In Re American Bank Note Holographics, Inc. Securities Litigation
Two putative plaintiff classes bring these consolidated actions against American Banknote Corporation (“ABN”), American Bank Note Holographies, Inc. (“Holographies”), their auditors, the underwriters of Holographies’ public offering, and several former officers of both corporations, for claims arising under Sections 11, 12(a) and 15 of the Securities Act of 1933 (“Securities Act”), 15 U.S.C. §§ 77(k), 77(i) and 77(o); and Section 10(b) and 20(a) of the Securities Exchange Act of 1934 (“Exchange Act”), 15 U.S.C. §§ 78j(b) and 78t(a), and Rule 10b-5 promulgated thereunder by the Securities and Exchange Commission (“SEC”), 17 C.F.R. § 240.10b-5. Defendants Holographies, ABN, the Underwriters and individual defendants Weissman and Macchiarulo, move separately to dismiss all claims against them in the consolidated Holographies’ Complaints pursuant to Rules 9(b) and 12(b)(6) of the Federal .Rules of Civil Procedure, and the Private Securities Litigation Reform Act of 1995 (“PSLRA”), 15 U.S.C. § 78U-4. 1 ABN and individual defendants Weissman, Gentile and Gorman move to dismiss the ABN Complaint pursuant to Rules 9(b), 12(b)(6) and the PSLRA.
For the reasons stated below, Plaintiffs’ claim against ABN under Section 11 of the Securities Act is dismissed. All other motions to dismiss the Holographies Complaint are denied. The motions to dismiss the ABN Complaint are also denied.
A. Class Plaintiffs
Plaintiffs in the consolidated action consist of two putative classes. The Holo-graphies Plaintiffs were investors who purchased common stock issued by American Bank Note Holographies in connection with the Company’s initial public offering (“IPO”) on July 15, 1998, and/or in the open market. during the period July 15, 1998 through February 1, 1999. The ABN Plaintiffs were shareholders of ABN who purchased shares in ABN during the period from May 2, 1996 through January 25, 1999.
The Holographies Plaintiffs have moved separately for class certification under Fed.R.Civ.P. 23(a) and 23(b)(3). Prior to imposition of the automatic stay, the Court had received no motion for class certification from the ABN Plaintiffs.
B. Defendants
American Banknote Corporation (“ABN”) is a Delaware holding company with subsidiaries in the United States and other countries. It conducts business in diverse fields, including transaction cards, which includes the production of stored value cards and so-called “smart cards”; transaction processing, which involves the servicing of third-party credit, debt, automated teller machines, and electronic benefit transactions, as well as loyalty and university card programs; and security printing, which involves the printing of, among other items, checks, money orders, passports, foreign currency, and stock and bond certificates.
American Bank Note Holographies (“Holographies”) was a wholly-owned subsidiary of ABN, whose primary business was, and continues to be, the production of holographic materials for use in security printing. Holographies commenced an initial public offering on or around July 15, 1998. Subsequent to the IPO, ABN and Holographies continued their operations as separate entities.
Morris Weissman was the founder of ABN. He was at all relevant times the Chairman and CEO of both Holographies and ABN, although he resigned from Ho-lographies on April 9, 1999. He continues to serve as Chairman and CEO of ABN. Joshua C. Cantor was at all relevant times President of Holographies. Richard P. Macchiarulo was at all relevant times Vice President of Finance, Chief Financial Officer, and Chief Accounting Officer of Holo-graphies. Patrick J. Gentile was at all relevant times Vice President and Corporate Comptroller of ABN. John T. Gorman has been Executive Vice President and Chief Financial Officer of ABN since 1990.
Deloitte & Touche, LLP (“Deloitte”) served as Holographies’ independent public accountant prior to, during and subsequent to the IPO, and was retained by the Audit Committee of the Holographies board to investigate the financial improprieties at issue in this suit. Nationsbanc Montgomery Securities, LLC (“Nations-banc”) served as lead underwriter for the Holographies IPO; 2 Lazard Freres, & Co., LLC (“Lazard”), Raymond James & Associates, Inc. (“Raymond James”) and Salomon Smith Barney Holdings, Inc. (“Smith Barney”) -served as co-managers of the IPO (collectively, the “Underwriters”).
The two actions here arise out of accounting irregularities in several quarters preceding the IPO that were discovered and disclosed by ABN and Holographies approximately .six months after the Holo-graphies IPO.
The following factual allegations in the consolidated Complaints are accepted as true for the purposes of this motion.
ABN is a holding company, which through several subsidiaries in the United States, Brazil, Australia and New Zealand, operates in a single industry — -secured products and systems. It has three principal product lines: transaction cards and systems; printing services and document management; and security printing solutions. In ABN’s Security Printing Solutions Group, the company designs and prints counterfeit-resistant documents, such as checks, passports, visas, birth certificates, Social Security cards, stock and bond certificates and currency.
Until July 1998, Holographies was a wholly owned subsidiary of ABN. During the fiscal years 1996 and 1997 and the first two quarters of 1998 (ending on June 30, 1998), the revenues of Holographies represented approximately 9.5% of ABN’s total revenues. Holographies manufactures mass-produced holograms and holographic material for use in security and counterfeiting-protection applications, such as credit cards, and for non-secure uses such as magazine advertisements and specialized packaging.
In 1996 and 1997, ABN was highly leveraged, and was looking to expanding its foreign presence to grow sales. To fuel its growth and pay for overseas acquisitions, ABN issued a series of debt securities (junk bonds), including 10 3/8% Senior Notes due June 1, 2002 (“10 % Notes”) “secured by a pledge of all the issued and outstanding shares of capital stock” of ABN and its then wholly-owned subsidiary Holographies, as well as 65% of the shares of American Banknote Brazil (its Brazilian subsidiary). Through this offering, ABN raised approximately $126.5 million. (ABN Compl. ¶ 35.) Other ABN efforts at financing were less successful. For example, as a result of concerns over the volatility of the economy in Brazil, where ABN derived 40% of its total revenues, ABN was forced to postpone a November 1997 $225 million bond offering. By the end of 1997, ABN’s long-term debt had reached $293 million, 43% of which represented the 10 % Notes. (Id.)
