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In Lemmer, this court recognized that GAAP requirements "often require the substantial application of judgment to the totality of circumstances."
Summary of this case from Schiller v. Physicians Resource Group Inc.Opinion
Civil Action No. 3:98-CV-0161-L
September 6, 2001
MEMORANDUM OPINION AND ORDER
Before the court are the following eleven motions, for which the court's ruling was delayed by the automatic bankruptcy stay pursuant to 11 U.S.C. § 362, since lifted by the court's order of February 2, 2001:
1. Defendant Nu-Kote Holding, Inc. and the Outside Directors' Motion to Dismiss, filed June 17, 1998;
2. Defendant David F. Brigante's Motion to Dismiss Complaint for Failure to State a Claim Upon Which Relief can be Granted, filed June 17, 1998;
3. Defendant Patrick E. Howard's Motion to Dismiss Complaint for Failure to State a Claim Upon Which Relief can be Granted, filed June 17, 1998;
4. Defendant Daniel M. Kerrane's Motion to Dismiss Complaint for Failure to State a Claim Upon Which Relief can be Granted, filed June 17, 1998;
5. Defendant James H. Groh' s Motion to Dismiss Complaint for Failure to State a Claim Upon Which Relief can be Granted, filed June 17, 1998;
6. Defendant John P. Rochon's Motion to Dismiss Complaint for Failure to State a Claim Upon Which Relief can be Granted, filed June 17, 1998;
7. Defendant C. Ronald Baiocchi's Motion to Dismiss Complaint for Failure to State a Claim Upon Which Relief can be Granted, filed June 17, 1998;
8. Defendant Anthony G. Schmeck's Motion to Dismiss Complaint for Failure to State a Claim Upon Which Relief can be Granted, filed June 17, 1998;
9. Lead Plaintiffs' Notice of Motion and Motion for Class Certification, filed June 22, 1998;
10. Motion to Dismiss the Complaint by Defendant Hans Paffhausen Under Rule 12(b) for Lack of Personal Jurisdiction and Failure to State a Claim Upon Which Relief can be Granted, filed July 29, 1998; and
11. Defendants' Request for Oral Argument on Defendants' Motions to Dismiss, filed October 29, 1998.
The court concludes that oral argument would not be helpful in addressing the motions to dismiss, and therefore denies Defendants' Request for Oral Argument. After careful consideration of the motions, responses, replies, evidence submitted, and the applicable law, the court, for the reasons that follow, grants all motions to dismiss by Defendants and denies as moot Plaintiffs Motion for Class Certification.
Generally the court cannot consider evidence beyond the pleadings in ruling on a Rule 12(b)(6) motion to dismiss. Defendants have submitted various papers which the court can consider in ruling on a motion to dismiss, without converting the motion into one for summary judgment. These include documents incorporated by reference in the Complaint, matters subject to judicial notice (such as filings with the SEC), stock prices, and matters of public record. Lovelace v. Software Spectrum, Inc., 78 F.3d 1015, 1017-18 (5th Cir. 1996); Davis v. Bayless, 70 F.3d 367, 371 n. 3 (5th Cir. 1995); In re CompUSA, Inc., Sec. Litig., Civ. A. No. 3:94-CV-1151-H, 1995 WL 811960, at *10 n. 14 (N.D. Tex. Oct. 30, 1995).
I. Factual and Procedural Background
On a Rule 12(b)(6) motion to dismiss, the court accepts the plaintiffs' factual allegations as true. Buckley v. Fitzsimmons, 509 U.S. 259, 261 (1993); Spivey v. Robertson, 197 F.3d 772, 774 (5th Cir. 1999), cert. denied, 530 U.S. 1229 (2000).
Nu-Kote Holding, Inc. ("Nu-Kote") developed and manufactured printing products, including both "impact" products such as typewriter ribbons and "non-impact" products such as ink-jet cartridges. As the market for impact printing products declined, Nu-Kote planned an aggressive expansion into non-impact printing. In February 1995, Nu-Kote acquired Pelikan Products ("Pelikan"), a large European seller of impact and non-impact printing products, in the largest acquisition Nu-Kote undertook, for which it issued 4.6 million shares of stock. Later in 1995, Nu-Kote purchased strategic assets of Jarfalla Industry Competence Center ("JICC"), a Swedish company with proprietary piezoelectric ink-jet technology. Plaintiff ("Lemmer") alleges that the Pelikan and JICC acquisitions were failures, but that Defendants concealed difficulties with the acquisitions and gave a false impression of future prospects for the company. In early November 1995, Nu-Kote stock reached its all-time high of $22-1/2 per share.
In July 1996, Nu-Kote disclosed that results for the second quarter of 1996 (the first quarter of Nu-Kote's fiscal year, which ran from April 1 to March 31) were below forecasted levels. The stock price fell as low as $8-7/8 per share. Lemmer alleges that Nu-Kote continued to provide false and misleading assurances and forecasts to conceal the extent of problems. On May 5, 1997, Nu-Kote announced that it incurred a huge operating loss for the first quarter of 1997 (the fourth quarter of Nu-Kote's fiscal year), due in part to large inventory writedowns. The eventual loss was $2.07 per share for the quarter and $2.28 per share for the fiscal year. Nu-Kote lost $0.69 per share for the fiscal year ending March 31, 1995, but had earned $0.58 per share for the fiscal year ending March 31, 1996. The loss for fiscal year 1997 was thus almost four times the earnings for fiscal year 1996. The price of Nu-Kote's stock collapsed to less than $1 per share.
