Ganino v. Citizens Utilities Co.

The plaintiffs-appellants appeal from a final judgment of the United States District Court for the District of Connecticut (Warren W. Eginton, Senior Judge), granting the defendants-appellees' motion to dismiss the Second Amended Complaint (the "Complaint") for failure to state a claim under Sections 10(b)1 and 20(a)2 of the Securities Exchange Act of 1934 (the "Exchange Act"), 15 U.S.C. §§ 78j(b) & 78t(a), and Rule 10b-53 promulgated thereunder, 17 C.F.R. § 240.10b-5. The district court held: (1) the misrepresentations regarding certain payments amounting to 1.7% of total annual revenue were immaterial as a matter of law; (2) the lack of share price movement following the release of corrective information was evidence of immateriality; and (3) the Complaint was defective as to one or more of the other elements of a Rule 10b-5 suit. For the reasons that follow, we reverse in part, vacate in part, and remand with instructions.

The plaintiffs in this action purchased or acquired the common stock of Citizens Utilities Company ("Citizens" or the "Company"), the corporate defendant, between May 7, 1996 and August 7, 1997 (the "Class Period"). [JA 260 ¶ 1] Alleging that Citizens' share price was fraudulently inflated during the Class Period, the plaintiffs seek to represent the class of all purchasers of Citizens common stock during the Class Period in this action against Citizens and three of its senior officers. [JA 262-63 ¶¶ 8-9; JA 265 ¶ 11] The following allegations are drawn from their Complaint, which we accept as true for purposes of this appeal.

Citizens is a publicly traded communications and public services company. [JA 262 ¶ 8] As of 1995, Citizens had reported over fifty consecutive years of increased revenue, earnings, and earnings per share, a fact which it emphasized in its public comments. Id. [JA 269 ¶ 22; JA 280 ¶ 33] In 1995, however, Citizens would not receive approximately $38 million in revenue from Pacific Bell. [JA 296-97 ¶ 60d] In order to continue to report increased earnings, the Company had to find another source of revenue. [Id.]

That replacement source was Hungarian Telephone & Cable Corporation ("HTCC"), a U.S. company which provides telephone services in Hungary under telecommunications concessions from the Hungarian government. [JA 268-69 ¶ 20] The concession contracts require HTCC to meet certain construction milestones. [JA 268 ¶ 20b] Failure to do so would subject HTCC to fines, reduction of its exclusivity period, or abrogation of the contracts. [JA 269 ¶ 20c-d] Unprofitable since its inception, HTCC by 1995 lacked the necessary funds to satisfy its contractual requirements and began looking for a source of financing. [JA 269 ¶ 21] Beginning in May 1995, HTCC and Citizens (through a wholly owned subsidiary of Citizens) entered into a series of agreements under which Citizens agreed in 1995 to make and/or guarantee loans to HTCC. In consideration for these loans and guarantees, Citizens received substantial fees (the "Financial Support Fees" or the "Fees"), consisting primarily of HTCC stock and options. [JA 270-71 ¶ 23] In addition, Citizens also provided management consulting services to HTCC. Id. ¶ 23. [JA 272 ¶ 24c]

1. Allegations of Material Misrepresentations

Although Citizens earned and received approximately $10.1 million in Financial Support Fees from HTCC in 1995, Citizens, according to the Complaint, fraudulently recognized this sum as 1996 first and second quarter income without proper disclosure. [JA 281 ¶ 34(f), 284 ¶ 36(f)] Because Citizens' 1995 annual financial statement ("1995 Form 10-K") filed with the Securities and Exchange Commission (the "SEC") stated that Citizens "ha[d] been compensated for . . . guarantees and financial support [to HTCC]," investors were allegedly misled into believing that the $10.1 million booked in 1996 was new income, unrelated to the 1995 HTCC loan and guarantee transactions. [JA 276 ¶ 26, 283 ¶ 37] See 15 U.S.C. § 78m(a)(2) (requiring quarterly and annual financial reports to be filed with the SEC); 17 C.F.R. § 240.13a-13(a).

a. May 7, 1996 Announcement of 1996 First Quarter Financial Results and First Quarter Form 10-Q