During the period from May 1996 through January 1999, the Class Period alleged by the ABN Plaintiffs, ABN filed annual Form 10-K and quarterly Form 10-Q reports with the SEC as required. Each of the filings contained, among other things, a consolidated financial statement for ABN that combined the results of its subsidiaries. ABN issued press releases that coincided with each filing, which discussed or quoted from the_ financial statements. These financial statements included the financial reports of ABN’s subsidiary, Holographies. In its form 10-K for fiscal year 1997, filed with the SEC on March 31, 1998, ABN admitted that its was highly leveraged; its long-term debt of approximately $293 million represented 84% of its total capitalization.
ABN viewed the spin-off and initial public offering of Holographies as a way to resolve its own debt problems. In a May 5, 1998 press release announcing the registration of the Holographies public offering, ABN noted that it intended to use a large portion of the proceeds to retire its senior secured debt, specifically, the 10 % Notes. As ABN CEO Morris Weissman stated in the release: “[W]e intend to de-leverage and are taking the necessary steps to insure the success of the program. In addition, we hope to raise capital for our subsidiaries so that they can continue to grow, unencumbered by the burden of heavy corporate debt.”
On July 13, 1998, Holographies filed Amendment 4 to its Registration Statement. On July 15, 1998, it filed its final Prospectus. The final Registration Statement and Prospectus contained financial statements for the years ended December 31, 1996 and 1997, as reported from audited financial statements by Defendant De-
Sales increased by $2.3 million, or 7.9%, from $28.6 million in 1996 to $30.9 million in 1997. The increase in sales was due “primarily to an increase in sales volume of security holograms, including a $6.9 million order from a major customer which was received and completed in December 1997 and which goods were transferred to the Company’s on-site secured facility. (Holographies Compl. ¶ 37.)
For the three-months ending March 31, 1997 and March 31, 1998, sales were reported as $5,241,000 and $7,035,000 respectively, with net income reported as $657,-000 for the quarter ended March 31, 1997, and $1,793,000 for the quarter ended March 31, 1998. In comparing these figures, the Prospectus stated:
Sales increased by $1.8 million, or $34.2%, from $5.2 million for the three months ended March 31, 1997 to $7.0 million for the three months ended March 31, 1998. The increase in sales was due primarily to increased sales volume of transaction cards and product authentication holograms. The increase in transaction card hologram volume was dues to the growth in loyalty programs, competition among financial institutions resulting in increased multi-card issuance and the increased use of automated teller machine and debit cards. The increase in product authentication hologram sales volume was due to higher demand for this product and new product authentication customers ... Cost of goods sold decreased by $0.2 million ... This decrease reflects the Company’s focus on controlling costs, improving production yields and the higher margins earned on security holograms. (Holographies Compl. ¶ 38)
The initial public offering of Holograph-ies was commenced on July 15, with an offering of 13,636,000 shares at $8.50 per share.
Morris Weissman, the Chairman and Chief Executive Office of ABN, was named Chairman and CEO of Holographies. ABN received the entire net proceeds of the offering — -approximately $106.7 million- — which it used to pay off some of its debt. In August, ABN announced a cash tender offer for $70 million of the 10 3/8% Senior Notes it had issued. Following the IPO, ABN, which had sold its entire holdings of Holographies in the IPO, had no remaining ownership of Holographies.
The price of Holographies stock rose from $8.50 per share in the IPO to a high (for the Holographies Class Period) of $18 per share on December 18, 1998. (Holo-graphies Compl. ¶ 53).
On January 19, 1999, Holographies issued a press release indicating that it was investigating certain transactions during the second and third quarters of 1998 that “resulted in the inappropriate recognition of revenue during such quarters” (Holo-graphies Compl. ¶ 50). Holographies noted that there may have been overstatements of revenue results in those two quarters that “may be material.” (Id.) According to the January 19, 1999 announcement; “[t]hese overstatements ... will require re-statements of [Holograph-ies’s] financial statements for such periods.” (Id.)
ABN issued a press release that same day, announcing that Holographies had issued the aforementioned press release and quoting that press release verbatim. The ABN press release went on to state:
[B]ased upon currently available information resulting from the in-progress1998 audit of the Company’s [Holo-graphies’] financial statements, sales and net income of the Company have been overstated for the second and third quarters of 1998. These overstatements may be material and will require restatement of the Company’s financial statements for such period. (Holo-graphies Compl. ¶¶ 88-89).
ABN conceded that the required restatement would result in a decrease in operating income and reported returns for the second quarter of 1998. Id.
The price of Holographies stock dropped sharply from $15.12 per share on January 19, 1999 to $4.56 per share on January 20, 1999. Less than one week later, on January 25,1999, Holographies reported:
Based upon currently available information, the company expects that revenues and net income for the year ended December 31, 1998 will be substantially lower than for the year ended December 31, 1997, and that the Company’s interim financial statements for each of the first three quarters of 1998 will require restatement. The Company also currently believes that net income of the Company has been overstated for each of the years ended December 31, 1997 and December 31, 1996 by approximately 10%. Accordingly, the Company’s financial statements as of December 21, 1997 and 1996 and for each of the three years in the period ended December 31, 1997 and the related Report of Independent Auditors should no longer be relied upon. (Holographies Compl. ¶ 51.)
On February 1, 1999, Holographies announced that the net income for the year ended December 31, 1997 had been overstated by more than 50%, rather than the 10% estimated in the January 25 announcement. Following this announcement, the price of Holographies common stock fell to $1.62 per share.