Lemmer filed this action on January 23, 1998, on behalf of herself and a putative class consisting of all persons (with certain exclusions) who purchased or otherwise acquired Nu-Kote stock between July 28, 1995 and May 29, 1997, inclusive (the "Class Period"). The Complaint asserts claims against Nu-Kote and eleven of the directors and officers of Nu-Kote: David F. Brigante ("Brigante"), the Chairman of the Board and CEO; Patrick E. Howard ("Howard"), the Chief Operating Officer; Daniel M. Kerrane ("Kerrane"), Executive Vice President and Chief Financial Officer; Hans Paffhausen ("Paffhausen"), the Managing Director of European Operations; James H. Groh ("Groh"), Executive Vice President — Sales/Marketing; C. Ronald Baiocchi ("Baiocchi"), Senior Vice President, North American Operations; Anthony G. Schmeck ("Schmeck"), Senior Vice President — Finance and Corporate Controller; Brian D. Finn ("Finn"), an outside director and member of the Audit Committee; John P. Rochon ("Rochon"), an outside director and member of the Audit Committee; Richard C. Dresdale ("Dresdale"), an outside director and member of the Audit Committee and Executive Committee; and Hubbard C. Howe ("Howe"), an outside director and member of the Executive Committee. Lemmer asserts claims against all Defendants under § 10(b) of the Securities Exchange Act of 1934 (the "Exchange Act"), 15 U.S.C. § 78j(b), and Rule 10b-5 promulgated thereunder, 17 C.F.R. § 240.10b-5, as modified by the Private Securities Litigation Reform Act of 1995 ("PSLRA"), codified in relevant part at 15 U.S.C. § 78u-4, 78u-5. She also asserts claims against Nu-Kote and Brigante under § 20(a) of the Exchange Act, 15 U.S.C. § 78t(a). II. Applicable Legal Standards A. Standard for Motion to Dismiss
Nu-Kote is no longer a Defendant in this action. It filed a Suggestion of Bankruptcy on November 18, 1998, stating that it had filed a petition seeking relief pursuant to Chapter 11 of the United States Bankruptcy Code, resulting in an automatic stay pursuant to 11 U.S.C. § 362. In order to pursue the action, Plaintiff filed a notice of voluntary dismissal without prejudice on October 4, 1999, which was opposed by various Defendants; no action was taken by the court. A subsequent status report from the parties advised that Nu-Kote's reorganization plan, effective December 31, 2000, would permit this case to go forward once Plaintiff dismissed her claims against Nu-Kote. The court's order of February 16, 2001 dismissed the claims against Nu-Kote, pursuant to Fed.R.Civ.P. 41(a)(1)(ii), with prejudice.
A motion to dismiss for failure to state a claim under Fed.R.Civ.P. 12(b)(6) "is viewed with disfavor and is rarely granted." Lowrey v. Texas AM Univ. Sys., 117 F.3d 242, 247 (5th Cir. 1997). A district court cannot dismiss a complaint, or any part of it, for failure to state a claim upon which relief can be granted "unless it appears beyond doubt that the plaintiff can prove no set of facts in support of his claim which would entitle him to relief." Conley v. Gibson, 355 U.S. 41, 45-46 (1957); Coates v. Heartland Wireless Communications, Inc., 26 F. Supp.2d 910, 913-14 (N.D. Tex. 1998) ("Coates I"); Blackburn v. City of Marshall 42 F.3d 925, 931 (5th Cir. 1995). In reviewing a Rule 12(b)(6) motion, the court must accept all well-pleaded facts in the complaint as true and view them in the light most favorable to the plaintiff. Baker v. Putnal, 75 F.3d 190, 196 (5th Cir. 1996). In ruling on such a motion, the court cannot look beyond the pleadings. Id.; Spivey v. Robertson, 197 F.3d 772, 774 (5th Cir. 1999), cert. denied, 530 U.S. 1229 (2000). The ultimate question in a Rule 12(b)(6) motion is whether the complaint states a valid cause of action when it is viewed in the light most favorable to the plaintiff and with every doubt resolved in favor of the plaintiff. Lowrey, 117 F.3d at 247. A plaintiff, however, must plead specific facts, not mere conclusory allegations, to avoid dismissal. Robertson v. Strassner, 32 F. Supp.2d 443, 445 (S.D. Tex. 1998); Zuckerman v. Foxmeyer Health Corp., 4 F. Supp.2d 618, 621 (N.D. Tex. 1998); Guidry v. Bank of LaPlace, 954 F.2d 278, 281 (5th Cir. 1992).
