Summary
finding relation back of additional fraudulent misrepresentations concerning different transactions because they were "part of the same basic scheme described in the original complaint"
Summary of this case from Quaak v. Dexia, S.A.Opinion
Civil Action No. 98-6740.
August 18, 2004
MEMORANDUM
In this class action plaintiffs allege that defendants committed securities fraud in violation of §§ 10(b) and 20(a) of the Securities Exchange Act of 1934, 15 U.S.C. §§ 78(b) and 78(t), and Securities and Exchange Commission Rule 10b-5, 17 C.F.R. § 240.10b-5.
I have before me motions to dismiss the corrected consolidated amended class action complaint, which I will refer to as the new complaint, under Federal Rules of Civil Procedure 12(b)(6) and 9(b) and the Private Securities Litigation Reform Act of 1995, 15 U.S.C. § 78u-4(b)(1) and (2) (2002). The individual defendants, Raymond Loewen and Paul Wagler, filed a joint motion to dismiss, the corporate defendant filed its own motion to dismiss and plaintiffs filed a memorandum in opposition to the motions. I have heard oral argument.
BACKGROUND
Because this is a motion to dismiss, I take all facts from the new complaint and consider them in the light most favorable to plaintiffs.
The factual background of this case can be found in my decision of July 16, 2003. In re The Loewen Group, Inc. Sec. Litig. 2003 U.S. Dist. LEXIS 15680 (E.D. Pa. July 16, 2003). Therefore, I will give only a brief recitation of the important facts.
Loewen Group, Inc. was a publicly held company specializing in the operation of funeral homes and cemeteries in Canada and the United States. The company's principal executive office was in Canada, but Loewen Group also maintained corporate offices in Covington, Kentucky and Trevose, Pennsylvania. At all times during the class period Loewen Group stock was traded on the New York Stock Exchange ("NYSE"). The company filed periodic reports with the NYSE and the United States Securities and Exchange Commission and was followed by analysts from a number of major brokerage firms.
Defendant Raymond Loewen was chairman of the board and CEO of Loewen Group at the beginning of the class period, which ran from March 5, 1997 through January 14, 1999. He resigned from these positions on October 9, 1998, after which he remained with the company as non-executive co-chairman of the board until January 1999. Defendant Paul Wagler was the Chief Financial Officer, a member of the company's executive committee and a director of the company when the class period began and held those positions until December 17, 1998. Twice during 1998 he assumed new positions, first as Executive Vice President, Finance and then as Executive Vice President, Operations and Chief Operating Officer. Although Mr. Wagler retired from the board in December 1998, he now serves as Chief Operating Officer of Alderwoods Group, Inc., the successor to Loewen Group.
Lead plaintiffs are the City of Philadelphia, through its Board of Pensions and Retirement, Phil Schwartz, James McGlathery, Terry Roberts, Kurt Mueller, Jr., Harley Puff and Morton Silas. Lead plaintiffs bring this action on behalf of themselves and all other persons who purchased or otherwise acquired Loewen Group common stock, preferred stock or call options during the class period.
In the two years leading up to the class period Loewen Group expanded its focus from funeral homes to include cemetery businesses. It acquired a large number of cemetery-related businesses. The new complaint focuses on three transactions in particular. In 1995 Loewen Group acquired Osiris, a company that held a large number of cemeteries and funeral homes. As a result of the transaction two of Osiris' principals, Lawrence Miller and William R. Shane, became senior executives in Loewen Group. The two other transactions occurred in 1996 and brought under Loewen Group control Prime Succession, Inc., a large funeral services company, and Rose Hills Memorial Park, a large cemetery and mortuary. The acquisitions of Prime Succession and Rose Hills were complex transactions that involved Blackstone Group, two newly-created holding companies and put/call option agreements.
In September 1996, six months before the beginning of the class period, Service Corporation International ("SCI"), the world's largest chain of funeral homes, made an unsolicited bid to buy all of Loewen Group's common stock for a higher price than the stock was currently trading for on the NYSE. Loewen Group's Board of Directors unanimously rejected the bid.
After rejecting SCI's bid, Loewen Group continued its well-publicized acquisition program. The new complaint alleges that at least some of the acquisitions were "poison acquisitions" designed to prevent a takeover by SCI. According to the new complaint SCI's efforts to takeover Loewen Group continued even after SCI announced that it was no longer interested in Loewen Group. During the class period Loewen Group accumulated a large debt load as a result of high prices paid for acquisitions and high operating costs. When the company began selling its assets and deferring the payment of dividends early in 1999 its stock quickly lost value.
Loewen Group's stock traded at a high of $35.50 per share on July 18, 1997. On January 14, 1999, the last day of the class period, the stock closed at $5.12 per share. By the end of May, 1999, the price was down to $0.56 per share. On June 1, 1999 the company filed to reorganize under Chapter 11 of the Bankruptcy Code.
II. Allegations
A. Alleged materially false and misleading statements and omissions made by defendants during the class period
There were numerous publications during the class period that reported or reflected Loewen Group's revenue, income and the value of its assets. It is not disputed that defendants disclosed the company's financial figures to the Securities and Exchange Commission, to various securities analysts and to the public directly. The disclosures include the following filings with the Securities and Exchange Commission: Forms 10-K and 10-Q and the company's Registration Statements and Prospectus. New compl. ¶¶ 84, 85, 89, 92-93, 95-96, 106-07, 113-14, 120-21, 134, 142-44. The new complaint also relies on press releases and interviews in which defendants reported the revenue, income and assets of Loewen Group. New compl. ¶¶ 81, 83, 90-91, 94, 99-101, 103-04, 111-12, 116-18, 122, 124, 129.
Plaintiffs claim that defendants' representations of Loewen Group's financial status were materially false and misleading. The alleged falsity is said to be a result of the following actions by defendants: (1) recording inflated values of properties and businesses held; (2) failing to deduct imputed interest created by its zero interest payment plans; (3) failing to adjust the value of accounts receivable for loss in value; (4) recording as assets covenants not to compete that were valueless; (5) recording as revenue dividends paid in preferred stock of two holding companies; and (6) not accounting for probable losses on put/call agreements related to the holding companies. These actions allegedly violated Canadian Generally Accepted Accounting Practices, which are set forth in the Canadian Institute of Chartered Accountants Handbook ("CICA Handbook"). Plaintiffs assert that the complained-of accounting practices resulted in artificially high valuation of Loewen Group's assets, revenue and income, which in turn resulted in artificially inflated stock prices.
In addition to the effect of the accounting treatment of the Prime Succession and Rose Hills transactions on Loewen Group's financial statements, plaintiffs make a claim that defendants' statements regarding the put/call options violated securities laws. New compl. ¶¶ 69-70. Plaintiffs challenge the validity of defendants 1996 and 1997 statement that "Any payment to Blackstone is subject to Blackstone or the Company exercising their respective rights under the Put or Call. It is not currently possible to determine whether Blackstone or the Company will exercise such rights." New compl. ¶ 69. According to plaintiffs defendants knew that Blackstone would exercise its put rights and should have recorded a contingent loss.
Plaintiffs also challenge the validity of statements made by defendants regarding the liquidity of the corporation, a plan to securitize receivables and a plan to repurchase 5% of the company's outstanding common and preferred stock. New compl. ¶ 42. Plaintiffs allege that the statements were fraudulent because the company's liquidity was so poor that it would have been impossible for Loewen Group to securitize any of its receivable or repurchase 5% of the outstanding shares. New compl. ¶¶ 143, 149.
B. Scienter Allegations
1. Motive and Opportunity
Plaintiffs point out several facts that set the background for the alleged motive to inflate artificially the price of Loewen Group common stock. First, in September 1996 Loewen Group's board rejected the bid by SCI to buy all Loewen Group common stock at a price significantly over market value. New compl. ¶ 35. Plaintiffs allege that the takeover threat continued through the class period, even though SCI announced before the class period began that it would not continue its takeover attempts. New compl. ¶¶ 34-44. A statement made by Mr. Loewen that was quoted in the Death Care Business Advisor indicates that he considered the takeover threat to be "intense" in October 1997 even though it had become "unofficial" the month before. New compl. ¶ 38.
Second, Loewen Group carried a large debt load. Certain debt covenants that bound Loewen Group during the class period required that the company maintain specific financial ratios. New compl. ¶ 143. Furthermore, the company required new sources of credit to continue its acquisitions and maintain operations.Id.
Plaintiffs argue that the individual defendants had the opportunity to commit the alleged fraudulent acts because they were part of the senior management of Loewen Group for most or all of the class period.
2. Circumstances Indicting Conscious Misbehavior or Recklessness
Plaintiffs plead facts that they argue support their claim that defendants acted with recklessness or conscious misbehavior. Because the individual defendants were top executive officers with Loewen Group during the class period plaintiffs argue that they should have known that the company's financial statements and statements about the liquidity of the corporation, the securitization of receivables and the plan to buyback shares were false and misleading. New compl. ¶¶ 173, 174.
The new complaint alleges that Loewen Group paid more than twice the EBITDA (earnings before interest, taxes, depreciation and amortization) factor for acquisitions that its competitors were willing to pay. New compl. ¶ 171. It also relies upon charges and losses taken on assets during and after the class period. New compl. ¶ 172. Plaintiffs point out that Loewen Group admitted in March 2001 that many of its properties had been overvalued on its books. Id. They also rely upon the fact that Loewen Group sought approval from the bankruptcy court to void or cancel existing contracts and covenants not to compete. Id.
