EP Medsystems Inc v. Echocath Inc

Opinions of the United

2000 Decisions States Court of Appeals

for the Third Circuit

12-26-2000

EP Medsystems Inc v. Echocath Inc

Precedential or Non-Precedential:

Docket 98-6461

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Filed December 26, 2000

UNITED STATES COURT OF APPEALS

FOR THE THIRD CIRCUIT

NO. 98-6461

EP MEDSYSTEMS, INC.,

Appellant

v.

ECHOCATH, INC.

On Appeal from the United States District Court

for the District of New Jersey

(D.C. Civil No. 97-cv-04926)

District Judge: Hon. Alfred J. Lechner, Jr.

Argued December 6, 1999

Before: SLOVITER, ROTH and COWEN, Cir cuit Judges

(Filed: December 26, 2000)

John J. Murphy, III (Argued)

Stradley, Ronon, Stevens & Young,

LLP

Cherry Hill, New Jersey 08002

Attorney for Appellant

Richard G. Primoff (Argued)

Rubin Baum Levin Constant &

Friedman

New York, New York 10112

Attorney for Appellee

OPINION OF THE COURT

SLOVITER, Circuit Judge.

EP MedSystems, Inc. appeals the dismissal with

prejudice of its securities action against EchoCath, Inc.

According to the complaint, the Chief Executive Officer of

EchoCath enticed MedSystems into investing $1.4 million

in EchoCath by assuring MedSystems that lengthy

negotiations had already taken place with four prominent

companies to market certain new EchoCath products and

that contracts with these companies were "imminent."

Relying on cautionary language contained in several public

documents filed by EchoCath with the Securities Exchange

Commission, the District Court held that these

representations, as well as other r elated representations,

were immaterial as a matter of law under the"bespeaks

caution" doctrine and the general test for materiality. It also

held that MedSystems failed to adequately plead scienter,

reasonable reliance, and loss causation and could not do

so. It accordingly dismissed the complaint without leave to

amend.

Our review of a decision granting a motion to dismiss is

plenary. We must accept as true all the factual allegations

in the complaint. See United States v. Gaubert , 499 U.S.

315, 327 (1991).

I.

BACKGROUND

The following facts are drawn largely fr om the amended

complaint and the documents attached to the pleadings by

the parties, including several EchoCath public filings with

the Securities Exchange Commission (SEC).

EchoCath is a small New Jersey research and

development company engaged in developing,

manufacturing, and marketing medical devices to enhance

and expand the use of ultrasound technology for medical

2

applications and procedures. Among the pr oducts that

EchoCath has developed with the company's pr oprietary

ultrasound technology are ColorMark, which highlights

metallic objects such as needles and other interventional

instruments in color to permit them to be seen on existing

ultrasound imaging screens, and EchoMark, which

electronically marks and displays the position of non-

metallic objects such as catheters within the body. The

parties refer to these two products as the"women's health

products." EchoCath describes its women's health products

as enabling physicians to perform pr ocedures such as

needle biopsies, catheterizations, and intravascular imaging

more safely and efficiently.

EchoCath consummated its initial public offering on

January 17, 1996 and issued a lengthy Prospectus that

included details of the company's technologies, future

plans, capitalization, collaborative agreements, and selected

financial data. The Prospectus also included the caution

that "[a]n investment in the securities of fered . . . is

speculative in nature and involves a high degr ee of risk,"

App. at 81, and set forth several pages of risk factors. In

particular, EchoCath cautioned investors that the company

"intend[ed] to pursue licensing, joint development and other

collaborative arrangements with other strategic partners

. . . [but] [t]here can be no assurance . . . that the Company

will be able to successfully reach agreements with any

strategic partners, or that other strategic partners will ever

devote sufficient resources to the Company's technologies."

App. at 84.

More than six months after the public of fering,

MedSystems began consideration of a sizable investment in

EchoCath. MedSystems is itself a small company involved

in the development, marketing, and sales of car diac

electrophysiology products used to diagnose and treat

certain cardiac disorders. See Amended Complaint P 5. In

August 1996, the chief executive officers of the two

companies met at EchoCath's plant in Monmouth Junction,

New Jersey, where MedSystems management tour ed

EchoCath's facilities to evaluate the technology under

development. See id. P 9.

3

Frank DeBernardis, the Chief Executive Officer (CEO) of

EchoCath, made a lengthy presentation during the August

meeting to David Jenkins, MedSystems President and CEO,

James Caruso, its Chief Financial Officer (CFO), and

Anthony Varrichio, a Director.See id. PP 9, 10. DeBernardis

represented that EchoCath had engaged in lengthy

negotiations to license its products and was on the verge of

signing contracts with a number of prominent medical

companies, which he identified as including Ur oHealth,

Johnson & Johnson, Medtronic, and C.R. Bar d, Inc., to

develop and market EchoCath's women's health pr oducts.

See id.

Negotiations between MedSystems and EchoCath

commenced "in earnest" in November 1996. See id. P 12.

Throughout the negotiations and until the closing in

February 1997, EchoCath's CEO continued to r epresent to

MedSystems officials that EchoCath was actively moving

forward with the line of women's health pr oducts described

in the August meeting, see id., and that the contracts with

UroHealth, Johnson & Johnson, Medtronic and C.R. Bard

to develop these products were "imminent," see id. P 15.

The complaint points to a specific telephone conversation

between December 16 and December 20, 1996 during

which EchoCath's CEO DeBernardis r eiterated these

representations to the CFO of MedSystems. See id. P 12.

On December 20, 1996, DeBernardis deliver ed a group of

documents to MedSystems, which included the pr eviously

issued 1996 EchoCath Prospectus and EchoCath'sfinancial

projections and marketing plan for fiscal years 1997 and

1998 entitled "EchoCath's Operating Model." See id. PP 13,

14. The Operating Model "outline[d] the sales and

marketing goals for the next two years (February 1996 -

January 1998)." App. at 29. It projected sales from the

women's health products of $852,000 in 1997 ($736,000

for ColorMark and $116,000 for EchoMark) and $3,286,000

in 1998 ($2.5 million for ColorMark and $786,000 for

EchoMark) and represented that these sales projections

were "conservative" estimates. App. at 19. The Operating

Model contained the statements that the Model "is intended

as a beginning guide, and it is expected that it will be

revised," and it is "a simplified for m of accounting" but it

4

"does reflect accurately cash and incomeflows." App. at 19,

29. The Operating Model included the statement that"[t]his

Model is driven by a number of assumptions." App. at 19.

The Operating Model also stated that EchoCath expected

other income in 1996 and 1997, including $450,000 in the

form of license fees and Milestone payments fr om

Medtronic, arising out of a licensing agr eement EchoCath

had with Medtronic for the use of leads with permanent

pacemakers and defibrillators, a grant of $560,000 from the

National Institute of Health, and $500,000 fr om another

company interested in using the EchoMark technology.

App. at 19. In the same paragraph, it noted that

"[n]egotiations for these contracts ar e in process." App. at

19.

In an additional communication to MedSystems on

December 23, 1996, this one by Daniel Mulvena, the Co-

Chairman of EchoCath's Board, EchoCath stated that it

anticipated that other outside investment in the company

would provide sufficient operating funds to allow EchoCath

to actively develop the women's health products for at least

18 to 24 months. See Amended Complaint P 26.

On February 27, 1997, MedSystems entered into a

subscription agreement with EchoCath to pur chase

280,000 shares of preferred EchoCath stock for

$1,400,000. See id. P 8. In the agr eement, MedSystems

specified that it "ha[d] not relied upon any representation or

other information (oral or written) other than as contained

in documents or answers to questions so furnished to

[MedSystems] by [EchoCath]," that it had "relied on the

advice of, or has consulted with, only its own Advisors,"

and acknowledged that "an investment in the Shar es

involves a number of very significant risks and

[MedSystems was] able to bear the loss of its entire

investment." App. at 63. Nonetheless, MedSystems alleges

in the complaint that it relied on the r epresentations from

EchoCath's CEO of imminent contracts, the for ecasted

sales, the expected fees and payments referr ed to in the

Operating Model, and the assurance that EchoCath would

have sufficient liquidity to continue operation for 18 to 24

months. See Amended Complaint P 32.