B. Standard for Pleading Securities Fraud
To survive dismissal, Plaintiffs must have alleged facts that show they are entitled to relief on their substantive cause of action. Plaintiffs assert a claim pursuant to Section 10(b) of the Securities Exchange Act, 15 U.S.C. § 78j, as amended by the PSLRA. Section 10(b) of the Exchange Act makes it unlawful for a person to:
use or employ, in connection with the purchase or sale of any security . . . any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the [Securities and Exchange] Commission may prescribe as necessary or appropriate in the public interest or for the protection of investors.15 U.S.C. § 78j(b). In relevant part, Rule 10b-5 makes it unlawful for any person, directly or indirectly, to:
make any untrue statement of material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading . . . in connection with the purchase or sale of any security.17 C.F.R. § 240.10b-5. To state a claim for securities fraud in violation of section 10(b) and Rule 10b-5, a plaintiff must allege (1) a misrepresentation or omission; (2) of a material fact; (3) made with the intent to defraud; (4) on which the plaintiff relied; and (5) which proximately caused the plaintiff's injury. Williams v. WMX Technologies, Inc., 112 F.3d 175, 177 (5th Cir. 1997); Tuchman v. DSC Communications Corp., 14 F.3d 1061, 1067 (5th Cir. 1994); Cyrak v. Lemon, 919 F.2d 320, 325 (5th Cir. 1990). In cases such as this, where a plaintiff alleges a "fraud on the market" theory, it is not necessary for the plaintiff to prove individual reliance on the false or misleading statement. In re Apple Computer Sec. Litig., 886 F.2d 1109, 1112-14 (9th Cir. 1989), cert. denied, 496 U.S. 943 (1990); Coates /, 26 F. Supp.2d at 914 n. 1; Zuckerman, 4 F. Supp.2d at 621. Instead, a plaintiff may show that he indirectly relied on the statements by relying on the integrity of the market price of the stock. Id. C. Rule 9(b) Requirements
Because section 10(b) claims are fraud claims, the plaintiff must also satisfy the pleading requirements imposed by Fed.R.Civ.P. 9(b). Melder v. Morris, 27 F.3d 1097, 1100 (5th Cir. 1994); Tuchman, 14 F.3d at 1067. Rule 9(b) requires certain minimum allegations in a securities fraud case, namely, the specific time, place, and contents of the false representations, along with the identity of the person making the false representation and what the person obtained thereby. Melder, 27 F.3d at 1100; Shushany v. Allwaste, Inc., 992 F.2d 517, 521 (5th Cir. 1993). This application of the heightened pleading standard of Rule 9(b) provides defendants with fair notice of the plaintiffs' claims, protects them from harm to their reputation and goodwill, reduces the number of strike suits, and prevents plaintiffs from filing baseless claims and then attempting to discover unknown wrongs. Melder, 27 F.3d at 1100; Tuchman, 14 F.3d at 1067.
D. Requirements of the PSLRA
The PSLRA has further reinforced this particularity requirement with respect to pleading securities fraud claims. Coates I, 26 F. Supp.2d at 914. The PSLRA provides that
the complaint shall 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, the complaint shall state with particularity all facts on which that belief is formed.15 U.S.C. § 78u-4(b)(1). A plaintiff alleging securities fraud must, therefore, not only allege the time, place, identity of the speaker, and content of the alleged misrepresentation, but also explain why the challenged statement or omission is false or misleading. Williams, 112 F.3d at 179. To satisfy Rule 9(b) and the PSLRA, a plaintiff must plead facts and avoid reliance on conclusory allegations. Tuchman, 14 F.3d at 1067; Coates I, 26 F. Supp.2d at 915.
The PSLRA also provides a "safe harbor" for forward-looking statements, which provides, with certain exceptions not relevant here, that
in any private action arising under this chapter that is based on an untrue statement of a material fact or omission of a material fact necessary to make the statement not misleading, a person . . . shall not be liable with respect to any forward-looking statement, whether written or oral, if and to the extent that . . . the plaintiff fails to prove that the forward-looking statement — (i) if made by a natural person, was made with actual knowledge by that person that the statement was false or misleading; or
(ii) if made by a business entity was —
(I) made by or with the approval of an executive officer of that entity; and
(II) made or approved by such officer with actual knowledge by that officer that the statement was false or misleading.15 U.S.C. § 78u-5(c)(1)(B) (emphasis added).
E. Scienter Requirement
In addition to the aforementioned pleading requirements, plaintiffs asserting securities fraud claims must allege facts demonstrating scienter. Lovelace v. Software Spectrum, Inc., 78 F.3d 1015, 1018 (5th Cir. 1996); Tuchman, 14 F.3d at 1068; Zuckerman, 4 F. Supp.2d at 622. Scienter is "a mental state embracing intent to deceive, manipulate, or defraud." Ernst Ernst v. Hochfelder, 425 U.S. 185, 193 n. 12 (1976); Lovelace, 78 F.3d at 1018. To adequately plead scienter, the plaintiff must set forth specific facts to support an inference of fraud. Lovelace, 78 F.3d at 1018; Tuchman, 14 F.3d at 1068. The PSLRA requires that "the complaint shall, with respect to each act or omission alleged to violate this chapter, 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). When a complaint fails to plead scienter in conformity with the PSLRA, dismissal is required. 15 U.S.C. § 78u-4(b)(3)(A); Coates v. Heartland Wireless Communications, Inc., 55 F. Supp.2d 628, 634 (N.D. Tex. 1999) ("Coates II"). A plaintiff may plead scienter by alleging facts to show that a defendant had both motive and opportunity to commit fraud, Branca v. Paymentech, Inc., No. Civ. A. 3:97-CV-2507-L, 2000 WL 145083, at *5 (N.D. Tex. Feb. 8, 2000), or by pleading facts which identity circumstances indicating Defendants' conscious or reckless behavior, so long as the totality of the allegations raises a strong inference of fraudulent intent. Zuckerman, 4 F. Supp.2d at 623; Robertson, 32 F. Supp.2d at 447.
III. Analysis
The § 10(b) and Rule 10b-5 claims are based upon: 1) financial statements that allegedly were not prepared in accordance with generally accepted accounting principles ("GAAP"); and 2) various statements by Defendants, or by analysts based on statements made by Defendants. The first category consists of alleged violations of GAAP relating to capitalization of costs associated with the development of piezoelectric ink jet print heads and failure to write down inventory values as sales problems developed. Complaint ¶ 72. Based on its careful examination of the Complaint, the court concludes that the second category consists of statements by Defendants and analysts which were either historical information for which (with the exception of alleged violations of GAAP) the accuracy is not contested; general optimistic statements essentially equivalent to puffery or vague evaluations of the business; or forward-looking predictions, projections, and estimates. Predictive statements are not "facts" which are "false" when made merely because the prediction turned out to be wrong, but such statements contain "at least three factual assertions that may be actionable: 1) The speaker genuinely believes the statement is accurate; 2) there is a reasonable basis for that belief; and 3) the speaker is unaware of any undisclosed facts that would tend seriously to undermine the accuracy of the statement." Rubinstein v. Collins, 20 F.3d 160, 166 (5th Cir. 1994). This is essentially the effect of the subsequently enacted PSLRA "safe harbor" for forward-looking statements, 15 U.S.C. § 78u-5(c)(1)(B), which requires a plaintiff to show that a defendant had actual knowledge of the omitted facts which would demonstrate that the predictive statement was not reasonable when made.