STANDARD OF REVIEW
Federal Rule of Civil Procedure 12(b)(6) permits a court to dismiss all or part of an action for "failure to state a claim upon which relief can be granted." Fed.R.Civ.P. 12(b)(6). In ruling on a 12(b)(6) motion, I must accept as true all well-pleaded allegations of fact, and any reasonable inferences that may be drawn therefrom, in plaintiffs' complaint and must determine whether "under any reasonable reading of the pleadings, the plaintiff may be entitled to relief." Nami v. Fauver, 82 F.3d 63, 65 (3d Cir. 1996) (citations omitted). "The complaint will be deemed to have alleged sufficient facts if it adequately put the defendant on notice of the essential elements of the plaintiff's cause of action." Id. Claims should be dismissed under Rule 12(b)(6) 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.Nevertheless, in evaluating plaintiffs' pleadings I will not credit any "bald assertions." In re Burlington Coat Factory Sec. Litig., 114 F.3d 1410, 1429 (3d Cir. 1997). Nor will I accept as true legal conclusions or unwarranted factual inferences. Conley v. Gibson, 355 U.S. 41, 45-46 (1957).
Because plaintiffs make claims of securities fraud, Federal Rule of Civil Procedure 9(b) and the Reform Act impose a higher level of scrutiny than that used for most Rule 12(b)(6) motions. The Court of Appeals has said that "Rule 9(b) and the Reform Act impose independent, threshold pleading requirements that, if not met, support dismissal apart from Rule 12(b)(6)." In re Rockefeller Ctr. Properties, Inc. Sec. Litig., 311 F.3d 198, 224 (3d Cir. 2002). A securities fraud complaint may be dismissed under Rule 9(b) and the Reform Act even if it would survive traditional Rule 12(b)(6) scrutiny. Id. The requirements of Rule 9(b) and the Reform Act will be discussed in detail hereafter.
On a motion to dismiss filed pursuant to Rule 12(b)(6) the materials at which I may look are limited. Burlington Coat Factory, 114 F.3d at 1424-25. To determine whether plaintiffs have met their burdens I may consider only the facts alleged in the complaint and the documents upon which the complaint relies.Id. I may consider a document not cited in or attached to the complaint only if it is "integral to or explicitly relied upon in the complaint." Id. at 1426, quoting Shaw v. Digital Equip. Corp., 82 F.3d 1194, 1220 (1st Cir. 1996).
DISCUSSION
I. Applicable LawPlaintiffs bring their claims under Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder. 15 U.S.C. §§ 78j(b) (2004) and 78t(a) (2004); 17 C.F.R. § 240.10b-5 (2004).
15 U.S.C. § 78(j), entitled "Manipulative and deceptive devices" declares:
It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce or of the mails, or of any facility of any national securities exchange —
(a) [omitted]
(b) To use or employ, in connection with the purchase or sale of any security registered on a national securities exchange . . . any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the Commission may prescribe as necessary or appropriate in the public interest or for the protection of investors.
15 U.S.C. § 78t(a) provides for joint and several liability for a supervisor who controls a subordinate who violates the Exchange Act.
17 C.F.R. § 240.10b-5, entitled "Employment of manipulative and deceptive devices" reads as follows:
It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce, or of the mails or of any facility of any national securities exchange,
(a) To employ any device, scheme, or artifice to defraud,
(b) 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, or
(c) To engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person,
in connection with the purchase or sale of any security.
A. Sections 10(b) and 20(a)
To state a valid securities fraud claim under Section 10(b), plaintiffs must first establish that defendants, in connection with the purchase or sale of a security, "made a materially false or misleading statement or omitted to state a material fact necessary to make a statement not misleading." Burlington Coat Factory, 114 F.3d at 1417. Additionally, plaintiffs must establish that defendants acted with scienter, as defined in the Reform Act, and that plaintiffs' reasonable reliance on defendants' misstatement proximately caused them injury. In re Phillips Petroleum Sec. Litig., 881 F.2d 1236, 1244 (3d Cir. 1989). Finally, plaintiffs must ensure that the complaint complies with the heightened pleading requirements of Rule 9(b) of the Federal Rules of Civil Procedure.
Plaintiffs concede that they may not collect on any judgment obtained against the corporate defendant because it is protected by its bankruptcy Order and Section 524(a)(1) of the Bankruptcy Code. Plaintiffs want to collect any judgment entered against Loewen Group from the individual defendants under the Reform Act's uncollectible share provision, 15 U.S.C. § 78u-4(f)(4). Loewen Group bases its motion to dismiss in part on the Bankruptcy Code.
Section 20(a) of the Exchange Act creates liability for "[e]very person who, directly or indirectly, controls any person liable" for an independent violation of the Exchange Act. 15 U.S.C. § 78t. Claims under Section 20(a) are derivative, therefore, and must be dismissed if the underlying Section 10(b) claim is dismissed. In re Advanta Corp. Sec. Litig., 180 F.3d 525, 541 (3d Cir. 1999).
B. Federal Rule of Civil Procedure 9(b)
Section 10(b) claims and their derivative Section 20(a) claims sound in fraud and therefore must comply with the pleading requirements of Federal Rule of Civil Procedure 9(b). Rule 9(b) requires that "the circumstances constituting fraud . . . be stated with particularity." The Court of Appeals has made clear that Rule 9(b) is to be "vigorously applied in securities fraud cases," although courts must be sensitive to a situation in which the factual information is in the defendant's control. Burlington Coat Factory, 114 F.3d at 1417-18.
Rule 9(b) does not require that the plaintiffs "plead the `date, place or time' of the fraud, but they must use an `alternative means of injecting precision and some measure of substantiation into their allegations of fraud.'" In re Nice Sys., Ltd. Sec. Litig., 135 F. Supp. 2d 551, 577 (D.N.J. 2001) (citations omitted). For a claim made under Section 10(b), plaintiffs can satisfy the specificity requirement of Rule 9(b) by pleading:
(1) defendants made a misrepresentation or omission;
(2) the misrepresentation or omission was material;
(3) the misrepresentation or omission was of a fact;
(4) defendants acted with scienter;
(5) plaintiffs reasonably relied on the misrepresentation or omission; and
(6) plaintiffs consequently suffered damage.
In re Westinghouse Sec. Litig., 90 F.3d 696, 710 (3d Cir. 1996).
C. The Requirements of the Private Securities Litigation Reform Act of 1995
There is yet another source of pleading requirements for federal securities fraud claims the Private Securities Litigation Reform Act of 1995, 15 U.S.C. § 78u-4(b)(1) and (2) (2004). The Reform Act heightens the pleading standards regarding the misrepresentations or omissions themselves and the state of mind of the defendants.
With respect to pleading a statement or omission, the Reform Act requires that a plaintiff "specify each statement alleged to have been misleading, the reason or reasons why the statement is misleading, and, if an allegation regarding the statement or omission is made on information and belief . . . state with particularity all facts on which that belief is formed." 15 U.S.C. § 78u-4(b)(1). In other words, a plaintiff must plead "the who, what, when, where and how: the first paragraph of any newspaper story." Advanta Corp., 180 F.3d at 534, quotingDiLeo v. Ernst Young, 901 F.2d 624, 627 (7th Cir. 1990).
With respect to pleading state of mind or scienter of the defendant, the Reform Act requires that "with respect to each act or omission . . . [plaintiffs] state with particularity facts giving rise to a strong inference that the defendant acted" with knowledge or recklessness. 15 U.S.C. § 78u-4(b)(2). Plaintiffs must plead facts supporting a "strong inference" of scienter by alleging either "facts establishing a motive to commit fraud and an opportunity to do so" or "facts constituting circumstantial evidence of either reckless or conscious behavior." Advanta Corp., 180 F.3d at 530, 534.
Plaintiffs cite articles published in several trade journals and newspapers as evidence that defendants violated securities fraud laws. Media sources can satisfy the heightened pleading requirements of the Reform Act. In re Daimlerchrysler AG Sec. Litig., 197 F. Supp. 2d 42, 98-103 (D. Del. 2002). To meet the pleading requirements media sources must be "sufficiently detailed to indicate that their reliability" and be "based on an independent investigative effort." Id. at 101-02. The articles plaintiffs rely upon were published in industry journals (e.g.The Death Care Business Advisor) and reputable newspapers (e.g.The Wall Street Journal) and meet the requirements of being independent and reliable. Therefore, I will consider them in determining whether plaintiffs have met their pleading burden.
II. Law Applied to Allegations Pleaded
A. Alleged materially false and misleading statements and omissions made by defendants during the class period
I will now address each allegedly false and misleading statement to determine if it states a claim under Section 10(b) and meets the pleading requirements of Federal Rule of Civil Procedure 9(b) and the Reform Act.
1. Financial statements
Plaintiffs allege that every financial statement Loewen Group published during the class period was materially false and misleading in violation of Section 10(b). The alleged violations are said to be the result of the use of fraudulent accounting for businesses and properties, an interest free or low-interest payment program, accounts receivable, certain covenants not to compete, certain in-kind dividends and two particular put/call agreements. I will examine each of these allegations in turn.
a. Businesses and Properties
During the class period Loewen Group acquired many cemetery properties and funeral home businesses. The parties dispute whether Loewen Group carried the acquired businesses on its books at the proper values. Plaintiffs claim that Loewen Group substantially overpaid for the acquired properties and kept them at inflated values in their books. The published asset valuations, plaintiffs argue, were consequently materially false and misleading.
In my 2003 decision I held that plaintiffs had not pleaded this claim with sufficient specificity to satisfy Rule 9(b) and the Reform Act because the claim was not supported by specific facts.Loewen Group, 2003 U.S. Dist. LEXIS 15680, at * 34-35. Plaintiffs did not plead the amount by which any acquisition was overvalued, the time at which and amount by which any asset should have been written down, who knew the assets were overvalued or what information was available to defendants that should have alerted them to the need for a writedown. Plaintiffs attempt to rectify those problems in the new complaint.
Plaintiffs allege that "[a] person who is actively engaged in purchases and sales of cemetery and funeral home properties at all relevant times, who had personal knowledge of the facts as a result of that participation, has advised plaintiffs that Loewen regularly paid 15% more than other acquirers of cemetery properties were willing to pay and a somewhat lesser premium for funeral homes." New compl. ¶ 62. Furthermore, plaintiffs state that Loewen Group was paying more than two times the factor of EBITDA for businesses that its competitors were. New compl. ¶¶ 89, 172. In addition to the allegations of overpayment for every acquisition plaintiffs have a specific claim regarding one acquisition, the 1995 purchase of Osiris, a company that held a number of cemeteries and funeral homes. New compl. ¶ 89. Two of Osiris' principals, Lawrence Miller and William R. Shane, became senior executives in Loewen Group as a result of the transaction and plaintiffs allege that $25 million of the book value assigned to the Osiris acquisition by Loewen Group was really paid to Miller and Shane as a signing bonus. Id.
