fail to state a claim under Sections 11 and

12(2).25

C. Whether Defendants Are Statutory "Sellers"

As an alternative basis for affirming the district

court's dismissal of the Section 12(2) claim, defendants argue

that the Wilensky plaintiffs have failed adequately to allege

their status as statutory "sellers."26 We conclude that the

complaint adequately alleges "seller" status only as to the

underwriter defendants. The dismissal of the Section 12(2)

claim as to the other defendants will accordingly be affirmed.

25. Defendants argue that, as a matter of fact, the market was
well aware in January 1994 or earlier that DEC might eventually
be forced to take further restructuring charges in fiscal year
1994. This, however, does not address whether the disclosures
in the prospectus supplement themselves "bespeak caution" as a
matter of law. Moreover, the evidence cited by defendants on
this point goes far beyond the allegations of the complaint.
While evidence of actual market knowledge might be proper grist
for the summary judgment mill on the question of materiality,
it cannot properly be considered in evaluating whether the
plaintiffs' complaint is legally sufficient to survive a motion
to dismiss under Rule 12(b)(6).

26. The district court, having dismissed the plaintiffs'
claims on other grounds, did not reach this issue. We may, of
course, affirm the district court's dismissal on any
independently sufficient ground. See Crellin Technologies,

Inc. v. Equipmentlease Corp., 18 F.3d 1, 13 (1st Cir. 1994).

-44-

In Pinter v. Dahl, 486 U.S. 622 (1988), the Supreme

Court described in detail the class of defendants who may be

sued as "sellers" under Section 12(1) of the Securities Act.

See id. at 641-44. Section 12(2) defines the persons who may

sue and be sued thereunder in language identical to the

language used in Section 12(1). Thus, Pinter's analysis of

"seller" for purposes of Section 12(1) applies with equal force

to the interpretation of "seller" under Section 12(2). See,

e.g., Ackerman v. Schwartz, 947 F.2d 841, 844-45 (7th Cir.

1991); In re Craftmatic Sec. Litig., 890 F.2d 628, 635 (3d Cir.

1989); Moore v. Kayport Package Express, Inc., 885 F.2d 531,

536 (9th Cir. 1989); Wilson v. Saintine Exploration & Drilling

Corp., 872 F.2d 1124, 1125-26 (2d Cir. 1989); Dawe v. Main St.

Management Co., 738 F. Supp. 36, 37 (D. Mass. 1990).

A person who "offers or sells" a security may be liable

under Section 12 to any person "purchasing such security from

him." 15 U.S.C. 77l(2) (emphasis added). Although the

"purchasing from" language in the statute literally appears to

contemplate a relationship between defendant and plaintiff "not

unlike traditional contractual privity," Pinter, 486 U.S. at

642, the Pinter Court held that Section 12 liability is not

limited to those who actually pass title to the suing

purchaser. See id. at 645. This is so because even "[i]n

common parlance," a person may "offer or sell" property without

actually passing title. Id. at 642. For example, a broker or

agent who solicits a purchase "would commonly be said . . . to

-45-

be among those 'from' whom the buyer 'purchased,' even though

the agent himself did not pass title." Id. at 644.

Furthermore, because "solicitation is the stage at which an

investor is most likely to be injured," id. at 646, the Court

found it consistent with the policies of the statute to permit

imposition of liability on a non-owner of securities who

"successfully solicits"27 the plaintiff's purchase of the

securities, provided that the solicitor is "motivated at least

in part by a desire to serve his own financial interests or

those of the securities owner." Id. at 647.28

The Pinter Court limited its holding in ways that govern

the result here. The Court held that the "purchasing . . .

from" requirement of Section 12 limits the imposition of

liability to "the buyer's immediate seller" and thus, "a buyer

cannot recover against his seller's seller." Pinter, 486 U.S.

at 643 n.21 (citations omitted). Second, the Court stated that

proof the defendant caused a plaintiff's purchase of a security

is not enough to establish that the defendant "solicited" the

sale for Section 12 purposes. See id. at 651 (explaining that

27. Section 2(3) of the Securities Act defines "sale" or
"sell" to include, among other notions, "every . . .
solicitation of an offer to buy, a security or interest in a
security, for value." 15 U.S.C. 77b(3); see Pinter, 486 U.S.

at 643.

28. The Court reasoned that where a person's motivation in
persuading another to purchase securities is solely to benefit
the buyer, it would be "uncommon to say that the buyer
'purchased' from him," and that such motivation makes it
difficult to characterize the person's act as "solicitation."
Pinter, 486 U.S. at 647.

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"[t]he 'purchase from' requirement of 12 focuses on the

defendant's relationship with the plaintiff-purchaser" and

rejecting use of a test under which defendant could qualify as

a seller if he was a "substantial factor" in causing the

transaction to take place). Finally, the Court indicated that

a person's "remote" involvement in a sales transaction or his

mere "participat[ion] in soliciting the purchase" does not

subject him to Section 12 liability. See id. at 651 n.27. A

defendant must be directly involved in the actual solicitation

of a securities purchase in order to qualify, on that basis, as

a Section 12 "seller." See In re Craftmatic, 890 F.2d at 636;

Capri v. Murphy, 856 F.2d 473, 478-79 (2d Cir. 1988); Dawe, 738

F. Supp. at 37.

We apply these principles to the Wilensky complaint.

The March 1994 public offering was made pursuant to a "firm

commitment" underwriting, as disclosed in the registration

statement and prospectus supplement. The plaintiffs do not

contend otherwise. In a firm commitment underwriting, the

issuer of the securities sells all of the shares to be offered

to one or more underwriters, at some discount from the offering

price. Investors thus purchase shares in the offering directly

from the underwriters (or broker-dealers who purchase from the

underwriters), not directly from the issuer. In fact, the

March 21, 1994 prospectus supplement represented that "[DEC]

has agreed not to, directly or indirectly, sell, offer or enter

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into any agreement to offer or sell, shares of [the offered

stock]."