5

In the fifteen months after MedSystems made its

investment, EchoCath failed to enter into a single contract

or to receive any income in connection with the marketing

and development of the women's health products. It also

did not receive the expected payments fr om license fees.

See id. P 25. In September 1997, EchoCath advised

MedSystems that EchoCath would run out of operating

funds in 90 days if new investment in the company was not

forthcoming. See id. P 27.

MedSystems filed suit in the United States District Court

for the District of New Jersey, alleging that EchoCath

intentionally or recklessly made misrepr esentations to

MedSystems in connection with the sale of securities in an

effort to induce MedSystems to purchase its securities, in

violation of Section 10 of the Securities Exchange Act of

1934, 15 U.S.C. S 78j, and Rule 10b-5. See id. PP 30, 35.

MedSystems also alleged a supplemental state law fraud

claim. MedSystems alleged that EchoCath was not on the

verge of signing contracts with any company to develop its

line of women's health products in August of 1996, or any

other time up to the closing on February 27, 1997. See id.

P 17. MedSystems also alleged that EchoCath knew when it

drew up the Operating Model that it was highly unlikely the

company would meet the performance r equirements on

which the Milestone payments were contingent. See id.

P 22. It further alleged that EchoCath made this misleading

projection in an effort to conceal EchoCath's true financial

condition and to induce MedSystems to invest in the

company. See id. P 23.

EchoCath moved to dismiss the complaint under Rule

12(b)(6) and Rule 9(b) of the Federal Rules of Civil

Procedure. It attached to its motion: (1) the January 17,

1996 Prospectus; (2) the February 27, 1997 Subscription

Agreement between EchoCath and MedSystems for the

purchase of the stock; (3) its annual 10-KSB r eport filed

with the SEC on December 12, 1996 for the 1996 fiscal

year ending August 31, 1996 ("Annual Report"), which

reported, inter alia, that as of August 31, 1996, EchoCath's

operations had not generated significant r evenues and

which contained substantial cautionary language; 1 (4)

_________________________________________________________________

1. Among the cautions contained in the Annual Report were statements

that "[n]o assurance can be given that the Company will successfully

6

EchoCath's quarterly update filed with the SEC on January

21, 1997 for the three months ending on November 30,

1996 ("Quarterly Report"), which reported that EchoCath

had minimal sales in the quarter, and that EchoCath "will

receive a series of payments totaling $950,000[from its

agreement with Medtronic] after the completion of certain

milestones," that its current cash r eserves, together with

anticipated sales, should be sufficient to fund r esearch and

development and other capital needs through December

1997, that it anticipated additional cash resources that

would be provided by the completion of unspecified

licensing agreements and strategic alliances, but that there

"can be no assurances that the Company will be able to

complete the aforementioned license agr eements and

strategic alliances on acceptable terms." App. at 214-15.

EchoCath took the position that these documents

established that any alleged misrepresentations were

immaterial under the "bespeaks caution" doctrine because

they contained sufficient cautionary language.

The District Court concluded as an initial matter that it

was appropriate to examine these documents without

transforming the motion to dismiss into a motion for

summary judgment, as they were expressly or implicitly

relied upon by MedSystems in its complaint. EP

MedSystems, Inc. v. EchoCath, Inc., 30 F . Supp. 2d 726,

741-42 (D.N.J. 1998). Although the complaint contains no

direct reference to the Annual Report or the Quarterly

Report, MedSystems does not contest that decision. There

is no indication that MedSystems ever received a copy of

these documents, but they were readily available to the

public.

The District Court then dismissed the complaint with

prejudice. In an exhaustive and lengthy opinion, the court

concluded that the representations wer e immaterial as a

_________________________________________________________________

commercialize any of its products or achieve profitable operations," that

the report contained "forward-looking statements" within the meaning of

the Private Securities Litigation Reform Act of 1995, and that many

known and unknown risks may cause the actual r esults to be materially

different from the company's futur e predictions. App. at 157-58.

7

matter of law under the "bespeaks caution" doctrine

because of the cautionary language accompanying these

alleged misrepresentations. See id. at 745-51, 760-69. The

court also stated that MedSystems had failed to plead

scienter with sufficient particularity as r equired by Rule

9(b) and 15 U.S.C. S 78u-4(b)(2). See id. at 751-56. Next,

the court found that MedSystems could not have

reasonably relied on EchoCath's optimisticfinancial

projections. See id. at 757-60. Finally, the court concluded

that MedSystems failed to plead loss causation. See id. at

769-71. Having dismissed the federal securities claim, the

District Court declined to retain jurisdiction over the

remaining state law fraud claim pursuant to 28 U.S.C.

S 1367(c)(3). See id. at 771-72.

The District Court had jurisdiction over the federal

securities claim under 15 U.S.C. SS 77v and 78aa and the

state fraud claim under 28 U.S.C. S 1367(a). W e have

jurisdiction under 28 U.S.C. S 1291. W e exercise plenary

review over the District Court's dismissal of MedSystems'

complaint under Rule 12(b)(6). See Wheeler v. T owanda

Area School Dist., 950 F.2d 128, 129 (3d Cir. 1991).

II.

DISCUSSION

Section 10(b) of the Securities Exchange Act pr ovides

that it is unlawful for any person to "use or employ, 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. S 78j(b). Rule 10b-5

makes it unlawful for a person to "make any untrue

statement of a material fact or to omit to state a material

fact necessary in order to make the statements made, in

the light of the circumstances under which they were made,

not misleading . . . in connection with the pur chase or sale

of any security." 17 C.F.R. S 240.10b-5(b). Together, these

provisions establish a private right of action for plaintiffs to

recover for false or misleading statements or omissions of

material fact. See In re Advanta Corp. Sec. Litig., 180 F.3d

525, 535 (3d Cir. 1999).

8

Under the legal principles governing actions alleging

securities fraud, MedSystems must prove that EchoCath (1)

made misstatements or omissions of material fact; (2) with

scienter; (3) in connection with the purchase or sale of

securities; (4) upon which MedSystems relied; and (5) that

MedSystems' reliance was the proximate cause of its injury.

See Weiner v. Quaker Oats Co., 129 F .3d 310, 315 (3d Cir.

1997). The District Court relied on these principles, and the

precedents applying them, in dismissing MedSystems'

complaint as a matter of law.

At the outset, it is important to recognize that there are

important distinctions between this case and the usual

securities actions for which these principles wer e

developed. Although EchoCath, like the companies sued in

those cases, sought to sell its securities in the market by

an offering accompanied by the January 1996 Pr ospectus,

MedSystems does not base its claim on public

misrepresentations or omissions that af fected the price of

the stock it purchased. Instead, it contends that it was

induced to make the substantial $1.4 million investment as

a result of personal representations directly made to its

executives by EchoCath's executives and that those

representations were false and misleading.

In one sense, this action is more akin to a contract action

than a securities action, and that may be the claim

encompassed in its state law fraud count that the District

Court did not consider. However, as MedSystems chose to

base its initial claim on the securities law, we cannot fault

the District Court for analyzing it as such. Nevertheless, the

distinction between the fact pattern alleged here and that

in the typical securities cases explains why it is difficult to

apply the precedent from those cases to many of the issues.

It is like the proverbial difficulty of fitting a square peg in

a round hole. While the question whether EchoCath's

alleged misrepresentations are immaterial as a matter of

law can be readily considered under the pr ecedent, it is far

more difficult to do so with the subsequent issues, such as

whether MedSystems pled scienter with sufficient

particularity, failed to plead reasonable r eliance, and failed

to plead loss causation. We consider each of these issues

hereafter, keeping in mind throughout not only this

9

distinction but also that the District Court dismissed the

complaint without leave to amend.