The new complaint relies upon prices for which the properties sold during and after the end of the class period as support for its claims that defendants overpaid for the acquisitions and failed to write down their book value. New compl. ¶¶ 63, 73, 164. Plaintiffs allege that the book values of Loewen Group's cemeteries and funeral homes were materially overstated by the fourth quarter of 1997, at which time the cemeteries and funeral homes acquired by the end of 1996 had lost at least 15% of their book value or $260 million. New compl. ¶ 108-09. Loewen Group's 1998 Form 10-K reported that it sold a group of 124 cemeteries for $193,000,000 and had to record a $333,900,000 loss on those properties. New compl. ¶ 165. Plaintiffs argue that if the properties sold at a "fair value," which defendants stated they did, the fact that the fair value was only 39% of the book value shows that the assets had been carried at inflated values on Loewen Group's books.
There are several additional facts that plaintiffs argue support their contention that Loewen Group carried their properties at inflated book values. Loewen Group's 1997 Form 10-K stated that the number of funeral services performed at locations owned for a year or more declined by 3.2% from 1996. Id., n. 7. Additionally, in 1998 Loewen Group took a $315.2 million charge to the Prime Succession and Rose Hills holdings, a charge that plaintiffs claim should have been made in 1996. New compl. ¶ 167.
Plaintiffs have compiled a number of statements by analysts and Loewen Group's postclass period Chairman that all support plaintiffs' claim that Loewen Group's assets were overvalued. A report in the March 23, 1998 Death Care Business Advisor stated "the company overpaid for properties in bidding wards with other consolidators." New compl. ¶ 166. In June 1999 the current Chairman of the Board of Loewen Group "faulted company founder Mr. Loewen for driving the Company into ever more acquisitions, despite rising purchase prices. . . ." New compl. ¶ 169 (quoting article from June 2, 1999 Wall Street Journal). Analysts appear to have agreed that Loewen Group overpaid for its acquisitions made during the class period. New compl. ¶ 170 ("[t]hey paid too much for acquisitions," Merrill Lynch Global Securities; "Ray Loewen bought up ever cemetery, funeral home and crematory he could. . . . All too often, they paid more than they were worth," Raymond James Assoc.).
Defendants first assert that the allegation regarding the purchase price for Osiris is time-barred. Plaintiffs filed the first complaint on December 29, 1998. The amended consolidated class action complaint, which I am considering now, was filed in August 2003.
Allegations under § 10(b) of the Exchange Act are governed by the one year limitations rule set forth in § 9(e) of the Act.Lampf v. Gilbertson, 501 U.S. 350, 364 (1991). The limitations period begins to run when plaintiffs "discovered or in the exercise of reasonable diligence should have discovered the basis for their claim." In re NAHC Sec. Litig., 306 F.3d 1314, 1325 (3d Cir. 2002). An investor should have known the basis for a claim of securities fraud when a "reasonable investor of ordinary intelligence would have discovered the information and recognized it as a storm warning" "of culpable activity." Id.
Plaintiffs claim that any new material in the new complaint relates back to the 1998 complaint so that none of their claims are time-barred. Under Rule 15(c)(2) of the Federal Rules of Civil Procedure "an Amendment of a pleading relates back to the date of the original pleading when the claim . . . asserted in the amended pleading arose out of the conduct transaction, or occurrence set forth or attempted to be set forth in the original pleading." Rule 15(c) is to be applied liberally in favor of allowing amendment if defendants had notice of the claim and would not be prejudiced by the amendment. In re Campbell Soup Co. Sec. Litig., 145 F. Supp. 2d 574, 602 (D.N.J. 2001). Other courts in this Circuit have held that amendments relate back if the amendments to the pleadings are based on the same fraudulent statements alleged in the first complaint. In re Nat'l Media Sec. Litig., 1994 U.S. Dist. LEXIS 16396, at * 7-8 (E.D. Pa. 1994); Hill v. Equitable Bank, 599 F. Supp. 1062, 1071-72 (D. Del. 1984). I agree and hold that when the first complaint was filed defendants became aware that the statements at issue were being challenged as fraudulent.
The complaint that plaintiffs filed in 1998 challenged the asset valuations reported by Loewen Group during the class period. Defendants have been on notice of claims regarding those valuations since that time. None of plaintiffs' claims relating to the alleged falsity of asset valuations, including the claim regarding and alleged signing bonus for Osiris principal, are time-barred.
Plaintiffs' claims relate only to the financial statements reported during the class period and, therefore, do not relate to the purchase price paid for the Osiris properties in 1995, but only to the book values at which the properties were held during the class period.
Defendants next ask me to dismiss this claim because it does not meet the pleading requirements of 9(b) or the Reform Act. They challenge plaintiffs' use of an unnamed source. Furthermore, defendants allege that the claim of overvalued assets is premised on no more than "fraud by hindsight," which is not a sufficient basis for a securities fraud claim. See Rockefeller Ctr. Properties, Inc., 311 F.3d at 225.
The source on whom plaintiffs rely for the statement that Loewen Group paid more than 15% more than its competitors would for cemetery properties and funeral homes is described as "[a] person who is actively engaged in purchases and sales of cemetery and funeral home properties at all relevant times, who had personal knowledge of the facts as a result of that participation. . . ." New compl. ¶ 62. Regarding whether a Section 10(b) plaintiff can use an unnamed source, I agree with and adopt the reasoning of my colleague, Judge Dalzell:
We will . . . not necessarily disregard averments of fact based on anonymous sources. If the averments are particularized, if they provide circumstantial assurance that "a person in the position occupied by the source would possess the information alleged," we will consider them as part of the constellation of facts alleged for why the defendants' statement is false or misleading. In re ATI Technologies, Inc., Sec. Litig., 216 F. Supp. 2d 418, 432-33 (E.D. Pa. 2002), following Novak v. Kasaks, 216 F.3d 300, 312-14 (2d Cir. 2000). In this instance plaintiffs have not provided sufficient information about the source to comply with the standard set forth in ATI Technologies. Plaintiffs do not say for whom the source worked or in what capacity. They have not specified how the source knew about the market for cemetery properties and funeral homes in general or in specific relation to the acquisitions made by Loewen Group. Because the identification of the source is insufficient under the pleading requirements of the Reform Act, I will not consider the source's assertions in determining whether the allegation of fraudulently inflated asset valuations survives the motion to dismiss.
Defendants argue that without the anonymous source plaintiffs are relying solely on the theory of "fraud by hindsight." Plaintiffs do point to the difference between the value at which certain properties were carried on Loewen Group's books during the class period and the price to which they were ultimately written down or for which they eventually sold.
The price for which properties sold is only relevant for one of the properties. Loewen Group sold the Osiris properties during the class period for what the company said was "their fair value." That value was only 39% of the value at which the company had been carrying the Osiris properties on its books. New compl. ¶ 165, 166. That sale took place before Loewen Group filed for bankruptcy. Because plaintiffs have evidence of what defendants believed was the fair value of the properties and they sold for far less than that before Loewen Group had declared bankruptcy plaintiffs have pleaded sufficient facts supporting the claim regarding Osiris.
Plaintiffs have also satisfied the pleading burden for their claim that defendants fraudulently overvalued other cemetery properties and funeral homes. Plaintiffs have provided me with information on which properties were overvalued and by how much. Plaintiffs indicate what reasonable purchase prices would have been, based on EBITDA, and when the properties should have been written down.
With respect to this allegation, defendants also assert that plaintiffs have not properly pleaded scienter. I will address scienter later in this decision.
b. Imputed Interest
Plaintiffs allege that Loewen Group's revenue and income reports were inflated because the company did not account properly for its zero percent financing incentive program. New compl. ¶ 90. The new complaint states that Loewen Group's revenue and income were overstated by $6.5 million in imputed interest in the first quarter of 1997. Id. Furthermore, the reported income for the first quarter of 1998 was allegedly overstated by approximately $3.5 million because of Loewen Group's failure to deduct imputed interest. New compl. ¶ 117.
While Loewen Group reported an increase of 2.4% in cemetery cross margins from the second quarter of 1996 to the second quarter of 1997, plaintiffs allege that if Loewen Group had deducted the imputed interest and provided an adequate reserve for accounts receivable the cemetery gross margin actually declined 7.7% during that period. New compl. ¶ 96. The new complaint states that the first quarter 1997 Form 10-Q overstated Loewen Group's cemetery gross margin by approximately 6% as a result of its failure to deduct the imputed interest on no or low interest payment plans. New compl. ¶ 92. It also alleges that the cemetery gross margins for the first quarter of 1998 were inflated by 22% because of Loewen Group's failure to record the $3.5 million in imputed interest and failure to create adequate reserves for uncollectible accounts receivable. New compl. ¶ 118.
Plaintiffs cite a March 15, 1998 report by Griffith McBurney Partners that states: "the company implemented a zero interest incentive program on its pre-need cemetery sales in 1997. Like any other financing incentive there is an imputed cost to the company providing this financing." Id. The Griffith report pointed out that Loewen Group did not reduce its income and revenue for the imputed interest in the first half of 1997 "and had to take a $10 million charge in Q4/97 (in addition to the $3 million taken in Q3/97) to account for the short fall." Id. The new complaint also alleges that Loewen Group "assured Griffiths McBurney Partners . . . that the Company would not" fail to record imputed interest in 1998. New compl. ¶ 115.
Defendants assert that the allegations of failure to account for imputed interest are timebarred. Loewen Group's failure to account for imputed interest is alleged to have resulted in materially false statements of income and revenue. Defendants knew from the first complaint filed this case that plaintiffs challenged all statements regarding Loewen Group's income and revenue during the class period. Therefore, plaintiffs' claims about failure to recognize imputed income are not time-barred.