Because the issuer in a firm commitment underwriting

does not pass title to the securities, DEC and its officers

cannot be held liable as "sellers" under Section 12(2) unless

they actively "solicited" the plaintiffs' purchase of

securities to further their own financial motives, in the

manner of a broker or vendor's agent. See Pinter 486 U.S. at

644-47. Absent such solicitation, DEC can be viewed as no more

than a "seller's seller," whom plaintiffs would have no right

to sue under Section 12(2). See id. at 644 n.21; PPM Am., Inc.

v. Marriott Corp., 853 F. Supp. 860, 874-75 (D. Md. 1994);

Louis Loss & Joel Seligman, Fundamentals of Securities

Regulation 1000-01 (3d ed. 1995) ("[I]t seems quite clear that

12 contemplates only an action by a buyer against his or her

immediate seller. That is to say, in the case of the typical

'firm-commitment underwriting,' the ultimate investor can

recover only from the dealer who sold to him or her." (emphasis

in original; footnotes omitted)).

The factual allegations in the complaint supporting the

purported status of DEC and the individual defendants as

Section 12(2) sellers are sparse, and all pertain to those

defendants' involvement in preparing the registration

statement, prospectus, and other "activities necessary to

effect the sale of the[] securities to the investing public."

Under Pinter, however, neither involvement in preparation of a

-48-

registration prospectus nor participation in "activities"

relating to the sale of securities, standing alone,

demonstrates the kind of relationship between defendant and

plaintiff that could establish statutory seller status. See

Pinter, 486 U.S. at 651 & n.27; Shapiro, 964 F.2d at 286.

Although the complaint also contains a conclusory allegation

that each defendant "solicited and/or was a substantial factor

in the purchase by plaintiffs" of securities in the offering,

the Supreme Court specifically rejected a proposed test under

which a defendant's being a "substantial factor" in bringing

about a sale could establish statutory seller status. See

Pinter, 486 U.S. at 651. Furthermore, the term "solicitation"

is a legal term of art in this context. In deciding a motion

to dismiss under Rule 12(b)(6), a court must take all well-

pleaded facts as true, but it need not credit a complaint's

"bald assertions" or legal conclusions. Washington Legal

Found. v. Massachusetts Bar Found., 993 F.2d 962, 971 (1st Cir.

1993) (quoting United States v. AVX Corp., 962 F.2d 108, 115

(1st Cir. 1992)). Here it is undisputed that the public

offering was conducted pursuant to a firm commitment

underwriting, and plaintiffs' bald and factually unsupported

allegation that the issuer and individual officers of the

issuer "solicited" the plaintiffs' securities purchases is not,

standing alone, sufficient.

While, on a different set of allegations, an issuer

involved in a firmly underwritten public offering could be a

-49-

"seller" for purposes of Section 12(2), we hold that the

Wilensky complaint does not contain sufficient non-conclusory

factual allegations which, if true, would establish that DEC or

the individual defendants qualify as such. However, the

complaint does adequately allege that the underwriter

defendants directly sold securities to the plaintiffs (in the

literal sense of passing title), consistent with the

underwriting arrangements disclosed in the prospectus

supplement of March 21, 1994. We conclude that the plaintiffs

have adequately alleged statutory seller status as against the

underwriter defendants, but not against DEC or the individual

defendants.

IV.

The Section 10(b) Claims

(Shaw Action)

The plaintiffs in the Shaw action assert claims under

Sections 10(b) and 20(a)29 of the Securities Exchange Act of

1934, 15 U.S.C. 78j(b), 78t(a), and Rule 10b-5 promulgated

thereunder, 17 C.F.R. 240.10b-5. The implied right of

private action under Section 10(b) and Rule 10b-530

29. Section 20(a) provides for derivative liability of persons
who "control" others found to be primarily liable under the
Exchange Act.

30. Section 10(b) proscribes the "use or employ[ment], 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." 15 U.S.C. 78j(b). Rule 10b-5 makes it
unlawful "[t]o make any untrue statement of a material fact or
to omit to state a material fact necessary in order to make the

-50-

complements the civil enforcement function provided by Sections

11 and 12(2) of the Securities Act by reaching beyond

statements and omissions made in a registration statement,

prospectus, or in connection with an initial distribution of

securities, to create liability for false or misleading

statements or omissions of material fact in connection with

trading in the secondary market. See Central Bank of Denver,

114 S. Ct. at 1445; Eckstein v. Balcor Film Investors, 8 F.3d

1121, 1123-24 (7th Cir. 1993), cert. denied, 114 S. Ct. 883

(1994).

In addition to proving that the defendant made a

materially false or misleading statement or omitted to state a

material fact necessary to make a statement not misleading, a

Rule 10b-5 plaintiff, unlike a plaintiff asserting claims under

Section 11 or 12(2) of the Securities Act, must establish that

the defendant acted with scienter, and that the plaintiff's

reliance on the defendant's misstatement caused his injury.

See Holmes v. Bateson, 583 F.2d 542, 551 (1st Cir. 1978); see

also San Leandro Emergency Medical Group Profit Sharing Plan v.

Philip Morris Cos., Inc., 75 F.3d 801, 808 (2d Cir. 1996). The

same standard of materiality, however, applies to claims under

Section 10(b) and Rule 10b-5 as to claims under Sections 11 and

12(2) of the Securities Act. See Lucia v. Prospect St. High

Income Portfolio, Inc., 36 F.3d 170, 172 n.3 (1st Cir. 1994).

statements made, in the light of the circumstances under which
they were made, not misleading . . . in connection with the
purchase or sale of any security." 17 C.F.R. 240.10b-5(b).