A.

General Principles of Materiality

That materiality is a prerequisite to a viable securities

action based on a misrepresentation is too well established

to require citation. Nor can there be any disagreement as to

the general definition of materiality under the securities

laws. As the Supreme Court has defined it, a

misrepresentation or omitted fact "is material if there is a

substantial likelihood that a reasonable shar eholder would

consider it important in deciding how to [act]." TSC

Industries, Inc. v. Northway, Inc., 426 U.S. 438, 449 (1976).

Although the TSC Industries case involved a proxy

solicitation dispute, the TSC Industries standard of

materiality was expressly applied by the Court to the S 10(b)

and Rule 10b-5 context in Basic Inc. v. Levinson , 485 U.S.

224, 232 (1988). According to the Court, for a

misrepresentation or omission to be material " `there must

be a substantial likelihood that the disclosur e of the

omitted fact [or misrepresentation] would have been viewed

by the reasonable investor as having significantly altered

the `total mix' of information made available.' " Id. at 231-32

(quoting TSC Industries, 426 U.S. at 449).

Material representations must be contrasted with

statements of subjective analysis or extrapolations, such as

opinions, motives and intentions, or general statements of

optimism, which " `constitute no mor e than `puffery' and are

understood by reasonable investors as such.' " In re

Advanta Corp. Sec. Litig., 180 F.3d at 538 (quoting In re

Burlington Coat Factory Sec. Litig., 114 F .3d 1410, 1428

n.14 (3d Cir. 1997)). In other words, some statements

would not alter the total mix of relevant infor mation

available to a reasonable investor. W e have recognized that

"[a]lthough questions of materiality have traditionally been

viewed as particularly appropriate for the trier of fact,

complaints alleging securities fraud often contain claims of

omissions or misstatements that are obviously so

10

unimportant that courts can rule them immaterial as a

matter of law at the pleading stage." In r e Burlington Coat

Factory Sec. Litig., 114 F.3d at 1426.

The materiality requirement has been further refined in

recent years. In 1995, Congress enacted the Private

Securities Litigation Reform Act (the "Reform Act") because

of significant evidence of abuse in private securities

litigation, particularly the filing of frivolous suits alleging

securities violations designed solely to coer ce companies to

settle quickly and avoid the expense of litigation. See S.

Rep. No. 104-98, at 4 (1990), reprinted in 1995

U.S.C.C.A.N. 679, 683; H.R. Conf. Rep. No. 104-369, at 31

(1990), reprinted in 1995 U.S.C.C.A.N. 730, 730. The

Reform Act contains, inter alia, a statutory safe harbor for

forward-looking written or oral statements. 2 Under that

provision, an issuer is not liable for a forwar d-looking

statement if it is "identified as a forwar d-looking statement,

and is accompanied by meaningful cautionary statements

identifying important factors that could cause actual

_________________________________________________________________

2. The Act defines "forward-looking statement" to include:

(A) a statement containing a projection of r evenues, income

(including income loss), earnings (including earnings loss) per

share,

capital expenditures, dividends, capital structure, or other

financial

items;

(B) a statement of the plans and objectives of man agement for

future operations, including plans or objectives relating to the

products or services of the issuer;

(C) a statement of future economic per formance, including any such

statement contained in a discussion and analysis offinancial

condition by the management or in the results of operations

included pursuant to the rules and regulations of the Commission;

(D) any statement of the assumptions underlying or relating to any

statement described in subparagraph (A), (B), or (C);

(E) any report issued by an outside r eviewer retained by an

issuer,

to the extent that the report assesses a forwar d-looking statement

made by the issuer; or

(F) a statement containing a projection or es timate of such other

items as may be specified by rule or regulation of the Commission.

15 U.S.C.A. S 78u-5(i)(1) (West Supp. 2000).

11

results to differ materially from those in the forward-looking

statement." 15 U.S.C.A. S 78u-5(c)(1)(A)(i) (West Supp.

2000). The safe harbor is also available for oral forward-

looking statements under certain conditions.3

In this case, the District Court did not rely on, nor did

EchoCath cite, the safe harbor provision as a basis for

finding the representations at issue immaterial as a matter

of law. This may be because the oral misrepr esentations on

which MedSystems brought suit were not identified as

forward-looking as required by the safe harbor provision.

See supra note 3. Instead, the District Court found that the

misrepresentations were immaterial under the "bespeaks

caution" doctrine as adopted by this court in In re Donald

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

Under the "bespeaks caution" doctrine, "cautionary

language, if sufficient, renders the alleged omissions or

misrepresentations immaterial as a matter of law." Id. at

371. In In re Trump Casino Sec. Litig., we held that a suit

brought by a class of investors who pur chased bonds to

provide funding for the acquisition and completion of the

Taj Mahal, a lavish casino/hotel on the boar dwalk of

Atlantic City, could not be maintained because the alleged

misrepresentations and omissions in the pr ospectus were

accompanied by warning signals in the text of the

prospectus that conveyed to potential investors the extreme

risks inherent in the venture and the variety of obstacles

the venture would face. See id. at 364. We stated that

"bespeaks caution" represents new nomenclature, but it "is

essentially shorthand for the well-established principle that

a statement or omission must be considered in context, so

that accompanying statements may render it immaterial as

a matter of law." Id.

_________________________________________________________________

3. Under the Reform Act, an issuer is not liable for any oral forward-

looking statements if (1) the issuer informs the audience that the

statement is forward-looking and that actual r esults may differ

materially from the predictions; (2) the issuer orally directs the

audience

to other "readily available" written documents that contain the additional

information about important factors relating to the forward-looking

statement; and (3) the identified documents set forth satisfactory

cautionary statements. See 15 U.S.C.A. S 78u-5(c)(2)(B) (West Supp.

2000).

12

Shortly thereafter, in Kline v. First Western Gov't Sec.,

Inc., 24 F.3d 480 (3d Cir. 1994), we considered application

of the "bespeaks caution" doctrine to alleged

misrepresentations and omissions in an opinion letter

written by a law firm to its client. W e rejected the position

that the disclaimers in the opinion letter entitled the law

firm to summary judgment. As we stated,"[n]ot just any

cautionary language will trigger application of the doctrine.

Instead, disclaimers must relate directly to that on which

investors claim to have relied." Id. at 489. Quoting In re

Trump Casino Sec. Litig., we recognized that:

[A] vague or blanket (boilerplate) disclaimer which

merely warns the reader that the investment has

risks will ordinarily be inadequate to pr event

misinformation. To suffice, the cautionary statements

must be substantive and tailored to the specific future

projections, estimates or opinions in the pr ospectus

which the plaintiffs challenge. 7 F.3d at 371-72.

Id.

Later, in In re Westinghouse Sec. Litig., 90 F.3d 696 (3d

Cir. 1996), we reversed the dismissal of a suit based on

alleged misstatements in Westinghouse's 1991 Prospectus.

The district court had held that the cautionary language in

the prospectus rendered the alleged misstatements

immaterial under the "bespeaks caution" doctrine. See id.

at 707. We held that "notwithstanding the cautionary

language" in the prospectus, the alleged misrepresentations

about the adequacy of the loan loss reserves likely "would

have assumed actual significance to a reasonable investor

contemplating the purchase of securities." Id. at 710.