On February 4, 1999, Holographies announced the resignation of defendants Cantor and Macchiarulo. (Holographies Compl. ¶¶ 16, 17.) On April 9, 1999, Ho-lographies announced the resignation of Weissman from the company. Holo-graphies’ new president and chief operating officer stated, “[The Holographies’] board decided it was in [the Company’s] best interest to rid itself, of those officials under whose watch the company ran into serious financial problems.” (Id. ¶ 55.)
On April 15, 1999, Holographies announced that: (a) its annual report on Form 10-K for the year ended December 18, 1998 would be delayed and that it also anticipated that its report on Form 10-Q for the first quarter of 1999, due to be released on May 17, 1999, would also be delayed; (b) its financial statements for the years ended December 31, 1997 and December 31, 1996 as well as the interim financial statements for each of the first three quarters of 1998, would require restatement; (c) it had been notified by its commercial banks, led by the Chase Manhattan Bank, that events of default existed under the Company’s Credit Agreement “as a result of the financial statement misstatements and related matters disclosed in the Company’s press releases of January 19, January 25, and February 1, 1999;” and (d) the SEC had initiated a formal investigation into the Company’s previously disclosed financial misstatements. (Id. ¶ 56.)
On April 20, 1999, ABN announced that its financial statements for the years ended December 31, 1997 and December 31, 1996, as well as the interim financial statements for the first three quarters of 1998, would require restatement concurrent with the restated financial statements of Holo-graphies. (ABN Compl. ¶ 2.) ABN further stated that it would seek a delay in filing its form 10-K for the fiscal year ended December 31, 1998 and disclosed that the SEC had initiated a formal investigation against it relating to Holographies’ revenue recognition issues.
A number of ABN and Holographies shareholders filed lawsuits. This Court consolidated these cases for pre-trial pur
At the time the motions were filed, neither ABN nor Holographies had filed a report on Form 10-K for the year ended December 31, 1998, or a report on Form 10-Q for the quarter ended March 31, 1999. On August 3, 1999, the New York Stock Exchange suspended trading in Ho-lographies and ABN stock and delisted both stock issues.
On December 8, 1999, ABN voluntarily filed for bankruptcy under Chapter 11 in the United States Bankruptcy Court for the Southern District of New York. See In re American Banknote Corp., Case No. 99 B 11577 (Bankr.S.D.N.Y.1999). The automatic stay of proceedings against ABN that was ordered as a result of ABN’s voluntary filing of bankruptcy under Chapter 11 has been lifted pursuant to the order of Bankruptcy Judge Carter Beatty for the purposes of deciding the motions before me. See In re American Banknote Corporation, Case No. 99 B 11577(PCB), Order Modifying Automatic Stay, (Bankr. S.D.N.Y.) (Mar. 16, 2000). I therefore address all the claims brought against the parties who have filed motions to dismiss.
III. Standards on a Motion to Dismiss
On a motion to dismiss under Fed. R.Civ.P. 12(b)(6), this Court must accept the well-pleaded factual allegations in the Complaint as true.
See Grandon v. Merrill Lynch & Co.,
This liberal pleading standard is modified by Fed.R.Civ.P. 9(b) in cases where fraud is alleged. In addition, the PSLRA requires application of a heightened pleading standard to claims brought under Section 10(b) of the Exchange Act. These special pleading rules are discussed below.
IV. Discussion of Holographies Class Claims
The Holographies Plaintiffs bring claims under the 1933 Securities Act and the 1934 Exchange Act.
A. The 1983 Securities Act Claims
The Holographies Plaintiffs allege violations of Section 11 of the Securities Act against Holographies, Deloitte, Nations-banc, Lazard, Raymond James, Smith Barney, and Defendants Weissman, Cantor and Macchiarulo; violations of Section 12(a)(2) against ABN, Holographies, Nati-onsbanc, Lazard, Raymond James and Smith Barney; and violations of Section 15 against ABN, Holographies, Weissman, Cantor and Macchiarulo. ABN, Holo-graphies, the Underwriters, Weissman and Macchiarulo move to dismiss the claims pursuant to Rules 9(b) and 12(b)(6) of the Fed.R.Civ.P. and the pleading requirements of the PSLRA.
Section 11 provides in relevant part:
In case any part of the registration statement, when such part became effective, contained an untrue statement of a material fact or omitted to state a material fact required to be stated therein or necessary to make the statements therein not misleading, any person acquiring such security (unless it is proved that at the time of such acquisition he knew of such untruth or omission) may, either at law or in equity, in any court of competent jurisdiction sue—
(1) every person who signed the registration statement;
(2) every person who was a director [or performing director functions] of the issuer;
(3) every person [named in the statement as] about to become a director;
(4) every accountant, [and other professionals who give certification of the registration or having prepared any valuation contained therein];
(5) every underwriter with respect to such security.
15 U.S.C. § 77k(a) (emphasis added).
An issuer is strictly liable for false statements and misrepresentations in the registration statement. See 15 U.S.C. § 77k(b).
Section 12(a)(2) of the 1933 Act establishes the liability of “any person who ... offers or sells a security ...”:
by means of a prospectus or oral communication, which includes an untrue statement of a material fact or omits to state a material fact necessary in order to make the statements, in light of the circumstances under which they are made, not misleading (the purchaser not knowing of such untruth or omission), and who shall not sustain the burden of proof that he did not know, and in the exercise of reasonable care could not have known, of such truth or omission ....
15 U.S.C. § 771 (2).
1. Plaintiffs Standing Under the 19SS Act
The threshold issue raised by the Defendants is whether the lead Plaintiffs named in the Holographies Complaint have standing to sue under Sections 11, 12 and 15 of the 1933 Act. Defendants contend that Plaintiffs’ claims under Sections 11 and 12(a)(2) of the Securities Act must be dismissed because standing to sue under those sections is limited to those shareholders who make stock purchases directly in an IPO. Those who purchase shares in the aftermarket may avail themselves of the anti-fraud remedies of the Exchange Act, which confers standing upon all shareholders who make market purchases, regardless of who the seller is.