-51-

Finally, a plaintiff asserting securities fraud must plead the

alleged "circumstances constituting fraud . . . with

particularity." Fed. R. Civ. P. 9(b).

The Shaw plaintiffs advance the same claims of

nondisclosure and misstatement championed by the Wilensky

plaintiffs. They allege further that those alleged

nondisclosures and misstatements were made with fraudulent

intent, that defendants' conduct artificially inflated the

market price of DEC common stock, and that this fraud on the

market caused the plaintiffs to suffer damages. The Shaw

plaintiffs also allege that defendants committed actionable

fraud by making optimistic statements to the public (outside of

any SEC filing) concerning the company's prospects throughout

the Class Period,31 even though they knew or recklessly

disregarded nonpublic information indicating that the company

was then in dire straits, as was ultimately disclosed on April

15, 1994. The defendants respond that they were under no duty

to disclose the information identified by plaintiff, and that

none of the statements attributed to them was materially false,

misleading, or otherwise actionable.

A. Nonactionability of Loosely Optimistic Statements

31. The Class Period (here, January 19 through April 15, 1994)
constitutes the time period during which members of the
putative plaintiff class purchased shares of DEC common stock.
We limit our analysis of the Shaw plaintiffs' claims of

affirmative misrepresentation to the statements allegedly made
by defendants within the Class Period. See In re Clearly

Canadian Sec. Litig., 875 F. Supp. 1410, 1420 (N.D. Cal. 1995).

-52-

The Shaw plaintiffs allege that the defendants made a

number of fraudulently optimistic statements about DEC through

media outlets (e.g., newspapers and trade publications) and

press releases issued by the company. The district court,

after analyzing each of the statements identified by the

plaintiffs, held as a matter of law that none was sufficiently

material to support a claim of securities fraud. We agree.

In most circumstances, disputes over the materiality of

allegedly false or misleading statements must be reserved for

the trier of fact. See Basic, 485 U.S. at 236; Lucia, 36 F.3d

at 176. But not every unfulfilled expression of corporate

optimism, even if characterized as misstatement, can give rise

to a genuine issue of materiality under the securities laws.

See Lucia, 36 F.3d at 176 (leaving open possibility that some

materiality determinations may be made as a matter of law). In

particular, courts have demonstrated a willingness to find

immaterial as a matter of law a certain kind of rosy

affirmation commonly heard from corporate managers and

numbingly familiar to the marketplace -- loosely optimistic

statements that are so vague, so lacking in specificity, or so

clearly constituting the opinions of the speaker, that no

reasonable investor could find them important to the total mix

of information available.32 See, e.g., San Leandro, 75 F.3d

32. Under the common law of fraud, courts typically would find
such statements to be mere "puffing" or sales talk upon which
no reasonable person could rely, and thus to be legally
insufficient to support a claim. See, e.g., Greenery

Rehabilitation Group, Inc. v. Antaramian, 628 N.E.2d 1291, 1293

-53-

at 807, 811 (holding not actionable statement that the company

"expect[ed] . . . another year of strong growth in earnings per

share"); Hillson Partners Ltd. Partnership v. Adage, Inc., 42

F.3d 204, 213 (4th Cir. 1994) (similar, where alleged

fraudulent statement was: "[the company] is on target toward

achieving the most profitable year in its history"); In re

Caere Corporate Sec. Litig., 837 F. Supp. 1054, 1057-58 (N.D.

Cal. 1993) ("[The company is] 'well-positioned' for growth.");

Colby v. Hologic, Inc., 817 F. Supp. 204, 211 (D. Mass. 1993)

("Prospects for long term growth are bright.").

Review of vaguely optimistic statements for

immateriality as a matter of law may be especially robust in

cases involving a fraud-on-the-market theory of liability. In

such cases, the statements identified by plaintiffs as

actionably misleading are alleged to have caused injury, if at

all, not through the plaintiffs' direct reliance upon them, but

by dint of the statements' inflating effect on the market price

of the security purchased. See Basic, 485 U.S. at 241-47; Rand

v. Cullinet Software, Inc., 847 F. Supp. 200, 205 (D. Mass.

1994). When the truth is disclosed and the market self-

corrects, investors who bought at the inflated price suffer

losses. Those losses can be deemed to have been caused by the

defendants' statements, even absent direct reliance by

(Mass. App. Ct. 1994), rev. denied, 417 Mass. 1103 (1994); Webb

v. First of Mich. Corp., 491 N.W.2d 851, 853 (Mich. App. 1992);

Rodio v. Smith, 587 A.2d 621, 624 (N.J. 1991); Hauter v.

Zogarts, 14 Cal.3d 104, 111-12 (1975) (en banc).

-54-

plaintiffs, because the statements were presumptively absorbed

into and reflected by the security's price. See Basic, 486

U.S. at 243-44 (quoting In re LTV, 88 F.R.D. at 143).

This presumption of investor reliance on the integrity

of stock prices has the primary effect of obviating the need

for plaintiff purchasers to plead individual reliance. But by

its underlying rationale, the presumption also shifts the

critical focus of the materiality inquiry. In a fraud-on-the-

market case the hypothetical "reasonable investor," by

reference to whom materiality is gauged, must be "the market"

itself, because it is the market, not any single investor, that

determines the price of a publicly traded security. See In re

Verifone Securities Litigation, 784 F. Supp. 1471, 1479 (N.D.

Cal. 1992) ("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."), aff'd, 11 F.3d 865

(9th Cir. 1993); see also In re Apple Computer Sec. Litig., 886

F.2d 1109, 1113-14 (9th Cir. 1989), cert. denied, 496 U.S. 943

(1990); cf. Easterbrook & Fischel, Corporate Law, supra, at 297

(explaining how unsophisticated investors "take a free ride on

the information impounded by the market").

