Opinion
99 Civ. 9938 (JSM)
October 4, 2000
For Plaintiffs, Keith M. Fleischman, Samuel H. Rudman, Cary L. Talbot, Milberg Weiss Bershad Hynes Lerach.
For Plaintiffs, Sandy A. Liebhard, Jeffrey M. Haber, Bernstein Liebhard Lifshitz.
For Plaintiffs, Fred T. Isquith Shane T. Rowley Wolf Haldenstein Adler Freeman Herz. 10016
For Plaintiff, Law Offices of Lawrence G. Soicher, Brian S. Barry, Law Offices of Brian S. Barry.
For Plaintiff, Lionel Z. Glancey Law Offices of Lionel Z. Glancey.
For Defendants, Mitchell A. Lowenthal Boaz S. Moag Kurt A. Mayr Cleary, Gottheb, Steen Hamilton.
For Defendants, Daniel A. Pollack Martin I. Kaminsky Pollack Kaminsky.
MEMORANDUM OPINION AND ORDER
In this securities fraud class action, Defendants move to dismiss on the ground that the complaint fails to satisfy the pleading requirements of the Private Securities Litigation Reform Act ("PSLPA"). The motion is granted.
Plaintiffs seek to represent a class of people who purchased the stock of Ogden Corporation ("Ogden") between March 11, 1999 and September 17, 1999. The March 11 date is significant because on that date Ogden announced plans to split itself into two separated companies, one combining its Entertainment and Aviation Divisions and the other containing its Energy Division. On September 17 Ogden announced that it would not be splitting up, that it was taking certain accounting write-offs, and that it was ceasing payments of its cash dividend. Not surprisingly, the announcement of September 17 caused a substantial drop in the price of Ogden's stock.
The principal claims in the amended complaint are that the defendants, the company and three of its principal officers, knew on March 11 that (1) the split-up of the company could not take place because the Entertainment and Aviation Divisions were too small and financially constrained to operate independently and (2) the Company should write-down at least $28.8 million in assets.
The PSLRA provides that
[i]n any private action arising under this chapter in which the plaintiff may recover money damages only on proof that the defendant acted with a particular state of mind, the complaint shall, with respect to each act or omission alleged to violate this chapter, state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind.15 U.S.C. § 78u-4 (b)(2).
The impact of this legislation on the pleading requirements in securities fraud cases such as this was carefully analyzed in the recent opinion of Judge Walker in Novak v. Kasaks, 216 F.3d 300 (2d Cir. 2000). In Novak, Judge Walker reviewed the history of the PSLRA and the cases in this circuit concerning the pleading requirements in securities fraud cases and concluded:
[P]laintiffs must allege facts that give rise to a strong inference of fraudulent intent. "The requisite `strong inference' of fraud may be established either (a) by alleging facts to show that defendants had both motive and opportunity to commit fraud, or (b) by alleging facts that constitute strong circumstantial evidence of conscious misbehavior or recklessness." Acito, 47 F.3d at 52 (quoting Shields, 25 F.3d at 1128) (internal citations omitted). However, this statement of the standard conceals the complexity and uncertainty that often surround its application. This difficulty in application stems, at least in part, from the "inevitable tension" between the interests in deterring securities fraud and deterring strike suits.
In this case Plaintiffs attempt to meet the first of the above standards by alleging that the defendants' motive for the frauds was their desire (1) to appear to be responding to an announced challenge to management by a large shareholder that had nominated its own slate of directors and (2) to use the stock of the company to make acquisitions. The problem with the first argument is that the proxy fight occurred almost a year before the period in which it is alleged the fraud took place and the insurgent lost the battle.
While the desire to inflate the price of stock to increase its value in making acquisitions may in some circumstances be sufficient to establish a motive for fraud, see Rothman v. Gregor, 220 F.3d 81, 93 (2d Cir. 2000), plaintiff's argument fails because the acquisitions for which the stock was issued occurred prior to the commencement of the class period and, therefore, the desire to make those acquisitions could not have been the motivation for the false statements allegedly made during the class period. For example, the principal false statement alleged is the statement that the company would split itself into two parts. Since this announcement was made on March 11, 1999, it could not have been motivated by a desire to increase the stock price for acquisitions that had already been completed.
