OPINION AND ORDER
I.
INTRODUCTION
The motion of defendants Chantal Pharmaceutical Corporation and Chantal Burnison to
II.
BACKGROUND For the purposes of the instant motion to dismiss, the Court will accept the allegations of the complaint as true.
North Star International v. Arizona Corporation Commission,
As of July 21, 1994, the price of Chantal common stock was at a 52-week low of $0.75 per share. Id. ¶ 28. Marksman alleges that Chantal was faced with “virtually non-existent revenues, rapidly eroding market capitalization, and a complete lack of funds necessary to secure FDA approval of any of its proprietary compounds.” Id. ¶29. Marksman claims that, as of December 31, 1994, Burnison herself owned or controlled 1,522,-103 shares of Chantal common stock, either directly or through an entity controlled by Burnison, CBD Pharmaceutical Corporation (“CBD”). Id. ¶ 12.
Marksman contends that Chantal and Burnison developed a plan to restore value to Chantal’s common stock by reporting high sales revenues on what were essentially consignment sales of Ethoeyn to a distributor. 1 According to Marksman, the defendants could then convert the value into cash by selling Chantal common stock to the public through a series of private placements and open-market transactions. Id. ¶29. The complaint alleges that Chantal and Burnison launched the plan by promoting Ethoeyn with a press release showing that favorable medical studies hailed it as a “breakthrough” in skin treatment. Id. ¶ 30. Thereafter, Marksman contends, Chantal began to report dramatically increased revenues. Id. ¶31. By mid-1995, “certain widely-read financial analysts” began to recommend the purchase of Chantal common stock. Id. ¶ 32.
Marksman alleges that on July 10, 1995, Chantal issued a press release announcing that it had recently signed a marketing agreement with Stanson Marketing (“Stan-son”) of Los Angeles for the purchase by Stanson of specified amounts of Ethoeyn from Chantal for distribution in North America.
Id.
¶ 34. Although the terms of the agreement were not disclosed at that time,
id.,
the marketing agreement also allegedly provided that Stanson would have the right to return the product within 60 days in the event that it was unable to distribute the product successfully.
Id.
¶ 36. Further,
According to Marksman, authorized accounting methods did not permit Chantal to immediately recognize sales revenues from the Stanson agreement because of the agreement’s terms. The complaint alleges that Chantal recognized revenue on the sales to Stanson immediately when the products were shipped, in violation of generally accepted accounting principles (“GAAP”). Id. ¶ 73; Opposition, 9. This accounting recognition allegedly overstated revenues for the fiscal year ending June 30, 1995, by approximately $3,000,000 and for the quarter ending September 30, 1995, by approximately $10,000,-000, and overstated receivables by at least $10,000,000 as of September 30, 1995. Complaint, ¶ 3. Marksman claims that Chantal’s financial statements also violated GAAP by faffing to disclose that the transaction with Stanson constituted a “related party transaction.” Id. ¶ 77.
On July 24, 1995, Bloomberg News Services reported representations by Burnison that Chantal Pharmaceutical Corp. expected to report “break even” earnings for fiscal 1995, on revenues of approximately $7,000,-000, which represented nearly an 8000% increase in revenues from fiscal 1994. Id. ¶ 38. Marksman alleges that Burnison knew, but did not disclose, that nearly 50% of the year’s estimated revenues, and 90% of the estimated revenues for the final quarter of fiscal 1995, were from the Stanson sales and that Stanson’s right to return the goods had not yet expired. Id.
As the price of Chantal stock began to rise, Marksman alleges, Chantal made a private placement of its stock. On August 8, 1995, Chantal announced the completion of a private placement of 1,000,000 shares of restricted common stock and 500,000 shares of convertible preferred stock, at a price of $4.90 per share, for a total of $7,350,000. Id. ¶ 44. Within a week of this announcement, Chantal’s stock rose to $12.25 per share. Id. On September 25, 1995, the Los Angeles Business Journal reported that Chantal’s stock price increase was being fueled mainly by the “company’s stellar sales figures announced in June and an agreement signed the same month between Chantal and Stan-son.” Id. ¶45. On September 27, 1995, Chantal announced results for fiscal 1995 that were consistent with Bumison’s July 24th estimate. Id. ¶ 46.