Thus, a claim that a fraud was perpetrated on the market

can draw no sustenance from allegations that defendants made

overly-optimistic statements, if those statements are ones that

any reasonable investor (ergo, the market) would easily

recognize as nothing more than a kind of self-directed

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corporate puffery. The market is not so easily duped, even

granted that individual investors sometimes are. See In re

Apple Computer, 886 F.2d at 1114; Wielgos v. Commonwealth

Edison Co., 892 F.2d 509, 515 (7th Cir. 1989); see also Raab, 4

F.3d at 289-90 ("[T]he market price of a share is not inflated

by vague statements predicting growth. . . . Analysts and

arbitrageurs rely on facts in determining the value of a

security, not mere expressions of optimism from company

spokesmen." (citations omitted)). This is particularly so with

respect to the securities of an actively traded and closely

followed company like DEC. Cf. LTV, 88 F.R.D. at 144 (citing

empirical studies demonstrating that assumptions about market

efficiency are strongest with respect to "[t]the prices of

stocks of larger corporations, such as those listed on the New

York Stock Exchange").

While we have no occasion or intention to adopt here a

per se rule that expressions of optimism uttered by corporate

managers can never support a claim of securities fraud, we

think that in this case, the statements outside of the

registration statement and prospectus identified by plaintiffs

as actionably misleading are -- with one exception discussed

separately below -- by their nature, too patently immaterial to

support a fraud-on-the-market claim.

We agree with the district court, for example, that a

claim of securities fraud cannot lie on the basis of the

statements made by defendant Steul (DEC's chief financial

-56-

officer) in January 1994, in reaction to the disappointing

earnings results for the quarter just ended. Steul was quoted

as saying that the company's transition to selling its Alpha

chip products was "going reasonably well" and that the company

"should show progress quarter over quarter, year over year."

We hold to be similarly not actionable (because patently

immaterial) Steul's comment of January 19, 1994 that the

company was "basically on track"; his comment of January 20,

1994 that "DEC was a very healthy company"; defendant Robert

Palmer's statement of the same date that he was "confident that

DEC was pursuing the right strategy"; and the February 8, 1994

statement by DEC's head of European operations (not a defendant

here) that he was "pretty optimistic" that the company would

"be able to stabilize [its] revenue" in the first half of

calendar year 1994 and "start to grow revenue" in the second

half. These statements all so obviously fail to pose any

"substantial likelihood" of being "viewed by the reasonable

investor" -- let alone the market -- "as having significantly

altered the total mix of information available," Basic, 485

U.S. at 231-32 (quotation omitted), that they are properly

deemed immaterial as a matter of law.33

33. Plaintiffs additionally argue that several forward-looking
statements allegedly made by defendants prior to the

commencement of the Class Period (January 19, 1994) gave rise
to a "duty to update," which defendants purportedly violated
during the Class Period. Plaintiffs point to a statement by
Steul in October of 1993 that the company's continuing
restructuring actions over the fiscal year "will probably be
smaller than the last four quarters"; a September 1993
statement that "[s]ervice revenues have continued to grow"; and

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B. Importance of Context: the "Break-Even" Statements

The Shaw plaintiffs allege that on January 20, February

23, and March 29, 1994, DEC made or was responsible for the

following statements to the public, on those respective dates:

"[w]e are operating very close to break-even"; "we're running

very close to break-even"; and "we are very close to break-

even." Plaintiffs assert that given the magnitude of the

losses actually disclosed to the public on April 15, 1994, the

"break-even" statements must have been false when made and

constituted actionable fraud.

Putting aside for the moment whether plaintiffs have

adequately alleged that these statements were made with

fraudulent intent, the statements, when read in isolation,

a statement by defendant Palmer on November 4, 1993 that the
prospect of turning a profit was a "reasonable expectation" in
fiscal year 1994. Whatever the circumstances in which a
company might be subject to a duty to "update" information
previously disclosed, we do not think that the pre-Class Period
statements identified by plaintiffs are of the kind that could
trigger any such duty. The alleged statement regarding
"service revenues" constitutes a statement of historical fact
not alleged to be false, and as such, does not provide the
basis for a duty to update. See Serabian, 24 F.3d at 361. The

other alleged statements are cautiously optimistic comments
that would not be actionable in the first instance. See San

Leandro, 75 F.3d at 811. They express, at most, "only the hope

of any company" for a positive future, and "lack the sort of
definite positive projections that might require later
correction." In re Time Warner, Inc. Sec. Litig., 9 F.3d 259,

267 (2d Cir. 1993), cert. denied, 114 S. Ct. 1397 (1994); see

also San Leandro, 75 F.3d at 811 (finding no duty to update

"subdued general comments" of optimism). Moreover, it seems
likely that any "duty to update" DEC's pre-Class Period
statements would have been extinguished by the company's
disclosure of financial information in the negative earnings
announcement of January 19, 1994, the first day of the alleged
Class Period.

-58-

provide reason for pause. The statements cannot accurately be

described as the kind of diffuse expressions of opinion or

optimism that can be deemed, by their nature, obviously

immaterial as a matter of law. Rather, they appear, in

isolation, to be statements quantifying the company's current

operating inflows as more or less approximating outflows, thus

inviting an inference that the end results for the third

quarter might turn out likewise. The rub, however, is the

context surrounding the statements. When evaluated in context,

the "break-even" statements do not give rise to a claim of

securities fraud.