By its terms, the "bespeaks caution" doctrine, like the

safe harbor provision in the Reform Act, is directed only to

forward-looking statements. When we first r ecognized the

doctrine, we stated that "when an offering document's

forecasts, opinions or projections are accompanied by

meaningful cautionary statements, the forwar d-looking

statements will not form the basis for a securities fraud

claim . . . ." In re Trump Casino Sec. Litig., 7 F.3d at 371

(emphasis added). In later cases, we confir med that the

doctrine only applied to forward-looking statements. See,

13

e.g., Semerenko v. Cendant Corp., 223 F.3d 165, 182 (3d

Cir. 2000) (noting that the plaintiffs"maintain that the

`bespeaks caution' doctrine is inapplicable, because the

statements related to present and historical facts that were

capable of verification and, as such, not forwar d-looking"

whereas "[t]he defendants . . . characterize the statements

. . . as forward-looking, and thus subject to the bespeaks

caution doctrine.").

The other courts of appeals have also held that the

"bespeaks caution" doctrine only applies to forward-looking

statements. See Grossman v. Novell, Inc. , 120 F.3d 1112,

1123 (10th Cir. 1997) (holding "bespeaks caution" doctrine

inapplicable to alleged statements relating to the company's

increased market share, pace of mer ger integration, and

"smooth" merger); In re Stac Elec. Sec. Litig., 89 F.3d 1399,

1408 (9th Cir. 1996) ("By definition, the bespeaks caution

doctrine applies only to affirmative, forwar d-looking

statements."); Shaw v. Digital Equip. Corp. , 82 F.3d 1194,

1213 (1st Cir. 1996) (explaining that a statement may

contain "both a forward-looking aspect and an aspect that

encompasses a representation of pr esent fact," and "[t]o the

extent that plaintiffs allege that the . . . 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.")

(emphasis omitted); Harden v. Raffensperger, Hughes & Co.,

Inc., 65 F.3d 1392, 1405-06 (7th Cir . 1995) (refusing to

apply "bespeaks caution" doctrine to statement of "hard

fact" regarding the company's "plans to restore profitability

to its day-to-day operations"); Rubinstein v. Collins, 20 F.3d

160, 167 (5th Cir. 1994) (discussing the"bespeaks caution"

doctrine's applicability to "predictive statements"). But cf.

Harris v. Ivax Corp., 182 F.3d 799, 805-06 (11th Cir. 1999)

(holding that statements made on the last day of a quarter

concerning the results for the quarter ar e forward-looking).

We have also recognized that for the"bespeaks caution"

doctrine to apply, the cautionary language must be directly

related to the alleged misrepresentations or omissions. See

Kline, 24 F.3d at 489. Although we have never explicitly

held that the cautionary language must actually

14

accompany the alleged misrepresentation or omission, we

have noted in many cases that the cautionary language did

accompany the representation. For example, in In re Trump

Casino Sec. Litig., we evaluated the plaintif fs' "assertion

that the Partnership believed the Taj Mahal could meet the

obligations of the bonds [set forth in the pr ospectus], [and]

also other relevant statements contained in the

prospectus." 7 F.3d at 369. W e noted that "an

accompanying statement may neutralize the ef fect of a

misleading statement." Id. at 372.

In Kline, we pointed out that the opinion letters at issue

contained cautionary language but ultimately concluded

that the disclaimer did not directly relate to the statements

by which plaintiffs claimed to have been misled, and thus

we concluded the claim could be maintained. See 24 F.3d

at 489-90. Similarly, in In re Westinghouse Sec. Litig., even

though the cautionary language appeared in the

prospectus, we held that it did not sufficiently negate some

of the claims. See 90 F.3d at 709.

EchoCath argues that the cautionary language need not

accompany the alleged misrepresentation, citing to our

decision in Weiner v. Quaker Oats Co., 129 F.3d 310 (3d

Cir. 1997). One of the alleged misrepr esentations was the

statement made by the CEO of Quaker Oats at a public

meeting on August 4, 1994 that he was "confident of

achieving at least 7% real earnings gr owth" in fiscal year

1995. Id. at 313. The district court dismissed this claim,

ruling that the projections of earnings growth were per se

reasonable and per se immaterial. Although we affirmed the

dismissal of this claim, we did so only after finding that a

subsequent statement in the 1994 Annual Report that the

company is "committed to achieving a real earnings growth

of at least 7 percent over time" neutralized the alleged oral

misrepresentation. Id. at 321 (emphasis in original). The

phrase "over time" inoculated Quaker Oats fr om any claims

of fraud based on a decline in earnings gr owth.

EchoCath seeks to draw from Weiner the general

proposition that the "bespeaks caution" doctrine applies if

the cautionary language in public filings addr esses the

substance of the alleged misrepresentations and provokes

uncertainty, even if the cautionary language does not

15

accompany or directly negate the misrepr esentations.

Weiner cannot stand for that proposition because we

specifically noted that the "bespeaks caution" doctrine was

only applicable if the forecasts, opinions and projections

were accompanied by a meaningful cautionary statement,

and the August 4 statement "was accompanied by no such

language." See id. at 320. Instead, we held that the

earnings growth projection was immaterial as a matter of

law under the general test for materiality because after

issuance of the Annual Report with its "over time"

language, "[n]o reasonably careful investor would find

material a prediction of seven-percent gr owth followed by

the qualifier `over time.' " Id. at 321.

Notwithstanding our precedent suggesting that the

"bespeaks caution" doctrine requir es the cautionary

language to accompany the misrepresentation, we need not

make such a holding today. Ultimately, this court may

recognize such a requirement, but we choose to exercise

restraint in that connection because we r ecognize that

possible fact scenarios may arise that we cannot now

envision. See Grossman, 120 F .3d at 1122 (rejecting notion

that cautionary language must accompany the

representation at issue).

Nonetheless, the absence of accompanying cautionary

language is an important factor in determining the

materiality of the misrepresentation. If the representation is

so obviously unimportant to an investor that r easonable

minds could not differ on the question of materiality, the

representation or omission will be immaterial as a matter of

law. See Weiner, 129 F.3d at 321. On the other hand,

"[m]ateriality is a mixed question of law and fact, and the

delicate assessments of the inferences a r easonable

shareholder would draw from a given set of facts are

peculiarly for the trier of fact." Shapir o v. UJB Financial

Corp., 964 F.2d 272, 280 n. 11 (3d Cir . 1992). We turn to

consideration of the misrepresentations alleged by

MedSystems in light of these general principles to

determine if dismissal at the pleading stage should be

upheld.

16

B.

Alleged Misrepresentations

1. "Imminent Contracts"

The principal allegation of MedSystems is that EchoCath

repeatedly misrepresented the existence of imminent

contracts for its women's health products. The complaint

alleges that EchoCath's CEO represented that it "had

engaged in lengthy negotiations with and was on the verge

of signing contracts with a number of companies including

UroHealth, Johnson & Johnson, Medtronic and C.R. Bard,

Inc. to develop and market [EchoCath's] women's health

products." Amended Complaint P 10; see also id. PP 12, 13,

15, 17. MedSystems also alleges that "[t]hr oughout the

negotiations and until the closing in February, 1997,"

EchoCath "continued to represent . . . that EchoCath was

actively moving forward with the line of women's health

products . . . ." Id. P 12. Allegedly, EchoCath's CEO

repeated these assurances to MedSystems' CFO during a

telephone conversation between December 16 and

December 20, 1996 and again on December 20 when

MedSystems was given the Operating Model. See id. PP 12-

14. On or about January 30, 1997, EchoCath's CEO

further assured MedSystems that "the deals he had

promised with outside companies to develop these products

were imminent." Id. P 15.

The District Court, referring to this claim as the Possible

Contracts Allegation, concluded that this repr esentation

was immaterial as a matter of law under both the

"bespeaks caution" doctrine and the general test of

materiality.4 Applying the "bespeaks caution" doctrine, the

court assumed that the imminent contracts repr esentation

was forward-looking but never explicitly deter mined that it

was. In addition, the court found that the documents

containing the cautionary language were "for the most

part contemporaneous" with the imminent contracts

_________________________________________________________________

4. We note that the District Court discussed the "bespeaks caution"

doctrine under its section on reliance, see EP MedSystems, 30 F. Supp.