The analyst report relied upon by plaintiffs indicates that Loewen Group instituted the no interest payment plan in 1997 and took a related $3 million charge in the third quarter of 1997 and a related $10 million charge in the fourth quarter of 1997. Defendants have not denied that they were using a no-interest payment plan in the first two quarters of 1997. If they were and did not take a related charge in those quarters the income reported for those quarters would have been materially false. Plaintiffs have adequately pleaded this claim and if plaintiffs have pleaded scienter properly this claim will survive the motion to dismiss.
c. Accounts Receivable
Regarding the accounts receivable, plaintiffs allege that Loewen Group's financial statements materially overstated the company's accounts receivable and materially understated the reserve for accounts receivable. New compl ¶¶ 64, 71, 73, 75-76, 91. In my 2003 decision I held that plaintiffs had not met the pleading requirement for this claim because the complaint did not include details about when and to what level the accounts receivable should have been written down, when and to what level the allowance should have been changed, why the allowance made by the corporation was unreasonable in light of the cancellations experienced, and how many accounts ultimately were uncollectible.Loewen Group, 2003 U.S. Dist. LEXIS 15680, at * 30-31. Plaintiffs attempt to rectify these problems in the new complaint.
Plaintiffs now assert that in 1998 Loewen Group officials had a meeting with people from a company called Duff Phelps wherein it was discussed that 40% of the company's cemetery receivables were delinquent. New compl. ¶ 64 and n. 3. The source for this fact is "a source who was personally present at Duff Phelps and received that information from them." Id. Defendants again question whether plaintiffs' use of an unnamed source satisfies the Reform Act's pleading requirements as explained in ATI Technologies, Inc., 216 F. Supp 2d at 432-33. Plaintiffs do not include any details that would "provide circumstantial assurance that `a person in the position occupied by the source would possess the information alleged.'" Plaintiffs do not say in what capacity the source attended the meeting. Simply stating that the source was present at the meeting does not satisfy the Reform Act's pleading requirements. Accordingly, I will not give any weight to the reported statement.
The new complaint alleges that Loewen Group knew it was required to increase its reserve for cemetery accounts receivable "by the first quarter of 1998" and that the fact that Loewen Group increased its reserve for accounts receivable from $57.9 million at the end of 1997 to $124 million at the end of 1998 "[d]emonstrat[es] the fact that more than 40% of the Company's receivables were uncollectible." New compl. ¶ 117, 131. Each time Loewen Group announced earnings below forecast because of charges taken to provide an increase in the allowance for cemetery receivables the company's stock dropped in value. New compl. ¶¶ 127, 128, 136, 140. Plaintiffs quote Mr. Wagler's statement on January 18, 1999 that Loewen Group's cemetery accounting was "not up to speed." New compl. ¶ 159.
Canadian GAAP provides that "[a]n account or note receivable should be written off as soon as it is known to be uncollectible or should be written down to its estimated realizable value as soon as it is known that it is not collectible in full." New compl. ¶ 76, CICA Handbook ¶ 3020.10. Plaintiffs argue that they cannot provide any information about which accounts were uncollectible because a company with a large number of small accounts receivable, like Loewen Group, bases its reserve on its portfolio for receivables as a whole. New Compl. ¶ 71. Plaintiffs are able to estimate that Loewen Group's reserve for the first quarter of 1997 was $3.9 million less than it should have been. New compl. ¶ 92 They arrived at that number by taking the difference between the 13% loss Loewen Group took on the sale of the cemetery receivable to an affiliate and the 8% reserve that Loewen Group maintained in the first quarter of 1997. Id. The new complaint also states that the income reported for the third quarter of 1997 was inflated by $3.6 million, and the annual income for 1997 inflated by $15 million, due to Loewen Group's understating its reserve for accounts receivable. New compl. ¶¶ 104, 106, 111. The new complaint does not state the source for the third quarter or annual 1997 figures.
Plaintiffs have not pleaded sufficient facts indicating that Loewen Group overvalued its accounts receivable and kept too small a reserve for uncollectible receivables. As I stated in my 2003 decision, "[n]either the increase in allowance toward the end of the class period nor the eventual financial ruin of Loewen Group are proof that defendants committed any acts worse than mismanagement." Loewen Group, 2003 U.S. Dist. LEXIS 15680, at * 30-31, citing In re Milestone Scientific Sec. Litig., 103 F. Supp. 2d 425, 465-66 (D.N.J. 2000). I will dismiss this claim.
In their opposition to the motions to dismiss, but not in the new complaint, plaintiffs cite to statements by industry analysts in 1998 to support their claim that Loewen Group overvalued its accounts receivable and undervalued the reserve for its accounts receivable. I will not consider these statements, however, because a plaintiff may not rely on new facts submitted in response to a motion to dismiss. Hammond v. City of Philadelphia, 2001 U.S. Dist. LEXIS 10182, at *8 (E.D. Pa. June 29, 2001).
d. Covenants Not to Compete
Regarding the covenants not to compete, plaintiffs allege that Loewen Group entered into covenants not to compete with funeral directors whose companies Loewen Group acquired and that those covenants were at all times worthless. New compl. ¶ 74. The new complaint alleges that the assets listed in Loewen Group's 1997 financial statements included approximately $70 million in covenants not to compete that were in fact valueless and should have been written off. New compl. ¶ 110. Plaintiffs base this assertion on the fact that Loewen Group sought to be relieved from 208 covenants not to compete after it filed for bankruptcy in 1999. New compl. ¶ 110.
In my view, this claim is based solely on a fraud by hindsight argument. The only fact pleaded in the new complaint is that Loewen Group asked the bankruptcy court to release it from the covenants not to compete, "which no longer had any value to the Company." New compl. ¶ 110
Plaintiffs have not pleaded in the new complaint facts showing the covenants not to compete had no value at the time the parties entered into them. Therefore, this claim will be dismissed.
Plaintiffs do not bring up statements made by funeral home owners who sold their businesses to Loewen Group until their brief in opposition to defendants' motions to dismiss. As I stated earlier, plaintiffs may not rely on new facts submitted in response to a motion to dismiss. Hammond v. City of Philadelphia, 2001 U.S. Dist. LEXIS 10182, at *8.
e. Dividends
Defendants recorded as revenue preferred stock received as dividends on Loewen Group's preferred stock holdings in Prime Succession and Rose Hills. New compl. ¶ 90. Plaintiffs allege that the treatment of payment in kind dividends as revenue violated Canadian GAAP because its value was not "measurable" and "ultimate collection" was not "reasonably assured." New compl. ¶ 66. The new complaint states that income reported for the third quarter of 1997 included $3.6 million in dividends that should not have been included and that Loewen Group's income for the year 1997 wrongly included $15.25 million in dividends. New compl. ¶¶ 104, 106, 111. The company's income reported for the first quarter of 1998 was allegedly inflated by $4.1 million in Prime Succession and Rose Hills dividends. New compl. ¶ 130.
Defendants challenge the claim regarding treatment of dividends as time-barred. As I held earlier, amendments found in the new complaint relate back to the original complaint and are not time-barred if they are additional reasons why the statements cited in the original complaint are false. Plaintiffs use the allegedly wrongful accounting treatment of dividends as another reason why defendants' publications of Loewen Group's income and revenue were false. Defendants have been on notice that plaintiffs were challenging their statements of revenue and income during the class period since the original complaint was filed. Therefore, plaintiffs' allegations regarding Loewen Group's accounting treatment of dividends are not time-barred.
Defendants next argue that the accounting treatment of the dividends was proper as evidenced by the audit and certification by KPMG's certified Canadian accountants. The proper treatment under Canadian GAAP is a question of fact that I cannot decide at this stage of the litigation.
I will consider defendants' argument that even if the treatment of the dividends were in error it did not amount to securities fraud because the method of accounting and amount of revenue recorded each quarter was disclosed in documents submitted to the SEC. This is a question of materiality. The issue of materiality is generally left to the jury; however, complaints may contain "claims of omissions or misstatements that are obviously so unimportant that courts can rule them immaterial as a matter of law at the pleading stage." Burlington Coat Factory, 114 F.3d at 1426. The materiality question asks of each statement: is the allegedly false statement, in the context in which it was publicized, "information that would be important to a reasonable investor in making his or her investment decision." Id. at 1425. Even if the accounting treatment of a particular item violates GAAP the error is not material if the method of accounting is disclosed. See Vosgerichian v. Commodore Int'l, 862 F. Supp. 1371, 1376-77 (E.D. Pa. 1994) (holding that even if accounting treatment violated GAAP that mistreatment as immaterial because all relevant information about the transaction was disclosed); Bay v. Palmisan, 2002 U.S. Dist. LEXIS 20848, at *27 (E.D. La. Oct. 25, 2002) (same).
Defendants quote statements made in Loewen Group's 1996 10-K that report the income recognized for the payment-in-kind dividends. Corrected Memo. in Support of Loewen Group's Mot. to Dismiss at p. 31. Loewen Group's forms 10-K disclosed that the dividends were paid in the form of shares of Prime and Rose Hills and that the dividends were recorded as income. Id., quoting 1996 10-K at p. 44. Because all relevant information was disclosed to investors in the form 10-K, the accounting treatment of the payment-in-kind dividends as income is not material, even if it violated GAAP.
Plaintiffs also challenge the veracity of a statement in Loewen Group's 1996 and 1997 forms 10-K that said "[t]he investments for which it is not practicable to estimate fair value comprise primarily the preferred share investments in Prime and RH Holdings." New compl. ¶ 67. Because plaintiffs did not provide me with a page number for that quote I have been unable to verify its accuracy. However, even assuming the quote is accurate it does not render the forms 10-K materially false and misleading. No reasonable investor would read the 10-K and not see the income attributed to the dividends. Therefore, all claims regarding the payment-in-kind dividends will be dismissed.
f. The Put/Call Agreements
Plaintiffs allege that Loewen Group's statements regarding and accounting treatment of the put/call agreements with Blackstone regarding Prime Succession and Rose Hills are instances of securities fraud. The statements challenged are found in Loewen Group's 1996 and 1997 Form 10-K where the company stated that "it is not currently possible to determine whether Blackstone or the Company will exercise [the Put or Call] rights" and that "it is not possible at this date to estimate the future amount that may be payable to Blackstone on the exercise of the Put or the Call." New compl. ¶¶ 85, 114.