In deciding a motion to dismiss a securities action, a

court may properly consider the relevant entirety of a document

integral to or explicitly relied upon in the complaint, even

though not attached to the complaint, without converting the

motion into one for summary judgment. See Watterson v. Page,

987 F.2d 1, 3-4 (1st Cir. 1993) (explaining that the main

problem of looking to documents outside the complaint -- lack

of notice to plaintiff -- is dissipated "[w]here plaintiff has

actual notice . . . and has relied upon these documents in

framing the complaint" (quoting Cortec Indus., Inc. v. Sum

Holding L.P., 949 F.2d 42, 48 (2d Cir. 1991), cert. denied, 112

S. Ct. 1561 (1992)); see also San Leandro, 75 F.3d at 808-09;

Romani, 929 F.2d at 879 n.3. Were the rule otherwise, a

plaintiff could maintain a claim of fraud by excising an

isolated statement from a document and importing it into the

-59-

complaint, even though the surrounding context imparts a

plainly non-fraudulent meaning to the allegedly wrongful

statement. We look to the full context of the "break-even"

statements attributed to defendant Steul.34

The first time the "break-even" statement appeared was

in a Boston Herald article headlined "Digital falls short with

$72.1M loss," published on January 20, 1994, the day after DEC

had announced its disappointing earnings results for the second

quarter of fiscal year 1994. The article attributed the

following statement to Steul:

The $72 million loss represents only 2.2 percent
of revenues, Steul said. "We are operating very
close to break-even. It's a lot of money, but on
the other hand it's small compared to what losses
have been in the past." Steul would not say when
Digital will again be profitable. "I hesitate to
give you an estimate because we just have too
much uncertainty in the immediate future"
[paragraph structure omitted].

It is plain that Steul's "break-even" characterization refers

to the fact that the $72 million loss that had just been

reported for the second quarter of fiscal year 1994 was, in

fact, only a small percentage of the company's total revenues.

The statement cannot reasonably be understood as a material

comment on the current status or anticipated results of the

company's third quarter. Since plaintiffs do not allege that

34. The full text of the news articles in which the "break-
even" statements appeared, and which are cited in the
complaint, have been provided to us in a jointly-prepared
appendix. Plaintiffs have not objected to the district court's
nor the defendants' making reference to the full text of those
articles.

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the characterization of "close to break-even" placed an

actionably fraudulent spin on DEC's second quarter results, the

statement in that context can be of no moment.

The second "break-even" statement appeared in a February

23, 1994 Wall Street Journal article. The article's author had

obtained an "internal" DEC finance review, and divulged its

contents as follows:

"We're running very close to break-even," the
[internal] review says, though "revenue is
uncertain for next two-plus quarters." The
review concludes that Digital "will still be in
turnaround for the next two or three quarters"
and that managers should "focus heavily on cash
conservation." There is a chance, it adds, "if
we keep at Q2 spending levels, that we can make a
profit this fiscal year." While Mr. Palmer
confirmed many of these points in an interview,
he wouldn't make any forecast. "This is a large
organization that was in deep trouble when I
started, and we still have a way to go"
[paragraph structure omitted].

The context of the "break-even" statement in the internal

review, as reported, sufficiently bespeaks caution to render

any forward-looking connotation that could otherwise be taken

from the statement immaterial as a matter of law. Cf. Polin v.

Conductron Corp., 552 F.2d 797, 806 n.28 (8th Cir. 1976)

(holding that statement by company that it "saw a 'possibility'

of a break-even soon" was immaterial as matter of law, since it

was phrased so as to "bespeak caution in outlook"), cert.

denied, 434 U.S. 857 (1977). Given the statements attributed

to the internal review that "revenue is uncertain for next two-

plus quarters"; that "[DEC] will still be in turnaround for the

next two or three quarters"; that "we still have a way to go";

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and given Palmer's reported refusal to make any forecast,

coupled with the absence of any specifics regarding the

authoritativeness or timeliness of the "internal" report, no

reasonable investor (nor the market) could have attached

importance to any forward-looking connotation of the "break-

even" statement described in the article.

A similar analysis applies to the "break-even" statement

that appeared in the March 29, 1994 issue of Financial World.

In that article, defendant Steul was quoted as saying "We are

very close to break-even. If it hadn't been for currencies,

and had we been able to ship everything ordered, we would have

been in the black in the second quarter." As with the Wall

Street Journal piece, neither the Financial World piece itself

nor the Shaw complaint specifies the date on which the

statement was actually made.35 But, again, Rule 9(b) issues

aside, the "break-even" comment is most naturally understood as

looking backward to the second quarter of fiscal 1994, not to

the future. Furthermore, to the extent that any other meaning

could be discerned, it is directly negated by other qualifying

comments attributed to Steul in the same article, including the

following:

What Digital needs at this point is time. Says
Steul, "Wall Street always wants quick results,
but it took a couple of years to get where we are
and it will take more than a couple of quarters
to turn it around."

35. It is unclear whether the statement quoted in Financial

World had been freshly made by Steul, or was recycled from pre-

existing sources. The Shaw complaint does not specify.

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This warning that favorable results would be slow to come is a

far cry from a "prediction of a break-even year," which is how

plaintiffs characterize Steul's comments. Additionally,

because plaintiffs allege that a fraud on the market was

committed by statements communicated in this financial

analyst's article, it is only fair to note that the tenor of

the article is one of skepticism about DEC's future

prospects.36 On the facts as alleged, the district court did

not err in concluding that the "break-even" statement in the

Financial World piece was immaterial as a matter of law.

C. Actionability under Section 10(b) of Omissions

and Misleading Statements in the Registration

Statement and Prospectus

The remaining statements and omissions alleged by the

Shaw plaintiffs to be fraudulent under Section 10(b) and Rule

10b-5 relate to the registration statement and prospectus for

DEC's March 1994 stock offering. These alleged misstatements

and omissions are identical to those that underlie the Wilensky

plaintiffs' claims under Sections 11 and 12(2) of the

Securities Act. We conclude that the Shaw plaintiffs may

pursue their Section 10(b) claim based on these alleged defects

36. For example, the article quotes statements by analysts
expressing skepticism about DEC's prospects, and cautions:
"Reasonable as [Steul's comments concerning a turn-around] may
sound, recall that it was only last September [1993] that
Steul's boss boasted that Digital was on its way back after
three years and over 83 billion of red ink." We need not
decide here whether an allegedly misleading statement appearing
in one source can be rendered immaterial as a matter of law, at
the pleading stage, by third-party commentary in that or a
different source.