On October 27, 1995, Chantal made a formal disclosure of earnings in its 1995 Form 10-K yearly report, which was filed with the SEC on that date. Id. ¶ 52. According to Marksman, the Form 10-K filing revealed for the first time that about 90% of Chantal’s revenues for the fourth quarter had come from Stanson, and Chantal attached a copy of the marketing agreement as one of the 22 exhibits to the 92-page Form 10-K. Id. ¶ 53. Marksman asserts, however, that the Form 10-K itself failed to discuss or refer to the marketing agreement, and did not disclose that revenues were allegedly being recognized in violation of GAAP. Id. ¶ 53.
Following the submission of the Form 10-K, Chantal continued to report earnings on its shipments to Stanson, and Chantal’s stock price continued to rise.
Id.
¶ 54. On November 14,1995, Chantal filed its Form 10-Q quarterly report with the SEC for the quarter ending September 30,1995.
Id.
According to the complaint, the Form 10-Q revealed that Chantal’s earnings for the final quarter of 1995 had surpassed its results for the entire fiscal 1995 period, with revenues of approximately $11,000,000 and net income of nearly $4,200,000.
Id.
This allegedly represented a 56% increase in revenues and a 93% increase in net income from Chantal’s reported results for all of fiscal 1995.
Id.
The complaint alleges that the Form 10-Q violated generally accepting accounting principles by reporting revenues from the sales to Stan-
Marksman claims to have made its first purchase of Chantal Pharmaceutical Corp. common stock beginning November 17,1995. Id. ¶ 9. By December 29, 1995, the stock price had risen to $28,125 per share. Complaint, ¶ 56. On that date, Chantal filed with the SEC a Registration Statement and Prospectus that covered shares sold by Chantal in a series of private placements during fiscal 1995 and that incorporated its financial results for fiscal 1995, allegedly made in violation of GAAP. Id. ¶ 57. Marksman contends that at some point in December, 1995, Burnison sold 300,000 shares of her own personally-held stock at prices of over $20 per share, for net proceeds of over $6,300,-000. Id. ¶ 57-58.
On January 6, 1996, Chantal’s well-publicized rise came to an abrupt halt. On that date, the financial journal Barron’s published an article questioning Chantal’s accounting and whether Chantal’s reported revenues represented a true sale, since the risk of ownership of the products did not appear to have transferred from Chantal to Stanson. Id. ¶ 60-61. Two days later, on January 8, 1996, Chantal’s stock lost 62% of its value, going from $19,125 to $7.31 per share on a trading volume in excess of 7,000,000 shares. Id. ¶ 62. Following the dramatic decline in the stock price, on January 9, 1996, Burnison announced that Chantal would retain an independent auditor to examine its accounting practices. Id. ¶ 64.
Marksman claims that it was the holder of 29,000 shares of Chantal stock as of January 5, 1996, acquired at an average price of approximately $21.50 per share. Id. ¶ 9. On January 8, 1996, following the publication of the Barron’s article, Marksman sold all 29,-000 shares at an average price of $7.53 per share, for a claimed net loss in excess of $300,000. Id. On February 7, 1996, Marksman filed the instant class action complaint in federal court against Chantal Pharmaceutical Corp. and Burnison.
III.
DISCUSSION
Marksman has asserted claims against the defendants under section 10(b) of the Securities Exchange Act of 1934 (“the 1934 Act”), 15 U.S.C. § 78j(b); Rule 10b-5 promulgated by the Securities and Exchange Commission, 17 C.F.R. § 240.10b-5; and Section 20(a) of the 1934 Act, 15 U.S.C. § 78t(a), all of which provide liability for deceptive conduct in connection with the sale of securities.
In re Worlds of Wonder Securities Litigation,
In order to prove a violation under Section 10(b) and Rule 10b-5, a plaintiff must show:
(1) a misrepresentation or omission or other fraudulent device; (2) a purchase or sale of securities in connection with the fraudulent device; (3) scienter by defendant in making the misrepresentation or omission; (4) materiality of the misrepresentation or omission; 5) justifiable reliance on the fraudulent device by plaintiff (or due diligence against it); and (6) damages resulting from the fraudulent device.