Such statements are not statements of material fact sufficient for a securities fraud claim, because reasonable investors (and the market in general) do not rely on them. See Raab v. General Physics Corp., 4 F.3d 286, 289 (4th Cir. 1993).
Lemmer contends that the alleged predictive statements and optimistic forecasts are misstatements of material fact because they omitted certain information which made the achievement of the forecasts unlikely and demonstrated that Defendants had no reasonable basis for believing the statements to be accurate. Complaint ¶¶ 9, 38, 50, 54, 62, 66, 70. That is, she bases her claims on omissions of material fact which Nu-Kote was required to communicate because they conflicted with Nu-Kote's vague statements about current operations and predictions about future results. Accordingly, the omissions of material fact on which the Complaint is based are subject to the "safe harbor" for forward-looking statements.
Defendants assert several reasons for dismissal of these claims, including inter alia that the complaint fails to: 1) adequately allege facts demonstrating scienter; 2) plead with particularity the facts upon which Lemmer's "information and belief" allegations are based; 3) allege fraudulent statements by Defendants other than Nu-Kote, Brigante, and Kerrane; 4) plead facts showing Defendants' actual knowledge that forward-looking statements were misleading; and 5) adequately plead the existence of false and misleading financial statements. Paffhausen, a German citizen and Swiss resident, asserts as an additional basis for dismissing the claim against him that his contacts with Texas were insufficient to establish personal jurisdiction. Finally, Defendants assert that the § 20(a) claim must be dismissed because it is derivative of the § 10(b) and Rule 10b-5 claim against Nu-Kote, which they contend must be dismissed for the reasons noted above.
A. Particularity, Facts Based on "Information and Belief or Concerning Defendants' State of Mind
Because it affects several of Defendants' arguments, the court first examines the PSLRA requirement concerning allegations based on information and belief. If allegations regarding an alleged misstatement or omission are based on information and belief, the plaintiff must "state with particularity all facts on which that belief is formed." 15 U.S.C. § 78u-4(b)(1). Defendants argue that Plaintiff has failed to state with particularity all facts upon which her information and belief as to certain allegations is based, and that therefore the court should dismiss Plaintiffs' Complaint pursuant to 15 U.S.C. § 78u-4(b)(3)(A).
The Complaint specifies the investigation of counsel, relying on a variety of sources, as the basis of Lemmer's allegations:
Because the PSLRA, § 21D(c) of the Exchange Act [ 15 U.S.C. § 78u-4(c)], requires complaints to be pleaded in conformance with Federal Rule of Civil Procedure 11, plaintiff has alleged the foregoing based upon the investigation of his [sic] counsel, which included a review of Nu-kote's SEC filings, securities analysts' reports and advisories about the Company, press releases issued by the Company, media reports about the Company, private investigations, and discussions with consultants, and, pursuant to Rule 11(b)(3), believes that after reasonable opportunity for discovery, substantial evidentiary support will likely exist for the allegations set forth herein.
Complaint ¶ 102. The court considers allegations based on "investigation of counsel" to be the equivalent, for purposes of the PSLRA, of allegations based on "information and belief." Branca, 2000 WL 145083, at *6; see also In re Silicon Graphics, Inc. Sec. Litig., 183 F.3d 970, 998 n. 21 (9th Cir. 1999) (Browning, J., concurring in part and dissenting in part) (plaintiff "relies on these sources precisely because she does not have direct personal knowledge of the defendants' alleged misconduct. Her complaint is therefore pled on information and belief"). The Complaint is thus subject to the requirements presented by the PSLRA, specifically § 78u-4(b)(1), which requires that all facts supporting information and belief allegations be stated with particularity.
The court concludes that, in several respects as noted below, Lemmer misconstrues this requirement. It is not sufficient to simply allege certain facts that support a final conclusion, when those "facts" themselves are conclusory; the PSLRA is satisfied only by facts, not conclusory allegations. Without descending too far into epistemological confusion, the court concludes that at least in rough terms there is a distinction between facts (objective and verifiable, or clearly warranted deductions from other facts) and conclusions (subjective and based on opinion, including deductions that may not be generally accepted). See Silicon Graphics, 183 F.3d at 984-85 (plaintiff must plead the relevant events and circumstances, in detail and specificity, with "adequate corroborating details" as appropriate). When the supporting "facts" are too general or subjective — for example, that "Nu-kote lacked the management personnel and management information systems and controls necessary to permit it to integrate the large number of acquisitions it had made," "Nu-kote's piezoelectric non-impact ink jet printer head technology was seriously flawed," and "many of Nu-kote's manufacturing facilities, both in Europe and in the U.S., were not state-of-the-art facilities," Complaint ¶ 9 — they constitute conclusions which require plaintiffs to state supporting facts.
The court concludes that it is also appropriate to require additional detail and particularity where it is not facially credible that the "facts" would have been presented as such in the sources from which they were purportedly obtained. In such situations, absent additional supporting detail, the most reasonable conclusion is that the "facts" are really conclusions drawn by a plaintiff (but not necessarily by other reasonable observers) from the actual information typically found in such a source. In such situations, the court concludes that the PSLRA requires a plaintiff to point to the actual information in the source, to enable the court to evaluate whether that information is enough to support a reasonable belief in the "facts" presented by the plaintiff. See Silicon Graphics, 183 F.3d at 984-85. "[M]ere boilerplate pleadings will rarely, if ever, . . . satisfy the PSLRA's particularity requirement." Id. at 985.
