Opinion
No. 97-C-177
March 8, 2000
MEMORANDUM OPINION AND ORDER
Plaintiffs bring this action against Defendants System Software Associates, Inc. ("SSA") and certain of its officers, Roger E. Covey ("Covey"), Terence H. Osborne ("Osborne"), Terry E. Notari ("Notari"), Joseph Skadra ("Skadra"), and Larry J. Ford ("Ford") for alleged violations of Sections 10(b) and 20(a) of the Securities Exchange Act, 15 U.S.C. § 78j(b), 78t. Plaintiffs seek to represent a class of purchasers of SSA common stock from August 22, 1994 through and including January 7, 1997 (the "Class Period"). Defendants now move to dismiss on grounds that an earlier state court class action settlement precludes Plaintiffs' cause of action. In the alternative, Defendants argue that the complaint fails to meet the heightened pleading standards of the Private Securities Litigation Reform Act of 1995 ("PSLRA"), 15 U.S.C. § 78u-4(b)(1), (2). For the reasons set forth below, Defendant's motion to dismiss is denied in part and granted in part, and the parties are directed to brief the class certification issues.
FACTUAL BACKGROUND
A. The Allegations
In their Second Consolidated Amended Class Action Complaint (hereinafter "Complaint"), Plaintiffs make the following factual assertions. Defendant SSA markets and develops business application software. (Compl. ¶ 18.) As class representatives, the named Plaintiffs each individually purchased SSA common stock between April 19, 1995 and January 7, 1997. ( Id. ¶¶ 7-17.) They allege that SSA's stock price was artificially inflated during the Class Period because Defendants improperly recognized revenue from at least three contracts: (1) a 1994 contract to provide software to Owens-Illinois, Inc. (hereinafter "O-I"); (2) a 1995 contract to provide software to Hewlett-Packard; and (3) a 1995 contract to provide software to Glaxo-Wellcome. ( Id. ¶ 2.) Defendants do not dispute that they recognized almost the entire price of these contracts, representing millions of dollars, in SSA's balance sheets despite the fact that the contracts provided for payment in installments and included contingencies based on SSA's ability to develop compatible software. (Def. Mot., at 11.) Defendants do, however, vigorously dispute the significance of these contingencies and the relationship between SSA's reported revenue and its stock price. The price of SSA stock rose steadily from late 1994, after the O-I contract was signed, to early 1996. (Compl. ¶ 3.) The stock price declined gradually in late 1996 and eventually crashed on January 7, 1997 when Defendants announced that SSA would restate its financial results for the 1994 and 1995 fiscal years to eliminate $30 million of previously reported revenue. ( Id. ¶¶ 2-3.) SSA also announced that the restatement was the result of a change in its accounting procedures. ( Id. ¶ 2.) SSA stock had traded as high as $30.52 per share during the Class Period, and closed at $11-3/8 after the restatement announcement. ( Id. ¶ 3.)
Plaintiffs bring this class action on behalf of persons or entities who purchased SSA common stock during the time period from August 22, 1994, through and including January 7, 1997. (Compl. ¶ 1.) None of the named Plaintiffs actually purchased SSA stock prior to April 19, 1995. ( Id. ¶¶ 7-17.) The court notes that the adequacy of the named Plaintiffs as representatives of the class is an issue for a motion for class certification, and is not properly resolvable on a motion to dismiss for failure to state a claim.
Plaintiffs allege SSA officers and senior managers knew the revenue recognition procedures were improper even before SSA entered the three contracts. ( Id. ¶¶ 25, 44.) In support of this assertion, Plaintiffs point to a report made by SSA's outside auditor, Price Waterhouse, L.L.P. (hereinafter the "Auditor"), in June of 1994. In this report, the Auditor warned SSA that its practice of premature revenue recognition "was a matter of particular concern" and is inconsistent with Generally Accepted Accounting Procedures (hereinafter "GAAP"). ( Id. ¶¶ 107-108.) Further, when the Auditor reviewed the O-I contract as part of SSA's fiscal year 1994 audit, it reported that contingencies in the contract rendered revenue recognition based on this contract improper and suggested that SSA's disclosures in its 1994 10-K, filed with the SEC and signed by individual Defendants Skadra, Ford, and Covey, did not meet the "spirit" of full and adequate disclosure. ( Id. ¶¶ 19, 20, 22, 109, 112.) In its report, the Auditor also referred to "an increasing number of software contracts that involve future obligations on the part of [SSA.]" Consequently, the Auditor entered extensive discussions with Skadra about inserting explanatory language into the 10-K, but Defendants declined to resubmit the form to the SEC. ( Id. ¶ 112.) The following year, the Auditor expressed the same concerns about SSA's revenue recognition practices, this time referring to the 1995 Hewlett-Packard and Glaxo-Wellcome contracts. ( Id. ¶ 122-127.) Plaintiffs allege that at this time, SSA agreed that its revenue recognition practice was improper but again chose not to heed the Auditor's suggestion that the revenue be restated. ( Id. ¶ 128.)
The individual officers and senior managers named in the Complaint are as follows: Covey, Chairman of the Board of Directors and CEO since October 31, 1994, (Compl. ¶ 19); Skadra, Vice President and CFO ( Id. ¶ 20); Osborne, President and COO ( Id. ¶ 21); Notari, Vice President of the North American division ( Id. ¶ 22); and Ford, Chairman of the Board of Directors and CEO until October 31, 1994 and Director until mid-1995. ( Id. 623.)
Neither party has provided the court with the date of SSA's fiscal year 1994 audit.
Although not named in this suit, the Auditor is defendant to another federal lawsuit based on these facts, Retsky v. Price Waterhouse, L.L.P., 97 C 7694.
In 1995, the relationship between O-I and SSA began to deteriorate after O-I expressed dissatisfaction with SSA's performance and the work yet to be done under the contract. ( Id. ¶¶ 113-116.) Plaintiffs allege that as early as August 2, 1994, Bill King, SSA's project manager for the O-I Contract, communicated to SSA senior managers his doubts that SSA would be able to develop software for O-I in a timely manner. ( Id. ¶ 103.) On September 6, 1994, King told Covey and other unidentified senior managers that he had "no confidence" that SSA could produce O-I's software by the contract date. ( Id. ¶ 104.) On September 29, 1994, in a written memorandum to senior management, King stated that the O-I contract was "in serious trouble," and expressed his fear that SSA would be sued. ( Id. ¶ 105.) The Complaint does not allege which of the Defendants, other than Covey, actually received these written memos from King. When SSA failed to deliver under the terms of the O-I agreement, O-I brought suit against SSA in November 1995, alleging, inter alia, breach of the 1995 contract. ( Id. ¶ 117.) SSA settled the case on April 18, 1996 for an undisclosed amount. ( Id.)