On May 7, 1996, Citizens publicly announced an after-tax net income of $38.9 million for the first quarter of 1996, up 15% from the corresponding period in 1995. [JA 279-80 ¶ 33] These results were reflected in its 1996 first quarter financial statement ("First Quarter Form 10-Q"). [JA 117 (line item "Net Income"), JA 280 ¶ 33] The defendants did not disclose that "as much as $6.9 million of the $38.9 million . . . was HTCC related income which was deceptively 'stored' by Citizens" until the first quarter of 1996. [JA 281 ¶ 34f] According to the Complaint, the defendants also concealed the fact that this $6.9 million made up most if not all of the reported 15% increase during the first quarter of 1996. [Id.]

b. August 15, 1996 Press Release and 1996 Second Quarter Form 10-Q

On August 15, 1996, Citizens issued another press release announcing "record . . . profits for the three- and six-month periods ended June 30, 1996," with the second quarter's net income of $46.3 million representing a 10% increase over the comparable period in the preceding year. [JA 281 ¶ 35] Citizens attributed this growth to "continuous above-average growth in volume and profitability in each of its sectors, particularly telecommunications." [JA 281-82 ¶ 35] These results were reflected in its 1996 second quarter financial report ("Second Quarter Form 10-Q"). [JA 129 (line item "Net Income"), JA 282 ¶ 35] The Complaint charges that the August 15, 1996 press release and the 1996 Second Quarter Form 10-Q both failed to disclose that "approximately $10 million of the $85.1 million of reported income for the six months ended June 30, 1996 was HTCC related income" which should have been recognized in 1995. [JA 283 ¶ 36f] The Complaint states that the defendants also concealed the fact that this approximately $10 million accounted for the full 10% increase in income for the first six months of 1996 over the comparable period in 1995. [Id.]

c. Subsequent Financial Statements and Press Releases

The $10.1 million of Financial Support Fees were also reported as part of the year-to-date earnings in Citizens' 1996 Third Quarter Form 10-Q, 1996 Form 10-K, and accompanying press releases. [JA 284-86 ¶¶ 38-41] An additional $11.2 million of Fees were booked in the last quarter of 1996 and reflected in the 1996 year-end statement ("1996 Form 10-K"). [JA 287 ¶ 42f] In total, the Fees at issue added up to approximately $22 million, or 1.7% of Citizens' total revenue for 1996. [JA 146 (line item "Total revenues")] As with the Form 10-Qs for the first two quarters of 1996, the defendants did not disclose in the Third Quarter Form 10-Q, 1996 Form 10-K, and accompanying press releases that the reported income included HTCC Fees earned and received in 1995. [Id.]

On April 30, 1997, Citizens issued a press release announcing lower than expected earnings for the first quarter of 1997. These results were reflected in the Company's 1997 First Quarter Form 10-Q. [JA 287-88 ¶ 43; JA 288 ¶ 44] Neither document attributed the drop in income to the decrease in HTCC Fees. Instead, according to the Complaint, the press release misleadingly focused on rising expenses. [JA 288 ¶ 43] Beginning in or about May 1997, industry analysts began to report weaknesses in Citizens' earnings position. [JA 288-89 ¶¶ 46-47] Their predictions were confirmed by Citizens in August 1997 with the filing of its 1997 Second Quarter Form 10-Q, which also disclosed that the reported income for the first two quarters of 1996 included material income from HTCC. [JA 289 ¶ 48]

d. Other Misrepresentations

The defendants allegedly made other material misrepresentations. According to the Complaint, the defendants failed to disclose that the Fees were non-recurring income, in violation of a Generally Accepted Accounting Principle ("GAAP")4 that companies report "extraordinary, unusual or infrequently occurring events and transactions." [JA 292 ¶ 53] See generally Accounting Principles Board ("APB") Opinion No. 30, ¶¶ 19-24 (1973) (explaining "Criteria for Extraordinary Items"). The defendants also allegedly concealed Citizens' control over HTCC and in fact, by employing "cost accounting," which under GAAP is appropriately used only to reflect a registrant's investment in a company the registrant does not dominate, Citizens falsely represented that it exercised no such control over HTCC. [JA 271-72 ¶ 24a; 277-79 ¶¶ 30-31] See generally APB Opinion No. 18, ¶¶ 5-17 (1971). According to the Complaint, Citizens' secret domination of HTCC was all the more significant because the Fees were paid in the form of HTCC stock and options, the price of which Citizens could manipulate using its influence over HTCC. [JA 290-91 ¶ 52]