The amended and consolidated Holo-graphies Complaint names three lead plaintiffs, David Slyman, Clarion Partners LLP and Ufuk Turkel. All three of them purchased shares in the aftermarket.
(See
Holographies Compl. ¶ 12). In
Gustafson v. Alloyd Co.,
Defendants contend that, where the named plaintiffs have no right to assert a claim, the claim must fail for lack of “representativeness” of the lead plaintiffs (or plaintiffs’) claim. (Def. Underwriter’s Rep.Br. at 4).
See Kirkwood v. Taylor,
Under
Gustafson,
the Slyman, Clarion Partners and Turkel do not have standing to maintain the 12(a)(2) claims against Defendants. However, the Complaint names a co-lead plaintiffs group, which includes David J. and Chaile Steinberg, Caroline Weisz, Beatrice Levy, Tom Yuan, Tim Feuz, Brian LeMay, Daniel Kursman, Ger-brilor International Corporation, Mei-Yu Chuang, Barry Goldberg, Royce Porkert, Thomas J. Panagiotatos, James S. Krieger, Muriel Motter, Alvin Pasternak, William Furling, III and Deborah Krohn, some of whom purchased shares directly in the IPO.
(See id.;
Schiller Aff.Exh. E; Saffer-stein Aff.Exh. A.) The nomination of a group of investors as co-lead plaintiffs is specifically contemplated by the PSLRA.
See
15 U.S.C. § 78u-4(a);
In re Network
Assocs.
Sec. Litig.,
Defendants are correct to note that the holding in
Gustafson
(which by its terms applies only to Section 12(1) of the 1933 Act) has been interpreted by some courts as requiring a plaintiff bringing a Section 11 to allege that it has purchased shares directly from the issuer in the public offering. The issue of plaintiff standing under Section 11 has been directly addressed by three district courts in this Circuit, with conflicting results.
Compare In re Fine Host Corp. Securities Litigation,
2. Section 11 Liability
ABN argues that the Holographies’ Plaintiffs’ Section 11 claim against it should be dismissed because ABN is not among the parties against whom a claim can lie for false or misleading statements contained in the registration statement. ABN contends that Holographies was the “issuer” of the Holographies shares offered in the IPO, not ABN. Defendant Holo-graphies argues, however, that “while Ho-lographies may be alleged to be the ‘issuer,’ it did not own any of the shares sold in the IPO (ABN did), and all the proceeds of such went to ABN.” (Holographies’ Mem. at 8.) Plaintiffs therefore contend that ABN was the defacto issuer.
As noted above, Section 11 enumerates the categories of persons liable for making misleading statements in a registration statement, which includes the “issuer” of the security. An “issuer” is defined under Section 2(a)(4) of the 1933 Act as “every person who issues
or proposes to issue
any security....” 15 U.S.C. § 77(b)(a)(4) (em
Any security may be registered with the Commission under the terms and conditions hereinafter provided, by filing a registration statement ... which shall be signed by each issuer, its principal executive officer....
15 U.S.C. § 77f(a) (emphasis added).
Liability under Section 11, however, is “reserved for parties ‘who are signators of the registration statement, directors or partners of the issuer, experts named as preparing or certifying a portion of the registration statement, or underwriters of that issue.’ ”
O’Sullivan v. Trident Microsystems, Inc.,
No. C 93-20621 (
The Holographies Plaintiffs argue that, even though ABN’s name was absent from the registration statement, it also functioned as the “issuer.” In support of this argument, they point to ABN’s own admission that it “sold its shares in Holo-graphies to various underwriters pursuant to a firm commitment underwriting,” (ABN Memo at 3-4 (citing Holographies Compl. ¶ 14)) which Plaintiffs describe as an “offering by [ABN].” (Holographies Compl. ¶ 14.) Moreover, Plaintiffs note that Morris Weissman, who signed the registration statement on behalf of Holo-graphies, served concurrently as CEO of ABN and Holographies. Plaintiffs argue that the registration statement was signed by an “officer of the issuer” (albeit in his Holographies capacity).
Plaintiffs cite no case law to support either of these arguments, and I find them without merit. First, the fact that Weiss-man held directorships in both ABN and Holographies may impute liability to ABN for misrepresentations (see discussion of Section 10-b liability below), but does not transform ABN into an “issuer.” As long as Weissman signed the statement as CEO of Holographies, Holographies was the issuer, within the meaning of the statute. Second, that ABN may have “offered” the securities or made solicitations regarding the sale of securities is relevant to its status as a statutory “seller” within the meaning of Section 12 (see below), but does not make it an “issuer” within the meaning of Section 11. By its clear language, Section 11 limits liability to signatory issuers, officers and directors, underwriters and auditors. The Section 11 claim is therefore dismissed as against ABN.
3. Section 12 Liability
All Defendants move to dismiss the Section 12 claims against them. Holographies moves on the ground that, even if Plaintiffs have standing to sue, Holographies is not a “seller” within the meaning of Section 12(a)(2), and thus cannot be liable as a matter of law. ABN moves to dismiss on the basis that it was not a statutory seller in the Holographies IPO. And the Underwriters argue that the Section 12(a)(2) claim against them fails because the Plaintiffs did not allege either that they purchased stock directly from the Underwriters or that the Underwriters directly solicited their stock purchases.
Plaintiffs respond that both Holograph-ies and Underwriters either sold or solicited the sale of the shares, so both are statutory sellers. Plaintiffs further respond that ABN transferred title of the shares to the underwriters and actively solicited the sale of the securities with the motive of serving its own financial interest, either one of which makes it a statutory seller.
Section 12(a)(2), as noted above, creates liability against any person who “offers or sells” newly issued securities “by means of a prospectus or oral communications.” 15 U.S.C. § 771(a)(2). The term “seller” was defined by the Supreme Court in
Pinter v. Dahl,
In applying the
Pinter
analysis to 12(2) claims, courts have consistently held that a plaintiff must plead or prove (1) that a defendant directly sold stock to the plaintiff or (2) directly solicited the plaintiffs purchase of stock.
