Appeal from the United States District Court for the Northern District of California. DC No. CV-86-4129-CAL, DC No. CV-86-0379-CAL, DC No. CV-87-1129-CAL, DC No. CV-86-1692-CAL, DC No. CV-87-1129-CAL, DC No. CV-86-3474-CAL, DC No. CV-86-3673-CAL, DC No. CV-87-0228-CAL, DC No. CV-87-6038-CAL, DC No. CV-88-3175-CAL. Charles A. Legge, District Judge, Presiding
Before: Canby And Kozinski, Circuit Judges And Carroll,*fn* District Judge
This appeal arises out of a private placement of stock in Spendthrift Farms, Inc. ("Spendthrift") that occurred in 1983. Several investors sued the co-owners of Spendthrift, Brownell Combs II ("Combs") and his father Leslie Combs II,*fn1 as well as consultants, attorneys, an investment bank, an accounting firm, and a commercial bank. In summary judgment and directed verdict rulings, the district court dismissed all claims against the professional defendants -- the attorneys, the investment bank, the accounting firm, and the commercial bank. Some of the claims against Combs and his consultant, Garth Guy ("Guy"), were submitted to a jury, which returned a verdict for the defense. The plaintiffs appeal the district court's summary judgment and directed verdict rulings as well as the jury verdict, which they contend was based on erroneous instructions. We affirm.
In the early 1980s, Spendthrift was the largest thoroughbred horse breeding operation in the world. In 1983, Brownell and Leslie Combs, each of whom owned 50% of Spendthrift, employed Guy to assist them in selling a portion of their interests in Spendthrift. At Guy's suggestion, the Combses decided to sell $35 million worth of stock in Spendthrift in a private placement, to be followed by a public offering by Spendthrift.
In connection with the private placement, Combs and Guy utilized the services of Charles R. Hembree and Edwin L. Schaeffer, both of whom were partners in Kincaid, Wilson, Schaeffer & Hembree, P.S.C. ("Kincaid firm"), a Kentucky law firm. Guy drafted, and Hembree reviewed, the Private Placement Memorandum ("PPM") in March of 1983. Guy also contacted the Central Bank & Trust Company ("Central Bank"), which agreed to consider loan applications from investors in the private placement. The PPM contained background on Spendthrift as well as a balance sheet valuing Spendthrift's assets at over $114 million and financial statements prepared by Deloitte, Haskins & Sells ("Deloitte"). The PPM was released on April 1, 1983, and Guy began to solicit investors by June. At the same time that the private placement was proceeding, Guy and Combs engaged the services of Bateman Eichler, Hill Richards, Incorporated ("Bateman Eichler"), and in particular Robert J. McGuiness, a stockbroker at Bateman Eichler, to serve as lead underwriter for the public offering, which was scheduled to occur a few months after the private offering was completed. Guy and the Combses also hired Frank Bryant as a financial consultant to Spendthrift in connection with the public offering.
After over 500 persons were contacted, 34 agreed to participate in the private placement for Spendthrift stock. Prior to purchasing shares, each of these investors signed a subscription agreement representing and warranting that he or she had carefully reviewed the PPM; that he or she had a net worth in excess of $5 million; that he or she possessed, either alone or with an investment advisor, sufficient knowledge and experience in financial and business matters to evaluate the risks of the investment; and that he or she understood that the investment in Spendthrift involved a substantial degree of financial risk. The private placement closing took place on August 4, 1983, with investors paying $7.50 per share (after a 4-for-3 stock split in September 1983). After the closing, work continued on the initial public offering, which closed on November 22, 1983. The public offering price was $12 per share, and the price per share remained above the level that the plaintiffs paid through 1984.*fn2 In 1985, the price of the Spendthrift stock declined dramatically. In February 1986, plaintiffs began filing the complaints that were consolidated in this litigation.
Nine actions were consolidated before Judge Charles A. Legge for pretrial and trial purposes. The plaintiffs, all of whom were investors in the private placement, alleged, inter alia, violations of Section 10(b) of the Securities and Exchange Act of 1934, 15 U.S.C. § 78j(b) (1988), and SEC Rule 10b-5, 17 C.F.R. § 240.10b-5 (1991), common law claims of fraudulent misrepresentation and negligent misrepresentation, and violations of Washington and Kentucky Blue sky laws.
In December 1988, the district court dismissed all plaintiffs' claims against four defendants: Central Bank, Bryant, Bateman Eichler, and McGuiness. The remaining defendants then moved for summary judgment on the alleged misrepresentations and omissions claimed by the plaintiffs. The district court ruled that dozens of the alleged misrepresentations and omissions were, as a matter of law, not actionable, and granted summary judgment on those claims. Trial proceeded on the remaining misrepresentation or omission claims against Hembree, the Kincaid firm, Combs and Guy. After plaintiffs completed their evidence on liability issues, the district court entered a directed verdict on behalf of Hembree and the Kincaid firm on all claims. The district court also directed a verdict in favor of Combs and Guy on certain claims, and ruled that some of the alleged misrepresentations and omissions that had survived summary adjudication were not actionable and would not be submitted to the jury. Claims against Combs and Guy were submitted to the jury for violation of Rule 10b-5, violation of the state securities statutes of Kentucky and Washington, and for common law fraud and negligent misrepresentation. The jury returned a verdict in favor of Combs and Guy on all claims.