E.g., Warren v. Reserve Fund, Inc.,
Marksman’s complaint does not make any allegations of specific reliance on any misrepresentations and indicates that the action is brought on a “fraud-on-the-market” theory. Complaint, ¶ 23. In a Section 10(b) and Rule 10b-5 action brought on a fraud-on-the-market theory, the plaintiff claims that he was induced to trade stock not by any particular representations made by corporate insiders, but by the artificial stock price set by the market in light of statements made by the insiders as well as other material public information.
In re Apple Computer Securities Litigation,
Defendants raise three arguments in their motion to dismiss: 1) Marksman has failed to state a claim for securities fraud insofar as it has failed to allege the false or misleading material statement(s) or omission(s) on the part of defendants essential for a Section 10(b) and Rule 10b-5 violation; 2) Marksman has failed to satisfy the heightened pleading standard for scienter applicable to securities fraud actions brought under Section 10(b) and Rule 10b — 5; and 3) in the absence of a cognizable Section 10(b) and Rule 10b-5 violation, Marksman has failed to state a claim against Burnison as a “controlling party” under Section 20(a) of the 1934 Act.
A. Allegation of a Material Misrepresentation or Omission
1. Rule 12(b)(6) Standard
Under Federal Rule of Civil Procedure 12(b)(6), a party may bring a motion to dismiss the plaintiffs claims on the grounds that they “fail to state a claim upon which relief can be granted.” Fed.R.Civ.P. 12(b)(6). A court reviewing a Rule 12(b)(6) motion must assess whether the facts alleged, if true, would entitle plaintiff to some form of legal remedy.
De La Cruz v. Tormey,
2. Misrepresentation
Marksman’s complaint alleges that defendants reported earnings on the sales of Ethocyn to Stanson before such reporting was permitted under generally accepted accounting standards, which had the effect of inflating Chantal’s income and artificially increasing its stock value. Generally Accepted Accounting Principles (“GAAP”) are the conventions, rules, and procedures that constitute the professional standards of the accounting profession.
United States v. Arthur Young & Co.,
Statement of Financial Accounting Standards No. 48 (“SFAS 48”) provides that when an enterprise sells its products with a right of return, the seller may not recognize revenue from the sale until the right of return has expired unless “[t]he buyer acquiring the product for resale has economic substance apart from that provided by the seller.”
2
Statement of Financial Accounting Standards No. 48 ¶ 6 (Fin. Accounting Standards Bd.1981) (hereinafter “SFAS 48”). In addition, SFAS 48 prohibits the immediate recognition of revenue on sales made with a right of return when the seller has no reasonable means to estimate future returns.
Id.
A company in these circumstances should not recognize any sales revenue until either: 1) the right of return has substantially expired, or 2) the company has become capable of making a
A company’s overstatement of revenues from what is essentially a consignment sale in violation of SFAS 48 can constitute a false or misleading statement of material fact necessary to establish a Section 10(b) and Rule 10b-5 violation.
Malone,
Marksman’s allegations fit the criteria identified in SFAS 48 for determining that a sales transaction is not appropriate for immediate revenue recognition. See SFAS 48 ¶ 6, 8. Defendants make no effort to contest these allegations or to rebut the contention that the immediate reporting of income was violative of SFAS 48. Assuming the allegations of the complaint are true, therefore, the immediate recognition of revenues on the sales to Stanson was improper under GAAP. 3 As a result, defendants’ alleged statements relying on such accounting methods, i.e., the July 24, 1995 statement regarding earnings, the September 27, 1995 statement regarding earnings, the October 27, 1995 Form 10-K, the November, 14, 1995 Form 10-Q, and the December, 29, 1995 Registration Statement and Prospectus, constituted false and misleading statements within the scope of the 1934 Act.
3. Materiality
Materially misleading statements or omissions by a defendant constitute the primary element of a Section 10(b) and Rule 10b-5 cause of action.
Basic Inc.,
In this case, the Court simply cannot say as a matter of law that the misrepresentation alleged was not “material.” Overstatement of revenues in violation of GAAP can constitute a material misrepresentation that gives rise to an action for securities fraud.
See In re Gupta Corp. Securities Litigation,
4. Was the Misrepresentation Cured by Disclosure of the Marketing Agreement?
Defendants maintain that there can be no actionable material misrepresentation or fraud in this case because the relevant information was actually disclosed to the market, in the form of the addendum of the marketing agreement to the Form 10-K. In essence, defendants believe that the disclosure of the marketing agreement as a discrete exhibit to the Form 10-K provided investors with a “complete and accurate rendering of all relevant information” concerning Chantal’s financial situation. Reply, 15.