2d at 760, though the doctrine actually concer ns materiality.

17

representation. EP MedSystems, 30 F. Supp. 2d at 767. It

later stated that cautionary language neutralized the

alleged misrepresentation "[i]rr espective of the time of

issuance of the [documents]." Id. at 769.

As we noted earlier, the "bespeaks caution" doctrine

applies only to forward-looking statements. On review, we

cannot say as a matter of law that the repr esentation was

not a present statement of fact. EchoCath's CEO had told

MedSystems that lengthy negotiations with the four

companies had already taken place and that the contracts

were "imminent." See Amended Complaint P 15. An event is

"imminent" if it is "ready to take place." WEBSTER'S THIRD NEW

INTERNATIONAL DICTIONAR Y 1130 (1976). A statement by the

CEO of EchoCath that contracts with four companies were

"ready to take place" may reasonably be construed as a

representation about the current state of negotiations

between EchoCath and the four companies it had

identified. As such, the representation could be reasonably

construed by a trier of fact to be a statement of fact rather

than a prediction of future events.

This view is consistent with that of other cir cuits. See,

e.g., Grossman, 120 F.3d at 1123 (concluding that the

"bespeaks caution" doctrine would not apply because the

statements at issue contained "then-present factual

conditions, or implied background factual assumptions a

reasonable investor would regard the speaker as believing

to be true."); Shaw, 82 F.3d at 1212-13 (finding a statement

that the company's reserves were adequate to cover costs

contained both "forward-looking" and"present-oriented"

aspects and was therefore not subject to the "bespeaks

caution" doctrine); Harden, 65 F .3d at 1405-06

(determining that a statement regar ding the company's

"plans" to restore profitability was "a present assertion of

fact, i.e., `plans' exist or are being for mulated").

There is also a question whether the cautionary language

cited by the District Court was sufficiently pr oximate to the

imminent contracts representations to meet the relatedness

test established by our precedent. The r epresentations were

not accompanied by any cautionary language. The

cautionary language referred to by the District Court to

have put MedSystems on notice that the contracts might

18

never be consummated was contained in the 1996

Prospectus, published in January 1996 in connection with

the initial public offering and given to MedSystems in

December 1996. That Prospectus had numer ous cautionary

warnings regarding the futur e of EchoCath.5

However, the 1996 Prospectus was published seven

months before the August 1996 meeting wher e EchoCath's

CEO first made the representation that it was "on the verge

of signing contracts" with the four companies. By the time

EchoCath gave the Prospectus to MedSystems, over ten

months had passed since its initial publication. W e cannot

discount the possibility that MedSystems executives would

have treated the cautionary language as applicable to the

earlier date when the Prospectus was issued. Whatever the

state of the negotiations between EchoCath and the four

companies when the Prospectus was published in January

1996, the MedSystems executives might have r easonably

believed that significant progress in the negotiations had

been made in the interim. This may be particularly so when

EchoCath's CEO has personally and repeatedly given

assurances that four contracts were "imminent."

The District Court found the necessary relatedness

because the Prospectus contained repr esentations similar

to those made by EchoCath's CEO in the August 1996

meeting. See EP MedSystems, 30 F. Supp. 2d at 747-48.

However, the Prospectus contained general language of

intentions to make arrangements and agreements with

_________________________________________________________________

5. For example, the Prospectus includes the following:

[EchoCath] has no binding commitments fr om any third parties to

provide funds to [EchoCath] . . . [and] there can be no assurance

that [EchoCath] will be able to obtain financing from any other

sources on acceptable terms. App. at 99.

[EchoCath] intends to pursue licensing, joint development and other

collaborative arrangements with other strategic partners. There can

be no assurance, however, that [EchoCath] will be able to

successfully reach agreements with any strategic partners, or that

other strategic partners will ever devote sufficient resources to

[EchoCath's] technologies. App. at 84.

No assurance can be given that [EchoCath] will ever be able to

establish commercial scale manufacturing operations. App. at 84.

19

third parties. Nothing in the Prospectus specifically refers

to the imminent contracts with the four companies

EchoCath identified in August 1996.

The District Court also cited to cautionary language

contained in EchoCath's Annual Report for the fiscal year

ending August 31, 1996 and the Quarterly Report for the

quarter ending November 30, 1996, which both cautioned

investors that there could be no assurance that EchoCath

would ever successfully commercialize any of its products

or complete any of the expected license agreements or

strategic alliances on acceptable terms. The Annual Report

was filed with the SEC on December 12, 1996 and pr ovided

information as of August 31, 1996, and the Quarterly

Report was filed on January 21, 1997 and pr ovided

information as of November 30, 1996. Whether they were

sufficient to neutralize the initial repr esentation of the four

imminent contracts made in the August 1996 meeting is

not so obvious as to be decided as a matter of law.

Moreover, MedSystems also alleged that EchoCath's CEO

repeated his assurance that the four contracts were

imminent between November 1996, when the parties began

negotiations for the subscription agreement, and February

1997, when the subscription agreement was finally closed.

See Amended Complaint P 12. Ther efore, we cannot agree

with the District Court that the cautionary language

contained in these documents rendered the imminent

contracts representation immaterial under the "bespeaks

caution" doctrine.

Nor do we agree that dismissal of the complaint should

be affirmed under the general test for materiality. The

District Court justified dismissal of the imminent contracts

claim because "[a]bsent a statement by EchoCath that the

contracts would be consummated, such statements, taken

in context, are not false and misleading," EP MedSystems,

30 F. Supp. 2d at 748, and cited as support our decision in

Weiner. The District Court also held that the 1996

Prospectus put MedSystems on notice of the possibility that

the four contracts might not be consummated. Ther efore,

according to the court, no reasonable sophisticated investor

would view such representations as altering the total mix of

information.

20

We find little support in Weiner where, as discussed

above, the claim that was dismissed was based on a public

statement of earnings growth projections that was followed

by an equally public qualifier. Her e, MedSystems bases its

claim on oral representations personally made by

EchoCath's CEO to executives of MedSystems fr om August

1996 until its subscription was finalized in February 1997,

a qualitatively different situation. A r easonable investor

could have viewed these representations as altering the

total mix of information.

EchoCath argues that even if MedSystems executives

believed that the contracts were imminent in August of

1996, they should have known by February 1997 when the

contracts had not been consummated that they could not

rely on the veracity of the representation. See Br. of

Appellee at 4. On the other hand, MedSystems had r eceived

no information from EchoCath during that period to

suggest that the contracts would not be consummated.

Thus, MedSystems could have reasonably consider ed that

there was no change in the information on which the

representation was based, inasmuch as EchoCath, which

was in a superior position than was MedSystems to

ascertain the facts, failed to update its earlier

representations. See Weiner, 129 F.3d at 318.

It follows that we cannot agree with the District Court

and EchoCath that the imminent contracts repr esentation

is immaterial as a matter of law.

2. Sales Projections

The MedSystems complaint states that DeBernar dis,

EchoCath's CEO, made representations to MedSystems

concerning anticipated income from the"women's health

products it had always represented it was committed to

marketing and developing." Amended ComplaintP 14.

These representations were contained in the Operating

Model for the fiscal years 1997 and 1998, which EchoCath

delivered to MedSystems in December 1996. Specifically,

the Operating Model states: "ColorMark sales ar e projected

to be $736,000 in the coming year and $2.5 million in the

second year. The EchoMark SSG catheter sales are

projected at $116,000 and $786,000 in the 1st and 2nd

21

year, respectively. We believe these sales projections are

conservative." App. at 19.

The District Court discussed the sales projections along

with the imminent contracts representation, apparently

recognizing that the projections would necessarily be based

on the consummation of the contracts for the women's

health products. We agree with this approach. Ordinarily,

sales projections such as these are characterized as

forward-looking statements that may fall within the

"bespeaks caution" doctrine. See In r e Advanta Corp. Sec.