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in the registration statement and prospectus. Because we hold

that the Shaw complaint survives Rule 12(b)(6) only to that

extent, we also conclude that the putative class on whose

behalf the Shaw complaint was brought must be narrowed

accordingly.

Material omissions and misleading statements in a

registration statement and prospectus are, in addition to being

actionable under the Securities Act by purchasers in the

offering, also actionable under Section 10(b) and Rule 10b-5 by

contemporaneous purchasers in the aftermarket, provided, of

course, that the additional elements of liability (scienter and

reliance) are established. See In re Ames Dept. Stores Inc.

Stock Litig., 991 F.2d 953, 963 (2d Cir. 1993); Fishman v.

Raytheon Mfg. Co., 188 F.2d 783, 786-87 (2d Cir. 1951); cf.

Huddleston, 459 U.S. at 383 ("[I]t is hardly a novel

proposition that the 1934 Act and the 1933 Act 'prohibit some

of the same conduct.'" (citation omitted)). In the context of

a fraud-on-the-market claim, this principle has a simple

rationale. The registration statement and prospectus speak not

only to those who purchase in the offering, but to the entire

market. If an issuer's registration statement contains a

misleading statement of fact about the company's financial

condition or omits material information required to be

disclosed, the impact of such statements or omissions, to the

extent material, would not necessarily be limited to the

securities covered by the registration statement. There is no

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logical reason that a registration statement and prospectus

could not serve as a vehicle for an alleged fraud on the

market, affecting all of the company's securities. Thus, even

though the Shaw plaintiffs purchased shares of DEC common stock

in the aftermarket, not shares of preferred stock in the

offering, their fraud-on-the-market claims may properly

encompass any material misstatements or omissions in the

registration statement. See In re Ames, 991 F.2d at 963-64.

We hold, then, that the same allegations of misleading

statements and omissions in the Wilensky complaint that state a

claim under Sections 11 and 12(2) also form the basis of a

cognizable claim under Section 10(b) and Rule 10b-5.37 The

allegations in the Wilensky complaint which we found lacking

are similarly without force in the Shaw complaint.

D. Limitation of the Shaw Class

37. In so holding, we do not intend to create a private right
of action under Section 10(b) for violations of any SEC rule.
Our holding is limited to the proposition that, in the context
of a public offering, plaintiffs who (through the market) rely
upon the completeness of a registration statement or prospectus
may sue under Section 10(b) and Rule 10b-5 for nondisclosures
of material facts omitted from those documents in violation of
the applicable SEC rules and regulations. Cf. Backman, 910

F.2d at 12-13 (suggesting that SEC regulations and insider
trading may create a duty to disclose under Rule 10b-5);
Roeder, 814 F.2d at 27 (same). But cf. In re Wells Fargo, 12

F.3d at 930 n.6 (declining to reach the issue). A different
rule would lead to the anomalous result of a Rule 10b-5
plaintiff being able to sue an individual insider selling his
company's securities for the nondisclosure of material
nonpublic information, but not being able to sue the issuer
itself for failing to disclose the same information in
connection with an offering.

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Our conclusion that the Shaw complaint states a claim,

but only to the extent it is based on the same statements and

omissions that form the basis of the surviving claims in the

Wilensky complaint, requires an important adjustment to be

made. The Shaw plaintiffs allege that they were injured when

they purchased DEC common stock at prices that were inflated as

a result of misleading statements and omissions by DEC and the

individual defendants. The named plaintiffs purport to

represent a class of persons who purchased DEC stock between

January 19 and April 15, 1994. However, because the only

allegations in the Shaw complaint that state a claim are those

that depend upon the purported misstatements and omissions in

the registration statement as of its effective date -- March

21, 1994 -- it follows that only those who purchased their

shares on or after March 21, 1994 (and before April 15, 1994,

when disclosure occurred) could have suffered cognizable

injury.

Of the four plaintiffs named in the Shaw complaint, only

Gary Phillips is alleged to have made his purchase within those

two limiting dates; thus only his claim may be reinstated. The

district court's dismissal of the claims of the three other

named plaintiffs is affirmed. On remand, the district court

should require the Shaw plaintiffs to amend their complaint to

redefine the "Class Period" accordingly.

V.

Rule 9(b)

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Defendants argue, as an alternative basis for affirming

the district court's dismissals, that both the Wilensky and

Shaw complaints fail to meet the requirement of Fed. R. Civ. P.

9(b) that claims of fraud be pleaded with "particularity." We

ask first whether the dictates of Rule 9(b) apply to the claims

asserted in the Wilensky complaint, and answer in the negative.

We then test the allegations of the Shaw complaint and conclude

that it satisfies Rule 9(b).

A. Whether Rule 9(b) Applies to the Wilensky Complaint

Rule 9(b) mandates that "[i]n all averments of fraud

. . ., the circumstances constituting fraud . . . shall be

stated with particularity." Fed. R. Civ. P. 9(b). The

threshold question is whether the Wilensky complaint, which

sets forth claims under Sections 11 and 12(2) of the Securities

Act, contains any "averments of fraud."