In a fraud-on-the-market case, the misleading effect of materially false information may be cured if the accurate information is otherwise transmitted to the public. In order to avoid Section 10(b) and Rule 10b-5 liability, however, the disclosure must be made with a “degree of intensity and credibility sufficient to effectively counterbalance any misleading impression created by the [defendants’] one-sided representations.”
In re Apple Computer,
Further, defendants’ contention that the addendum disclosure in the Form 10-K was sufficient to put the market on notice of the accounting methods used and their potential impropriety is unaccompanied by any plausible explanation of how a reasonable investor could draw such a conclusion.
Cf. Virginia Bankshares, Inc. v. Sandberg,
The Court cannot agree with defendants that the release of an inconspicuous addendum renders misleading financial and other public statements presumptively consistent with the strictures of Section 10(b) and Rule 10b-5, especially where it is unclear that the contents of the addendum directly address the allegedly misleading information in the statements.
See Virginia Bankshares,
Because the Court concludes that Marksman has alleged facts sufficient to allow reasonable minds to disagree about whether the statements made here were misleading, dismissal is not warranted on the grounds that Marksman has failed to allege a material misrepresentation or omission.
B. Has Scienter Been Adequately Pled?
1. Rule 9(b) Requirements
Under Federal Rule of Civil Procedure 9(b), in a securities fraud action, a pleading is sufficient if it identifies the circumstances of the alleged fraud so that the defendant can prepare an adequate answer.
7
Fecht,
Although defendants’ motion is ostensibly brought, in part, under Rule 9(b), defendants do not specifically argue that the complaint falls short of the requirements of Rule 9(b) itself. In any event, the Court is satisfied that the complaint highlights in sufficient detail the precise dates, manner, content, and nature of the statements alleged to be fraudulent or misleading.
See, e.g., Ross v. A.H. Robins Co.,
2. The Private Securities Litigation Reform Act’s Heightened Pleading Standard
As defendants point out, under the very recent Private Securities Litigation Reform Act of 1995 (“PSLRA”), Public Law 104-67 (codified at 15 U.S.C. § 78u-4 (1995)), which amends the Securities Exchange Act of 1934, 8 the pleading standard in securities fraud cases has been made more rigorous, beyond mere Rule 9(b) requirements. A complaint alleging securities fraud must “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 the facts on which that belief is formed.” 15 U.S.C. § 78u-4(b)(1), Pub.L. No. 104-67 § 21D(b)(1). Moreover, in order to sufficiently allege scienter the complaint must now “state with particularity facts giving rise to a strong inference that the defendant acted with the requisite state of mind.” 15 U.S.C. § 78u-4(b)(2), Pub.L. No. 104-67 § 21D(b)(2). If the complaint fails to do so, dismissal is required. 15 U.S.C. § 78u-4(b)(3)(A), Pub.L. No. 104-67 § 21D(b)(3)(A).
Under pre-PSLRA Ninth Circuit authority, a plaintiff could plead scienter with conclusory allegations so long as the complaint set forth the circumstances indicating the fraudulent nature of the statements.
GlenFed,
a. The “Motive and Opportunity” Test
Defendants argue that the PSLRA has rejected the Second Circuit’s “motive and opportunity” test for pleading scienter along with more lenient standards like the GlenFed rule. Defendants contend that “Congress necessarily had to eliminate the ‘motive and opportunity’ analysis if it wanted to strengthen the standard for pleading scienter.” Reply, 5. Defendants make the argument that the “motive and opportunity” test would subject every corporate defendant to securities fraud actions every time there is a downturn in stock value, since every corporate issuer of a security that is the subject of a claimed misstatement has the “opportunity” to make the misstatement and a “motive” to sell its stock at a higher price. Id.
Although defendants cite no recent cases to support their contention, 10 and the body of the PSLRA contains no references to the “motive and opportunity” test, defendants point to the legislative history of the statute. In its Conference Report, the conference committee emphasized that it was strengthening existing pleading requirements, and therefore did not intend to codify the Second Circuit’s case law interpreting the scienter pleading standard. H.R. Conf. Rep. 104-369, 104th Cong., 1st Sess., 41 (1995), U.S.Code Cong. & Admin.News at 740.