Litig., 180 F.3d at 536. In fact, the pr ojections were

accompanied by a number of warnings. The Operating

Model stated at the outset that "[t]his Model is driven by a

number of assumptions," and warned that"[t]his Model is

a simplified form of accounting, but does r eflect accurately

cash and income flows." App. at 19. It further stated that

the sales and marketing goals outlined were"intended as a

beginning guide, and it is expected that [they] will be

revised." App. at 29. Such statements could be sufficient to

neutralize the materiality of the sales projections in the

same document.

However, we do not understand MedSystems to be

arguing that its claim can be maintained on the basis of the

sales projections independent of the imminent contracts

representation. At oral argument, its counsel stated that

the sales projections and financial model wer e tied into the

representation that these contracts wer e imminent. He

further conceded that the sales projections tur n on the

validity of that representation and that the imminent

contracts representation is by far the most important

misrepresentation in this case. Ther efore, we are not

prepared to hold that the sales pr ojections are completely

immaterial at this pleading stage of the proceeding, as they

may reinforce the materiality of the imminent contracts

representation.6

_________________________________________________________________

6. Because the sales projections are not an independent basis for the

action, we need not consider whether they would be actionable under

our language in Weiner, where we declined to recognize a per se rule of

immateriality for earnings growth projections. See 129 F.3d at 320 n.12.

We noted that a per se rule would immunize companies from "the need

22

3. Milestone Payment and Other Licensing Receipts

MedSystems also alleged that EchoCath's Operating

Model misrepresented the likelihood that it would receive

$450,000 in "Milestone payments" under its r ecent contract

with Medtronic, and $500,000 from a company that wished

to use EchoMark technology for "guiding pr ostrate

treatments." Amended Complaint PP 22, 24. Like the

imminent contracts, none of the payments eventuated.

However, unlike the imminent contracts r epresentation

which was made by the CEO of EchoCath personally to

MedSystems executives on various occasions, the

statements regarding the expected r eceipts cannot be

viewed as statements of present fact but rather are forward-

looking. The Operating Model described the Milestone

payment and other licensing fees as "[o]ther income over

the coming two-year period." App. at 19 (emphasis added).

The statement is thus akin to the "over time" statement in

Weiner which neutralized an earnings growth projection.

See 129 F.3d at 321. Indeed, the qualifying language

accompanied the representation and we see no reason why

the "bespeaks caution" doctrine would be inapplicable. The

District Court did not err in holding these statements to be

immaterial.

4. Sufficiency of Funds

The final misrepresentation alleged in the complaint

concerns the statement made on December 23, 1996 by the

Co-Chairman of EchoCath's Board to r epresentatives of

MedSystems that the investment by MedSystems together

with "other outside investments" would pr ovide EchoCath

_________________________________________________________________

to speak truthfully about the future." Id.; see also Kline, 24 F.3d at 486

(stating that opinions are actionable under federal securities law if made

without a reasonable genuine belief or factual basis); Eisenberg v.

Gagnon, 766 F.2d 770, 776 (3d Cir . 1985) ("opinion must not be made

with reckless disregard for its truth or falsity") (quotation omitted).

MedSystems did allege that EchoCath "did not genuinely believe and

ha[s] no reasonable basis to support the projections set forth" in its

Operating Model, an allegation that, if proven, will be equally relevant

to

the representation about the imminence of the contracts upon which

this case is based. Amended Complaint P 18.

23

with sufficient operating funds to allow it to actively develop

and market the products for at least 18 to 24 months.

Amended Complaint P 26. The District Court concluded

that this statement was neither misleading nor material

when examined in light of cautionary language surr ounding

a similar statement in the January 1996 Prospectus. See

EP MedSystems, 30 F. Supp. 2d at 751. But nearly a year

had passed from issuance of the Prospectus until the

representation at issue, which would likely have negated

whatever effect might be attributable to the cautionary

language in the Prospectus. MedSystems executives could

have reasonably believed that new developments had

occurred that prompted the Co-Chair man to make that oral

representation.

However, we agree with the District Court's conclusion

that the representation is not material. As alleged, the

representation was of "anticipated" investment in EchoCath

-- not guaranteed. Amended Complaint P 26. Unlike the

imminent contracts representation, the Co-Chairman's

statements did not refer to specific companies (besides

MedSystems itself). Nor was this representation repeated

over a six-month period. MedSystems was well awar e that

it was dealing with a start-up company and should have

expected that cash flow would be an issue. No r easonable

investor could find that one optimistic statement made by

the company's board member affects the total mix of

information available to that investor . Therefore, the

claimed misrepresentation relating to anticipated

sufficiency of funds is immaterial.

To summarize, in applying the materiality principle to the

alleged misrepresentations, we conclude that the imminent

contracts representation as well as the r elated sales

projection do not fall within the "bespeaks caution" doctrine

as the District Court held but that they may be viewed by

a factfinder as statements of present fact. Therefore, they

may not be dismissed as immaterial as a matter of law. On

the other hand, the District Court did not err in dismissing

the claims regarding the expected r eceipts from other

contracts and the anticipated sufficiency of funds, although

our analysis differs to some extent fr om the District

Court's.

24

C.

Scienter

EchoCath argues on appeal that the District Court

correctly held that dismissal of the complaint was also

warranted on the ground that MedSystems failed to meet

the heightened pleading required for the scienter element in

securities fraud cases. Rule 9(b) of the Federal Rules of

Civil Procedure, which applies to all complaints filed in

federal court, provides that "[i]n all averments of fraud or

mistake, the circumstances constituting fraud or mistake

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

1995 Reform Act requires, inter alia, that a "complaint

shall, with respect to each act or omission alleged to violate

[the Securities Exchange Act], state with particularity facts

giving rise to a strong inference that the defendant acted

with the required state of mind." 15 U.S.C.A. S 78u-4(b)(2)

(West Supp. 2000). After considering these r equirements,

we recently held that it "remains sufficient for plaintiffs [to]

plead scienter by alleging facts `establishing a motive and

an opportunity to commit fraud, or by setting forth facts

that constitute circumstantial evidence of either reckless or

conscious behavior.' " In r e Advanta Corp. Sec. Litig., 180

F.3d at 534-35 (quoting Weiner, 129 F.3d at 318 n.8).

The District Court read our decision in In re

Westinghouse Sec. Litig., 90 F.3d 696, to hold that we must

analyze the allegations of the complaint separately rather

than in their totality. We need not decide how In re

Westinghouse Sec. Litig. would apply her e. Our earlier

conclusion that the representations as to expected receipts

from other contracts and the representation as to the

anticipated sufficiency of funds are immaterial obviates any

need to consider whether these allegations meet the

standard for pleading scienter. It follows that we need only

analyze the sufficiency of the pleading as to the

representation of the imminence of the contracts with four

identified companies and the related sales pr ojections.

MedSystems' complaint alleges that "[c]ontrary to

EchoCath's repeated representations to EP MedSystems,

EchoCath was not on the verge of signing contracts with

25

UroHealth, Johnson & Johnson, Medtronic, C.R. Bard, Inc.

or any other company to market and develop a line of

women's health products in September, 1996 or at any

other time up to the closing of February 27, 1997."

Amended Complaint P 17. Moreover,"EchoCath knew at all

times relevant hereto that it had no r easonable prospects of

entering into the contracts it had identified to EP

MedSystems." Id. P 18. The complaint then notes that

"EchoCath has failed to entered [sic] in to a single contract

and has yet to receive any income fr om the sale of women's

health products" since September 1996. Id. P 19 (emphasis

in original).