Near the same time of the filing of the O-I action, in October of 1995, the SEC initiated an investigation into SSA's revenue recognition practices for the years 1994 and 1995. ( Id. ¶¶ 136-137.) On August 1-2, 1996, the SEC deposed James Eidam, the Auditor's engagement partner, regarding the revenue recognition of the O-I, Glaxo-Wellcome and Hewlett-Packard contracts. After his deposition was taken, Eidam allegedly told SSA that the Auditor would not consent to the use of its report in the 1996 SEC filings unless the revenue reporting issues were resolved. ( Id. ¶¶ 112, 139.) Obviously unwilling to heed the Auditor's advice, on or about November 4, 1996, SSA severed its relationship with the Auditor. ( Id. ¶ 79.) Also on November 4, 1996, SSA announced Osborne's retirement. ( Id. ¶ 80.) SSA retained a new outside auditor who presumably also came to the conclusion that fiscal year 1994 and 1995 revenue should be restated: on January 7, 1997, Defendants announced the restatement. ( Id. ¶ 84.) The Complaint does not allege who at SSA made the decision to terminate the relationship with the Auditor, or the decision to retain a new auditor.
The record does not reflect the conclusion, if any, of that investigation.
The Complaint does not allege which individual Defendants were so told.
B. The State Court Settlement
The present case represents the consolidation of seven cases filed in federal court within days of Defendants' restatement announcement in 1997. One day before Plaintiffs filed this complaint, however, another set of lawyers filed a securities fraud class action against the same Defendants, excluding Ford, in the Circuit Court of Cook County, Steinberg v. System Software Assoc., Inc., No. 97 CH 00287. (Def. Mot., Ex. 3.) Following extensive discovery, the parties to the state court action agreed to mediate their dispute. (Def. Mot., Ex. 7, Aff. of Gary S. Caplan.) On June 27, 1997, after several mediation sessions, Steinberg, the named plaintiff, agreed to settle for an amount of cash and stock totaling approximately $3 million. (Def. Mot., Ex. 8, Settlement Agreement.) The next day, an Illinois court entered an order simultaneously granting preliminary approval of the settlement and certifying a nationwide class of
Gary Caplan, a partner at Sachnoff Weaver, is legal counsel to SSA. (Caplan Aff. ¶ 1.)
[a]ll purchasers of Systems [sic] Software Associates, Inc. ("SSA") stock during the period between November 21, 1994 and January 7, 1997, inclusive, and who may have been damaged thereby. Excluded from the Class are defendant System Software, its officers, directors, subsidiaries or affiliates and defendants Roger E. Covey, Terence H. Osborne, Terry E. Notari and Joseph Skadra.
(Pl.'s Opp., Ex. 3, Order Preliminarily Approving Settlement and Providing for Notice ¶ 1.) A formal settlement notice, including the aforementioned language, was mailed to prospective class members on July 18, 1997. (Def. Mot., Ex. 9 (hereinafter "Notice").) The Notice states that for purposes of damage calculation, any shares purchased within the class period and sold during the class period would be excluded from the computation of recognized losses. Specifically, the Notice states:
For purposes of determining the number of shares purchased and held by an Eligible Class Member at the end of the Class Period, . . . there shall be excluded from the computation of Recognized Loss any shares purchased within the Class Period and sold during the Class Period.
( Id., at 2.) The Notice also provided prospective class members with the opportunity to appear at the settlement hearing and the opportunity to opt out of the class. ( Id., at 3-4.) Finally, the Notice provided that class members who did not opt out would be bound by the settlement, and therefore be precluded from any potential recovery from this federal lawsuit. ( Id., at 2-3.)
This court entered the order consolidating the present action on March 12, 1997, prior to the settlement of the state class.
Before the state court entered a final order approving the settlement, on August 22, 1997, Plaintiffs to this suit filed a petition to intervene in the state court settlement proceedings, challenging the adequacy of the state court plaintiff as class representative and the reasonableness of the settlement. See Steinberg v. System Software Assocs., Inc., et al., 306 Ill. App.3d 157, 163, 713 N.E.2d 709, 712-13 (1st Dist. 1999). A settlement hearing was held on September 30, 1997, during which the state court expressed particular concern about the interplay between the state court settlement and the federal cause of action. (Def. Reply, at 2-3.) When questioned at the hearing, Defendant's attorney gave the following explanation:
The firm of Sachnoff Weaver represented the Defendants both in the state action and in the present action.
And if this case is settled, this case is going to be approved and under the Supreme Court holding, in that it would be preclusive of the Federal case.
Except — and this is the last point, they have a case. They have a three month class. We're not selling, they have a defendant Larry Ford. We're not dealing. They have people that trade in and out, we're not settling. They're welcome to this case, Judge. They're welcome to that case. I would continuing (sic) and win that case in like a zillion dollars. More power to them.
(Pl.s' Opp., Ex. 1, September 30, 1997 Transcript of Settlement Hearing.) On that same day, the court entered an order of final judgment and dismissal and subsequently denied the petition to intervene filed by Plaintiffs in this case. See Steinberg v. System Software Assocs., Inc., et al., 306 Ill. App.3d 157, 160, 713 N.E.2d 709, 711 (1st Dist. 1999).
Plaintiffs filed an unsuccessful appeal from the denial of their petition to intervene. ( Id.) In the course of the appeal, Steinberg's attorney attempted to correct the ambiguity in the Notice by stating that the Notice should be read as including: " . . . all purchasers of [stock] during the period between November 21, 1994 and January 7, 1997, inclusive, who still held that stock on January 7, 1997." (emphasis added) (Pl.s' Opp., Ex. 5, Brief of Appellee Steinberg, at 6.) In his brief in opposition to Plaintiffs' appeal, Steinberg further argued that the persons who bought and sold the SSA stock between November 21, 1994 and January 7, 1997 were "unaffected" by the settlement and therefore had no standing to object. ( Id.) The Illinois Appellate Court rejected Plaintiffs' appeal, finding the settlement class adequately represented. In its decision, the court declined to address the issue of the allegedly defective Notice, concluding that this issue was "more properly the subject of the federal case that remains after the state settlement." See Steinberg v. System Software Assocs., Inc., et al., 306 Ill. App.3d 157, 169, 713 N.E.2d 709, 716-17 (1st Dist. 1999).