The Court confronts an issue of first impression, given the very recent passage of the PSLRA, and thus finds itself compelled to resolve the issue without the aid of any pronouncements from sister courts. Ultimately, however, the Court believes that the “motive and opportunity” test has not been discarded. Notwithstanding defendants’ citation to the legislative history, a number of considerations militate against their argument.
First, the conference committee emphasized that the Second Circuit’s pleading standards were the most stringent of any circuit’s, and thus it is reasonable to assume that Second Circuit jurisprudence comes closest to approximating the PSLRA’s new requirements.
See id.
It is worthy of note that the language used by the PSLRA to articulate its scienter pleading standard,
i.e.,
“strong inference,” mirrors language traditionally employed by the Second Circuit in its application of Rule 9(b) to scienter pleadings.
E.g., Shields,
The Court is unimpressed with defendants’ enthusiastic reliance on an oblique reference to “motive, opportunity and recklessness” in a footnote to the Conference Committee Report for their argument that the “motive and opportunity” test has been jettisoned.
11
The footnote, embedded as it is in the legislative history and not the body of the statute, implies that Congress chose not to codify motive and opportunity as pleading requirements but does not indicate that Congress chose to specifically disapprove the motive and opportunity test. The Court has little doubt that when Congress wishes to supplant a judicially-created rule it knows how to do so explicitly, and in the body of the statute.
See
42 U.S.C. § 2000bb(a)-(b) (Religious Freedom Restoration Act’s (“RFRA”) declaration of purpose);
Muslim v. Frame,
Moreover, the “motive and opportunity” test does not appear to present a barrier to the achievement of Congress’s clear purpose of making scienter allegations more difficult to plead. The test itself is an exacting analysis courts have employed to assess whether the quantum and quality of factual allegations in the complaint,
beyond
mere allegations that a material misrepresentation occurred, actually create an inference that a defendant acted with an intent to defraud. There is no reason to assume that the PSLRA’s requirement that the inference now be a “strong” one is inconsistent with the test’s analytic framework for sifting through factual allegations.
See
H.R.Conf.Rep. 104-369, 41, U.S.Code Cong.
&
Admin.News at 740 (noting that Congress intended to strengthen
existing
pleading requirements). On the contrary, the fact that Second Circuit courts applying the “motive and opportunity” test have traditionally done so with the express recognition that the plaintiffs allegations must yield a “strong” inference of fraudulent intent supports the conclusion that the test is wholly consistent with the PSLRA’s standard.
E.g., Shields,
In this regard, the Court finds instructive a portion of the legislative history not referred to by defendants. In its report on the passage of the PSLRA, the Senate Banking, Housing, and Urban Affairs Committee articulated its position that the new pleading standard is derivative of prior Second Circuit jurisprudence in securities fraud cases:
The Committee does not adopt a new and untested pleading standard that would generate additional litigation. Instead, the Committee chose a uniform standard modelled upon the pleading standard of the Second Circuit. Regarded as the most stringent pleading standard, the Second Circuit requires that the plaintiff plead facts that give rise to a “strong inference” of defendant’s fraudulent intent. The Committee does not intend to codify the Second Circuit’s caselaw interpreting this pleading standard, although courts may find this body of law instructive.
S.Rep. No. 98, 104th Cong., 1st Sess., 15 (1995), U.S.Code Cong. & Admin.News at 694. The Conference Committee report confirms this understanding of the Act’s derivative nature. H.R. Conf. Rep. 104-369, 41, U.S.Code Cong. & Admin.News at 740 (stating that “[t]he Conference Committee language is based in part on the pleading standard of the Second Circuit”).
On balance, therefore, the Court finds itself unpersuaded by defendants’ interpretation of the PSLRA. As the discussion above makes clear, there is no basis to conclude that Congress eradicated,
sub silentio,
the
b. Marksman Has Successfully Pled Motive and Opportunity
Marksman contends that Burnison and Chantal engaged in deceptive conduct in order to: 1) enhance the value of Chantal stock; 2) complete a substantial private placement of Chantal common stock; 3) protect and enhance Burnison’s executive position and the compensation and prestige she held thereby; and 4) sell a substantial portion of Burnison’s stock holdings at artificially inflated prices. Complaint, ¶ 15. There is no question about Chantal and Burnison’s “opportunity” to carry out the means,
ie.,
misrepresentations about Chantal’s financial performance to the public, necessary to accomplish these benefits.