In contrast to those statements, Prime Succession and Rose Hill as early as October 1996 and February 1997, respectively, each published that "By virtue of the Put/Call Agreement, it is likely that the Company will become a wholly owned subsidiary of Loewen Group." New Compl. ¶ 70. Plaintiffs also claim that Loewen Group's description of the Prime Succession and Rose Hills transactions as "joint ventures" was misleading. New compl. ¶ 83. Plaintiffs asset that the Prime Succession and Rose Hills transactions with Blackstone were not instances of unusually structured legal financing, but rather "designed to keep the debt associated with acquiring the properties off its balance sheet and to allow [Loewen Group] to improperly record dividend revenue." New compl. ¶ 53.
The accounting treatment being challenged is Loewen Group's failure to record contingent losses for the put/call agreements. Plaintiffs claim that failure violated the Section 3290.12-13 of Canadian GAAP, which states:
The amount of a contingent loss should be accrued in the financial statements by a charge to income when both of the following conditions are met:
a. it is likely that a future event will confirm that an asset had been impaired or a liability incurred at the date of the financial statements; and
b. the amount of the loss can be reasonably estimated.
New compl. ¶ 77. Plaintiffs claim that Loewen Group knew from the time of the original transactions that if Loewen Group exercised the call it would cost Loewen Group approximately $200 million and even more if Blackstone exercised the put. New compl. ¶ 86. Loewen Group recorded a contingent liability to Blackstone of $128 million in the fourth quarter of 1998. New compl. ¶¶ 70, 87. Plaintiffs allege that the liability should have been recorded in Loewen Group's 1996 financial reports. New compl. ¶ 87.
Defendants argue that the allegation of fraudulent statements regarding Prime Succession and Rose Hills is time-barred. This situation requires a different analysis than the allegations already discussed because the statements themselves were not included in the original complaint. Plaintiffs argue that even though the statements themselves did not appear in the original complaint the allegations based on them are not time-barred because they are a part of the scheme to defraud investors that was originally plead.
It is common for securities fraud plaintiffs to clarify and recast some of their claims in amended pleadings. In re Campbell Soup Co. Sec. Litig., 145 F. Supp 2d at 602. The new claims need not be exactly the same as those originally plead, but under Federal Rule of Civil Procedure 15(c) they do have to arise out of the same conduct, transaction or occurrence set forth in the original complaint.
Plaintiffs rely on a Southern District of New York case that held that new allegations relate back under Rule 15(c) if they are "natural offshoot[s]" of the "basic scheme" to defraud investors that was pleaded in the original complaint. In re Chaus Sec. Litig., 801 F. Supp 1257, 1264 (S.D.N.Y. 1992). TheChaus plaintiffs' first complaint alleged that the defendants used various accounting manipulations to falsely inflate income and asset values. Later they sought to amend their complaint to add a claim that the defendants failed to account properly for uncollectible receivables. The court found that the new allegations related back to the original complaint under Rule 15(c) because the original complaint gave the defendants notice that they were being sued for false financial statements during the class period and that the allegations regarding the accounts receivable were part of the same "`basic scheme' to defraud investors by misrepresenting the company's earnings and profitability." Id.
Like the amended claims in Chaus the new claims regarding defendants' statements about Prime Succession and Rose Hills are part of the same basic scheme described in the original complaint. The alleged falsity of the statements is material because it affected the financial statements published by Loewen Group. The 1998 complaint put defendants on notice that all statements made during the class period regarding the financial condition of the company were being challenged. Plaintiffs' claims regarding the specific statements about the nature of financial effect of the Prime Succession and Rose Hills transactions are not time barred.
Although the claims are not time-barred, plaintiffs have failed to plead facts showing that the statements "it is not currently possible to determine whether Blackstone or the Company will exercise [the Put or Call] rights" and that "it is not possible at this date to estimate the future amount that may be payable to Blackstone on the exercise of the Put or the Call" were false. Prime Succession and Rose Hills did say that "[b]y virtue of the Put/Call Agreement, it is likely that the Company will become a wholly owned subsidiary of Loewen Group," but that statement does not conflict with those by defendants. Whether the puts or the calls were exercised, Prime Succession and Rose Hills would become subsidiaries of Loewen Group. Prime Succession and Rose Hills did not specify whether it would be the puts or the calls that would be exercised. Nor do plaintiffs claim that the companies estimated a payment that would be made to them upon the execution of the puts or calls. Therefore, the claim regarding those two statements will be dismissed.
Nor will the claim regarding Loewen Group's statement that its transactions with Blackstone were a "joint venture" survive the motion to dismiss. The label used to describe the transactions is immaterial in light of the disclosures regarding the transactions made by Loewen Group in its filings with the SEC. The 1996 10-K revealed that "[u]pon a Call, Blackstone will receive, at a minium, its original investment plus a 24.1% compound return per annum thereon regardless of the calculated equity value." Memo. in Support of Loewen Group's Mot. to Dismiss at p. 33. Because Loewen Group disclosed the potential nature of the relationship wherein Blackstone would receive 24.1% interest on its investment the description of the relationship as a "joint venture" would not mislead a reasonable investor. It is immaterial and plaintiffs' claim based on that statement will be dismissed.
In contrast to the claims based on the statements, the claims based on the accounting treatment of the Prime Succession and Rose Hills put/call agreements are pleaded sufficiently and will survive the motion to dismiss. When it became likely that Prime Succession and Rose Hills would become part of Loewen Group and the amount of the loss to Loewen Group could have been estimated reasonably, the company should have recorded a contingent loss. Whether that occurred prior to the loss recorded in 1998 is a question of fact that cannot be decided on a motion to dismiss.
2. Statements Regarding Liquidity
Plaintiffs allege that the following statement, made in Loewen Group's 1997 Form 10-K and Forms 10-Q for the first and second quarters of 1998, was materially false and misleading:
The Company intends to fund its on-going expansion programs through a combination of debt equity offerings and borrowing under its credit facilities. . . . The Company plans to finance principal repayments on debt primarily by the issuance of additional debt or equity or borrowings under revolving credit facilities and plans to ensure financing is available well in advance of scheduled repayment dates, thereby protecting the Company's liquidity and maintaining it[s] financial flexibility.
New compl. ¶¶ 142, 144. The reasons for the alleged falsity are: (1) Loewen Group announced that it planned to spend $500 million in acquisitions in 1998; (2) Loewen Group had been in default on debt covenants and forced to seek waivers from those lenders; (3) it had a negative operating cash flow of $173 million in 1997; and (4) its long-term debt had increased from less than $1.5 billion at the beginning of 1997 to almost $2 billion at the time the 1997 Form 10-K was issued. New compl. ¶ 143. For those reasons, plaintiffs argue, "unless the Company's income improved materially it would again be in violation of its debt covenants, its debt ratings would decline and it would find itself unable to borrow the vast sums necessary to even fund its huge negative cash flows. . . ."Id.
Plaintiffs have not pleaded facts that support their theory that Loewen Group's statements about liquidity were false or misleading at the time they were made. By plaintiffs' own admission the steps that Loewen Group "intended" and "planned" to take could have been accomplished if "the Company's income improved materially." New compl. ¶ 143. This claim will be dismissed.
3. Statements Regarding Securitization of Cemetery Receivables
Plaintiffs point to several statements that defendants made regarding a plan to securitize cemetery receivables. Mr. Wagler reportedly told a group of institutional investors in January 1998 that Loewen Group was "exploring the possibility of securitizing its receivables." New compl. ¶ 145. In July 1998 Duff and Phelps reported that Loewen Group had an "intention to securitize at least a portion of its cemetery installment contracts." New compl. ¶ 146. The Financial Post of Canada reported in August 1998 that Loewen Group "may securitize installment payments on cemetery plots in a move to put some life into the ailing company's finances." New compl. ¶ 147. That same month Standard Poor's reported that Loewen Group's "immediate liquidity remains adequate, reflecting availability under its US $600 million bank facility and the opportunity to securitize cemetery installment contracts." New compl. 148.
Plaintiffs allege that the statements made by defendants to investors and analysts were false and misleading because 40% of Loewen Group's receivables were uncollectible, a situation that meant there was "no realistic prospect that the Company could securitize those receivables." New compl. ¶ 149. Plaintiffs attempt to show that the statements were material by pointing out that they led analysts to report to investors that the securitization plan would help Loewen Group's "immediate liquidity" needs. Id.
Defendants argue that the allegation of fraudulent statements regarding securitization of receivables is time-barred. I do not reach that question because the statements are immaterial.
The Reform Act specifically provides protection for forward looking statements, which include "statement[s] containing a projection of revenues, income (including income loss), earnings (including earnings loss) per share, capital expenditures, dividends, capital structure, or other financial items" and "statement[s] of the plans and objectives of management for future operations, including plans or objectives relating to the products or services of the issuer." 15 U.S.C. § 78u-5(i)(1)(A) and (B) (2004). The "safe harbor" provision protects forward looking statements from securities fraud liability if plaintiffs fail to prove that the person making the statement had actual knowledge that the statement was false or misleading. 15 U.S.C. § 78u-5(c). Therefore, to survive a motion to dismiss plaintiffs must plead facts that support the inference that the person making the statement had actual knowledge that the statement was false or misleading.