The Complaint alleges that the defendants made the purported misrepresentations knowingly or recklessly. That is, defendants Leonard Tow and Robert DeSantis, senior officers of Citizens, believed throughout most of 1995 that a new source of income was needed to replace revenue from Pacific Bell that ceased in 1994. [JA 296 ¶ 60d] However, by the end of 1995, after the HTCC Fees were already paid in, Citizens found that it was able to meet earnings projections even without the Fees. [Id.] Not only were the HTCC Fees not needed in 1995 to replace lost revenue from Pacific Bell, but if Citizens had recognized the HTCC Fees in 1995, the Fees would have so increased Citizens' 1995 earnings that the Company would have difficulty meeting expectations for increased earnings in 1996. See id.. [JA 281 ¶ 34(f)] Thus, according to the Complaint, the defendants manipulated the recognition of the Fees in order to manage the income trend.

The defendants allegedly had other corporate and personal motives to maintain an artificial earnings growth trend, thus propping up Citizens' share price. In 1996, Citizens engaged in a stock-for-stock acquisition of another company and placed a debenture offering to finance its telecommunications expansion. [JA 297 ¶ 61(a)-(b)] Both of these transactions, the Complaint states, were well-served by an inflated stock price. As to the individual defendants, Livingston Ross (also a senior Citizens officer) and DeSantis purportedly engaged in insider trading during the Class Period, and all three individual defendants benefitted by securing their executive privileges. [Id. ¶ 61(c)-(d)]

In 1988 the plaintiffs filed this action, asserting violations of § 10(b) of the Exchange Act and the corresponding Rule 10b-5 against all defendants, and violation of § 20(a) of the Exchange Act against the individual defendants as persons controlling Citizens. [JA 299-304 ¶¶ 62-76] The plaintiffs also sought to certify this action as a class action under Rule 23 of the Federal Rules of Civil Procedure. The defendants moved to dismiss the Complaint in its entirety, arguing that: (1) the nondisclosures at issue were immaterial because the information was already publicly available; (2) the plaintiffs failed to plead scienter with particularity; (3) the amount of Fees they allegedly "deceptively stored" was immaterial as a matter of law since it comprised a de minimis 1.7% of Citizens' total pre-tax revenues during the class period; (4) the plaintiffs' allegations of GAAP violations, without corresponding fraudulent intent, failed to state a claim; and (5) the Complaint failed to state a § 20(a) claim because the underlying § 10(b)/Rule 10b-5 charges are not viable. [JA 86-108]

The district court granted the defendants' motion to dismiss. See Ganino v.Citizens Utilities Co., 56 F. Supp. 2d 222 (D. Conn. 1999). Focusing on the issue of materiality, the court quoted a newspaper article which observed that "'[m]ost auditors -- and their corporate clients -- define materiality as any event or news that might affect a company's earnings, positively or negatively, by 3% to 10% . . . . [it] has become standard practice in corporate America. Thus, if a particular charge or event doesn't meet the 3% to 10% level, companies feel they don't have to disclose it.'" Id.at 226 (alteration in original) (quoting Elizabeth MacDonald, SEC Readies New Rules for Companies About What is "Material" for Disclosure, WALL ST. J., Nov. 3, 1998, at A2). [JA 225] Applying this 3% to 10% range, the court held that "the amount in issue here -- 1.7% of Citizens' revenues for the relevant time period, pursuant to GAAP -- is immaterial as a matter of law." Id. at 227. In addition, the court found that the lack of change in Citizens' stock price following the filing of the 1997 Second Quarter Form 10-Q on August 7, 1997, to be evidence of immateriality. See id.

Because the alleged misrepresentations were held to be legally immaterial, the court found it unnecessary to discuss the other grounds for dismissal urged by the defendants. It stated summarily that "[n]evertheless, the Court has thoroughly examined [the other] elements [of a Rule 10b-5 claim] and plaintiffs' supporting authority, and holds that such would not change the outcome of this case." Id. This appeal followed.