C. The Motion to Dismiss
Relying on the same "fraud on the market" theory alleged by the state court plaintiff, Plaintiffs here allege that Defendants knowingly and recklessly perpetrated a fraud on the market because each knew that SSA's accounting procedures were materially misleading yet nevertheless represented to the investing public that the financial reports accurately stated the company's revenue. (Compl. ¶¶ 26-76.) Plaintiffs also bring claims against individual officers of SSA as "controlling persons" under Section 20(a) of the Exchange Act for failing to exercise reasonable and prudent supervision over SSA's management, policies and financial controls. ( Id. ¶ 28.) Each named officer allegedly participated in the drafting, preparation and/or approval of SSA's shareholder reports, quarterly and annual financial reports, press releases and SEC filings despite having the ability and opportunity to prevent the issuance of such documents or to correct them. ( Id. ¶ 32-34.) Plaintiffs maintain that Class Members purchased shares of stock during the Class Period in reasonable reliance on Defendants' material omissions and on the integrity of the market price for SSA stock. ( Id. ¶ 147.) Defendants now argue that this case should be dismissed because the previous state court class action settlement bars Plaintiffs' claims and, in the alternative, that Plaintiffs fail to adequately allege fraud under the heightened pleading standards of the PSLRA.
DISCUSSION
A. Standard of Review
Defendants move to dismiss Plaintiffs' complaint on two grounds: (1) that this court is barred from hearing the case by the doctrine of res judicata; and (2) that Plaintiffs' complaint fails to meet the heightened pleading standards of the PSLRA. Pursuant to Federal Rule of Civil Procedure 8(c), res judicata is an affirmative defense. See FED. R. CIV. P. 8(c). The Seventh Circuit has held that the proper posture for dismissing a complaint based on an affirmative defense is a motion for summary judgment rather than a motion brought pursuant to Federal Rule of Civil Procedure 12(b). See Anderson v. State of Illinois, 70 F.3d 1275 (7th Cir. 1995). Accordingly, as both sides have submitted evidentiary material, the court construes Defendants' motion to dismiss on res judicata grounds as a motion for summary judgment, to be granted only if "there is no genuine issue as to any material fact and . . . the moving party is entitled to judgment as a matter of law." FED. R. CIV. P. 56(c); see also Flores v. Preferred Tech. Group, 182 F.3d 512, 514 (7th Cir. 1999). When determining whether this standard is met, the court views all the evidence in the light most favorable to the nonmoving party, and draws all inferences in the nonmovant's favor. See Dixon v. Godinez, 114 F.3d 640, 642-43 (7th Cir. 1997).
Defendants' motion to dismiss a securities fraud complaint implicates Federal Rules of Civil Procedure 12(b)(6) and 9(b) as well as the PSLRA. A motion to dismiss pursuant to Federal Rule of Civil Procedure 12(b)(6) does not test whether Plaintiffs will prevail on the merits but instead assesses whether Plaintiffs have properly stated a claim. See Scheuer v. Rhodes, 416 U.S. 232, 236 (1974). A court may dismiss a complaint for failure to state a claim 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." See Maple Lanes, Inc. v. Messer, 186 F.3d 823, 824-25 (7th Cir. 1999) (quoting Conley v. Gibson, 355 U.S. 41, 45-6 (1957)). On a motion to dismiss, the court draws all inferences and resolves all ambiguities in favor of the plaintiff, and assumes that all well-pleaded facts are true. See Long v. Shorebank Dev. Corp., 182 F.3d 548, 554 (7th Cir. 1999) (citation omitted). "Rule 9(b) requires that 'the circumstances constituting fraud . . . be stated with particularity.'" See In re Healthcare Compare Corp. Sec. Litig., 75 F.3d 276, 281 (7th Cir. 1996). The PSLRA amendments to the Securities Exchange Act of 1934 raised the pleading standards in securities fraud cases, requiring the plaintiff to "state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind." See 15 U.S.C. § 78u-4(b)(2). SSA moves to dismiss Plaintiffs' complaint on res judicata grounds and for failure to state a claim under the heightened pleading standards of the PSLRA.
B. Res Judicata
Under the Full Faith and Credit Act, 28 U.S.C. § 1738, the settlement of a state securities action may preclude similar pending federal securities class action suits arising out of the same facts. See Matsushita Elec. Indus. Co. v. Epstein, 516 U.S. 367, 387 (1996). According to Matsushita, in the absence of a contrary federal law, state law determines whether a state court settlement precludes related federal proceedings. See id. at 375 (citing Marrese v. American Acad. of Orthopaedic Surg., 470 U.S. 373, 381-2 (1985)). If a state court would be precluded from hearing the case under state law, the federal court is similarly barred, unless exceptional circumstances justify a refusal to give preclusive effect to the state court's judgment. Id. A failure of the state court to satisfy constitutional due process requirements would constitute an exceptional circumstance allowing the federal court to hear the claims. Id. at 884-5 (Ginsburg, J., Stevens, J. and Souter, J., concurring) (citations omitted).
Under Illinois law of res judicata, courts are precluded from hearing claims where: (1) there has been a final judgment on the merits rendered by a court of competent jurisdiction; (2) the parties involved are the same or in privity; and (3) the causes of action are the same. See River Park, Inc. v. City of Highland Park, 184 Ill.2d 290, 302, 702 N.E.2d 883, 889 (1998); Schnitzer v. O'Connor, 274 Ill. App.3d 314, 324, 653 N.E.2d 825, 832 (1st Dist. 1995). Neither party disputes that a court of competent jurisdiction authorized the settlement in the state court case, nor that Plaintiffs' cause of action arises out of the same facts. Rather, the parties disagree as to whether the class proposed in this case is the same or in privity with the class in the state court proceedings. Noting the addition of three months to the state court class period and the inclusion of purchasers who sold SSA stock during the class period, Plaintiffs argue that their proposed class is not in privity with the state court class. Even if the class here is in privity with the class in the state court, Plaintiffs contend that judgment ought not bar this action because defects in the state court proceedings violated due process and support a collateral attack on the judgment.
In addressing these arguments, the court notes that Plaintiffs' proposed class may fairly be divided into three distinct subclasses: (1) a subclass consisting of purchasers of SSA stock between November 21, 1994 and January 7, 1997 who still held that stock on January 7, 1997 (hereinafter the "Purchasers and Holders"); (2) a second subclass consisting of purchasers of SSA stock between November 21, 1994 and January 7, 1997 who sold their stock prior to January 7, 1997 (hereinafter the "In and Out Purchasers"); and (3) a third subclass consisting of purchasers of SSA stock from August 22, 1994 to November 20, 1994, inclusive, regardless of whether they still held that stock on January 7, 1997 (hereinafter the "Early Class").