The Court of Appeals considered forward looking statements inIn re Advanta Securities Litigation, 180 F.3d 525 (3d Cir. 1999). The pertinent alleged misstatement in Advanta was "as [Advanta] converts more than $5 billion in accounts that are now at teaser rates of about 7% to its normal interest rate of about 17%. . . ." Id. at 536. The Court considered Advanta's statement a "plan to reprice its teaser-rate accounts to a rate of about 17%." Id. If Advanta's more definite-sounding statement was a forward looking statement, Mr. Loewen's statement that Loewen Group was "exploring the possibility of securitizing its receivables" qualifies as a forward looking statement. So do the reports made by Duff Phelps and The Financial Post that Loewen Group had an "intention to securitize at least a portion of its cemetery installment contracts" and that Loewen Group "may securitize installment payments on cemetery plots."
To survive the motion to dismiss on this claim plaintiffs must plead specific facts that would support an inference that Mr. Loewen or another executive officer had actual knowledge that Loewen Group had no intention of exploring the possibility of securitizing receivables. Plaintiffs have not pleaded such facts. Even if, as plaintiffs claim, it would have been nearly impossible to succeed in securitizing the receivable, plaintiffs have not pleaded any facts showing that defendants had no intention of exploring the possibility. This claim will be dismissed.
4. Statements Regarding the Stock Repurchase Plan
In a September 15, 1997 press release Loewen Group announced that it had authorized a plan to repurchase 5% of Loewen Group's outstanding common and preferred stock. New compl. ¶ 100. Plaintiffs allege that this statement was materially misleading because "in light of the Company's announced intent to spend many hundreds of millions of dollars on acquisitions and its ever increasing negative cash flows . . . it would make it highly improbable, if not impossible, that the Company could obtain the necessary financing to both pursue its ambitions acquisition program and spend more than $100 million repurchasing its stock." Id.
Defendants argue that the allegation of fraudulent statements regarding the stock repurchase plan is time-barred. I do not reach that question because the statements are immaterial.
This claim will be dismissed because plaintiffs have failed to show that the statements were material, even if they were false. Material information is "information that would be important to a reasonable investor in making his or her investment decision."Burlington Coat Factory, 114 F.3d at 1425. The materiality question is an objective one that asks of each statement: is the allegedly false statement, in the context in which it was publicized, "information that would be important to a reasonable investor in making his or her investment decision." Id. It is a mixed question of law and fact. Ieradi v. Mylan Labs. Inc., 230 F.3d 594, 599 (3d Cir. 2000). At this stage of the litigation I will make a legal analysis regarding materiality while accepting as true all well pleaded allegations in the new complaint. If "alleged misrepresentations or omissions are so obviously unimportant to an investor that reasonable minds cannot differ on the question of materiality," dismissal is proper. Shapiro v. UJV Fin. Corp., 964 F.2d 272, 281 n. 11 (3d Cir. 1992). If the question is not so clear it must be left to the jury. Ieradi, 230 F.3d at 599.
As reported in the September 15, 1997 Form 8-K, the entire statement reads "the company said that its board of directors has authorized a plan to purchase 3.6 million Common shares (approximately 5% of the outstanding common shares) and up to 440,000 Series C Preferred Shares (approximately 5% of the outstanding Series C Preferred Shares) from time to time and as market and business conditions warrant, on the open market." Appendix to Loewen Group's Mot. to Dismiss, F1. The plan was not implemented, simply "authorized." It was clearly not to be implemented unless market and business conditions warranted. The plan told investors no more than that the corporation could buy back shares if and when it saw fit. The statement is immaterial as a matter of law.
B. Pleading Scienter
Not only must plaintiffs making Section 10(b) claims meet factual pleading requirements as to the details of the alleged fraudulent acts, they also must plead facts that support that each defendant acted with the required state of mind.
The Reform Act requires that a securities fraud complaint "state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind." 15 U.S.C. § 78u-4(b)(2). In this Circuit a plaintiff may establish this strong inference "either (a) by alleging facts to show that defendants had both motive and opportunity to commit fraud, or (b) by alleging facts that constitute strong circumstantial evidence of conscious misbehavior or recklessness." Burlington Coat Factory, 114 F.3d at 1418. Furthermore, "while under Rule 12(b)(6) all inferences must be drawn in plaintiffs' favor, inferences of scienter do not survive if they are merely reasonable. . . . Rather, inferences of scienter survive a motion to dismiss only if they are both reasonable and `strong' inferences." In re Alpharma Inc. Sec. Litig., 372 F.3d 137, 150 (3d Cir. 2004), quoting In re Navarre Corp. Sec. Litig., 299 F.3d 735, 741 (8th Cir. 2002).
1. Plaintiffs' pleading of motive and opportunity
The District Court for the Southern District of New York has succinctly described the analysis of motive pleading: "The question turns, then, on the concreteness of the allegations; a generalized desire to maintain a higher stock price will not rise to the level of motive for [Section 10(b)] purposes. However, the artificial inflation of a stock price in order to achieve some more specific goal may satisfy the pleading requirement." In re Complete Mgmt., Inc. Sec. Litig., 153 F. Supp. 2d 314, 328 (S.D.N.Y. 2001).
a. Mr. Loewen's Alleged Motives
Plaintiffs cite two motives specific to Mr. Loewen. First is his sale of Loewen Group stock to Canadian Imperial Bank of Commerce. According to plaintiffs, Loewen pledged his Loewen Group stock to obtain a multi-million dollar loan and in November 1998 sold all of the pledged shares to the bank to reduce his outstanding debt by $91 million. New compl. ¶¶ 175-77. Mr. Loewen characterizes the transfer of shares as a repossession. This is a factual issue that I cannot decide on a motion to dismiss. Therefore, I will consider the claim as part of plaintiffs' pleading of Mr. Loewen's motive to commit securities fraud.
The second motive plaintiffs allege specifically regarding Mr. Loewen is his desire to thwart the takeover bid by SCI. New compl. ¶ 178-84. The Burlington Coat Factory Court stated that a specific takeover bid could motivate corporate officers to create fraudulently a temporary raise in stock price. Id.; see also Weiner v. The Quaker Oats Company, 129 F.3d 310, 318 n. 8 (3d Cir. 1997). Although SCI withdrew its official takeover bid in January 1997, plaintiffs have provided evidence that Mr. Loewen considered the threat to be ongoing in October of that year. New compl. ¶ 179, quoting an article in the October 23, 1997 Death Care Business Advisor. Mr. Loewen purchased a large amount of Loewen Group stock from June 1997 through January 1998, using his own money and borrowed money. By September 1998 it was reported that Mr. Loewen had "pledged more than 85% of his stake [in Loewen Group], valued at $151 million, as collateral" for loans he used to purchase more Loewen Group stock. New compl. ¶ 182, quoting an article in the September 15, 1998 edition of The Financial Post. Another article reported that "[m]any industry analysts believe[d] that Ray Loewen [was] merely positioning himself to fend off another takeover attempt by increasing his family's purchase of ownership in the company, which [then stood] about between 16 and 18 percent." New compl. ¶ 181, quoting an article in the November 20, 1997 Death Care Business Advisor. On October 24, 1999 The Los Angeles Times reported: "In 1996, Service Corps attempted a hostile takeover of Loewen Group. In response, Loewen Group's founder went on a buying spree partly intended to run up enough debt to make his company less appetizing. He succeeded a bit too well." New compl. ¶ 170. Loewen's purchase of more than 3,000,000 shares of Loewen Group stock during the class period cannot negate the showing of motive. Viewing all properly pleaded facts in the light most favorable to plaintiffs, it is possible that Loewen bought the shares as part of an attempt to thwart SCI's takeover bid.
Plaintiffs have also pleaded facts showing that Mr. Loewen had the opportunity to commit the alleged fraud. In addition to being one of the founders of Loewen Group, he described himself as a hands-on chairman of the board and CEO. He told analysts in 1998 that he was involved in the day-to-day operations of Loewen Group "[f]rom about seven in the morning until about 12 at night." New compl. ¶ 173.
b. All Defendants' Motives
Plaintiffs claim that all defendants shared a motive to commit fraud in Loewen Group's need to obtain financing and comply with existing debt covenants. New compl. ¶ 185. A company's ability to borrow money depends on its debt/equity ratio and the ratio of its earnings to interest charges. The new complaint states that by early 1998 Loewen Group's bank credit had been reduced from $1 billion to $600 million. New compl. ¶ 115. It also claims that the company's negative cash flow increased from negative $173 million in 1997 to $376 million in 1998. Id. Furthermore, some of the company's debt covenants required the company to maintain a certain interest coverage ratio. The new complaint alleges that these financial requirements motivated defendants to inflate Loewen Group's equity and earnings and under report its debt and interest charges.
The need to comply with debt covenants may be considered as contributing motive to commit securities fraud. P.R. Diamonds, Inc. v. Chandler, 91 Fed. Appx. 418 (6th Cir. 2004); Howard v. Everex Sys., Inc., 228 F.3d 1057 (9th Cir. 2000); Wilson v. Bernstock, 195 F. Supp. 2d 619 (D.N.J. 2002). The desire to maintain a high credit rating is not sufficient, however, to satisfy the requirement for pleading motive. In In re E.Spire Communications, Inc. Sec. Litig., 127 F. Supp. 2d 734 (D. Md. 2001), the District Court in Maryland considered a motive pleading very similar to that made by plaintiffs. The E.Spire plaintiffs alleged that "e.spire had severe cash flow problems and that if it could not satisfy certain debt covenants . . . it would be unable to continue to borrow much needed funds to maintain its operations." Id. at 744. The District Court stated that even severe cash flow problems cannot by themselves satisfy the pleading requirement for motive because otherwise every corporation that experienced a decline in the price of its stock would face a securities fraud action. Id. The District Court of New Jersey agreed. Wilson, 195 F. Supp. 2d at 636-37.
Plaintiffs' only allegation of motivation regarding Mr. Wagler is based on the need for financing and to comply with debt covenants. Because that is not a sufficient allegation of motive, plaintiffs have failed to plead motive for Mr. Wagler by showing motive and opportunity.