See Shields,
The “motive” prong is a little less clear, however. Substantial authority exists to indicate that the first three of Marksman’s alleged “motives” are insufficient in themselves to sustain a strong inference of intent to defraud. In
Acito v. IMCERA Group, Inc.,
The last “motive” allegation made by Marksman, however, is sufficient to constitute a basis for the scienter element of a Section 10(b) and Rule 10b-5 claim. Allegations that a corporate insider either presented materially false information, or delayed disclosing materially adverse information, in order to sell personally-held stock at a huge profit can supply the requisite “motive” for a scienter allegation.
See Acito,
Where a corporate insider sells only a small fraction of his or her shares in the corporation, the inference of scienter is weakened.
Acito,
Twenty percent of a corporate insider’s shares, especially where the dollar amounts involved are high, may constitute a “suspicious amount” sufficient to support a scienter allegation.
See Alfus,
The allegations of the complaint establish, therefore, that defendants had both the “opportunity” and the “motive” to issue materially fraudulent statements to investors regarding Chantal’s financial performance. The complaint’s theory of “motive” and “opportunity” is consistent with the relevant events alleged, i.e., the defendants’ extreme overstatement of revenues on the only product marketed by Chantal, the unprecedented rise in Chantal’s stock value, and Burnison’s subsequent large-volume insider trading. As a result, the Court finds that Marksman has sufficiently pled facts giving rise to a “strong inference” of scienter under the “motive and opportunity” test.
c. Strong Circumstantial Evidence of Conscious Behavior or Recklessness
Even assuming,
arguendo,
that the “motive and opportunity” test does not yield the requisite “strong inference,” Marksman may still successfully plead a strong inference of scienter under the Second Circuit’s “circumstantial evidence” test.
Glickman,
If the “circumstantial evidence” method is used, the strength of the circumstantial allegations must be correspondingly greater.
Id.
(citing
Beck v. Manufacturers Hanover Trust Co.,
As stated above, defendants here controlled and approved the issuance of accounting and financial statements for Chantal Pharmaceutical Corp. during the relevant periods, and had direct access to information concerning Chantal’s financial conditions and operations. According to the complaint, Chantal’s July 24, 1995 and September 27, 1995 statements about earnings, the recorded sales for the final quarter of fiscal 1995 contained in the Form 10-K statement, the November 14, 1995 Form 10-Q, and the December 29, 1995 Registration Statement and Prospectus were all materially false and misleading in that they relied in large part on earnings assessments made in violation of SFAS 48. According to the complaint, the earnings assessments derived from the Stan-son agreement constituted a significant share of Chantal’s total earnings for the last quarter of 1995. The facts that the allegedly overstated revenues constituted such a significant portion of Chantal’s total revenues and that the allegedly misleading financial and other public statements bore defendants’ imprimatur tend to support the conclusion that the defendants acted with scienter. In addition, the allegations that Burnison divested herself of a substantial portion of her shares at a considerable profit and that Chantal completed a substantial private placement of its stock following the rise in Chantal’s stock value, which was allegedly precipitated by the fraudulent disclosures, strongly support the conclusion that defendants’ misstatements of revenues and earnings were made with either a specific or reckless intent to defraud. 13
Defendants pose an argument that they believe negates the inference from the circumstances alleged: they contend that Burnison’s actions in the overall sequence of events do not support a strong inference of fraudulent intent because she sold her shares
after
disclosure of the terms of the marketing agreement.
See, e.g., Ferber v. Travelers Corp.,
Even assuming, arguendo, that the manner in which defendants disclosed the marketing agreement was presumptively sufficient to put investors on notice of its terms (a conclusion that the Court does not accept, supra), defendants’ argument still lacks merit. The Court has no basis to conclude that the marketing agreement itself explained the manner in which Chantal would recognize revenues on the sales to Stanson. In addition, neither the Form 10-K nor the audited financial statements released by defendants discussed the existence of the marketing agreement or the fact that the agreement covered revenues recorded and recognized prior to the end of the fiscal year. Complaint, ¶ 53. As a result, defendants’ disclosure of the agreement does not support the conclusion that they intended to dispel the allegedly misleading effect of the financial statements. It also, therefore, does not negate the inference that defendants made the material misstatements with either a specific or reckless intent to defraud.