Fraud is not an element of a claim under either Section

11 or 12(2), and a plaintiff asserting such claims may avoid

altogether any allegations of scienter or reliance. See

Shapiro, 964 F.2d at 288; Lucia v. Prospect St. High Income

Portfolio, Inc., 769 F. Supp. 410, 416 (D. Mass. 1991), aff'd,

36 F.3d 170 (1st Cir. 1994). However, despite the minimal

requirements of Sections 11 and 12(2), a complaint asserting

violations of those statutes may yet "sound[] in fraud." Haft

v. Eastland Financial Corp., 755 F. Supp. 1123, 1126 (D.R.I.

1991). For example, if a plaintiff were to attempt to

establish violations of Sections 11 and 12(2) as well as the

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anti-fraud provisions of the Exchange Act through allegations

in a single complaint of a unified course of fraudulent

conduct, fraud might be said to "lie[] at the core of the

action." Hayduk v. Lanna, 775 F.2d 441, 443 (1st Cir. 1985).

In such a case, the particularity requirements of Rule 9(b)

would probably apply to the Sections 11, 12(2), and Rule 10b-5

claims alike. "It is the allegation of fraud, not the 'title'

of the claim that brings the policy concerns [underlying Rule

9(b)] . . . to the forefront." Haft, 755 F. Supp. at 1133;

accord Shapiro, 964 F.2d at 287-88 (applying Rule 9(b) to

Section 11 and 12(2) claims "grounded in fraud"); Lucia, 769 F.

Supp. at 416-17 (same).

As the district court noted, the Wilensky complaint

avoids grounding its Section 11 and 12(2) claims on any

allegations of fraud. Although the complaint does assert that

defendants actually possessed the information that they failed

to disclose, those allegations cannot be thought to constitute

"averments of fraud," absent any claim of scienter and

reliance. Otherwise, any allegation of nondisclosure of

material information would be transformed into a claim of fraud

for purposes of Rule 9(b). In the circumstances, we hold that

the Wilensky complaint was not subject to the pleading

requirements of Rule 9(b).

B. Whether the Shaw Complaint Satisfies Rule 9(b)

The defendants' primary challenge to the sufficiency of

the Shaw complaint under Rule 9(b) is that it fails to allege

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specific facts that would permit a reasonable inference that

defendants had knowledge of information foretelling the

financial results for the third quarter of fiscal year 1994

prior to the quarter's end. We limit our analysis to those

allegations in the Shaw complaint that state a cognizable claim

for securities fraud. The issue is thus whether the plaintiffs

have sufficiently pleaded that defendants knew facts as of

March 21, 1994 that indicated the third quarter was going to

turn out as it did, and that the company would soon thereafter

announce further restructuring actions necessitating an

additional restructuring charge for the fiscal year. Although

the question is close, we think that the complaint survives

Rule 9(b) scrutiny.

This court has been "especially rigorous" in applying

Rule 9(b) in securities fraud actions "to minimize the chance

'that a plaintiff with a largely groundless claim will bring a

suit and conduct extensive discovery in the hopes of obtaining

an increased settlement, rather than in the hopes that the

process will reveal relevant evidence.'" Romani, 929 F.2d at

878 (quoting New England Data Servs., Inc. v. Becher, 829 F.2d

286, 288 (1st Cir. 1987)). We have emphasized that the

particularity requirement cannot be avoided "simply through a

general averment that defendants 'knew' earlier what later

turned out badly." Greenstone v. Cambex Corp., 975 F.2d 22, 25

(1st Cir. 1992). A securities plaintiff cannot plead "'fraud

by hindsight.'" Id. (quoting Denny v. Barber, 576 F.2d 465,

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470 (2d Cir. 1978)). This means that a plaintiff may not

simply contrast a defendant's past optimism with less favorable

actual results, and then "contend[] that the difference must be

attributable to fraud." DiLeo v. Ernst & Young, 901 F.2d 624,

627 (7th Cir.), cert. denied, 498 U.S. 941 (1990). Rather,

Rule 9(b) requires that the complaint "set[] forth specific

facts that make it reasonable to believe that defendant knew

that a statement was materially false or misleading."

Greenstone, 975 F.2d at 25 (collecting cases); see also

Serabian, 24 F.3d at 361 (quoting Greenstone).

Here, the complaint cannot fairly be characterized as

resting on conclusory allegations of the defendants' knowledge.

The plaintiffs provide a series of factual allegations relating

to a combination of developments known to the company (e.g.,

failing product pricing strategies, market resistance to new

products, wayward compensation policies, failure to implement

downsizing plans) that could have provided a basis for advance

knowledge of the information disclosed on April 15, 1994.38

38. In asserting that defendants had direct knowledge of DEC's
third quarter operating results as they developed, plaintiffs
allege that "[m]ore so than the management of most companies,
DEC's management, including the Individual Defendants, was
virtually immediately cognizant of the Company's sales
information" by virtue of the company's use of "a highly-
efficient reporting system which allows the Company to forward
sales and cost information to senior management virtually as
sales are made." The defendants argue that these allegations
should be viewed with skepticism and as the product of nothing
more than "pure speculation." Speculation or not, we think
that the plaintiffs' allegations of a "highly-efficient
reporting system" may speak to the question of how defendants

might have known what they allegedly knew, but absent some
indication of the specific factual content of any single report

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These factual allegations, together with other aspects of the

complaint discussed below, provide a basis for a reasonable

inference that defendants knew facts by March 21 indicating

that the third fiscal quarter would be disastrous, and that

accelerated restructuring efforts requiring a further

restructuring charge were likely to follow.39 Cf. Serabian,

24 F.3d at 365; In re Wells Fargo, 12 F.3d at 931.

In additional support of their allegations of

defendants' knowledge, plaintiffs assert that two insiders of

the company, neither of whom is a defendant here, sold DEC

stockholdings during the third fiscal quarter. One, the

company's treasurer, sold 1,625 shares (68% of the officer's

total holdings) on February 11, 1994. The other, the general

manager and vice president of the company's personal computer

business, sold 2,000 shares (20% of his position) on March 22,

1994.

generated by the alleged reporting system, do not independently
provide a factual basis for inferring any such knowledge. On
balance, we do not think that generalized allegations regarding
the existence of an internal "reporting system" substantially
assist a securities fraud complaint in overcoming the hurdle of
Rule 9(b). See Pitten v. Jacobs, 903 F. Supp. 937, 949-50

(D.S.C. 1995); cf. Arazie v. Mullane, 2 F.3d 1456, 1467 (7th

Cir. 1993) (refusing to credit "scanty" allegations concerning
internal documents, absent indication of "who prepared the
projected figures, when they were prepared, how firm the
numbers were, or which . . . officers reviewed them").