We review de novo a district court's dismissal of a complaint pursuant to Rule 12(b)(6), accepting all factual allegations in the complaint as true and drawing all reasonable inferences in the plaintiffs' favor. See Friedl v. City of New York, 210 F.3d 79, 83 (2d Cir. 2000); Koppel v. 4987 Corp., 167 F.3d 125, 130 (2d Cir. 1999) (internal quotation omitted). We uphold a dismissal only if "it appears beyond doubt that the plaintiff can prove no set of facts in support of his claim which would entitle him to relief." Id.(internal quotation marks and citations omitted).

Section 10(b) of the Exchange Act bars conduct "involving manipulation or deception, manipulation being practices . . . that are intended to mislead investors by artificially affecting market activity, and deception being misrepresentation, or nondisclosure intended to deceive." Field v. Trump, 850 F.2d 938, 946-47 (2d Cir. 1988) (internal quotation marks and citation omitted); see Press v. Chemical Inv. Serv. Corp., 166 F.3d 529, 538 (2d Cir. 1999). To state a claim under § 10(b) and the corresponding Rule 10b-5, a plaintiff must plead that the defendant, in connection with the purchase or sale of securities, made a materially false statement or omitted a material fact, with scienter, and that the plaintiff's reliance on the defendant's action caused injury to the plaintiff. See In re Carter-Wallace, Inc. Sec. Litig., 150 F.3d 153, 155-56 (2d Cir. 1998); San Leandro Emergency Med. Group Profit Sharing Plan v. Philip Morris Cos., 75 F.3d 801, 808 (2d Cir. 1996); Acito v. IMCERA Group, Inc., 47 F.3d 47, 52 (2d Cir. 1995).

The plaintiffs' principal contentions on appeal are that the district court erred in deciding that the Complaint failed to allege material misrepresentations and scienter. Neither they nor the defendants interpret the district court's dismissal of the Rule 10b-5 claims as having any other basis. Accordingly, we consider only the elements of materiality and scienter.

At the pleading stage, a plaintiff satisfies the materiality requirement of Rule 10b-5 by alleging a statement or omission that a reasonable investor would have considered significant in making investment decisions. See Basic Inc. v. Levinson, 485 U.S. 224, 231 (1988) (adopting the standard in TSC Indus., Inc. v. Northway, Inc., 426 U.S. 438, 449 (1976), for § 10(b) and Rule 10b-5 actions); Glazer v. Formica Corp., 964 F.2d 149, 154-55 (2d Cir. 1992). "'[T]here must be a substantial likelihood that the disclosure of the omitted fact would have been viewed by the reasonable investor as having significantly altered the 'total mix' of information made available.'" Basic, 485 U.S. at 231-32 (quoting TSC Indus., 426 U.S. at 449)). It is not sufficient to allege that the investor might have considered the misrepresentation or omission important. On the other hand, it is not necessary to assert that the investor would have acted differently if an accurate disclosure was made. Cf. Folger Adam Co. v. PMI Indus., Inc., 938 F.2d 1529, 1533-34 (2d Cir. 1991) (holding that jury charge which may have misled jury to believe that information is material only if it is outcome-determinative was error). An omitted fact may be immaterial if the information is trivial, see Basic, 485 U.S. at 231 (citation omitted), or is "so basic that any investor could be expected to know it," Levitin v. Painewebber, Inc., 159 F.3d 698, 702 (2d Cir. 1998) (internal quotation marks omitted), cert. denied, 525 U.S. 1144 (1999). Therefore, whether an alleged misrepresentation or omission is material necessarily depends on all relevant circumstances of the particular case.

Materiality is a mixed question of law and fact. See TSC Indus., 426 U.S. at 450. We have held that, when presented with a Rule 12(b)(6) motion, "a complaint may not properly be dismissed . . . on the ground that the alleged misstatements or omissions are not material unless they are so obviously unimportant to a reasonable investor that reasonable minds could not differ on the question of their importance." Goldman v. Belden, 754 F.2d 1059, 1067 (2d Cir. 1985); see Azrielli v. Cohen Law Offices, 21 F.3d 512, 518 (2d Cir. 1994).

a. Numerical Benchmark

The district court held that the alleged misrepresentations of the HTCC Fees as having been received in 1996 were immaterial as a matter of law because the Fees amounted to only 1.7% of Citizens' 1996 total revenue. The plaintiffs and the SEC, as amicus curiae, contend that the court's exclusive reliance on a single numerical or percentage benchmark to determine materiality was error. Their position is supported by ample authority. In Basic, the Supreme Court expressly rejected the use of a numerical formula:

A bright-line rule indeed is easier to follow than a standard that requires the exercise of judgment in the light of all the circumstances. But ease of application alone is not an excuse for ignoring the purposes of the Securities Acts and Congress' policy decisions. Any approach that designates a single fact or occurrence as always determinative of an inherently fact-specific finding such as materiality, must necessarily be overinclusive or underinclusive.