1. The In and Out Purchasers
The court first considers whether the In and Out Purchasers are bound by the final state court judgment. Contrary to Defendants' assertion in their brief before this court (Def.'s Memo. in Support of Mot. to Dismiss, at 6-7), the record suggests that the plaintiffs to the state court settlement did not seek to represent the In and Out Purchasers in the negotiations. Specifically, Steinberg's attorney told the Illinois Appellate Court that the settlement notice sought to exclude persons who sold SSA stock within the critical time period, and in arguing that Plaintiffs should not be permitted to intervene in the state court action, he further explained that the In and Out Purchasers "are excluded from the Class . . . [and are therefore] unaffected by this settlement." (Pl.s' Opp., Ex. 5, Brief of Appellee Steinberg, at 6.) The representations of Defendants' lawyer to the Illinois Appellate Court are less clear but generally support the idea that the In and Out Purchasers and the Early Class were not part of the settlement. That the In and Out Purchasers were excluded from the settlement is the only conclusion consistent with the Illinois courts' decisions regarding the adequacy of the state court representative and the only one consistent with the parties' representations before that tribunal. Defendants make no arguments that under Illinois law a party excluded from a settlement class is nevertheless in privity with the settlement class. The court concludes that the In and Out Purchasers' claims are not barred by res judicata, and therefore it need not address whether the In and Out Purchasers were afforded due process in the state court proceedings.
Defendants argue that their representations to the Illinois Appellate Court that some federal claims may continue after the settlement does not mean that Defendants intended to allow these purchasers to pursue their claims in this court. (Def. Mot., at 8 n. 4.) While there is nothing inherently wrong with the logic of this argument, Defendants in the same breath represent that the Illinois courts were extremely sensitive to the contours of the settlement in relation to the claims of the federal Plaintiffs. ( Id.) Together with the arguments it now makes before this court, Defendants' line of reasoning comes very close to suggesting that in explaining the relationship between the state court action and the present action, Defendants purposely misled the Illinois Appellate Court, or at least failed to correct the Steinberg's assertion that the In and Out Purchasers were excluded from the class, by suggesting that the In and Out Purchasers may still have a claim in federal court. (Pl.s' Opp., Ex. 1, Sept. 30, 1997 Transcript of Settlement Hearing.) While this court chooses to give the Defendants the benefit of the doubt, it reminds them that this court does have the power to estop a party from acting inconsistently with its conduct in prior cases. See Feldman v. American Memorial Life Ins. Co., 196 F.3d 783, 789 (7th Cir. 1999) (doctrine of judicial estoppel prevents a party from adopting a position in a legal proceeding contrary to a position successfully argued in an earlier legal proceeding).
2. The Early Class
Defendants do not dispute that purchasers in the Early Class were never considered part of the state court settlement or that they did not receive the Notice. Rather, relying exclusively on Torcasso v. Standard Outdoor Sales, Inc., 157 Ill.2d 484, 490, 626 N.E.2d 225, 228 (1993), Defendants argue that the interests between the Early Class and the state court settlement class are identical for res judicata purposes because their respective causes of action are identical. Defendants correctly note that under Illinois law, res judicata extends not only to every matter that was actually determined in the prior suit but also to every other matter that might have been raised and determined in it. See Torcasso, 626 N.E.2d at 228, 157 Ill.2d at 490. Torcasso, however, was not a class action suit and Defendants do not elaborate as to how its holding should be applied to suits of a class nature. Instead, Defendants rely primarily on a theory of virtual representation developed in federal courts for Rule 23 cases. Defendants offer no arguments that the Illinois courts also recognize the notion of virtual representation, a doctrine recently acknowledged as "amorphous" by the Seventh Circuit in Tice v. American Airlines, Inc., 162 F.3d 966 (7th Cir. 1998), cert. denied, 119 S.Ct. 2396 (1999).
In a footnote to its brief, Defendant suggests that the inclusion of the Early Class is simply a tactical move by Plaintiffs to prevent preclusion. (Def. Mot., at ¶ n. 3.) While there are cases in which the naming of additional plaintiffs have been found veiled attempts to avoid preclusion, this case is not one of them. See e.g., In re Chicago Police Officer Promotions, Nos. 91 C 668, 90 C 950, 90 C 1923, 89 C 6247, 90 C 4984, 90 C 5456 89 C 7262, 1991 WL 134218, at *5 (N.D.Ill. July 16, 1991). Plaintiffs filed this Complaint just one day after the state court cause of action began and six months before the state court certified the settlement class.
Even assuming Illinois recognizes the theory of virtual representation, the theory clearly has no application here. The state court settlement provided benefits to members of a defined class, and barred further claims brought by members of that class, but not claims of persons not included in the class. Defendants' arguments to the contrary are almost identical to those rejected in Chancellor v. Nationwide Credit, Inc., No. 98 C 4431, 1999 WL 259951, at *1 (N.D.Ill. April 6, 1999). The defendant in Chancellor had settled Fair Debt Collection Practices Act claims with a class of plaintiffs which did not include plaintiff Chancellor. When Chancellor subsequently sued the defendant for the same violations as alleged by the prior settlement class, the defendant sought to preclude the action on the basis of res judicata, arguing that the Chancellor class was virtually represented by the settlement class. The Chancellor court held that privity could not exist between individuals representing a class and individuals not part of that class. See id. at *3-4. Like the plaintiff in Chancellor, members of the Early Class did not participate in settlement negotiations, were not notified of the state court settlement, and are not entitled to receive any benefits from it.
Defendants attempt to distinguish Chancellor on grounds that members of the Early Class had a full and fair opportunity to participate in the state court settlement but chose not to participate or opt out. The effort is unconvincing. Defendants do not explain how the Early Class could have had the opportunity to participate in the state settlement negotiations when they received no Notice and when the state court plaintiff did not seek to represent their interests. Nothing in the state court settlement therefore precludes the Early Class from making its claim before this court.
The court pauses here to note that the addition of individual Defendant Ford to the federal cause of action neither adds to nor detracts from the res judicata argument. Defendants argue that Plaintiffs added Ford to the complaint as a strategic maneuver to get around the "identity of parties" element of res judicata. The court rejects this argument, however, because there is no identity of parties with respect to the Early Class and the In and Out Purchasers and the state court class members anyway. Further, while the record does not offer explicit reasons for Ford's exclusion from the state court cause of action, this court notes that he acted as CEO only until October 1994, before the beginning of the critical time period defined in the state court action. It therefore does not appear that he could have been joined as a Defendant in a state court proceeding that did not include purchasers before this date.
3. The Purchasers and Holders
Next, this court turns to the claims of the Purchasers and Holders. As a subclass, this group is identical to the one represented in the state court settlement. Notably, it does not appear that the individuals seeking redress here opted out of the settlement and its preclusive effects. The parties do not dispute that under Illinois law, this subclass is bound to that settlement by the doctrine of res judicata. Rather, they dispute whether the failure to make any findings of fact regarding the adequacy of the state plaintiff as representative and whether the Notice violated due process requirements and prejudiced these purchasers.