39. We reject defendants' argument that the complaint fails
adequately to particularize the roles of the individual
defendants in the purported fraud. Cf. Serabian, 24 F.3d at

367-68.

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Of course, the mere fact that insider stock sales

occurred does not suffice to establish scienter. See Tapogna

v. Egan, 141 F.R.D. 370, 373 (D. Mass. 1992). However,

allegations of "insider trading in suspicious amounts or at

suspicious times" may permit an inference that the trader --

and by further inference, the company -- possessed material

nonpublic information at the time. See Greenstone, 975 F.2d at

26 (citing In re Apple Computer, 886 F.2d at 1117); see also

Rubinstein, 20 F.3d at 169-70 (characterizing sufficiently

suspicious trading as "presumptively probative of bad faith and

scienter"). Here, the level of suspicion warranted by the

alleged insider stock sales is marginal: the first sale

occurred more than a month prior to the date of concern here

(March 21, 1994); and the second sale, though made at what

might be considered a "suspicious" time, involved a small

(albeit not insignificant) percentage of the insider's total

holdings of DEC stock. Nonetheless, we think that the

plaintiffs' allegations of insider trading, inasmuch as they

are at least consistent with their theory of fraud, provide

some support against the defendants' motion to dismiss under

Rule 9(b).

Finally, in testing the allegations of the complaint

against Rule 9(b), we need not turn a blind eye to the obvious:

the proximity of the date of the allegedly fraudulent

statements and omissions to both the end of the quarter then in

progress and the date on which disclosure was eventually made.

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While the short time frame between an allegedly fraudulent

statement or omission and a later disclosure of inconsistent

information does not, standing alone, provide a sufficient

factual grounding to satisfy Rule 9(b), see Arazie, 2 F.3d at

1467-68, there is nothing in Rule 9(b) that precludes

consideration of such temporal proximity as a circumstance

potentially bolstering the complaint's claims of fraud. See

Fecht, 70 F.3d at 1083-84. On the facts as alleged in this

case, we think that the proximity of the date of the allegedly

misleading statements and omissions to the end of the ongoing

quarter (and the date of eventual disclosure) provides some

circumstantial factual support to be taken into account in

determining whether the complaint pleads an adequate basis for

inferring defendants' culpable knowledge.

We have no intention here of diluting the stringent

mandate of Rule 9(b). But in determining the adequacy of a

complaint under that rule, we cannot hold plaintiffs to a

standard that would effectively require them, pre-discovery, to

plead evidence. Rule 9(b) proscribes the pleading of "fraud by

hindsight," Denny, 576 F.2d at 470, but neither can plaintiffs

be expected to plead fraud with complete insight. We conclude

that the portions of the Shaw complaint that survive Rule

12(b)(6) scrutiny also satisfy the particularity requirements

of Rule 9(b).

VI.

Conclusion

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The district court erred in dismissing the Wilensky and

Shaw complaints in their entirety. Portions of both complaints

survive Rule 12(b)(6), but only to the extent that they allege:

(i) that the registration statement filed in connection with

the public offering of March 21, 1994, failed to disclose

material information in DEC's possession as of that date that

would have alerted the market to the likelihood of disastrous

quarterly results; and (ii) that the statement in the

prospectus supplement as to the "adequacy" of the restructuring

reserve remaining as of March 21, 1994 was materially false or

misleading.40 We hold, however, that the Wilensky complaint

fails to state a claim under Section 12(2) of the Securities

Act as to DEC and the individual defendants. Furthermore, in

light of the limited basis on which we permit the Shaw action

to go forward, only the claims of the single named plaintiff

who purchased DEC shares after March 21, 1994 may be

reinstated, and the allegations in the Shaw complaint

pertaining to the scope of the putative plaintiff class must be

modified accordingly. Finally, the requirements of Fed. R.

Civ. P. 9(b) do not apply to the Wilensky complaint as

currently pleaded, and the surviving portion of the Shaw

complaint does satisfy Rule 9(b). On remand, the district

40. The district court did not state any independent reasons
for dismissing the Wilensky plaintiffs' derivative claims under

Section 15 of the Securities Act or the Shaw plaintiffs' claims

under Section 20(a) of the Exchange Act and for common law
negligent misrepresentation. Those claims should, therefore,
be reinstated and permitted to proceed to the extent consistent
with this opinion.

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court may choose to require the plaintiffs to amend their

complaints in accordance with these conclusions.

In closing, we note that although the issues of

materiality and knowledge raised by the two complaints preclude

terminating this litigation on the pleadings, nothing we say

here is intended to foreclose the possibility that those and

other issues, after discovery and an opportunity for factual

development, might be susceptible to resolution on motions for

summary judgment. To borrow wise words from one of our prior

decisions: "Despite our conclusion that certain allegations

survive threshold consideration, we note that plaintiffs remain

a great distance from actually proving" any violations of the

federal securities laws. Serabian, 24 F.3d at 365-66.

Affirmed in part, reversed in part, and remanded. No

costs are awarded.

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