On appeal, plaintiffs contend that: 1) the district court improperly withheld from the jury three misrepresentations that allegedly violated Rule 10b-5 and constituted both fraud and negligent misrepresentation; 2) the district court misconstrued the loss causation requirement of Rule 10b-5 and therefore erred both in entering a directed verdict for the defendants on four alleged omissions and in giving improper instructions on three alleged misrepresentations that did go to the jury;*fn3 3) the district court erred in dismissing some of plaintiffs' fraud and negligent misrepresentation claims; 4) the district misconstrued both Washington and Kentucky Blue sky laws.*fn4
I. THE THREE REPRESENTATIONS THAT ALLEGEDLY VIOLATED RULE 10b-5 AND CONSTITUTED FRAUD AND NEGLIGENT MISREPRESENTATION
The district court granted a directed verdict for the defendants on three alleged misrepresentations in the PPM, concluding that they were not actionable. The plaintiffs appeal the district court's ruling, arguing that they should have been allowed to present their claims to the jury as violations of Rule 10b-5 and as a basis for pendent fraudulent misrepresentation and negligent misrepresentation claims. We review a directed verdict under the same standard applied by the district court; a directed verdict is proper when the evidence permits only one reasonable Conclusion as to the verdict. Peterson v. Kennedy, 771 F.2d 1244, 1256 (9th Cir. 1985), cert. denied, 475 U.S. 1122, 90 L. Ed. 2d 187, 106 S. Ct. 1642 (1986).
A. The Allegedly Misleading Comparison of Spendthrift with Other Horse Breeding Companies
The plaintiffs' first challenge to the directed verdicts relates to an allegedly misleading comparison between Spendthrift and three publicly-traded horse breeding companies. The PPM contained a chart listing three other horse breeding companies, all of which had had a public offering. The chart indicated that each of them was trading at a market value that was higher than the companies' latest published book value, and that the average premium was 321%. Below the chart, the PPM had a brief Discussion of the other companies that included the following statement: "Assuming that Spendthrift were valued as highly by the public as [the three publicly traded companies], the current public market value would be 421 percent of the equity, or in excess of $383,000,000."*fn5 The plaintiffs object to this statement because the 321% "premium over equity" for the three public companies was the average ratio between the companies' market value and their book value, whereas the $383 million market value suggested for Spendthrift constituted a 321% premium over Spendthrift's appraised fair market value. The relevance of this distinction is that the appraised value of Spendthrift was significantly higher than its book value. The plaintiffs claim -- and the defendants do not dispute -- that 421% of the book value of Spendthrift was only about $45 million. The result, according to the plaintiffs, was that the PPM contained a misleading comparison that inflated the value of Spendthrift and induced them to buy the stock.
The problem with the plaintiffs' argument is that the PPM contained a number of disclaimers in the paragraph immediately after the statement regarding the other companies:
While the management of Spendthrift believes that the current values are extremely high, they do represent the market as it exists today in these companies. This means that a 35 percent interest in Spendthrift, should Spendthrift be valued at the same premiums as the companies listed above, would be worth $134,000,000 in today's market. It should be emphasized that this does not represent an estimate by Management of the value of Spendthrift, nor does it represent what Management feels that Spendthrift would be worth if it went public today, nor should any investor take comfort that these values in any way represent the worth of Spendthrift. Management is saying that the values that are represented in the tables [outlined above] are, to the best of its knowledge, an actuality. As can be seen [above], International Thoroughbred Breeders [one of the three companies in the chart] has a total market value of $98,000,000 as of March 1, 1983. The total value that the sellers are placing on Spendthrift Farm, Inc. for the purpose of this placement is $100,000,000.
The district court relied on these disclaimers in dismissing the claim of misrepresentation:
I don't think there's really anything that is a misrepresentation of fact in here at all. It seems to me it's a cute exercise in mathematics, but I think page 103 [containing the chart and the paragraphs quoted above] particularly is riddled with disclosures particularly that last paragraph that a reader is not to rely upon this and that the value of $100 million is stated and not the multiplied values that are presented up above.
We agree with the district court that no rational jury could find the comparative figures to have been material in light of their openly hypothetical nature and the specific disclaimers. A fact is material if there is "'a substantial likelihood that, under all the circumstances, the omitted fact would have assumed actual significance in the deliberations of the reasonable shareholder.'" Grigsby v. CMI Corp., 765 F.2d 1369, 1373 (9th Cir. 1985) (quoting TSC Industries, Inc. v. Northway, Inc., 426 U.S. 438, 449, 48 L. Ed. 2d 757, 96 S. Ct. 2126 (1976)); see also SEC v. Seaboard Corp., 677 F.2d 1301, 1306 (9th Cir. 1982); Smolen v. Deloitte, Haskins & Sells, 921 F.2d 959, 964 (9th Cir. 1990). The investors here were by no means neophytes or persons otherwise unacquainted with business and financial affairs. The district court was entitled to take that fact into account in determining whether a reasonable shareholder in their position would consider the comparison figures significant. See Hughes v. Dempsey-Tegeler & Co., 534 F.2d 156, 177 (9th Cir.), cert. denied, 429 U.S. 896, 50 L. Ed. 2d 180, 97 S. Ct. 259 (1976).