Basic, 485 U.S. at 236 & n.14 (1988) (citing House Committee on Interstate and Foreign Commerce, Report of the Advisory Committee on Corporate Disclosure to the Securities and Exchange Commission, 95th Cong., 1st Sess., at 327 (Comm. Print 1977)); see also FASB, Statement of Financial Accounting Concepts No. 2, ¶ 125 (1980) ("[M]agnitude by itself, without regard to the nature of the item and the circumstances in which the judgment has to be made, will not generally be a sufficient basis for a materiality judgment.").

Following Basic, we have consistently rejected a formulaic approach to assessing the materiality of an alleged misrepresentation. For example, in Press, we considered when failure to disclose the specifics of a securities markup5 would be material. See Press, 166 F.3d at 534-37. Under § 10(b) of the Exchange Act, a seller has a duty to disclose the details of a markup if the markup is "excessive." See id. at 534. We declined in that case to establish a specific range beyond which a markup would be deemed "excessive," holding instead that courts must assess a broad range of factors. See id. at 535. In Glazer, we rejected the notion that merger talks are not material as a matter of law unless the discussions had ripened into an agreement-in-principle on price and structure. Glazer, 964 F.2d at 156. We held that the materiality of merger negotiations depends on the specific facts of each case. See id. See also In re Home Health Corp. of America, Inc. Sec. Litig., No. Civ. A. 98-834, 1999 WL 79057, at *6-7 (E.D. Pa. Jan. 29, 1999) (declining to hold immaterial as a matter of law failure to report loss of a de minimis percentage of total revenue where qualitative factor rendered the loss significant); In re Kidder Peabody Sec. Litig., 10 F. Supp. 2d 398, 410 (S.D.N.Y. 1998) (relying on Basic and declining to hold as a matter of law that misstatements affecting profits by no more than 2.54% were immaterial).

With respect to financial statements, the SEC has commented that various "[q]ualitative factors may cause misstatements of quantitatively small amounts to be material." SEC Staff Accounting Bulletin ("SAB") No. 99, 64 Fed. Reg. 45150, 45152 (1999) (to be codified at 17 C.F.R. pt. 211, subpt. B) (representing interpretations and practices followed by the SEC's Division of Corporation Finance and the Office of the Chief Accountant in administering disclosure requirements of federal securities law).6 Of particular relevance to this action are the following:

* whether the misstatement masks a change in earnings or other trends

* whether the misstatement hides a failure to meet analysts' consensus expectations for the enterprise[.]

Id. Unlike, for example, a rule promulgated by the SEC pursuant to its rulemaking authority, see15 U.S.C. § 78w(a), SAB No. 99 does not carry with it the force of law. See, e.g., Christensen v. Harris County, 120 S. Ct. 1655, 1662-63 (2000) (explaining that interpretations contained in opinion letters, like those in policy statements, agency manuals, and enforcement guidelines, which are not, for example, the result of a formal adjudication or notice-and-comment process, lack the force of law); General Elec. Co. v. Gilbert, 429 U.S. 125, 141 (1976) (stating that courts may give less weight to guidelines than to administrative regulations which Congress has declared shall have the force of law or to regulations which, under the enabling statute, may themselves supply the basis for imposition of liability) (superseded by statute on other grounds). Nonetheless, because SEC staff accounting bulletins "constitute a body of experience and informed judgment," Skidmore v. Swift & Co., 323 U.S. 134, 140 (1944), and SAB No. 99 is thoroughly reasoned and consistent with existing law -- its non-exhaustive list of factors is simply an application of the well-established Basic analysis to misrepresentations of financial results -- we find it persuasive guidance for evaluating the materiality of an alleged misrepresentation. See Christensen, 120 S. Ct. at 1663 (quoting Skidmore, 323 U.S. at 140); Gilbert, 429 U.S. at 125.

