Assignment:
STEVEN KLEIN, WARREN BRANDWINE v. GENERAL NUTRITION COMPANIES, INC. U.S. COURT OF APPEALS FOR THE THIRD CIRCUIT
FACTS: Steven Klein and Warren Brandwine purchased shares of General Nutrition Companies (GNC) common stock between February and May 1996. During this time period, GNC sold over 1.5 million shares in a public offering, realizing proceeds of over $33 million. At the end of May 1996, GNC announced that its store sales would be 3-6 percent lower than the previous quarter. Consequently, the price of GNC stock fell from around $21.50 to $14. Klein and Brandwine asserted that GNC violated several securities regulations by failing to disclose material facts in its prospectus. They argued that GNC's failure to disclose this information led to an artifi cially infl ated stock price for the offering of securities. Consequently, Klein and Brandwine sued GNC under Sections 11 and 12(a)(2) of the Securities Act, which creates a private cause of action when a registration statement or prospectus omits a material fact that is required to make the other statements not misleading. The district court dismissed the case, and Klein and Brandwine appealed. ISSUE: Did the defendant's failure to disclose in the prospectus (1) a loss of third-party advertising support; (2) a worldwide shortage of deodorized distillate, a raw material used to produce vitamin E; and (3) the fact that GNC's new store openings would siphon business from existing stores violate Sections 11 and 12 of the Securities Act? REASONING: For a fact's nondisclosure to violate the act, the fact must be material, meaning that "there is a substantial likelihood that a reasonable [investor] would consider it important in deciding how to [act], . . . taking into account such factors as the certainty of the information, its availability in the public domain, and the need for the information in light of cautionary statements being made." Applying those factors, the nondisclosed information was immaterial. Regarding the loss of advertising support from third parties, the defendant simply had a concern that a decrease in sales by the third party might affect that party's ability to supply GNC with free advertising; a concern is not defi nite enough to require disclosure. When an event is contingent or speculative in nature, it is diffi cult to ascertain whether the reasonable investor would have considered the omitted information signifi cant at the time. The free advertising was actually not suspended until a month after the public offering. The worldwide vitamin E shortage did not need to be disclosed because it was public knowledge, and, furthermore, it was expected to be temporary. Federal securities laws do not require a company to state the obvious. Finally, the failure of the prospectus to disclose that, at the time of the public offering, same-store sales were being adversely affected by the opening of new stores in close proximity to existing locations was not a violation because the prospectus adequately cautioned investors that GNC's expansion plans might not be achieved and might not be profi table. DECISION AND REMEDY: The court held that "[a]ll of the alleged omissions are immaterial as a matter of law." The judgment was affi rmed in favor of the defendant. SIGNIFICANCE OF THE CASE: The case helps illustrate the kind of information that must be disclosed in a prospectus.
CRITICAL THINKING
This case was based on omitted information. An important skill in critical thinking is being able to determine whether omitted information is important. Klein and Brandwine felt that the omitted information was important, but the court did not. With whom do you agree, and why?
ETHICAL DECISION MAKING
What stakeholders benefited from the court's decision? Using your favorite ethical perspectives, do you think that these stakeholders deserved the benefi ts they derived from the court's decision? Why?