Plaintiffs are correct in asserting that a court judgment cannot bind absent class members unless that forum has provided minimal procedural due process protections to the absent members. See Phillips Petroleum Co. v. Shutts, 472 U.S. 797, 811-12 (1985). At a minimum, in a class action settlement, due process requires that (1) an absent plaintiff be provided with notice and an opportunity to be heard and participate in the litigation; and (2) the named plaintiff at all times adequately represents the interests of the absent class members. See id. at 812; see also Richard's Lumber Supply Co. v. U.S. Gypsum Co., 545 F.2d 18, 21 (7th Cir. 1976). Plaintiffs urge this court to deny the preclusive effects of the state court settlement on the Purchasers and Holders class, alleging that defects in the state court procedures violated due process.
First, Plaintiffs argue that the state court erred by not making specific findings of fact as to the adequacy of the state court plaintiff representative. Indeed, Plaintiffs are correct in their assertion that under Illinois law, a court must find that the prerequisites of class representation are present before it certifies a class action suit. See Wheatley v. Board of Educ. of Township High School Dist. 205, 99 Ill.2d 481, 486, 459 N.E.2d 1364, 1367 (1984). Plaintiffs cite no Illinois cases suggesting that a court's action in certifying a class without making specific findings on each of the certification requirements constitutes reversible error. Instead, Plaintiffs rely exclusively on a Sixth Circuit Court of Appeals holding that a court's failure to make an explicit finding as to the adequacy of the class representative violates the requirements of Rule 23. See In re American Med. Sys., Inc., 75 F.3d 1069 (6th Cir. 1996). Under Matsushita, however, for purposes of determining the res judicata effect of a state court judgment, the inquiry is whether the original suit met the state law procedural requirements. In this case, the Illinois Appellate Court was unmoved by Plaintiffs' argument that putative class members were prejudiced because the trial court made no specific findings on the adequacy of the class representative. The Illinois Appellate Court rejected that argument and found both that the class was represented by able counsel with extensive experience in class action litigation and that the lower court did not abuse its discretion when it certified the settlement class. See Steinberg v. System Software Assocs., Inc., et al., 306 Ill. App.3d 157, 169, 713 N.E.2d 709, 716 (1st Dist. 1999). Further, Plaintiffs point to nothing in the record suggesting that the interests of the named plaintiff were not common and typical of the class, that prosecution or discovery was inadequate, or that the settlement agreement was not a product of arms-length negotiations; to the contrary, the negotiations were mediated by an objective outsider, former Illinois Appellate Court Justice Anthony Scariano. The state court's decision on this issue is entitled to full faith and credit here because Plaintiffs suffered no prejudice from the fact that the state court judge failed to make specific findings as to the representative's adequacy when he certified the state court class.
Next, Plaintiffs argue that Purchasers and Holders absent from the state court proceedings were prejudiced by the dissemination of a defective Notice, and therefore suffered due process violations. In a class action settlement, due process requires that absent plaintiffs receive notice as well as an opportunity to be heard. See Phillips Petroleum Co. v. Shutts, 472 U.S. 797, 812 (1985). "The notice must be the best practicable, 'reasonably calculated, under all the circumstances, to apprise interested parties of the pendency of the action and afford them an opportunity to present their objections.'" See id. (quoting Mullane v. Central Hanover Bank Trust Co., 339 U.S. 306, 314-15 (1950)). Further, due process requires that an absent plaintiff be provided with the opportunity to opt out of the proposed class. Id.
Plaintiffs argue that even though the Purchasers and Holders received the Notice, they could not have understood that persons who sold their SSA stock before the end of the critical period were not included. Plaintiffs present the court with the hypothetical situation of a Purchaser and Holder who may have ultimately decided to opt out of the class after concluding he or she could recover more on his or her own rather than having to share the recovery with the In and Out Purchasers. The court is unconvinced by this hypothesis and concludes that the Notice was not defective. Although the definition of the settlement class in the Notice did not explicitly exclude those purchasers who may have sold their SSA stock during the critical period, the Notice did state that SSA stock sold within the period would be excluded from the computation of damages. The Notice also provided putative class members with the opportunity to appear at a hearing on the settlement. The Notice conveyed the information sufficient to apprise interested parties of the pendency of the action, and provided an opportunity to appear and be heard, therefore satisfying the demands of due process. See Air Lines Stewards Stewardesses Ass'n. v. American Airlines, Inc., 455 F.2d 101, 108 (7th Cir. 1972).
Such language is arguably more accurate because there may be persons who sold a portion of their SSA stock during the critical period but retained another portion.
For the reasons set forth above, the court concludes that only a portion of Plaintiffs' proposed class is subject to preclusion by the state court settlement. The court therefore denies Defendants' motion to dismiss on res judicata grounds with respect to the Early Class and the In and Out Purchasers, but grants the motion with respect to the Purchasers and Holders. The court's determination that the claims of the In and Out Purchasers and the Early Class are not barred by the state court settlement is not a reflection of the court's view of the relative merits of their claims, which will no doubt be the subject of further argument. For now, however, the court rejects arguments that neither subclass can prove damages. Defendants correctly note that under the PSLRA, damages are limited to the difference between an investor's purchase price and the ninety-day average trading price of the stock following any curative disclosure. See 15 U.S.C. § 78u-4(e). As discussed in more detail below, Defendants would count the relevant ninety days against the supposed curative disclosure in either of two newspaper articles published in the fall of 1995. As explained below, this court does not find either of those articles curative within the meaning of the PSLRA. If, after certification, Defendants still believe that Plaintiffs' damages are too minimal to maintain the cause of action, an early offer of judgment pursuant to Federal Rule of Civil Procedure 68 may satisfy Defendants' concerns.
C. Pleading Requirements
Defendants also make a number of arguments in an attempt to establish that Plaintiffs fail to meet the heightened pleading standards of the PSLRA. The Seventh Circuit has explained that in order to state a claim under Rule 10b-5 of the Securities Exchange Act, a plaintiff must allege "that the defendant (1) made a misstatement or omission, (2) of material fact, (3) with scienter, (4) in connection with the purchase or sale of securities, (5) upon which plaintiff has relied and (6) that reliance proximately caused plaintiff's injuries." See In Re HealthCare Compare Corp. Sec. Litig., 75 F.3d 276, 280 (7th Cir. 1996). A misstatement or omission is material if there was a "substantial likelihood that disclosure of the omitted fact would have been viewed by a reasonable investor as having significantly altered the 'total mix' of information available." See TSC Indus., Inc. v. Northway, Inc., 426 U.S. 438, 449 (1976). Because a 10b-5 claim alleges fraud, it must also meet the standards of FED. R. CIV. P. 9(b) which requires that facts supporting an inference of fraud be pleaded with specificity. See HealthCare Compare, 75 F.3d at 280-81. Defendants argue that Plaintiffs' claims are barred by the statute of limitations, that Plaintiffs have failed to plead detrimental reliance, that Plaintiffs have failed to properly plead scienter, that Plaintiffs have failed to allege each individual Defendant's participation in the fraud, and that Plaintiffs have not adequately alleged control person liability. The court addresses each argument in turn.