Although the Court is not in a position to determine on the instant motion that defendants’ conduct did indeed constitute a Section 10(b) and Rule 10b-5 violation, the circumstances alleged by plaintiff are certainly sufficient to allow a strong inference either that defendants were acting with a specifically deceptive and manipulative intent, or at least that their conduct constituted such an extreme departure from the standards of ordinary care regarding the danger of misleading investors as to constitute recklessness. Taking Marksman’s particularized factual allegations as true, the Court finds that the complaint successfully creates a “strong inference” of scienter. Dismissal is therefore not warranted.
C. Controlling Person Liability
Section 20(a) of the 1934 Securities Act imposes joint and several liability on any “person who, directly or indirectly, controls any person liable” for securities fraud under the Act,'“unless the controlling person acted in good faith and did not directly or indirectly induce” the violations. 15 U.S.C. § 78t(a);
In re Gupta Corp.,
Defendants’ motion to dismiss the claim for “controlling person” liability against Burnison under Section 20(a) of the 1934 Act is brought under Rule 12(b)(6), on the sole basis that there can be no Section 20(a) liability where a plaintiff has failed to state a claim under Section 10(b) and Rule 10b-5. Motion, 16. As the Court’s decision above is that Marksman has sufficiently stated such a claim, this is not a valid basis for dismissal. In addition, the Court is satisfied that the complaint has sufficiently stated a claim for controlling person liability. Marksman’s claim is made against Chantal Burnison in her capacity as Chairman of the Board, Chief Executive Officer, and Principal Financial and Accounting Officer of Chantal Pharmaceutical Corp. Complaint, ¶ 87. Marksman’s complaint adequately alleges Bumison’s “actual participation in the corporation’s operation [and] influence” such that the consequences of control may be imposed.
See Burgess v. Premier Corp.,
D. Motion for Certification
On April 19,1996, shortly after the motion to dismiss came on for hearing, defendants moved for certification of the Court’s order of decision for interlocutory appeal under 28 U.S.C. § 1292(b). The Court finds that the hereinabove order involves a “controlling question of law as to which there is substantial ground for difference of opinion and that an immediate appeal from the order may materially advance the ultimate termination of the litigation.” 28 U.S.C. § 1292(b);
see Goodyear Tire & Rubber v. McDonnell Douglas Corp.,
CONCLUSION
For the foregoing reasons, it is the Court’s decision that defendants’ motion to dismiss be denied in its entirety. Defendants’ motion for certification is hereby granted.
IT IS SO ORDERED.
Notes
. A consignment sale is one in which goods are delivered by a consignor to a dealer or distributor (the consignee) primarily for sale by the consignee, and the consignee has the right to return any unsold commercial units of the goods in lieu of payment. Malone v. Microdyne Corp., 26 F.3d 471, 476 n. 6 (4th Cir.1994). Because a product return cancels the sale, any sale made with the right of return creates doubt about whether the transaction actually constitutes an exchange. Dennis Kremer, Revenue Recognition (PLI Litig. & Admin. Practice Course Handbook Series, 1984).
. According to SFAS 48, this characterization applies primarily to
buyers that exist 'on paper,’ that is buyers that have little or no physical facilities or employees. It prevents enterprises from recognizing sales revenue on transactions with parties that the sellers have established primarily for the purpose of recognizing such sales revenue.
Statement of Financial Accounting Standards No. 48 ¶ 6 n. 2 (Fin. Accounting Standards Bd. 1981).
. Marksman also alleges that Chantal’s statements violated SFAS 57, which governs "related party transactions.” See SFAS 57. According to Marksman, the buyout options between Chantal and Stanson created a "related party” situation between Chantal and Stanson, whereby "one party controls or can significantly influence the management or operating policies of the other to an extent that one of the transacting parties might be prevented from fully pursuing its own separate interests.” Complaint ¶ 79 (quoting SFAS No. 57 ¶ 24(e)). According to the complaint, defendants failed to make any specific disclosure that the Stanson marketing agreement constituted a "related party” transaction, as SFAS 57 requires. Id. ¶ 77. Because the alleged violations of SFAS 48 at issue here are sufficient to constitute the misrepresentations required for a Section 10(b) and Rule 10b-5 violation, the Court need not address the alleged violations of SFAS 57.