2. Plaintiffs' pleading of circumstantial evidence of conscious misbehavior or recklessness by defendants
Another way to satisfy the Reform Act's pleading requirement regarding scienter is to plead strong circumstantial evidence of conscious misbehavior or recklessness by defendants. Advanta Corp., 180 F.3d at 530, 534. "A reckless statement is one involving not merely simple, or even inexcusable negligence, but an extreme departure from the standards of ordinary care, and which presents a danger of misleading buyers or sellers that is either known to the defendant or is so obvious that the actor must have been aware of it." Advanta, 180 F.3d at 535. Because plaintiffs have shown motive and opportunity for Mr. Loewen, I will now consider the pleading of reckless or conscious misbehavior on the part of Mr. Wagler. I also need only consider plaintiffs' pleading of reckless or conscious misbehavior regarding the three claims for which the new complaint meets the other pleading requirements: (1) the claim of fraudulent reports of the value of Loewen Group's businesses and properties; (2) the claim of failure to deduct imputed interest on low- or no-interest financing; and (3) the claim of failure to record contingent liabilities for the put/call agreements.
Plaintiffs allege that Wagler knew that the cemetery properties Loewen Group acquired could not make enough income to justify the purchase prices Loewen Group paid for them. New compl. ¶ 171.
The facts that plaintiffs claim demonstrate Mr. Wagler's knowing misrepresentations of the cemetery assets can be grouped into three categories. First, plaintiffs point out actions taken after the end of the class period. New compl. ¶ 172. Loewen Group took charges adding up to hundreds of millions of dollars on sales of its assets beginning in 1999. During the bankruptcy Loewen Group asked the court to void existing purchase agreements for cemetery properties. Second, plaintiffs rely on several statements made after the end of the class period. Id. In March 2001 Loewen Group admitted "that the prices obtained in its asset disposition program and the write downs to fair value show that . . . many of its properties were overvalued in the Company's annual earnings reports." Id. A March 1999 edition of the Canadian National Post stated regarding Loewen Group's 1995 purchase of Osiris: "At the time, Loewen Group was buying Osiris more to acquire experiences cemetery management than for its assets." Id. Third, plaintiffs states that Loewen Group paid 24-times EBITDA for the Rose Hills and Prime Succession businesses. Id.
In some instances plaintiffs admit facts that contradict their assertion that defendants engaged in conscious misbehavior. In regards to their allegation that defendants overstated the value of the businesses Loewen Group acquired, plaintiffs say that Loewen Group "based its willingness to pay more than other acquirers would on assumptions that the profitability of the acquired properties would increase dramatically after acquisition." New compl. ¶ 62. If Mr. Wagler believed that Loewen Group could dramatically increase the profitability of the businesses the bought there was no fraud involved.
Statements made, charges taken and low sales prices received after the end of the class period cannot be used as evidence that defendants knew they were overstating the value of their assets during the class period. It is improper to plead fraud by hindsight. In re Tseng Labs., Inc., 954 F. Supp. 1024, 1030 (E.D. Pa. 1996). Furthermore, the size of a financial adjustment or loss does not by itself evidence fraud. DiLeo, 901 F.2d at 627 ("even a large column of big numbers need not add up to fraud); Kennilworth Partners L.P. v. Cendant Corp., 59 F. Supp. 2d 417, 429-30 (D.N.J. 1999) ("sheer magnitude" of restatement does not lead to inference of scienter).
Plaintiffs' only pleading that supports a theory that Mr. Wagler knew or was reckless in not knowing during the class period that Loewen Group's assets were overvalued is their claim that Loewen Group was paying more than two times the factor of EBITDA for businesses that its competitors were. New compl. ¶ 172. Mr. Wagler held the positions of Chief Financial Officer and non-executive co-chairman of the board during the class period. If Loewen Group was paying more then twice the EBITDA factor its competitors were for funeral homes and cemetery properties, as I must assume on this motion to dismiss, it is strong circumstantial evidence of conscious misbehavior or recklessness by Mr. Wagler. Therefore, plaintiffs have met the scienter pleading burden for Mr. Wagler for this claim.
Factual pleading regarding the accounting treatment of imputed interest and the put/call agreements together with pleading regarding Wagler's role in the corporation constitute sufficient pleading of scienter for Mr. Wagler for those claims.
Stating that a defendant held an executive position in a corporation is not sufficient as a pleading of scienter.Advanta, 1998 U.S. Dist. LEXIS 10189, at *24 (E.D. Pa. July 9, 1998) ("A director, officer, or even the president of a corporation often has superior knowledge and information, but neither the knowledge nor the information invariably attaches to those positions. . . ."). However, if a plaintiff pleads alleged fraud concerning the corporation's core business and the defendant held a position from which he would have been aware of the true facts and misleading disclosures, scienter is pleaded sufficiently. See Campbell Soup Co., 145 F. Supp. 2d at 599;In re Tel-Save Sec. Litig., 1999 U.S. Dist. LEXIS 16800, at *14 (E.D. Pa. Oct. 19, 1999); In re Aetna Inc. Sec. Litig., 34 F. Supp. 2d 935, 953 (E.D. Pa. 1999) The claims regarding the accounting treatment of the imputed interest and the put/call agreements concern allegedly fraudulent financial statements. The positions that Mr. Wagler held at Loewen Group put him in a particular position to monitor the company's accounting methods and financial statements. Therefore, I find that plaintiffs have pleaded scienter for Mr. Wagler for all remaining claims.
D. Leave to Amend
Although leave to amend is to be granted liberally, there are several reasons for which leave to amend a dismissed claim may be denied. Fed.R.Civ.Pro. 15(a); Oran v. Stafford, 226 F.3d 275, 291(3d Cir. 2000). One reason that justifies denying leave to amend is undue delay. Oran, 226 F.3d at 291. The Oran Court affirmed the district court's denial of leave to amend a dismissed complaint. The plaintiffs in Oran had already amended their complaint once. Their case was a year and a half old. Plaintiffs in this case have filed three complaints: the first complaint in 1998, the consolidated class action complaint in 2002 and the pending complaint. This case is has been active for three years. In light of these facts, I find that plaintiffs have been given sufficient opportunities to include all factual allegations in their complaint and to allow another amendment would create undue delay. Therefore, plaintiffs are not granted leave to amend the claims that I will dismiss.
The first complaint was filed on December 29, 1998, but the case was in suspense from June 9, 1999 until December 21, 2001.
E. Loewen Group's Bankruptcy Claims
Loewen Group raises two additional points. First, it argues that the November 30, 2001 and December 5, 2001 orders of the United States Bankruptcy Court for the District of Delaware, which discharged its debts under 11 U.S.C. § 524(a), make it impossible for plaintiffs to retain Loewen Group as a defendant (1) because the § 524(a) discharge alone voids any suit against Loewen Group or, alternatively, (2) because the discharge renders moot any suit against Loewen Group. Second, in the event plaintiffs are allowed to sue to establish its nominal liability so as to trigger the "uncollectible share" provision of the Reform Act, 15 U.S.C. § 78u-4(f)(4), Loewen Group asserts that plaintiffs should be required to pay its reasonable legal fees. I disagree with Loewen Group on both points. I hold that plaintiffs may sue Loewen Group solely to establish its nominal liability under the Reform Act, and that plaintiffs need not pay Loewen Group's legal fees.
I have not found any case that considers whether a plaintiff may sue a bankrupt debtor whose debts have been discharged under 11 U.S.C. § 524(a) solely to establish the debtor's liability and collect from co-defendants under the "uncollectible share" provision of the Reform Act. Analogous cases, however, suggest that such a suit is permissible, and that I need not modify debtor defendant's § 524(a) injunction for the suit to proceed.In re Munoz, 287 B.R. 546, 555 (B.A.P. 9th Cir. 2002); In re Edgeworth, 993 F.2d 51, 53 (5th Cir. 1993); Green v. Welsh, 956 F.2d 30, 33 (2d Cir. 1992); In re Jet Florida Sys., Inc., 883 F.2d 970, 976 (11th Cir. 1989). These decisions rely primarily on 11 U.S.C. §§ 524(a) and 524(e). Section 524(a)(2) says that a bankruptcy discharge "operates as an injunction against the commencement or continuation of an action, the employment of process, or an act to collect, recover, or offset any such debt as a personal liability of the debtor."
Courts that have allowed suits to proceed against bankrupt defendants have reasoned that § 524(e) trumps § 524(a); § 524(e) states that "discharge of the debtor does not affect the liability of any other entity on, or the property of any other entity for, such debt." In other words, these courts have refused to permit bankruptcies to relieve third parties, typically insurers, from their obligations. In this case, the individual defendants could be obliged by 15 U.S.C. § 78u-4(f)(4) to pay a portion of any judgment against Loewen Group (since that judgment will uncollectible against Loewen Group), and Loewen Group's § 524(a) discharge will not excuse them from their statutory obligation.
Loewen Group mistakenly relies on In re Columbia Gas Transmission Corp., 219 B.R. 716 (S.D.W. Va. 1998). In that case, the obligation of debtor defendant's insurance could be activated only by a judgment requiring defendant to pay $200,000 out of its own pocket. Because the § 524(a) injunction prevented plaintiff from collecting anything from debtor defendant, the insurer's obligation was never activated. Munoz, Edgeworth, Green, and Jet Florida Systems are distinguishable fromColumbia Gas, because the insurance policies in those cases required no activation payment from the insured bankrupt defendant. In this case, individual defendants' statutory obligation requires no activation payment by Loewen Group, so Loewen Group's § 524(a) bankruptcy discharge presents no obstacle to plaintiffs' suit to establish Loewen Group's nominal liability solely for the purpose of collecting from the individual defendants under the uncollectible share provision of the Reform Act.
Loewen Group next argues that plaintiffs' claim is moot, because "it will never be possible for defendant to provide any relief." Bryan v. All Out Die Cutting, Inc., 32 Fed. Appx. 651, 651-52 (3d Cir. 2002). As a technical matter, this is true; shielded by its § 524(a) bankruptcy discharge, Loewen Group will never have to pay anything to plaintiffs. Loewen Group, however, ignores the cases that allowed plaintiffs to sue debtor defendants despite not being able to collect from them directly. Munoz, 287 B.R. at 555; Edgeworth, 993 F.2d at 53; Green, 956 F.2d at 33; Jet Florida Sys., 883 F.2d at 976.