See Capri,
Under this analysis, ABN, Holographies and the Underwriters are all “sellers.”
First, ABN owned the shares, and it passed title of the shares it owned. The Complaint also alleges active solicitation of sales which “included participating in the preparation of the false and misleading Registration Statement and Prospectus and participating in ‘road shows’ to promote the sale of [Holographies] common stock.” (Holographies Compl. at ¶ 88).
ABN argues that, because it is not the issuer and because the Underwriters passed title to the ultimate buyers of the stock, ABN cannot be held liable as the “seller.” In addition, ABN contends that the mere allegation that ABN issued a press release announcing the Holographies IPO and participated in preparation of the Prospectus and in “road shows,” is inadequate to make a claim that ABN solicited sales under the Pinter test. However, it has been specifically alleged that ABN was motivated to actively solicit sales in order to raise as much money as possible in the IPO. I must presume that allegation to be true at this point in the litigation.
Thus, ABN is a seller, under both prongs of Pinter.
Second, the Underwriters are sellers. The Underwriters argue that, under Pinter, a conclusory allegation concerning solicitation of unspecified investors in not sufficient to state a Section 12(a)(2) claim. However, Plaintiffs point out that the Holographies IPO 'was a “firm commitment” offering in which the Underwriters directly passed title to public investors.
In a “firm commitment” underwriting:
the underwriters agree that they will purchase the shares being offered for the purpose of resale to the public. The underwriters must pay for and hold the shares for their own account if they are not successful in finding public purchasers. This form of underwriting is almost always used by the larger underwriters and provides the greater assurance of raising the desired funds.
R. Jennings & H. Marsh, Jr.,
Securities Regulation
135 (6th ed.1987).
Third, Holographies was a seller. Holographies argues that precisely because the IPO was a firm commitment underwriting, it was not a seller or solicitor of purchases. Holographies further contends that it was never the “owner” of the shares sold in the IPO; rather, ABN, its parent company, was the “owner” of Holographies prior to the IPO. Thus, only ABN could transfer title to the shares.
While it may be true that Holographies was not the owner, and therefore could not transfer title to the shares, Holographies nonetheless actively solicited the sale of the shares through participation in preparation of the registration statement and prospectus and in road shows, “with a motivation to serve [its] own financial interests
or those of the securities’ owner”
here, ABN.
Degulis v. LXR Biotechnology, Inc.,
The facts of In re U.S.A. Classic Sec. Litig. [1995 Transfer Binder] Fed.Sec. L.Rep. (CCH) ¶ 98,837 (S.D.N.Y. Jan. 19, 1995) are similar to those here. There, the parent company owned all the stock of the newly public former subsidiary, which was sold through underwriters in a public offering. The Court denied both the corporate parent’s and the former subsidiary’s motions to dismiss the Section 12(a)(2) claim on the ground they were not statutory sellers, holding the underwriters and the parent corporation to be “sellers” (since they passed title to the stock), and holding the subsidiary to be a “seller” because it solicited the sale of U.S.A. Classic’s stock. Id. at 93,047.
3. Pleading Requirements under 1933 Act
Fraud is not an element of claims brought under Sections 11 and 12(a)(2) of the Securities Act, and, ordinarily, the heightened pleading requirements of Federal Rule of Civil Procedure 9(b) do not apply to such claims. Nonetheless, the Defendants each argue that the pleading requirements of 9(b) should be applied to Section 11 and 12(a)(2) claims here because: (1) the Complaint bases the Securities Act claims on the same facts which serve as the basis for the 10(b) claims; and (2) the Complaint alleges fraudulent intent.
See Schoenhaut v. American Sensors, Inc.,
Plaintiffs respond that their claims against the Underwriters sound in negligence, and are not subject to Rule 9(b). They also assert that the Section 11 and 12(a)(2) claims against the other Defendants are also not subject to heightened pleading. Finally, Plaintiffs argue that even if the 1933 Act claims were subject to Rule 9(b) standards, they have pled with sufficient particularity.
The claims against Defendants ABN, Holographies, Macchiarulo and Weissman
However, for the reasons stated in my discussion of the 1934 Exchange Act Section 10(b) claims below, I find that Plaintiffs have pled with sufficient particularity to meet the Rule 9(b) and the PSLRA pleading requirements. (See infra.)
The claims against the Underwriters do not sound in fraud. The Holographies Complaint does not allege a Rule 10b-5 claim against the Underwriters, nor does it allege that the Underwriters acted fraudulently. (See Holographies Compl. ¶¶ 78, 86.) In fact, the Complaint expressly disclaims fraud claims against the Underwriters: “Plaintiffs repeat and reallege each of the allegations set forth in the foregoing paragraphs, except to the extent any allegations contained above may be interpreted to sound in fraud, such allegations are expressly not incorporated under this Count.” (Holographies Compl. ¶¶ 78, 86.) Therefore, no heightened pleading requirement applies.
The Plaintiffs have also not pleaded “fraudulent intent” against the Underwriters. The Underwriters contend that the allegations in the Complaint introduce the Underwriters’s state of mind: “Defendants failed to disclose the existence of known trends, events or uncertainties that it [sic] reasonably expected would have a material unfavorable impact on net revenues or income or that were reasonably likely to result in the Company’s liquidity decreasing in a material way.” (Holographies Compl. ¶ 59.) Nothing in this paragraph, however, alleges fraudulent intent or state of mind. It merely contends that the Prospectus and Registration Statement contained information that was materially false and misleading.
The cases cited by the Underwriters to support their contention that heightened pleading applies to the claims against them are distinguishable. In those cases, the plaintiffs alleged both Section 11 and 12(a)(2) violations and 1934 Exchange Act Section 10(b) violations against the moving defendants.