1. Statute of Limitations
Defendants argue, first, that Plaintiffs' allegations are barred by the statute of limitations. Under the PSLRA, an individual may bring suit only within one year from the time the individual knew or should have known that a claim was available. See Whirlpool Fin. Corp. v. GN Holdings, Inc., 67 F.3d 605, 609-10 (7th Cir. 1995). An individual should know of a claim when a common sense inquiry into "suspicious circumstances" would have easily revealed the fraud. See Law v. Medco Research, Inc., 113 F.3d 781, 786 (7th Cir. 1997). Defendants argue that Plaintiffs should have known about the alleged fraud as early as October 5, 1995 when the Wall Street Journal Europe published an article suggesting that SSA may have been overly aggressive in recording sales for which it had not yet been paid and for which payment might yet be withdrawn. (Def. Mot., Ex. 21.) Defendants also point to a Bloomberg Business News dated November 22, 1995, which mentioned O-I's lawsuit against SSA. (Def. Mot., Ex. 20.) Defendants argue that this information was widely published, easily discoverable by Plaintiffs fourteen months prior to SSA's restatement announcement, and should have triggered further investigation by Plaintiffs.
Defendants fail to acknowledge, however, their own emphatic denials of any improprieties published in these very same articles. In the Wall Street Journal Europe article, Defendants represented that their accounting procedures were "fair and reasonable" and suggested that SSA's deal with O-I would not adversely affect their profit-and-loss statement because it had "lots and lots of reserves." In the Bloomberg News article, SSA claimed that the O-I lawsuit "would [not] affect its financial condition." Defendants also fail to acknowledge the existence of other articles and press releases published about the same time which did not question the accuracy of SSA recorded revenue, but rather suggested that the company was reporting record earnings and revenue. (Compl. ¶¶ 54-83.) Indeed, on the same day as the Bloomberg News article, a securities analyst from Alex. Brown Sons recommended SSA stock as a "strong buy" and reported that SSA management had indicated that the company had full reserves for any losses from the O-I contract. (Compl. ¶ 67.) One month later, an analyst at the META Group reported that the market expected SSA to continue its sales growth. (Compl. ¶ 68.) On November 16, 1996, Standard Poor's gave SSA stock its highest rating. (Compl. ¶ 83.)
More importantly, only the one Wall Street Journal article even addressed SSA's revenue accounting methods. The other article relied on by Defendants suggests that the market's only really concern about SSA's revenue was the outcome of the O-I contract dispute, rather than the method used by SSA to record revenue. Specifically, the Bloomberg News article mentioned that O-I had paid half the contract price but said nothing about the fact that Defendants had nevertheless reported more than two-thirds of the contract price as 1994 revenue. Defendants do not explain how Plaintiffs would be led to investigate SSA's practices based on one published article nor how such an investigation would have led them to the conclusion that SSA's accounting procedures were indeed improper.
2. Reliance
Defendants' second challenge to the adequacy of Plaintiffs' allegations focuses on the issue of reliance. Again noting the October 1995 Wall Street Journal Europe article, Defendants argue that Plaintiffs cannot prevail on their fraud on the market theory because the market was aware of SSA's revenue recognition practices and the stock price during this period therefore reflected the true value of the company. Under the fraud on the market theory, Plaintiffs need not allege facts showing individual reliance. They may, instead, raise a rebuttable presumption of reliance by alleging that (1) Defendants made public misrepresentations; (2) the misrepresentations were material and would induce a reasonable investor to misjudge the value of the shares; (3) the shares were traded on an open and efficient market; and (4) that Plaintiffs traded shares between the time the misrepresentations were made and the truth revealed. See Basic Inc. v. Levinson, 485 U.S. 224, 248 n. 27 (1988).
The fraud on the market theory presumes that because the market is interposed between sellers and buyers of stock, misleading statements reflected in the market defraud individual purchasers even if those purchasers do not directly rely on those misstatements. See id. at 241-42. Defendants may rebut the presumption of reliance by establishing that any alleged misstatement did not lead to a distortion in price or that an individual plaintiff would have purchased stock even if the misstatement were known to be false. Id. at 248. Apart from one analyst in an October 1995 article, Defendants have offered no support for the contention that the market suspected any misstatement or ever suspected that the O-I dispute would lead SSA to lose money already recognized. Construing all facts in favor of Plaintiffs, this single article is insufficient to defeat this presumption. Any disparity between a Plaintiff's assumption that stock was traded on an informed market, and the notion that the market could remain misinformed despite some evidence to the contrary is a matter for trial. Id. at 249 n. 29.
3. Scienter
Defendants' third argument is that the Early Class members cannot establish scienter. Scienter, as applied to a securities fraud claim, refers to a mental state embracing the intent to deceive, manipulate or defraud. Ernst Ernst v. Hochfelder, 425 U.S. 185, 193 n. 12 (1976). Only intentional misstatements violate Section 10(b) and Rule 10B-5. Id. at 214. The PSLRA requires that the scienter allegation be supported with particular facts which give rise to a strong inference that defendants acted with fraudulent intent. See 15 U.S.C. § 78-4(b)(2). One court in this district has characterized the PSLRA as effectively codifying the standard employed by Second Circuit, which requires a plaintiff "to plead the factual basis which gives rise to a 'strong inference' of fraudulent intent." See Danis v. USN Communications, Inc., 73 F. Supp.2d 923, 936-37 (N.D.Ill. 1999) (quoting O'Brien Nat'l Property Analysts Partners, 936 F.2d 674, 676 (2nd Cir. 1991)); see also In re Advanta Corp Sec. Litig., 180 F.3d 525, 533 (3rd Cir. 1999) (PSLRA "establishes a pleading standard approximately equal in stringency to that of the Second Circuit"); but see Bryant v. Avado Brands, Inc., 187 F.3d 1271, 1282 (11th Cir. 1999) (PSLRA does not codify the "motive and opportunity" test formulated by the Second Circuit for pleading scienter).
The Seventh Circuit has not yet addressed the PSLRA pleading standard, but this court presumes the Court of Appeals will continue to require securities fraud complaints to recite facts and circumstances constituting the alleged fraudulent conduct. DiLeo v. Ernst Young, 901 F.2d 624, 628 (7th Cir. 1990). This standard requires plaintiffs to plead "the who, what, when, where and how: the first paragraph of any newspaper story." Id.