The two Court of Appeals cases cited by the district court support the approach we take here. In Parnes v. Gateway 2000, Inc., 122 F.3d 539 (8th Cir. 1997), the Eighth Circuit held that the alleged misrepresentations, which amounted to 2% of total assets, were immaterial as a matter of law "[t]aken in context." Id. at 547 (emphasis added). The court did not rely on the single numerical benchmark, but also took into consideration the fact that the case involved a high-risk/high-yield investment, and that the risk factors had been prominently disclosed in a prospectus. Id. at 542-43, 547. Similarly, in Glassman v. Computervision Corp., 90 F.3d 617 (1st Cir. 1996), the First Circuit Court of Appeals considered whether a 3% to 9% drop in quarterly revenue was immaterial as a matter of law. It stated, in dicta, that "[w]here a variable, although material, is of only minor predictive value, disclosure of a rough estimate of that variable's value can obviate the need for more specific disclosure." Id. at 633 (emphasis added). The clear implication of this statement is that a 3% to 9% drop may be material depending on the circumstances. To the extent that the two district court decisions also cited in the opinion below adopted a bright-line test for materiality, we disagree with their approach. See Shuster v. Symmetricon, Inc., No. 94-20024, 1997 WL 269490, at *8 (N.D. Cal. Feb. 25, 1997); Ferber v. Travelers Corp., 802 F. Supp. 698, 708 (D. Conn. 1992).

b. Relevant Line Item

The plaintiffs argue that the district court erred by comparing the Fees to Citizens' total revenue instead of total income. In so holding, the district court mistakenly believed that the plaintiffs' argument rested on an invalid accounting principle:

Although defendants assert that the amount of plaintiffs' alleged nondisclosure amounts to $6.9 million, or approximately 2% of Citizens' revenues, plaintiffs[] allege that this statement was inaccurate by 15.78% because Citizens used GAAP principles, rather than Equity Accounting.7

Ganino, 56 F. Supp. 2d at 224 (emphasis added). In fact, however, the plaintiffs' contentions with respect to the booking of the 1995 Fees as 1996 income depended not so much on the use of equity accounting as on the characterization of the Fees as income rather than revenue. Misstatements of income could be material because "earnings reports are among the pieces of data that investors find most relevant to their investment decisions." In re Burlington Coat Factory, 114 F.3d at 1420 n.9; see In re Kidder Peabody, 10 F. Supp. 2d at 410. The Complaint alleged that the Fees were "pre-tax income (revenue for which there was no corresponding expense)" [JA 279] and repeatedly compared the Fees to the "Net Income" line item on the Form 10-Qs. Whether the plaintiffs will be able to prove that the Fees had no offsetting expenses -- and therefore can be properly recorded as income -- is an issue of fact that cannot be decided at this stage of the litigation. On a motion to dismiss, the allegations in the Complaint must be accepted as true. Accordingly, the Fees should be treated as and compared to Citizens' pre-tax income.

The defendants do not dispute that the items in issue should be compared to like items on the corporate financial statement. On the contrary, they themselves point to numerous cases that did exactly that. See, e.g. Parnes, 122 F.3d at 545 (comparing reserves for dubious accounts receivable to total assets); In re Westinghouse Sec. Litig., 90 F.3d 696, 715 & n.15 (3d Cir. 1996) (comparing loss reserves, which for accounting purposes "most immediately" affects income, to total income for relevant period); Glassman, 90 F.3d at 633 (comparing dollar amount of backlog orders, a revenue item, to total revenues); Ferber, 802 F. Supp. at 707 (comparing real estate investments to total "invested assets"); In re First Chicago Corp. Sec. Litig., 769 F. Supp. 1444, 1454 (N.D. Ill. 1991) (comparing allegedly risky real estate loan to total real estate loan portfolio for year). Rather, the defendants challenge the assertion that the Fees went directly to Citizens' bottom line as income, a factual dispute that cannot be resolved without further development of the record.

c. Relevant Timeframe

We next consider the relevant timeframe. The plaintiffs, joined by the SEC, maintain that the court should have considered the impact of the alleged misrepresentations on all misstated items in the financial statement for all relevant periods, not only for the year as a whole. In this case, the Complaint alleged that substantial portions of the income reported during the first two quarters of 1996 were in fact the 1995 Fees. Accordingly, the plaintiffs and the SEC contend that the court should have assessed the impact of the Fees on Citizens' quarterly income. The defendants argue that the court correctly compared the Fees to annual results only, because the plaintiffs theorized that the defendants deferred recognition of the Fees in order to maintain Citizens' annual growth trend.