A particular application of the foregoing concerns allegations about a defendant's state of mind. A defendant's intent or knowledge is rarely directly addressed in the sources of information on which plaintiffs in securities class action lawsuits typically rely. The PSLRA specifically requires a plaintiff to "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). The court concludes that this requirement applies to the "actual knowledge" required for a forward-looking statement, id. § 78u-5(c)(1)(B), as well as scienter allegations that a defendant "acted with intentionality or deliberate recklessness," Ronconi v. Larkin, 253 F.3d 423, 429 (9th Cir. 2001).
B. Allegations Concerning Involvement of Individual Defendants
The Complaint repeatedly alleges that misrepresentations were made by Nu-Kote or Defendants collectively. The only individual Defendants to whom specific representations are attributed are Brigante and Kerrane. Complaint ¶¶ 25, 30-32, 34-37, 40-44, 46-49, 51, 58-61, 64-65, and 68-69. There are no alleged representations attributed to Howard, Paffhausen, Groh, Baiocchi, Schmeck, Finn, Rochon, Dresdale or Howe. The Complaint therefore does not meet the particularity requirements of Rule 9(b) and the PSLRA with respect to the claims against these nine Defendants.
Lemmer makes two arguments that the Complaint's allegations are sufficient with respect to these Defendants: that representations by Nu-Kote can be attributed to them, as senior members of management, under the "group pleading doctrine"; and that representations by Nu-Kote, Brigante and Kerrane can be attributed to the other Defendants because the representations were issued as part of a scheme to defraud. The court finds neither argument persuasive.
The group pleading doctrine is inconsistent with the particularity requirements of PSLRA and therefore no longer is a viable means of pleading securities fraud. Coates I, 26 F. Supp.2d at 915; Branca, 2000 WL 145083, at *8. Lemmer cites Zuckerman to the contrary, but the court finds the arguments in Coates I and Branca more persuasive, including the discussion in Coates I concerning why Zuckerman is not persuasive.
For the "scheme to defraud" argument, Lemmer relies on Cooper v. Pickett, 137 F.3d 616 (9th Cir. 1997), which held that participants in a scheme to defraud can be held liable for violations of § 10(b) and Rule 10b-5. Id. at 624-25. This argument is disingenuous at best. Cooper addressed the distinction between aiding and abetting liability, prohibited for securities fraud in Central Bank of Denver v. First Interstate Bank of Denver, 511 U.S.I 64 (1994), and direct liability. Significantly, Cooper held that "Central Bank does not preclude liability based on allegations that a group of defendants acted together to violate the securities laws, as long as each defendant committed a manipulative or deceptive act in furtherance of the scheme" Cooper, 137 F.3d at 624 (emphasis added). In that case, the complaint alleged specific misleading statements (to analysts) by the defendant in question. Id. Lemmer makes no allegations of acts specifically attributed to Defendants other than Brigante and Kerrane. Her only allegations as to the scheme to defraud are vague, general, and unsupported by specific details that might support a strong inference of such a scheme.
Each of the defendants actually knew the allegedly false statements about Nu-kote's business and future prospects were false and misleading when made. Each of the defendants is liable as a participant in a fraudulent scheme and course of business that operated as a fraud or deceit on purchasers of Nu-kote stock, including false and misleading statements and/or concealed material, adverse facts. The fraudulent scheme and course of business: (a) deceived the investing public regarding Nu-kote's products and business; (b) deceived the commercial markets regarding Nu-kote's success in integrating the Pelikan acquisition and developing new products; (c) created false financial results during the 4thQ of FY96 and the first three quarters of FY97; and (d) caused plaintiff and other members of the Class to purchase Nu-kote stock at inflated prices.
Complaint ¶ 24. Allowing such general, unsupported allegations of a fraudulent scheme, without any details that support a strong inference of such a scheme such as acts of participation by each of the Defendants, would vitiate the particularity requirements of the PSLRA. This approach is precluded for the same reasons that the group pleading doctrine is precluded.
Because Lemmer has failed to allege specific misrepresentations by individual Defendants other than Brigante and Kerrane, the court concludes that she has failed to satisfy the heightened pleading standards required by Rule 9(b) and the PSLRA with respect to those Defendants. Accordingly, Defendants Howard, Paffhausen, Groh, Baiocchi, Schmeck, Finn, Rochon, Dresdale and Howe are entitled to dismissal of the § 10(b) and Rule 10b-5 claims against them. 15 U.S.C. § 78u-4(b)(3)(A).
C. Allegations Concerning Misrepresentations
As noted above, the alleged misrepresentations on which Lemmer relies fall into two categories: omissions of material facts that would undermine the basis for and preclude a reasonable belief in the forward-looking predictions, forecasts and estimates; and violations of GAAP in Nu-Kote's financial statements with respect to capitalization of costs associated with the development of piezoelectric ink jet print heads and failure to write down inventory values timely. The court concludes that neither category is sufficient, because of the PSLRA requirements that "if an allegation regarding the statement or omission is made on information and belief, the complaint shall state with particularity all facts on which that belief is formed," and that the 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)(1), (2).