. As an initial matter, a statement in the Form 10-K highlighted by defendants that there was a potential "concentration of credit risk" with respect to receivables owed by Stanson does not
. Under SEC regulations, for example, a material deviation from GAAP on the face of financial statements will be presumed to be misleading despite footnotes or other disclosures to the statements. 17 C.F.R. § 210.4-01(a)(l).
. It is true that a defendant may sometimes be able to rebut the presumption of reliance in a fraud-on-the-market action under Section 10(b) and Rule 10b-5 by showing that sophisticated buyers, or "market makers,” were not taken in by the misrepresentations at issue,
Cione v. Gorr,
. Rule 9(b) states that
[i]n all averments of fraud or mistake, the circumstances constituting fraud or mistake shall be stated with particularity. Malice, intent, knowledge, and other condition of mind of a person may be averred generally.
Fed.R.Civ.P. 9(b).
. Congress passed the PSLRA on December 22, 1995.
. Defendants propose, without substantial argument, that the PSLRA has abolished securities fraud liability for merely reckless conduct. The Court does not agree. First, defendants’ suggestion that strengthening the pleading standard for scienter must necessarily result in a change to the nature of the scienter required makes little sense. Second, while it is true that the PSLRA elevates the mental state requirement to “actual knowledge” for certain specified situations, the Court finds no basis to conclude that Congress altered the mental state requirement for the type of Section 10(b) and Rule 10b-5 violation at issue in this case.
First, although the PSLRA provides a “safe harbor” for certain "forward-looking statements,” requiring that a plaintiff must prove actual knowledge of falsity in order to establish liability for such statements, 15 U.S.C. § 77z-2, Pub.L. No. 104-67, § 21E(c), the misrepresentations alleged in this case, with the possible exception of Bumison’s July 24, 1995 statement, do not fall within the category of "forward-looking statements.” Second, the PSLRA’s provision that joint and several liability may only be imposed on a person who "knowingly committed” a violation of the securities laws is expressly limited so as not to "creaté, affect, or in any manner modify, the standard for liability associated with any action arising under the securities laws.” 15 U.S.C. § 78u-4(g)(1)-(10) (emphasis added).
The legislative history of the PSLRA does not indicate that Congress acted to eliminate recklessness as a basis for scienter in actions like the instant one. The version of the bill originally adopted by the House expressly provided for liability based on reckless conduct,
see
H.R. 1058, 104th Cong., 1st Sess. (1995), U.S.Code Cong. & Admin.News 1995 at 679, and contained a definition of recklessness based largely on the Seventh Circuit's decision in
Sundstrand Corp. v. Sun Chemical Corp.,
Admittedly, the text and legislative history of the PSLRA indicate some ambivalence on the part of Congress regarding recklessness liability in securities fraud cases. At least one commentator has observed that Congress appears to have “studiously avoided” the question, preferring instead to leave it to judicial resolution. Avery, Securities Litigation Reform, 51 Bus. Law at 337, 369-371. Legislative silence, however, does not give the Court grounds to conclude that recklessness is no longer an adequate basis to establish scienter for the violation alleged here.
. The Court notes that at least two of the cases proffered by defendants,
Glickman v. Alexander & Alexander Services, Inc.,
. The text accompanying the footnote states that "[b]ecause the Conference Committee intends to strengthen existing pleading requirements, it does not intend to codify the Second Circuit’s case law interpreting this pleading standard,” and the footnote itself states that "[flor this reason, the Conference Report chose not to include in the pleading standard certain language relating to motive, opportunity, or recklessness.” H.R. Conf. Rep. 104-369, 41 & n. 23, U.S.Code Cong. & Admin.News at 740 & n. 23.
. According to the complaint, the public statements at issue were made by Burnison, and at least two of the allegedly misleading financial statements were signed personally by Burnison. Complaint, ¶ 53-54.
. The fact that Chantal’s independent auditor may have approved the accounting methods will not shield Chantal from liability for deception such methods may have caused.
See In re Chambers,
. Although not perfectly coextensive, the Financial Accounting Standards of GAAP and the anti-fraud rules promulgated pursuant to § 10(b) of the 1934 Securities Act serve similar purposes, and some courts have treated violations of the former as indicative that the latter were also violated.
Malone,