Even if the comparison was one between apples and oranges, as plaintiffs claim, the PPM made clear that the multiples were derived from the book values of the other companies and from the appraised value of Spendthrift. At worst, the only effect of this flaw was to produce an inflated hypothetical figure of $383 million at which the public might come to value Spendthrift. The PPM expressly disavowed that figure as a statement of the value of Spendthrift and advised investors not to rely on it. The PPM valued the enterprise instead at $100 million for purposes of the private placement. The district court did not err in concluding that no rational jury could find that reasonable investors in plaintiffs' positions could have relied on the $383 million figure.
The lack of materiality of the comparison defeats the claims under section 10(b) and Rule 10b-5. See Huddleston v. Herman & MacLean, 640 F.2d 534, 543 (5th Cir. 1981) (for a 10b-5 claim, plaintiff must establish "(1) a misstatement or an omission (2) of material fact (3) made with scienter (4) on which the plaintiff relied (5) that proximately caused his injury."), aff'd in part and rev'd in part on other grounds, 459 U.S. 375, 74 L. Ed. 2d 548, 103 S. Ct. 683 (1983). It also defeats the fraud and negligent misrepresentation claims, because justifiable reliance is an element of both of those claims under California law. See Continental Airlines v. McDonnell Douglas, 216 Cal. App. 3d 388, 264 Cal. Rptr. 779, 784 (Cal. Ct. App. 1989); Cicone v. URS Corp., 183 Cal. App. 3d 194, 227 Cal. Rptr. 887, 890 (Cal. Ct. App. 1986); B.E. Witkin, California Procedure, Pleadings § 666 (3rd ed. 1985); see also Smolen, 921 F.2d at 964. The district court accordingly did not err in ruling that the comparison was not actionable.
B. The Allegedly Improper Treatment of Privileges to Breed on the Income Statement
The second alleged misrepresentation involves privileges to breed ("PTBs"), which are breeding rights in a stallion that has been syndicated. After two weeks of trial, the plaintiffs attempted to introduce evidence that it was improper for spendthrift both to recognize income upon requisition of a PTB and to recognize income each year when the PTB produces actual revenues. The district court ruled that the plaintiffs were precluded from introducing evidence on this alleged misrepresentation, because they failed to identify that issue in the list of alleged misrepresentations that they were required to file as part of the pretrial proceedings.
The plaintiffs contend that the Judge abused his discretion*fn6 in so ruling, because, first, the pretrial list of alleged misrepresentations was "an informal road map," and, second, the plaintiffs raised the issue in their pretrial list. Neither of these contentions has merit.
With respect to plaintiffs' first argument, the record reveals that the pretrial order was intended to produce a complete list of alleged misrepresentations. The genesis of the list was a request by the defendants shortly before the trial (but after considerable discovery) that the plaintiffs identify all of the alleged misrepresentations, so that the defendants could challenge the legal sufficiency of each of them. In response to this request, the district court issued a conference order which required that "Plaintiff shall serve and file by Friday, October 21, 1988, a list of each alleged misrepresentation or misleading omission of material fact which they assert defendants have made." Nothing in the conference order suggests any informality regarding the list. The court's apparent intention was to give the defendants notice of all the alleged misrepresentations, and to that end it required the plaintiffs to identify each of their claimed misrepresentations and omissions. Allowing the plaintiffs to introduce a new claim of misrepresentation would have defeated the purpose of the order. The court properly ruled, therefore, that the order did not permit the plaintiffs to present evidence of a newly discovered alleged misrepresentation at trial.
Plaintiffs' second argument also does not withstand scrutiny. Plaintiffs contend that two of the entries on the list of alleged misrepresentations encompass their PTB claim. First, they point to their claim that "the appraisal based financial statements in the PPM were false and misleading in including contingent privileges-to-breed in Spendthrift's balance sheet." This assertion is an attack on the balance sheet, on the theory that it should not have included contingent assets and that PTBs were contingent. This issue, which the district court did permit the plaintiffs to present, is entirely different from the question of whether or not the income statement should have recognized income from both the receipt and the sale of a PTB. The two claims are wholly independent of each other. The district court correctly ruled, therefore, that this entry on the list of alleged misrepresentations did not raise the issue of the PTBs' treatment on the income statement.
The second entry on the pretrial list that plaintiffs identify as including their claim about PTBs on the income statement is their assertion that "the PPM misrepresented that the income statements included in [the] PPM were prepared in accordance with generally accepted accounting principles." This statement, however, is so general that it cannot be construed as presenting plaintiffs' claims about the PTBs on the income statement. As the district court stated, "there's really no identification in that [entry] of any specific points that they're pointing out, and I just don't think you can use a catch-all like that to save an issue." Indeed, a holding that this general statement encompasses the PTB claim would frustrate the purpose of the list of alleged misrepresentations, as it would allow ...