See Geiger v. Solomon-Page Group, Ltd.,
Section 15 Control Liability
Section 15 establishes liability for “control persons”who:
[B]y or through stock ownership, agency, or otherwise, or who, pursuant to or in connection with an agreement or understanding with one or more other persons by or through stock ownership, agency, or otherwise, controls any person liable under sections 77k or 77l of this title shall also be liable ...
15 U.S.C. § 77o.
In order to survive a motion to dismiss a claim for controlling person liability under Section 15, plaintiffs must allege “(1) an underlying primary violation by the controlled person; (2) control [by the defendant] over the controlled person; and (3) particularized facts as to the controlling person’s culpable participation in the fraud perpetrated by the controlled person.”
Ellison v. American Image Motor Co., Inc.,
B. 1931 Securities Exchange Act Claims
The Holographies Plaintiffs allege that ABN, Holographies, Weissman and Mac-chiarulo violated Section 10(b) of the Exchange Act and Rule 10b-5, on a “fraud on the market” theory of liability. (Holo-graphies Compl. ¶¶ 97-112). Defendants move for dismissal on the basis that Plaintiffs have failed adequately to plead scien-ter or to meet the heightened fact pleading requirements of Rule 9(b) and the PSLRA.
1. Section 10(b) and Rule 10b-5 Liability
To state a cause of action under Section 10(b) of the Exchange Act and Rule 10b-5 promulgated thereunder,
5
a plaintiff must plead that, in connection with the purchase and sale of securities, the defendant (1) made a misstatement or omission (2) of a material fact, (3) made with scienter, (4) on which the plaintiff relied (5) that proximately caused his injury.
See Chill v. General Electric Co.,
Holographies, Macchiarulo and Weiss-man each contend that, where the complaint is made against multiple defendants, it is insufficient to make blanket references to the acts and scienter of all of them, without identifying the nature of each defendant’s state of mind and participation in the alleged fraud.
See Shields v. Citytrust Bankcorp, Inc.,
While it is true that there can be no aider and abettor liability under 10(b) and Rule 10b-5,
see N. A v. First Interstate Bank of Denver,
a. Material Misrepresentation or Omission
The claims made against Weiss-man, Macchiarulo and Holographies include the central allegation that each of them made material misrepresentations in public financial disclosure statements, including the financial reports that were incorporated in the Prospectus and Registration Statement. (Comp.lffl 99, 100). In addition, Weissman is alleged to have made misrepresentations in several press statements. The test for materiality under Rule 10b-5 is whether there is “a substantial likelihood that a reasonable shareholder would consider it important in deciding how to [act].”
Basic Inc. v. Levinson,
Weissman contends that Plaintiffs’ pleadings are insufficient because the only statements actually attributed to him in the Complaint are not actionable as a matter of law. Weissman’s statements appeared in the press releases dated May 5 and July 14,1998:
[W]e intend to de-leverage and are taking the necessary steps to insure the success of this program ... Out most important goal in 1998 is to enhance shareholder value. We hope to prove to the market that inherent values of our underlying operating subsidiaries, not apparent when evaluating American Banknote on the basis of traditionally consolidated earnings per share, are indeed significant. (May 5, 1998 Release; Compl. ¶ 34.)
This IPO is a win-win for both companies. With the IPO proceeds, ABN is in a vastly improved financial condition. ABNH can now concentrate on continuing the profitable growth of its core security holography business as well as explore business and market expansion opportunities. (July 14, 1998 Release; Compl. ¶ 41.)
Weissman argues that these statements are the sort of generalized, optimistic statements about the future that courts have found not to be actionable because they are immaterial as a matter of law.
See, e.g., In re Advanta Corp. Sec. Litig.,
I am constrained to disagree. Weiss-man’s statements did not reflect generalized optimism about the future, but rather the position that Holographies was, at the time he made the statement, a valuable company — indeed, more valuable than the market valuation of its parent, ABN, reflected. He further stated that, following the IPO, Holographies would be able to concentrate on continuing the profitable growth it had begun while a subsidiary of ABN. As it turns out, all this was untrue at the time the statements were made. Weissman’s statements are thus distinguishable from the Advanta and San Le-andro statements the Second Circuit found to be mere “puffery,” and satisfy the materiality requirement.
Weissman and Macchiarulo further argue that they cannot be held liable under a theory of “group publication” for any alleged misrepresentations made in public financial statements — the Holo-graphies 10-Qs, 10-Ks and the Prospectus and Registration Statement. Plaintiffs argue that they allege more than “group publication” of the alleged misleading and inaccurate financial statements; they allege that Weissman and Macchiarulo actually participated in the preparation of the publications and that they signed the reports. (Holographies Compl. ¶¶ 37, 43, 45, 47, 48.) By alleging that Weissman and Macchiarulo, in their respective capacities as CEO and CFO of Holographies, each participated in the preparation and publication of the financial reports, Plaintiffs have pleaded the facts of their participation in the misrepresentation with adequate particularity. (Holographies Compl. ¶ 105.)
ABN argues that the statements at issue cannot be attributed to it and that it therefore cannot be held to have committed fraud. This ignores two key facts: (1) Prior to the IPO, Holographies operated as a fully-owned subsidiary of ABN; and (2) Weissman was CEO and President of ABN at the same time he was CEO of Holographies. While it is true that a subsidiary’s fraud cannot be “automatically”
I further find that, independent of the statements made by Weissman, ABN can be found liable under Section 10(b)(5) for its omission of a material fact. Judge Brieant of this Court recently reaffirmed this point in
In re Oxford Health Plans, Inc. Sec. Litig.,
b. Pleading Scienter
As noted above, to plead scienter adequately, Plaintiffs must plead facts showing a strong inference of fraudulent intent through allegations of (1) motive and opportunity to commit fraud or (2) circumstantial evidence of conscious misbehavior or recklessness. I find that Plaintiffs have met their burden.