As noted above, the court concludes that the first category of alleged misrepresentations — omissions of material facts that would undermine the basis for and preclude a reasonable belief in the forward-looking predictions, forecasts and estimates — are subject to the PSLRA "safe harbor" for forward-looking statements. Accordingly, claims based on these alleged misrepresentations cannot prevail unless Lemmer can demonstrate actual knowledge of the facts alleged omitted. Because the Defendants' actual knowledge is at issue, these claims are also subject to the PSLRA requirement that the 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); see Ronconi, 253 F.3d at 429. Lemmer fails to do so. The Complaint contains only conclusory allegations that Defendants knew the information allegedly omitted. See, e.g., Complaint ¶ 18 ("Because of their positions and access to material non-public information available to them but not to the public, each of these defendants knew that the adverse facts specified herein had not been disclosed to and were being concealed from the public and that the positive representations which were being made were then materially false and misleading."), id. ¶ 24 ("Each of the defendants actually knew the allegedly false statements about Nu-kote's business and future prospects were false and misleading when made."). These conclusory allegations are simply insufficient, and do not meet the particularity requirement of 15 U.S.C. § 78u-4(b)(2).
The accounting requirements which Lemmer references implicate judgment in the application of standards, rather than a mere mechanical application of clear-cut rules. The court notes, for example, the following guidance as to these specific issues in authoritative sources of GAAP. As to costs associated with the development of piezoelectric ink jet print heads, the accountant must first identify the type of activities being performed, as some activities "typically would be included in research and development," Financial Accounting Standards Board ("FASB") Statement of Financial Accounting Standards ("FAS") No. 2, ¶ 9 (emphasis added), while other activities "typically would be excluded from research and development," id. ¶ 10 (emphasis added). Even those costs identified with research and development activities (including materials, equipment, facilities, and intangibles purchased from others) may be capitalized as intangible assets rather than immediately expensed if they "have alternative future uses (in research and development projects or otherwise)." Id. ¶ 11. As to the application of the "lower of cost or market" principle for inventories, "judgment must always be exercised and no loss should be recognized unless the evidence indicates clearly that a loss has been sustained. There are therefore exceptions to such a standard." Committee on Accounting Procedure, American Institute of Certified Public Accountants ("AICPA"), Accounting Research Bulletin No. 43, ch. 4, ¶ 9. "Furthermore, where the evidence indicates that cost will be recovered with an approximately normal profit upon sale in the ordinary course of business, no loss should be recognized even though replacement or reproduction costs are lower." Id. Thus, if the decline in market price below cost appears to be only temporary, the inventory need not be written down.
Based on the foregoing, the GAAP requirements upon which Lemmer relies appear often to require the substantial application of judgment to the totality of the circumstances. The court therefore concludes that the "proper" treatment of the items referred to in the Complaint is in reality a conclusion rather than a fact. Because Lemmer's allegations of GAAP violations are made on information and belief, she therefore must "state with particularity all facts on which that belief is formed," 15 U.S.C. § 78u-4(b)(1) (emphasis added), to permit an evaluation of whether that information is enough to support a reasonable belief in her conclusion. She has failed to do so. The court notes that the Complaint alleges subsequent write-offs of inventory and capitalized costs associated with piezoelectric products, see Complaint ¶ 82, but that is insufficient basis to conclude that those amounts should have been expensed or written off earlier. Circumstances change. That circumstances may have dictated a write off at one date has little if any probative value in determining whether circumstances at an earlier date would also have dictated a write off.
Cf. Thor Power Tool Co. v. Commissioner, () ("Accountants long have recognized that `generally accepted accounting principles' are far from being a canonical set of rules that will ensure identical accounting treatment of identical transactions. `Generally accepted accounting principles,' rather, tolerate a range of `reasonable' treatments. . . .").
Indeed, the relevant allegation in the Complaint concerning capitalization of research and development costs is that "Nu-kote deferred (capitalized as an asset rather than expensing as incurred) the following amount of piezoelectric-related costs during the Class Period." Complaint ¶ 78. This statement does not even clearly allege that the "piezoelectric-related costs" were for research and development; Defendants assert that these costs are startup manufacturing costs instead. Lemmer's response in her brief is that the actual nature of the costs — research and development or startup manufacturing — is properly addressed at trial. This ignores the requirement that she plead, at this point, specific facts from which the court can evaluate whether that information is enough to support a reasonable belief in the allegations of violations of GAAP.
Lemmer has failed to allege with particularity facts: 1) giving rise to a strong inference of Defendants' actual knowledge of the alleged omissions; and 2) supporting her conclusion, based on information and belief, that Nu-Kote's financial statements violated GAAP. The court concludes that she has failed to meet the PSLRA pleading standards concerning her allegations of misrepresentations or omissions of material facts. 15 U.S.C. § 78u-4(b)(1),(2). Accordingly, all Defendants are entitled to dismissal of the § 10(b) and Rule 10b-5 claims against them. 15 U.S.C. § 78u-4(b)(3)(A).
D. Allegations of Scienter
To adequately plead scienter, the plaintiff must set forth specific facts to support an inference of fraud. Lovelace, 78 F.3d at 1018; Tuchman, 14 F.3d at 1068. The PSLRA requires that "the complaint shall, with respect to each act or omission alleged to violate this chapter, 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). A plaintiff may plead scienter by alleging facts to show that a defendant had both motive and opportunity to commit fraud, Branca, 2000 WL 145083, at *5, or by pleading facts which identify circumstances indicating Defendants' conscious or reckless behavior, so long as the totality of the allegations raises a strong inference of fraudulent intent. Zuckerman, 4 F. Supp.2d at 623; Robertson, 32 F. Supp.2d at 447. The Complaint alleges scienter under both the motive and opportunity test and the conscious and reckless behavior test.
Lemmer identifies three motives for Defendants to have engaged in securities fraud: 1) their compensation through bonuses and stock options; 2) concealment of their alleged mismanagement; and 3) the ability to execute Nu-Kote's acquisition strategy without diluting earnings by making acquisitions with stock at artificially high prices. None is persuasive. The first two are clearly insufficient, as they are general allegations that could be made about virtually any large public corporation. Allowing general allegations common to most corporations to meet the PSLRA requirement that "the complaint shall, with respect to each act or omission alleged to violate this chapter, 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) (emphasis added), would render the requirement meaningless. By virtue of their widespread and common application to most corporations, such alleged motives would allow, at best, a weak inference that does not satisfy the PSLRA requirement.