MedSystems argues that these allegations constitute

strong circumstantial evidence of conscious misbehavior or

recklessness. The District Court, on the other hand, viewed

the complaint as merely alleging fraud by hindsight. It is, of

course, true that we generally require mor e than a showing

that a predicted event did not occur in or der to sustain a

claim of fraud. See In re Advanta Sec. Litig., 180 F.3d at

536-37. And in In re Burlington Coat Factory Sec. Litig., 114

F.3d at 1429, we stated that it is not enough for a plaintiff

to state that defendants had no reasonable basis for

making the representation. However , we believe that when

multiple promised events fail to occur, there is a point

where a strong inference of fraud can be made. As

MedSystems notes, four contracts with independent

companies, each characterized as imminent, failed to

materialize within a year of the representations. While it is

possible that all of these companies discover ed some

characteristic of EchoCath or its products that explained

why the putative contracts did not materialize, we cannot

dismiss the possibility that EchoCath, in an ef fort to coax

a substantial investment, did not fairly repr esent to

MedSystems the status of its negotiations with these

companies.

As we noted earlier, this case presents a factual situation

unlike that in our prior precedent and, indeed, unlike those

that were the basis for the 1995 Reform Act. The legislative

history of the Reform Act makes clear that it was primarily

directed at the abuse and misuse of securities class action

lawsuits where defendant companies "choose to settle

26

rather than face the enormous expense of discovery and

trial." S. Rep. No. 104-98, at 9 (1995), r eprinted in 1995

U.S.C.C.A.N. 679, 688. As the Senate Report states:

The fact that many of these lawsuits arefiled as

class actions has had an in terrorem ef fect on

Corporate America. A whole stable of "professional

plaintiffs," who own shares--or sometimes fractions of

shares--in many companies, stand ready to lend their

names to class action complaints.

* * *

The "victims" on whose behalf these lawsuits are

allegedly brought often receive only pennies on the

dollar in damages. Even worse, long-term investors

ultimately end up paying the costs associated with the

lawsuits. As the Council for Institutional Investors

advised: "We are * * * hurt if a system allows someone

to force us to spend huge sums of money in legal costs

by merely paying ten dollars and filing a meritless

cookie cutter complaint against a company or its

accountants when that plaintiff is disappointed in his

or her investment."

Id. (footnotes omitted).

MedSystems stands in contrast to the professional

plaintiffs who were the focus of the statute. MedSystems

invested the substantial sum of $1.4 million in EchoCath.

It did so on the basis of personal repr esentations by

EchoCath executives to MedSystems officers concer ning

negotiations that had occurred and the imminent results

expected of those negotiations. MedSystems' complaint is

not a "cookie cutter complaint" or a class action brought by

shareholders with an insignificant inter est in the company;

it is an individual action, based on a transaction arising

from direct negotiations between the parties to the action.

It is difficult to see how MedSystems could have pled

fraud or scienter with more specificity without having been

given the opportunity to conduct any discovery. Her e, the

necessary information as to the status of EchoCath's

negotiations with the four companies lies in the defendant's

hands. In cases prior to the Reform Act, we noted that the

27

pleading standard required by Fed. R. Civ. P. 9(b) could be

relaxed "when factual information is peculiarly within the

defendant's knowledge or control." Craftmatic Sec. Litig. v.

Kraftsow, 890 F.2d 628, 645 (3d Cir . 1990); see also

Shapiro, 964 F.2d at 285 (r eversing the dismissal of the

complaint and granting the plaintiff an opportunity to state

in the complaint that the necessary information is held by

the defendant). We acknowledge the Refor m Act's

heightened pleading requirement for the defendant's state

of mind, but we believe that MedSystems' allegations are

sufficient under the particular facts of this case, which is

not the typical class action that Congress intended to

target.

In analyzing the effect of the Reform Act on pleading

scienter, the Second Circuit concluded that the Reform Act

"effectively raised the nationwide pleading standard to that

previously existing in this circuit and no higher (with the

exception of the `with particularity' requir ement)." Novak v.

Kasaks, 216 F.3d 300, 310 (2d Cir . 2000). In In re Advanta

Corp. Sec. Litig., we noted that Congress essentially adopted

the Second Circuit's interpretation. See 180 F.3d at 584.

This court's earlier requirement for pleading scienter did

not differ materially from that of the Second Circuit. See In

re Burlington Coat Factory Sec. Litig., 114 F.3d at 1418.

MedSystems has conceded that it does not have

information as to the status of the EchoCath negotiations

with the four companies, if indeed there wer e negotiations,

as it has not had the opportunity to acquire such

information. We conclude that will suffice under the Reform

Act.

The District Court also found that the cautionary

language in the January 1996 Prospectus and EchoCath's

Operating Model eviscerated any inference of the requisite

intent to commit fraud. However, as we commented earlier,

cautionary language in the publicly disseminated

Prospectus in January 1996 hardly negates any possible

inference of fraud as to personal statements made from

August 1996 to February 1997. There is no suggestion that

EchoCath ever cautioned MedSystems before it made its

investment in February 1997 that there was a change in

the status of its four "imminent" contracts. Under these

28

circumstances, we believe that the scienter pleading

requirement has been adequately met.

D.

Reliance

It is undisputed that a plaintiff seeking r elief under Rule

10b-5 must show reasonable reliance on a false statement

or omission of material fact. See Kline, 24 F.3d at 487-88.

MedSystems' complaint alleges that its executives believed

the "representations concerning EchoCath's line of women's

health products were true and would not have made its

substantial investment in EchoCath if it had known these

representations were false." Amended Complaint P 16. The

District Court treated the imminent contracts

representation as involving future pr edictions by EchoCath

that contained no guarantee that the contracts would be

consummated. The court repeated its position that the

representation was contradicted by disclaimers and

cautionary language in the 1996 Prospectus, the Annual

Report, and the Quarterly Report filed with the SEC. See EP

MedSystems, 30 F. Supp. 2d at 758. Thus, the court found

that any reliance by MedSystems on the r epresentation was

unreasonable as a matter of law.

Our consideration of the District Court's analysis leads

us to a conclusion similar to that we reached in our

discussion on materiality where we concluded that none of

the documents containing cautionary language sufficiently

neutralized the materiality of the imminent contracts

representation. It follows that reliance on the repeated oral

representations by EchoCath's CEO was not unreasonable

as a matter of law because of those documents.

In Straub v. Vaisman & Co., Inc., 540 F.2d 591, 598 (3d

Cir. 1976), we identified a variety of factors that should be

considered in determining whether the plaintiff 's reliance

was reasonable. These factors include the existence of a

fiduciary relationship, plaintiff 's opportunity to detect the

fraud, the sophistication of the plaintiff, the existence of

long-standing business or personal relationships, and

access to the relevant information. See id. EchoCath argues

29

that MedSystems was a very sophisticated investor and

that it should have taken more care to per form due

diligence before it signed the subscription agr eement. But,

as we noted in Straub, "a sophisticated investor is not

barred by reliance upon the honesty of those with whom he

deals in the absence of knowledge that the trust is

misplaced. Integrity is still the mainstay of commer ce . . . ."

Id.

Nor did MedSystems have access to information that

would have suggested that the imminent contracts

representation was false. Whether MedSystems, after being

told by EchoCath's CEO for the second time that contracts

with four companies were imminent, should have

approached one or more of the four companies and asked

for a verification of the present state of negotiations is an

issue for the trier of fact, not for a judge ruling on the

sufficiency of the pleadings. We cannot say that

MedSystems' reliance on the imminent contracts

representation was unreasonable as a matter of law.

E.

Loss Causation

Finally, we turn to EchoCath's contention that dismissal

was appropriate because the complaint fails to plead loss

causation. The Reform Act provides that in a securities law

action, "the plaintiff shall have the bur den of proving that

the act or omission of the defendant . . . caused the loss for

which the plaintiff seeks to recover damages." 15 U.S.C.A.