Opportunity requires showing “the means and likely prospect of achieving concrete benefits by the means alleged;” motive can be demonstrated through pleading facts showing that “concrete benefits that could be realized by one or more of the false statements.”
Shields v. Citytrust Bancorp, Inc.,
Plaintiffs adequately allege that Weissman, Macchiarulo and Holographies each had the opportunity to perpetrate the alleged fraud by reporting false and misleading financial information. Weissman was at all relevant times Chairman and CEO of both ABN and Holographies. (Holographies Compl. ¶ 15). Macchiarulo was at all relevant times Vice President Finance, Chief Financial Officer and Chief Accounting Officer of Holographies, and in that capacity was specifically responsible for Holographies’ financial reporting.
(Id.
¶ 17). Such senior executives have the opportunity to commit fraud.
See, e.g., San Leandro,
As discussed above, ABN had the most to win by inflating the price of the IPO, and was thus motivated to make statements or omit facts that would result in a higher price. As ABN notes, however, the statements were made by Weiss-
Weintraub is wholly inapposite in a case like this one, where the alleged wrongdoer was affiliated with two related corporations. In Weintraub, some of the directors of a corporation that was the target of a hostile takeover bid also served on the board of the corporation that made the unwelcome offer. Plaintiffs alleged that the target company issued false and misleading statements when it asserted that it was not aware of any reason for unusual trading in its stock. The Court found that the fact that three interlocking directors had actual knowledge of the takeover could not be imputed to the target corporation and its other officers.
Obviously, that case is not this case. Here, the two corporations were parent and subsidiary, and Weissman’s allegedly misleading statements were made to bolster both ABN and Holographies. Regardless of the letterhead used, he made them in his capacity as a director of both corporations. Moreover, the Complaint alleges that Weissman had knowledge of the actual sales and revenue figures of Holo-graphies in his capacity as CEO of ABN and as CEO of Holographies. Thus, Weissman’s scienter can fairly be imputed to ABN.
As to Holographies’ motive, Plaintiffs allege that Holographies received a concrete benefit from its participation in the scheme to inflate the price of its public offering, i.e., to enhance its ability to raise cash under the $30 million credit facility agreement with Chase Manhattan Bank. (Holographies Compl. ¶ 107). Holograph-ies’ argument that the credit facility actually represented a “burden” on Holo-graphies resulting from the IPO is without merit. The ability of Holographies to borrow its own cash- — unfettered by the already debt-laden ABN — was a benefit of the IPO. I thus find it a sufficient motive to raise an inference of fraudulent intent on the part of Holographies.
Plaintiffs have failed to plead motive against Weissman and Macchiarulo. Plaintiffs allege that Weissman and Mac-chiarulo each stood to benefit from the inflated offering price through enhancing the value of their personal holdings of Holographies stock; protecting and enhancing their executive compensation and positions; and further advancing the IPO in order to raise badly needed funds to satisfy ABN’s substantial debt. (Holo-graphies Compl. ¶ 106).
Generic allegations that seek to infer motive from benefits that are generally held by similarly situated executives have been routinely rejected by courts as insufficient to show motive. For example, in
Acito v. IMCERA Group, Inc.,
While Plaintiffs allege that Weiss-man and Macchiarulo were beneficiaries of
I must, therefore, analyze whether Plaintiffs have, in the alternative, alleged strong circumstantial evidence of conscious misbehavior or recklessness.
Plaintiffs allege that, as the two most senior officials at Holographies, Weissman and Macchiarulo had the authority and responsibility to enforce the company’s revenue recognition policies. (Holographies Compl. ¶ 20). They further allege that, for several quarters leading up to the IPO, Weissman and Macchiarulo signed and released financial statements to the SEC that violated Generally Accepted Accounting Principles in that they incorrectly inflated revenues. These inflated numbers were, by the Defendants’ own later admissions, significant: Holographies revenues were inflated by over 50% as a result of the accounting violations. Plaintiffs further allege that Weissman and Macchiarulo were present at each of the company’s quarterly sales meetings, and that, as senior officials, they had reason to know what the actual sales figures and revenues of Holographies were — both when it was a subsidiary of ABN and after it was spun off. In sum, Plaintiffs allege more than mere GAAP violations; they allege a long-term scheme to “cook the books” in a way that benefitted ABN, Ho-lographies and, of course, the individual defendants who ran those companies.
It is well established that the allegation of a violation of GAAP, without more, does not meet the scienter pleading requirements of 10(b)(5) or the PSLRA.
See Chill,
I also find Plaintiffs have alleged adequately that the material misstatements were the proximate cause of the drop in the stock price. Because they plead under a theory of “fraud on the market” Plaintiffs dp not need to plead reliance.
See Basic Inc. v. Levinson,
V. The ABN Complaint
The ABN Plaintiffs bring two claims: (1) Against ABN, Weissman, Gorman and Gentile for securities fraud in violation of 10(b) of the Exchange Act and SEC Rule 10b-5; and (2) Against Weissman, Gorman and Gentile as “control persons” of ABN under Section 20(a) of the Exchange Act. ABN and the Individual Defendants move to dismiss the 10(b) claim on the grounds that Plaintiffs inadequately plead facts in support of their claim and that Plaintiffs also fail to plead facts giving rise to a strong inference of scienter as required by Rule 9(b) and the PSLRA. The Individual Defendants move to dismiss the Section 20(a) claim on the ground that the underlying claim against ABN is deficient. In addition, the Individual Defendants argue that, even if the claim against ABN is sufficient to survive the 12(b)(6) motion, the Plaintiffs have failed to allege culpable conduct on the part of the individual officers.