A plaintiff may allege scienter by either (1) showing that defendants had both the motive and opportunity to commit fraud or (2) establishing strong circumstantial evidence of conscious behavior or recklessness. See Rehm v. Eagle Fin. Corp., 954 F. Supp. 1246, 1253 (N.D.Ill. 1997) (quoting Shields v. Citytrust Bancorp, Inc., 25 F.3d 1124, 1128 (2nd Cir. 1994)); Press v. Chemical Inv. Servs. Corp., 166 F.3d 529, 538 (2nd Cir. 1999). Unlike the factual circumstances constituting the fraud, motive and intent may be averred generally, FED. R. CIV. P. 9(b); In Re Discovery Zone Sec. Litig., 943 F. Supp. 924, 937 (N.D.Ill. 1996), so long as facts that support an inference of circumstantial evidence of scienter are specific. See Rehm, 954 F. Supp. at 1255. The mere fact that a company restates its revenue does not establish scienter. See Goldberg v. Household Bank, F.S.B., 890 F.2d 965, 979 (7th Cir. 1989) ("Restatements of earnings are common . . . only intentional misstatements violate Section 10(b) and Rule 10b-5.").
Plaintiffs attempt to establish both that Defendants had motive and opportunity and that factual circumstances constituting the fraud establish scienter. In this case, Plaintiffs allege, for example, that scienter can be inferred from an examination of individual Defendants' respective sales of stock during the class period. Motive and opportunity may be inferred from the allegation that Defendants sold or intended to sell stock from their personal reserves during the class period. See Discovery Zone, 943 F. Supp at 937 (citing Marksman Partners, L.P. v. Chantal Pharm. Corp., 927 F. Supp. 1297, 1312 (C.D.Cal. 1996)). It is not enough, however, that defendants merely sold personal stock during the class period. Rather, a plaintiff must show that the sale was drastically out of line with prior trading practices and that the sale was timed to maximize personal benefit from undisclosed inside information. See Freeman v. Decio, 584 F.2d 186, 197 n. 44 (7th Cir. 1978); Rehm, 954 F. Supp. at 1254. Regardless of the significance of any individual defendant's trading patterns, the inference is obviously strongest when examined collectively — e.g. where the individual defendants bought or sold shares in a common pattern. See Acito v. IMCERA Group, Inc., 47 F.3d 47, 54 (2nd Cir. 1995).
Notably, Plaintiffs in this case merely catalogue the sales each individual Defendant made during the Class Period, without referring to sales made prior to this period. (Compl. ¶ 102.) The Complaint fails to plead that these stock sales were out of line with Defendants' previous sales of stock. Collectively, there is no discernable pattern to the stock sales of the type that would lead someone to suspect that stock sales were coordinated in any way. In short, the Complaint fails to establish scienter based on motive and opportunity.
Plaintiffs' failure to present allegations concerning stock sales that reflect motive and opportunity does not conclude the issue of scienter. Plaintiffs may also establish scienter by alleging that Defendants acted with reckless indifference to warnings about SSA's revenue practices. See Bryant v. Avado Brands, Inc., 187 F.3d 1271, 1282 (11th Cir. 1999) (recklessness is sufficient to allege scienter under PSLRA); In re Advanta Corp. Sec. Litig., 180 F.3d 525, 534 (3rd Cir. 1999) (same). Reckless conduct is conduct that deviates from the standard of ordinary care, to the extent that an alleged error was either known to the defendant or so obvious that the defendant must have known about it. See Rehm, 954 F. Supp at 1255; Discovery Zone, 943 F. Supp at 937. "The more serious the error, the less believable are defendants' protests that they were completely unaware of [the company's] true financial status and the stronger is the inference that defendants must have known about the discrepancy." Rehm, 954 F. Supp. at 1256. In Rehm, the court noted that a refusal to see the obvious or investigate the doubtful may in some cases give rise to an inference of recklessness. 954 F. Supp. at 1255. Nevertheless, the allegations that Defendants seriously departed from the GAAP does not alone establish scienter. Id. at 1246; In re Comshare, Inc. Sec. Litig., 183 F.3d 542, 552 (6th Cir. 1999). A complaint must also show facts supporting an inference that defendants recklessly disregarded the deviance or acted with gross indifference to the misrepresentations in its financial statements. See Rehm, 954 F. Supp. at 1246.
Rehm involved a class action suit brought by persons who purchased or acquired stock of the defendant corporation and alleged that the defendant and its executive officers materially misrepresented the corporation's known credit losses and net income in violation of the Securities Exchange Act of 1934. In Rehm, the court found that a significant GAAP violation, combined with statements mitigating the seriousness of a credit loss problem, raised a strong inference that the defendants there acted with knowledge of their public misstatements or with willful blindness to the truth. Id. The allegations made in Plaintiffs' Complaint are almost identical to those made in Rehm, with the exception that unlike the defendants there, Defendants here were clearly on notice of the alleged GAAP deviation. The Complaint alleges specific facts to show that despite the warnings and recommendations of the Auditor and despite the lost revenue from the O-I contract, Defendants nevertheless refused to acknowledge that SSA's revenue had been misstated and made numerous public statements that expressed confidence in the company's balance sheets.
Defendants vigorously maintain that a "best efforts" clause in the O-I contract precludes their conduct from meeting the reckless standard. Under this disingenuous reasoning, Defendants argue that it was proper for the company to report the revenue from the O-I Contract, or at least proper for Defendants to believe the revenue was appropriately reported, because SSA was under no obligation to actually create all the software requested by O-I. Setting aside the issue of whether Defendants would have this court believe that O-I would enter a $12 million contract in which SSA could collect the entire contract price even if it were unable to produce the requested software, the court finds the Complaint adequate. Plaintiffs have alleged that even before the O-I contract was signed, the Auditor had warned Defendants about improper revenue recognition practices, that Defendants failed to restate the 1994 revenue immediately after the O-I settlement, and that these revenue recognition practices were not limited to the O-I Contract but included at least two other contracts. The Complaint establishes more than enough circumstantial evidence to support an inference that Defendants acted with gross indifference to the misrepresentations in SSA's financial statements.
4. Individual Defendants
Defendants next turn to individual defendants Ford, Notari, and Osborne, making various arguments as to why the Early Class fails to establish facts specific to them. While Ford signed the 1994 10Q form, Defendants argue that because he was CEO only until October 1994, Early Class claims are based solely on the improper recognition of the O-I Contract and that Plaintiffs fail to allege any specific facts regarding Ford's knowledge that O-I revenue should not have been immediately recognized. Defendants note, further, that while all individual defendants signed at least one of System Software's 10Q and 10K forms for 1994 and 1995, only Covey, Skadra, and Ford made any public statements during the class period. Defendants maintain that therefore the claims against Notari and Osborne must be dismissed. As described above, under the PSLRA, Plaintiffs need only raise the inference that Defendants acted with reckless indifference to the original error — here the misstatement of the revenue.