S 78u-4(b)(4) (West Supp. 2000). Although this provision

does not deal with pleading, the District Court, describing

loss causation as the "causal link between the alleged

misrepresentations and the harm incurred when a security

is purchased and sold," EP MedSystems , 30 F. Supp. 2d at

770 (quotation omitted), concluded that MedSystems failed

to plead loss causation. The court stated that the plaintiff

must show that the misrepresentations"caused the decline

in value rather than merely inducing the transaction," id.

(quotation omitted), and noted that MedSystems did not

allege that the value of its investment has declined, but

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rather "that it has `sustained substantialfinancial losses'

as a direct result of the fraudulent misr epresentations [by

EchoCath]." Id. at 771 (quoting Amended Complaint P 34).

Before our recent decision in Semer enko v. Cendant

Corp., 223 F.3d 165 (3d Cir. 2000), we generally stated that

the "misrepresentation must touch upon the reasons for

the investment's decline in value." In r e Phillips Petroleum

Sec. Litig., 881 F.2d 1236, 1244 (3d Cir . 1989) (citing

Huddleston v. Herman & MacLean, 640 F .2d 534, 549 (5th

Cir. 1981)). In Semerenko, we equated loss causation with

proximate cause, stating that there must be a "sufficient

causal nexus between the loss and the alleged

misrepresentation." 223 F.3d at 184. The plaintiff class in

Semerenko, which is representative of the usual securities

case, alleged that it purchased shares at a price that was

inflated due to misrepresentations by several directors and

officers and that when the truth was made known, the

price dropped to its true value. See id. at 185.

The complaint in Semerenko stated:

[T]he misrepresentations . . . dir ectly or proximately

caused, or were a substantial contributing cause of,

the damages sustained by plaintiff and the other

members of the Class. The misstatements . . . had the

effect of creating in the market an unr ealistically

positive assessment of Cendant, as well as of its

financial condition, causing ABI's common stock to be

overvalued and artificially inflated at all r elevant times.

223 F.3d at 186.

The defendants argued that the plaintif f class did not

adequately plead loss causation, but we rejected that

argument. Drawing all reasonable infer ences in a light most

favorable to plaintiffs, we found that an allegation that the

misrepresentations "directly or pr oximately caused, or were

a substantial contributing cause of, the damages sustained

by plaintiff " adequately pled loss causation. Id. Semerenko,

which was issued after the District Court decided this case,

adopted a practical approach, in effect applying general

causation principles.

Some of the other courts of appeals have also adopted a

practical view of loss causation. For example, the Eighth

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Circuit has stated that "[p]laintif fs are not required to meet

a strict test of direct causation under Rule 10b-5; they need

only show some causal nexus between [the defendant's]

improper conduct and plaintiff 's losses." In re Control Data

Corp. Sec. Litig., 933 F.2d 616, 619 (8th Cir. 1991)

(quotation omitted). The Second Circuit similarly held that

loss causation "embodies notions of the common law tort

concept of proximate causation." AUSA Life Ins. Co. v. Ernst

and Young, 206 F.3d 202, 216 (2d Cir. 2000) (quotation

omitted). In Ambassador Hotel Co., Ltd. v. W ei-Chuan

Investment, 189 F.3d 1017, 1027 (9th Cir . 1999), the Ninth

Circuit stated that "the loss causation r equirement limits

the ability of plaintiffs to recover for losses sustained on the

basis of factors unrelated to any misrepr esentation or

fraud." As the Eleventh Circuit stated in Robbins v. Koger

Properties, Inc., 116 F.3d 1441, 1447 (11th Cir. 1997), "the

loss causation requirement must be applied on a case-by-

case basis."

In considering loss causation, it is important to r ecognize

once again how this case differs from the usual securities

action. In the usual securities action, plaintif fs complain

because some announcement emanating from the

company, whether regarding a tender of fer, see Semerenko,

223 F.3d at 169, earnings, see In r e Burlington Coat Factory

Sec. Litig., 114 F.3d at 1416, pr ojected earnings, see

Weiner, 129 F.3d at 312, or the company's financial

condition, see In re Westinghouse Sec. Litig., 90 F.3d at 701,

fraudulently represented the actual state of affairs.

Plaintiffs claim that, as a result, they purchased the

securities at a price that was artificially inflated, only to

suffer a loss when the true situation was made known. See,

e.g., Hayes v. Gross, 982 F .2d 104, 105 (3d Cir. 1992)

(involving a claim that defendants knowingly or r ecklessly

misrepresented the company's financial condition, thus

artificially inflating the stock price).

This case differs. In this case, MedSystems claims that as

a result of fraudulent misrepresentations made in personal

communications by EchoCath executives, it was induced to

make an investment of $1.4 million which tur ned out to be

worthless.7 None of the cases in this circuit is analogous,

_________________________________________________________________

7. While the complaint may not have set forth that damage theory with

specificity, MedSystems' counsel clarified its damage theory at the oral

argument.

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and counsel have not referred us to a similar case in

another circuit nor have we found one. It follows that

although we take guidance from the language in other

cases enunciating general principles, the holdings are to

some extent inapplicable here.

The causation issue becomes most critical at the pr oof

stage. Whether the plaintiff has proven causation is usually

reserved for the trier of fact. See, e.g. , Huddleston, 640 F.2d

at 549-50 (reversing for failure to submit causation to the

jury). MedSystems' complaint was dismissed at the pleading

stage. Although, as noted above, the allegation that it

"sustained substantial financial losses as a direct result of

the aforementioned misrepresentations and omissions on

the part of EchoCath" could have more specifically

connected the misrepresentation to the alleged loss, i.e.,

investment in a company with little prospects, when we

draw all reasonable inferences in plaintif f 's favor, we

conclude that MedSystems has adequately alleged loss

causation.

III.

CONCLUSION

The District Court, in its scholarly opinion leading to its

conclusion to dismiss MedSystems' complaint in its entirety

as a matter of law, applied the law of the cir cuit as to some

of the requirements of a securities action too restrictively.

While Congress and some judicial decisions have tended to

cabin the large securities class actions that may have been

filed without adequate basis, some of the District Court's

conclusions do not withstand our analysis. W e are informed

by more recent precedent of this court that was not

available to the District Court. Moreover , the District Court

failed to recognize that this complaint by MedSystems does

not fall into the pattern of the usual securities action and

that application of certain legal requir ements must be

adjusted to fit the particular action.

Specifically, we have concluded that MedSystems' central

allegation, that EchoCath's CEO gave MedSystems

executives assurances that, after lengthy negotiations,

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contracts with four identified companies wer e "imminent"

and provided sales projections that wer e an integral part of

these assurances, should not have been dismissed. This

was a statement of fact in the context in which pr esented

by MedSystems' complaint that could be found to meet the

requirement of materiality. The allegation that EchoCath

knew or had reason to know that this was not the case

adequately met the requirement of pleading scienter. A trier

of fact could find that reliance was r easonable and that

there was the requisite causal connection between the

assurances and MedSystems' loss, i.e., its investment.

On the other hand, we have concluded that the District

Court did not err in dismissing the allegations as to certain

other expected income and anticipated sufficiency of funds

because there was qualifying language that should have

put a reasonable investor on notice of the risk. It follows

that we will reverse the dismissal of the complaint, and also

direct reinstatement of the state fraud count.

In remanding to the District Court we do not suggest that

it is obliged now to permit a wide ranging discovery effort

by plaintiff. We have been influenced to some extent by

MedSystems' counsel's statements that limited discovery

into the facts surrounding the central allegation should

disclose in short order whether there was an adequate

basis in fact for the assurances given from August 1996

through February 1997. If there is some evidence that there

was inadequate basis for such assurances, then, of course,

it becomes an issue for the jury.

For the reasons set forth, we will reverse the order

dismissing the complaint and remand for further

proceedings in accordance with this opinion. Each party to

bear its own costs.

A True Copy:

Teste:

Clerk of the United States Court of Appeals

for the Third Circuit

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