A. Section 10(b) Liability
In the ABN Complaint, Plaintiffs allege that Weissman, Gorman and Gentile, as officers of ABN, had participated in a fraudulent scheme to misstate the financial status of the ABN subsidiary Holographies in order to inflate the value of the Holographies IPO, which in turn would benefit ABN, since the entire proceeds of the IPO went straight into the corporate coffers of ABN. Plaintiffs further allege that the Individual Defendants were insiders who controlled the day-to-day operations of ABN and Holographies; instigated and carried out the improper accounting scheme; and prepared, signed and/or approved the false financial statements that are the subject of the ABN Complaint. (ABN Compl. ¶¶ 12-15, 27, 40-48. 57-65. 74-79, 100, 105, 109-118). They claim that, as a result of the overstatement of Holographies’ revenues in ABN’s public financial disclosures for 1996 and 1997, the value of ABN’s shares dropped during the class period (May 2, 1996 through January 25, 1999) from a high of $6.75 per share to a low of $0.8125 per share.
The gravamen of the claim against Gorman, Executive Vice President and CFO of ABN, and Gentile, Vice President and Corporate Comptroller of ABN, is that they filed financial statements in violation of GAAP and SEC guidelines as part of a scheme to defraud ABN shareholders. Plaintiffs here fail to allege facts that create a strong inference of fraudulent intent on the part of Gorman or Gentile. As noted above, an allegation of the mere existence of executive incentive compensation is insufficient to plead motive.
Plaintiffs argue in the alternative that they have alleged conscious misbehavior or recklessness on the part of Gorman and Gentile sufficient to create a strong inference of fraud. Plaintiffs allege that, as insiders of ABN, Gorman and Gentile had unique access to the day-to-day operations of the Holographies subsidiary, a subsidiary whose activities were almost entirely indistinguishable from ABN’s. (ABN Compl. ¶ 112-118.) They also allege that Gorman signed the 10-Qs and 10-Ks alleged to contain material misstatements, which were filed with the SEC in 1996 and 1997, and that Gentile signed the 10-Qs filed in 1998.
Recognizing the limitations of alleging fraud by hindsight and of basing a 10(b) claim solely on violations of accounting rules, I nonetheless find that Plaintiffs have sufficiently plead recklessness or conscious misbehavior on the part of Gentile and Gorman. Here, as with the Holo-graphies claim, the magnitude of the accounting irregularities removes the actions from the sphere of mere corporate mismanagement to the realm of reckless behavior. As the Comptroller and CFO of ABN respectively, Gentile and Gorman were, as Plaintiffs allege, uniquely situated to control the revenue recognition procedures of ABN. That revenues were radically inflated over a period of two years, and in repeated 10-Q and 10-K filings with the SEC, is circumstantial evidence of recklessness giving rise to a strong inference of fraud. I conclude that it would be error to dismiss the Complaint prematurely against Gorman and Gentile.
I therefore deny the motion to dismiss the claims against Weissman, Gentile and Gorman.
B. Control Person Liability wider Section 20(A)
In order to survive a motion to dismiss a claim under Section 20(a), “plaintiffs must allege (1) an underlying primary violation by the controlled person; (2) control [by the defendant] over the culpable participation in the fraud perpetrated by the controlled person; and (3) particularized facts as to the controlling person’s culpable participation in the fraud.”
Ellison
Weissman, Gentile and Gorman argue that Plaintiffs have not met the third prong because they have failed to plead any facts demonstrating their culpable participation in ABN’s acts. By pleading that the Individual Defendants engaged in specific conduct while serving as Chairman and CEO, Executive Vice President and Corporate Comptroller, respectively, of ABN throughout the Class Period, the Plaintiffs have alleged particularized facts that give rise to a strong inference not only of the power to direct and control the culpable acts of ABN, but also participation in those acts.
For the foregoing reasons, the ABN Defendants motion to dismiss the ABN Complaint is denied.
This constitutes the decision and order of the Court.
Notes
. Deloitte and Cantor have filed Answers to the Holographies Complaint and have no mo-lions before the Court.
. Nationsbanc Montgomery Securities, LLC is now known as Bank of America Securities, LLC following the merger of its parent corporation, NationsBanc Corp. with BankAmerica Corp. (Underwriters' Mem. at 1).
. For example, after
Pinter,
there is no separate aider and abettor liability under Section 12.
See Wilson v. Saintine Exploration & Drilling Corp.,
. Defendant ABN cites cases in this district standing for the proposition that, in order to be liable under Section 12(a)(2) as a "solicitor” of sales, defendant must be alleged to have personally solicited the sale from plaintiff.
See In re Gas Reclamation, Inc. Sec. Litig.,
. Section 10(b) of the Exchange Act provides in relevant part that:
It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce or of the mails, or of any facility of any national securities exchange — ...
(b) To use or employ, in connection with the purchase or sale of any security registered on a national securities exchange or any security not so registered, any manipulative or deceptive device or contrivance in contravention of such rules an regulations as the Commission may prescribe as necessary or appropriate in the public interest or for the protection of investors.
15 U.S.C. § 78j.
SEC Rule 10b-5 provides:
It shall be unlawful for any person, directly or indirectly, by the use of any means of instrumentality of interstate commerce, or of the mails or of any facility of any national securities exchange,
(a) To employ any device, scheme or artifice to defraud,
(b) To make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading, or
(c) To engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person, in connection with the purchase or sale of any security.
17C.F.R. § 240.10b-5.
. The PSLRA provides in relevant part:
The complaint shall, with respect to each act of omission alleged ... state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind.
15 U.S.C. § 78u-4(b)(2).
. In
Hudson Technologies,
Judge Koeltl also held that plaintiffs had failed to allege facts sufficient to show a motive to commit fraud. There, as here, plaintiffs alleged that defendants sought to inflate the company’s financial results (1) “out of a desire to exaggerate [the company's] performance and to maintain their own positions within the company,” (2) “to enhance the value of their personal stock and facilitate their stock sales,” and (3) out of "a desire to keep the price of the stock inflated so that [the company] could engage in specific corporate transactions.”
Id. 1999
WL 767418, at *9-10,