We reject the defendants' contention. Materiality is determined in light of the circumstances existing at the time the alleged misstatement occurred. See Pommer v. Medtest Corp., 961 F.2d 620, 625 (7th Cir. 1992); City Nat'l Bank of Fort Smith v. Vanderboom, 422 F.2d 221, 230 (8th Cir. 1970); Spielman v. General Host Corp., 402 F. Supp. 190, 194 (S.D.N.Y. 1975) ("The determination of materiality is to be made upon all the facts as of the time of the transaction and not upon a 20-20 hindsight view long after the event." (footnote omitted)), aff'd, 538 F.2d 39 (2d Cir. 1976). Thus, we held in Kaiser-Frazer Corp. v. Otis & Co., 195 F.2d 838, 843 (2d Cir. 1952), that an overstatement of fourth quarter earnings was not rendered immaterial simply because profits for the year as a whole were not affected by the misrepresentation because "the prospective purchaser was entitled to a full disclosure of all the facts that were known to the Corporation at the time the [financial statement] was issued." See also Glassman, 90 F.3d at 633 (comparing quarterly results); SEC v. Keller Indus., Inc., 342 F. Supp. 654, 657 n.5 (S.D.N.Y. 1972) (recognizing that a publicly filed interim quarterly report can be actionable under Rule 10b-5 if it contains material misstatements).

Citizens' own press releases implicitly acknowledge the significance of quarterly financial statements. For example, its May 7, 1996 press release touted first quarter results as a predictor of annual performance, stating that the Company was "well on its way toward its 52nd consecutive year of increased revenues, net income and earnings per share." [JA 280] See also 5B Arnold S. Jacobs, Litigation and Practice under Rule 10b-5 § 61.02[c], at 3-193 (West 1999) (noting that a company's decision to issue press release may show that company thought the data significant). Therefore, we think it appropriate to compare the Fees to not only annual, but also quarterly financial results.

d. This Complaint

Applying the foregoing principles to this action, we conclude that the Complaint alleged material misrepresentations in the 1996 First and Second Quarter Form 10-Qs and corresponding press releases, namely, the alleged misrepresentation of $10.1 million of Fees received in 1995 as 1996 income. The $6.9 million of 1995 Fees booked during the first quarter of 1996 equaled 17.7% of Citizens' reported after-tax net income ($38.9 million), and 11.7% of its pre-tax net income ($58.78 million) for that quarter. The $10.1 million reflected in the 1996 Second Quarter Form 10-Q amounted to 11.9% of after-tax net income ($85.15 million), and 8% of pre-tax net income ($126.62 million) for the first six months of 1996. We believe it is inappropriate to determine at this stage of the litigation that these substantial amounts, both in absolute terms and as percentages of total net income for the respective quarters, were immaterial as a matter of law.

Aside from the magnitude of the overstatements, the Complaint alleged that the defendants deceptively stored the Fees until 1996 in order to manage the Company's 1995 and 1996 income, and that they did so in order to conceal Citizens' failure to meet analysts' expectations and to sustain its 51-year earnings trend. The Complaint asserted that the $6.9 million of Fees reported in the First Quarter Form 10-Q accounted for "a substantial portion, if not all, of the increase in income for the first quarter 1996 compared to the first quarter of 1995[.]" [JA 281 ¶ 34f] Moreover, according to the Complaint, analysts' projections of Citizens' "income for the first six (6) months of 1996 were met and exceeded only as a result of th[e] additional HTCC-related income, and the increase in income for the first six months of 1996 compared to the first six months of 1995 was due entirely to the income recognized from HTCC." [JA 283 ¶ 36f] Viewed in this context, it cannot be said that no reasonable investor would have considered the misreporting of 1995 Fees as 1996 income to be significant or to have altered the total mix of information affecting their investment decisions. We therefore conclude that the Complaint alleged material misrepresentations. We need not and do not decide whether the purported misstatements regarding Citizens' control of HTCC and the non-recurring nature of the Fees are also material.

e. Market Response