I agree with plaintiffs that Nat'l Iranian Oil Co. v. Mapco Int'l, Inc., 983 F.2d 485 (3d Cir. 1992) refutes Loewen Group's argument. There, the Court declared that a case is "moot if there will never be any possibility of satisfying a favorable judgment, thus permanently precluding all forms of relief." Mapco, 983 F.2d at 489, citing Triland Holdings Co. v. Sunbelt Service Corp., 884 F.2d 205, 208 (5th Cir. 1989). The Court also stated that "if a trial court's order will have possible collateral legal consequences, a case is not moot." Mapco, 983 F.2d at 490; see also In re Establish Inspection of Metal Bank of Am., Inc., 700 F.2d 910, 913-14 (3d Cir. 1983). The Reform Act's uncollectible share provision, which makes the individual defendants partially liable for any judgment against Loewen Group, is a collateral legal consequence that rescues this case from mootness.
A debtor defendant shielded by a § 524(a) bankruptcy discharge may be sued to establish the liability of a third party only if the debtor is a necessary party — "a party in whose absence the suit against the third party would be dismissed under applicable tort and procedural laws." In re Catania, 94 B.R. 250, 253 (Bankr. D. Mass. 1989). The only case I have found that sets forth a formal test for the "necessary party" requirement is In re Czuba, 146 B.R. 225 (Bankr. D. Minn. 1992). TheCzuba court defined the term "necessary party" by quoting Federal Rule of Civil Procedure 19(a). Thus, a party is "necessary" under Czuba if:
(1) in the [party's] absence complete relief cannot be accorded among those already parties; and
(2) the [party] claims an interest relating to the subject of the action and is so situated that the disposition of the action in the [party's] absence may —
(a) as a practical matter impair or impede the [party's] ability to protect that interest, or
(b) leave anyone already a party subject to a substantial risk of incurring double, multiple or otherwise inconsistent obligations by reason of the [party's] claimed interest.Czuba, 146 B.R. at 229.
Few cases question whether debtor defendant is a "necessary party," because the typical case involves a plaintiff suing a debtor solely as a prerequisite to recovery against the debtor's insurer. In those cases, the debtor's presence as a party is necessary, either because the insurance policy itself requires a judgment against the debtor, or because state law forbids direct suits against insurers.
The first prong of the Czuba "necessary party" test justifies retaining Loewen Group as a defendant. The text of 15 U.S.C. § 78u-4(f)(4) — the uncollectible share provision — shows that Loewen Group must be a party in order for the provision to operate:
(A) In general. Notwithstanding paragraph (2)(B), [if] upon motion made not later than 6 months after a final judgment is entered in any private action, the court determines that all or part of the share of the judgment of the covered person is not collectible against that covered person, and is also not collectible against a covered person described in paragraph (2)(A), each covered person described in paragraph (2)(B) shall be liable for the uncollectible share as follows. . . ."15 U.S.C.S. § 78u-4(f)(4)(A) (2004) (emphasis added). It is clear that the uncollectible share provision does not operate unless the party in question qualifies as a "covered person" under the statute. The Reform Act defines a "covered person" as "(i) a defendant in any private action arising under this title; or (ii) a defendant . . . who is an outside director of the issuer of the securities that are the subject of the action." 15 U.S.C.S. § 78u-4(f)(10)(C) (2004). Loewen Group must be a party for the plaintiffs to recover under the Reform Act's uncollectible share provision. Without Loewen Group as a defendant, I would be unable to accord the complete relief required by the first prong of theCzuba "necessary party" test.
The second prong of the Czuba "necessary party" test is inapplicable because Loewen Group does not claim an interest relating to the subject of this action; it has nothing to lose or gain from this litigation. Nor would its dismissal subject the individual defendants to a substantial risk of multiple liability.
The two prongs of the Czuba "necessary party" test make it clear that plaintiffs will be harmed if Loewen Group is dismissed and that Loewen Group and the individual defendants will lose nothing if it is retained. Other courts have held that potential harm to plaintiffs' interests suffices to make a debtor a necessary party. In re Stanton, 121 B.R. 438, 440-41 (Bankr. S.D.N.Y. 1990) ("[D]ebtor . . . is a necessary party in [the] action in order for the state court to determine the entire controversy with respect to the rights of all the parties in the case"); In re McGraw, 18 B.R. 140, 141 (Bankr. W.D. Wis. 1982) ("Without [debtor], the plaintiffs cannot establish the requisites of the respondeat superior doctrine, nor can negligence be apportioned among the parties as required per Wis. Stats. § 895.045"). I agree and hold that Loewen Group is a necessary party and should not be dismissed.
In fact, the individual defendants would benefit if Loewen Group were dismissed. Under 15 U.S.C. § 78u-4(f)(3)(A), the jury would be required to apportion some fault to Loewen Group (if the evidence warranted such a conclusion), yet plaintiffs would be unable to collect any of Loewen Group's liability from the individual defendants under the uncollectible share provision.
It should be noted that two events would call for the dismissal of Loewen Group. First, if plaintiffs were to obtain summary judgment on either of the individual defendants' liability for a knowing violation of the securities laws, then that individual defendant would become jointly and severally liable to the plaintiffs. 15 U.S.C.S. § 78u-4(f)(2)(A) (2004). If that should happen, Loewen Group would be dismissed, because plaintiffs would be guaranteed recovery from the jointly and severally liable individual defendant. Czuba, 146 B.R. at 229-30 (holding that defendant employer's joint and several liability for its bankrupt employee's sexual harassment rendered the bankrupt employee an unnecessary party).
Second, if this Court were to grant plaintiffs summary judgment, concluding that the individual defendants were 100% or 0% at fault, Loewen Group would have to be dismissed. In the former case, Loewen Group would not be liable for anything at all, and the uncollectible share provision could not operate. In the latter case, Loewen Group would be solely liable, and the § 524(a) injunction would prevent plaintiffs from recovering on their judgment.
The Czuba and Catania courts — both district courts — required plaintiff to pay debtor defendant's "reasonable costs of defense" if no third party would agree to bear those costs.Catania, 94 B.R. at 253; Czuba, 146 B.R. at 229. However, all the Courts of Appeals that have addressed the issue squarely have rejected this requirement. Green, 956 F.2d at 34; In re Walker, 927 F.2d 1138, 1142 (10th Cir. 1991); Jet Florida Sys., 883 F.2d at 976.
I adopt the reasoning of the Green, Walker and Jet Florida Systems courts and hold that plaintiffs in this case are not required to pay Loewen Group's legal expenses. By virtue of the § 524(a) discharge injunction, plaintiffs cannot collect on any judgment against Loewen Group. Therefore, there is no reason for Loewen Group to defend itself in court; plaintiffs can do nothing to threaten Loewen Group's fresh start. If Loewen Group wishes to defend its reputation, it must do so at its own expense.Nor may Loewen Group seek compensation for the time and effort it expends complying with plaintiffs' discovery requests.See In re Pappas, 106 B.R. 268, 271 (Bankr. D. Wyo. 1989) (holding that time debtor defendant loses because of litigation is not compensable).
Edgeworth is unpersuasive on this issue. The Edgeworth defendant's insurance company bore the cost of the defense so the statement that plaintiff would have to cover the costs of defense if no third party did is dicta. Edgeworth, 993 F.2d at 54.
F. Section 20(a) Claims
The individual defendants moved to dismiss the entire complaint but did not make any arguments specific to the Section 20(a) claims. A corporate officer or director can be liable under Section 20(a) for exercising control over a corporation that has committed securities fraud. In re MobileMedia Secs. Litig., 28 F. Supp. 2d 901, 940 (D.N.J. 1998). Plaintiffs alleging a Section 20(a) violation must plead facts showing a primary violation of the securities fraud laws by the company and circumstances establishing the individual defendants' control over the company. Id.
I have already held that plaintiffs have pleaded several Section 10(b) violations by Loewen Group. I need only consider whether plaintiffs have pleaded control by Loewen and Wagler. Claims under Section 20(a) are not subject to the heightened pleading requirements of Federal Rule of Civil Procedure 9(b) or the Reform Act. Tel-Save, 1999 U.S. Dist. LEXIS 16800, at *18-19. The pleading of facts that "support a reasonable inference that [defendants] had the potential to influence and direct the activities of the primary violator" will survive a motion to dismiss. Id., quoting In re Health Mgmt. Inc. Sec. Lit., 970 F. Supp. 192, 205 (E.D.N.Y. 1997). The new complaint alleges that Loewen and Wagler possessed control over the company due to their executive, managerial and/or directorial positions and their shareholdings in the company. New compl. ¶ 197. It also alleges that Loewen and Wagler exercised the control to cause the company to commit securities fraud. Id.
For each of the sufficiently pleaded Section 10(b) violations plaintiffs have pleaded Section 20(a) violations by Loewen and Wagler. For those Section 10(b) claims that will be dismissed the corresponding Section 20(a) claims will also be dismissed.
An appropriate Order follows.
ORDER
AND NOW, this day of August, 2004, in consideration of defendants' motions to dismiss, plaintiffs' opposition thereto, oral argument by the parties and the various supplemental memoranda and briefs that have been filed, and for the reasons set forth in the accompanying memorandum, defendants' motions to dismiss are DENIED as to the following claims:(1) the § 10(b) claim of materially misleading reporting of the value of Loewen Group's businesses and properties
(2) the § 10(b) claim of failure to account properly for imputed interest on zero interest finance plans;
(3) the § 10(b) claim of failure to record contingent losses on the put/call agreements with Blackstone regarding the Prime Succession and Rose Hill investments; and
(4) the § 20(a) claims related to those three § 10(b) claims.
The remainder of defendants' motions to dismiss are GRANTED. All claims for which the motions were not specifically denied are DISMISSED WITH PREJUDICE.