The parties address "opportunity" only in passing, and there appears to be no genuine dispute concerning the opportunity for senior executives of a company to issue misrepresentations and manipulate the stock price. The court therefore assumes without deciding that the "opportunity" part of the test has been satisfied.
In a letter to the court dated March 15, 1999, Plaintiff's counsel argued for a lenient interpretation of the scienter requirement, citing Press v. Chemical Inv. Servs. Corp., 166 F.3d 529 (2d Cir. 1999). Press allowed a minimal pleading of scienter for failure to disclose standard delays in remitting funds from a Treasury bill at maturity, based on a motive of retaining the proceeds to "have the `float' or use of the funds." Id. at 538. The court agrees that this was a minimal showing, but notes that Press also indicates, in justifying the decision, that "we are not inclined to create a nearly impossible pleading standard when the `intent' of a corporation is at issue" and that a stricter standard "would make virtually impossible a plaintiff's ability to plead scienter in a financial transaction involving a corporation, institution, bank or the like that did not involve specifically greedy comments from an authorized corporate individual." Id.(emphases added). Because this case requires a determination of the intent of individuals and also involves specific alleged misrepresentations by those individuals, Press is inapposite.
The alleged motive based on the use of stock in acquisitions concerns corporate behavior that is nearly as common as providing incentive compensation to senior executives. Many corporations have generalized, non-specific interests in acquisitions, and use their own stock in making such acquisitions; thus, they would share the motive attributed to Defendants. The allegation of such a general motive, without specific supporting details taking it beyond the routine, simply is insufficient to give rise to the required strong inference of scienter. The court assumes arguendo that motive would be adequately alleged by describing specific planned acquisitions using stock, for which the amount of stock to be issued was tied to stock price and the timing of which was closely related to the alleged misrepresentations, or at least specific attempted acquisitions which had progressed to the point of determining the compensation to be paid. The court need not decide that, however, as Lemmer has alleged nothing beyond a general "acquisition by stock" strategy, based on vague, general statements by Nu-Kote. The court concludes that this alleged motive is also insufficient to establish a strong inference of scienter.
The Complaint alleges only one acquisition using Nu-Kote stock during the Class Period, that of JICC, and that occurred on July 31, 1995, just a few days into the period. Various Defendants' Appendix, Tab 8 p. F-10 (Nu-Kote's Form 10-K for fiscal year ended March 31, 1996, Notes to Consolidated Financial Statements). Defendants contest even that allegation, pointing out that Nu-Kote's Form 10-K indicates that stock was not used for the JICC acquisition. Id. (describing consideration for the Pelikan acquisition as including stock but indicating only monetary consideration for the JICC acquisition); id. p. F-6 (audited Consolidated Statements of Changes in Shareholders' Equity, indicating no issuance of stock during the fiscal year from April 1, 1995 through March 31, 1996). Even assuming arguendo that the JICC acquisition did use Nu-Kote stock, the court takes judicial notice that the lead time for acquisitions using stock typically precludes last-minute adjustments to the amount of stock to be issued. The court concludes that an acquisition on July 31, 1995, that may or may not have used Nu-Kote stock, does not constitute a credible motive for an alleged scheme to defraud extending from July 28, 1995 to May 29, 1997.
As to conscious and reckless behavior, Lemmer points to the allegation that Defendants "were Nu-Kote's top officers and directors whose functions required them to be informed about the Company's business condition and its financial results," Plaintiff's Brief at 21, and allegations that Defendants knew the representations and financial statements were false when they were issued, see, e.g., Complaint ¶¶ 18, 24. This type of conclusory allegation "fails to provide the specific facts upon which an inference of conscious behavior may be based." Melder, 27 F.3d at 1102. Here, Lemmer has pleaded no facts indicating that at the time the allegedly false statements were made, Defendants had actual knowledge of contradictory facts, and thus the Complaint does not state a claim for securities fraud. See Tuchman, 14 F.3d at 1069; Coates I, 26 F. Supp.2d at 920. Similarly, rote and conclusory allegations of recklessness do not support an inference of intent to defraud. Melder, 27 F.3d at 1103-04; Coates II, 55 F. Supp.2d at 641.
Lemmer's allegations, whether considered individually or collectively, do not raise a strong inference of fraudulent intent and therefore do not adequately plead scienter. 15 U.S.C. § 78u-4(b)(2); Zuckerman, 4 F. Supp.2d at 623; Robertson, 32 F. Supp.2d at 447. Accordingly, all Defendants are entitled to dismissal of the § 10(b) and Rule 10b-5 claims against them. 15 U.S.C. § 78u-4(b)(3)(A).
E. Section 20(a) Claim
The § 20(a) claim against Brigante is derivative of the § 10(b) and Rule 10b-5 claim against Nu-Kote. Section 20(a) provides that
The Complaint asserts a § 20(a) claim against both Brigante and Nu-Kote, but § 20(a) only establishes liability against the controlling person. This liability is joint and several with the liability of the controlled person, but the liability of the controlled person is not established by § 20(a) itself. The court therefore construes this claim as only asserted against Brigante.