The Seventh Circuit has held that a plaintiff pleading fraud under the Rule 9(b) standard must "reasonably notify the defendants of their purported role in the scheme." See Vicom, Inc. v. Harbridge Merchant Servs., Inc., 20 F.3d 771, 776-7 (7th Cir. 1994) (quoting Midwest Grinding Co. v. Spitz, 976 F.2d 1016, 1020 (7th Cir. 1992)). Plaintiffs allege that the Auditor questioned SSA's revenue recognition procedures in the spring of 1994, before the O-I Contract was signed. Plaintiffs also allege that Ford was a corporate insider, identifying his position as CEO in 1994 and Director of SSA in 1995. Plaintiffs further allege that Notari, the Vice President of the North American Division and Osborne, President and COO of SSA, were corporate insiders. Plaintiffs make particular allegations as to how SSA, including Ford, Notari, and Osborne, perpetrated a fraud on the market by improperly recognizing revenue. Plaintiffs do not plead, because they do not and cannot at this point know, whether Ford, Notari, and Osborne actually read the Auditors' reports. Nevertheless, the facts are sufficient to establish that Ford, Notari, and Osborne, as senior management at SSA, knew or should have known about SSA's revenue practices and support an inference that they should have known about the terms of the $12 million contract with O-I.
Because this court finds that Plaintiffs have adequately pleaded facts indicating how the individual Defendants knew of the misstatements, it is unnecessary to address Defendants' somewhat undeveloped attack on Plaintiffs' mention of the group publication doctrine as a premise for liability against Notari and Osborne. Because the issue is a serious one, however, this court must at least recognize the argument. In the group publication doctrine, individual liability can be inferred from the collective actions of corporate officers, such as the publication of an annual report. Defendants argue that the PSLRA's heightened pleading standards have abolished the group publication doctrine because at least one court has held that the doctrine is now "suspect." Allison v. Booktree Corp., 999 F. Supp. 1342, 1350 (S.D.Cal. 1998). It appears, however, that some circuits have explicitly held that the group publication doctrine survives the amended PSLRA. See, e.g, Schwartz v. Celestial Seasonings, Inc., 124 F.3d 1246, 1254 (10th Cir. 1997); In Re GlenFed, Inc. Sec. Litig., 60 F.3d 591, 593 (9th Cir. 1995); Powers v. Eichen, 977 F. Supp. 1031, 1040 (S.D.Cal. 1997). While the Seventh Circuit has not yet explicitly addressed the issue, there are at least two recent cases in which the courts of the Northern District of Illinois used the doctrine and apparently none in which the doctrine was rejected. See Discovery Zone, 943 F. Supp at 937-8; Koehler v. Nationsbank Corp., No. 96-C-2050, 1997 WL 80928, *1 (N.D.Ill. Feb. 20, 1997). This court cannot address the issue today because Defendants do not make a single argument as to why the PSLRA may call the group publication doctrine into question except to note the dicta from one court, not in this district. Without deciding the issue, this court adopts the group publication theory — to the extent that any inferences mentioned above may seem to rely on that theory — for purposes of this opinion only.
5. Control Persons
Finally, Defendants assert that the Early Class fails to establish that either Notari or Osborne are individually liable as control persons under Section 20(a) of the Exchange Act. To plead control person liability, Plaintiffs must adequately allege that each "control person" participated in or exercised control over SSA in general and that he possessed the "power or ability to control [the specific] transactions upon which the primary violation was predicated," whether or not that power was exercised. See Harrison v. Dean Witter Reynolds, Inc., 974 F.2d 873, 881 (7th Cir. 1992). That a person acted in good faith and did not directly or indirectly induce the act or acts constituting the alleged violation is an affirmative defense to control person liability. Id. Failure to supervise or exercise due diligence precludes a good faith defense. Id.
In support of their argument that Plaintiffs fail to establish Notari and Osborne as control person, Defendants cite language from a Ninth Circuit opinion (misidentified as a Seventh Circuit opinion) that "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 these positions." See Rosenbloom v. Adams, Scott Conway, Inc., 552 F.2d 1336, 1339 (9th Cir. 1977). While this statement is true, Defendants failed to note that Rosenbloom dealt with whether the plaintiff, a board member of the defendant company, was a corporate insider precluded from making a 10(b) claim against the corporation. The plaintiff board member submitted an affidavit to the effect that as a board member he was merely a figurehead in the company. Id. In the affidavit, he declared that he exercised no control over the operation of company's business practices, and that the company's board of directors, of which he was a member, had not met for several years. Id. Rather than making a conclusive determination on the adequacy of the pleadings alleging control person liability, the Ninth Circuit merely held that given the affidavit, there was a genuine issue of fact concerning the plaintiff's access to information. The court further noted that plaintiff bore a formidable burden of proving that, in spite of his status as a corporate insider, he nevertheless had no access to the information in dispute. Id.
Plaintiffs allege that at all relevant times Osborne was the President and COO of SSA, and that Notari became Vice President of the SSA's North American Division in October 1994. (Compl. ¶¶ 21, 22.) Unlike the other individual Defendants, neither Osborne nor Notari signed or filed any of the relevant forms with the SEC nor made any public statements regarding SSA's financial status. The allegation that Osborne was President and COO of the company nevertheless suggests that he had some power to control SSA's revenue recognition procedures and its press statements or annual reports. The Complaint need not establish whether he exercised that power. Whether Notari's role as Vice President of SSA North America supports the same conclusion is less certain. The role of a Vice President, as compared to a President or COO, varies widely among companies. Some companies, for example, have only one Vice President while others confer numerous individuals with the rank, a rank that may not carry substantial control or responsibility. Defendants offer no assistance in delineating either Osborne or Notari's duties at SSA. Therefore, construing all facts in favor of the Plaintiff, the court concludes that the allegation naming Notari as Vice President sufficiently alleges that he was a controlling person at SSA. This conclusion is buttressed by the fact that at least the O-I Contract was presumably a North American venture.
Finally, the court notes that a motion for summary judgment on the fraud allegations may yield a conclusion different from that reached here today. Although the parties failed to cite the case, the court acknowledges that the court in Advanta affirmed the dismissal of the complaint in that case on the grounds that "allegations that a securities-fraud defendant, because of his position within the company, 'must have known' a statement was false or misleading" are inadequate under the heightened pleading standards adopted by PSLRA. See In re Advanta Corp. Sec. Litig., 180 F.3d 525, 539 (3rd 1999). Advanta is distinguishable on the facts; here Plaintiffs do allege that at least some managers at SSA received notice from the Auditor about the adverse affects of the company's revenue reporting methods. On a motion for summary judgment, however, discovery should indicate which of the individual SSA officers and managers, if any, had actual knowledge of the problems with reporting revenue. The court invites the parties to pursue such a motion.
CONCLUSION
For the reasons stated above, Defendants' motion for summary judgment on res judicata grounds is denied in part and granted in part, and Defendants' motion to dismiss (Doc. No. 96-1) for failure to state a claim is denied (Doc. No. 96-1). The court expects Plaintiffs to move promptly for class certification.