[e]very person who, directly or indirectly, controls any person liable under any provision of this chapter or of any rule or regulation thereunder shall also be liable jointly and severally with and to the same extent as such controlled person to any person to whom such controlled person is liable, unless the controlling person acted in good faith and did not directly or indirectly induce the act or acts constituting the violation or cause of action.15 U.S.C. § 78t(a). "To warrant a finding of liability under § 20(a) a plaintiff must show that the defendant controls a person upon whom liability could be imposed for a violation of the Securities Exchange Act." Paul F. Newton Co. v. Texas Commerce Bank, 630 F.2d 1111, 1119 (5th Cir. 1980). Lemmer contends that Brigante is a controlling person of Nu-Kote by reasons of his position as a director and officer and his substantial stock ownership, and asserts liability against Brigante under § 20(a), derivative of Nu-Kote's liability under § 10(b) and Rule 10b-5.
Arguably, a § 20(a) claim cannot be asserted against a defendant who is also charged with primary violation of § 10(b) and Rule 10b-5; that is, secondary liability under § 20(a) is an alternative, not a supplement, to primary liability under § 10(b) and Rule 10b-5. See Kalnit v. Eichler, 85 F. Supp.2d 232, 246 (S.D.N.Y. 1999). Because Lemmer asserts a claim against Brigante under § 10(b) and Rule 10b-5, this would preclude a § 20(a) claim against him. The court need not decide the issue, however, as the § 20(a) claim would fail anyway. It cannot succeed without a finding that Nu-Kote is liable. Even if such were not precluded by Lemmer's voluntary dismissal of Nu-Kote, any claim against Nu-Kote under § 10(b) and Rule 10b-5 fails for the reasons noted above, concerning the PSLRA particularity requirements and inadequate allegations of scienter. Accordingly, Brigante is entitled to dismissal of the § 20(a) claim against him.
IV. Conclusion
Because all of the claims pleaded by Lemmer are defective for the reasons noted above, the court need not consider other reasons for dismissal advanced by Defendants. In light of the court's ruling, the question arises whether Lemmer should be allowed to amend, as she requested in the event that the court determined the Complaint was insufficient. The decision to allow amendment of pleadings is within the sound discretion of the court. Norman v. Apache Corp., 19 F.3d 1017, 1021 (5th Cir. 1994). In determining whether to allow an amendment of the pleadings, the court considers the following: undue delay in the proceedings, undue prejudice to the opposing parties, timeliness of the amendment, and futility of the amendment. See Foman v. Davis, 371 U.S. 178, 182 (1962); Chitimacha Tribe of Louisiana v. Harry L. Laws Co., Inc., 690 F.2d 1157, 1163 (5th Cir. 1982).
The court concludes that allowing Lemmer to replead is inappropriate for three reasons. First, there are multiple deficiencies with the Complaint. Claims against all Defendants are subject to dismissal for failure to satisfy the PSLRA particularity requirements (facts supporting allegations based on information and belief or concerning Defendants' state of mind) and failure to adequately plead scienter. Claims against all Defendants other than Brigante and Kerrane are further subject to dismissal for failure to plead specific misrepresentations, or manipulative or deceptive acts, by those Defendants. Further grounds for dismissal might well exist in Defendants' arguments that the court did not address. The extent of the deficiencies in the Complaint is a strong indication that amendment would be futile.
Second, Plaintiff's counsel has substantial experience in securities litigation and is well aware of the relevant pleading requirements, as evidenced by several cases cited by Defendants in which complaints by Plaintiff's counsel were dismissed for some of the same deficiencies as noted here. See, e.g., In re Secure Computing Corp. Sec. Litig., 120 F. Supp.2d 810 (N.D. Cal. 2000); Havenick v. Network Express, Inc., 981 F. Supp. 480 (E.D. Mich. 1997); Zeid v. Kimberley, 973 F. Supp. 910 (N.D. Cal. 1997), vacated, 201 F.3d 446 (9th Cir. 1999). The Complaint also alleges a thorough investigation before filing suit. Complaint ¶ 102. This experience, familiarity with the pleading requirements, and extent of investigation leads the court to conclude that the Complaint represents Lemmer's best case. See Jacquez v. Procunier, 801 F.2d 789, 792-93 (5th Cir. 1986) ("At some point a court must decide that a plaintiff has had fair opportunity to make his case; if, after that time, a cause of action has not been established, the court should finally dismiss the suit."); Morrison v. City of Baton Rouge, 761 F.2d 242, 246 (5th Cir. 1985) ("We can assume, therefore, that the specific allegations of the amended complaint constitute the plaintiffs' best case. . . .").
On remand, the district court again dismissed the complaint, and was affirmed on appeal. Zeid v. Kimberley, 2001 WL 357526 (9th Cir. April 9, 2001) (unpublished).
Finally, the court notes that, although Lemmer requests that she be allowed to amend her Complaint, she has not identified how she proposes to improve the Complaint so as to cure the defects identified above. She also did not file a motion to amend the Complaint after Defendants filed their motions to dismiss. Her response brief was filed more than two months after the motions to dismiss, and another three months went by before Nu-Kote filed its Suggestion of Bankruptcy. Still more time has elapsed since the stay of this action was lifted. Despite a lengthy opportunity, Lemmer has taken no action to identify to the court any proposed changes that would cure the Complaint's deficiencies.
In a letter to the court dated March 15, 1999, Plaintiff's counsel argued that the automatic bankruptcy stay did not stay proceedings as to the individual Defendants, implying that Lemmer's opportunity to amend the Complaint did not end even when the Suggestion of Bankruptcy was filed five months after the motions to dismiss.
For all of these reasons, the court concludes that Lemmer has already stated her best case and amendment would be futile. The court therefore denies her request to be allowed to amend the Complaint. Accordingly, all nine of the pending motions to dismiss are granted and this action is hereby dismissed with prejudice in its entirety. As a result, Lemmer's Motion for Class Certification is denied as moot. Judgment will issue by separate document, as required by Fed.R.Civ.P. 58.
It is so ordered.