Even if the stock acquisitions had occurred after the beginning of the class period, the complaint does not contain facts demonstrating that these acquisitions were so substantial and important to the company that they would have motivated its principal officers to commit fraud. The complaint also refers to other acquisitions made during the same year where no stock was used and there is no reason to believe that the use of stock was essential to the acquisition program.
As Judge Walker observed in Novak:
Plaintiffs could not proceed based on motives possessed by virtually all corporate insiders, including: (1) the desire to maintain a high corporate credit rating, see San Leandro Emergency Med. Group Profit Sharing Plan v. Philip Morris Cos., Inc., 75 F.3d 801, 814 (2d Cir. 1996), or otherwise sustain "the appearance of corporate profitability, or of the success of an investment," Chill, 101 F.3d at 268; and (2) the desire to maintain a high stock price in order to increase executive compensation, see Acito, 47 F.3d at 54, or prolong the benefits of holding corporate office, see Shields, 25 F.3d at 1130. Rather, plaintiffs had to allege that defendants benefitted in some concrete and personal way from the purported fraud.216 F.3d at 307-08 (emphasis added). The amended complaint in this case does not allege the type of personal benefit to the individual defendants that would give rise to a strong inference of an intent to defraud.
The question that remains is whether the amended complaint can be sustained because it alleges facts that constitute strong circumstantial evidence of conscious misbehavior or recklessness.
With respect to the announcement that the company planned to split itself into two parts, the plaintiffs argue that evidence of an intent to defraud is found in the fact that on the day after the company announced that the spin-off of the Entertainment and Aviation Divisions would not take place, the company's new president stated that these divisions were "too small and financially constrained" to operate as a stand-alone company. However, the March 11 announcement said that the company was exploring ways to spin-off the two divisions and had retained Goldman Sachs to advise it in this regard. The fact that the company abandoned these plans after a period of review with its outside expert is no evidence that the company's original statement of its intention was fraudulent. Indeed, the fact that the company announced that it was hiring an expert to assist it with the plan is evidence that the company's officers did not have sufficient expertise to finalize a judgment on the proposed spin-off and should have put the public on notice that the plans might change after the experts had adequate time to study the proposal. Thus, the amended complaint's allegations concerning the announcement that the company intended to split itself into two parts do not give rise to a "strong inference" that the defendants acted with fraudulent intent.
Similarly, the allegations concerning the company's delay in writing off $28.8 million in assets do not give rise to a "strong inference" of fraudulent intent. The defendants argue that the failure to write off these assets did not make the company's financial statements false because the company had $4 billion in assets and annual revenues of approximately $2 billion. While Plaintiffs argue that the issue of materiality of the false statements is an issue of fact to be decided by the jury, the Court need not decide that issue because even if the plaintiffs are correct that the financial statements were false in a material respect, the amended complaint does not establish that the defendants acted with fraudulent intent.
In considering whether the amended complaint alleges facts "giving rise to a strong inference" that the defendants acted with fraudulent intent, it is important to consider how significant the dollar value of the write-off s was compared to the total assets and revenue of the company. While the failure to write off assets that would clearly be material to the company's financial statements might by itself be enough to give rise to an inference of fraudulent intent on the part of the corporate officers, where, as here, the assets in question amount to only a small fraction of the company's net worth, the mere fact that a proper application of General Accepted Accounting Principles ("GAAP") would have resulted in an earlier write-off does not provide any evidence that the senior corporate officers acted with fraudulent when they issued the financial statements in question. As Judge Walker noted in Novak:
allegations of GAAP violations or accounting irregularities, standing alone, are insufficient to state a securities fraud claim. See Stevelman, 174 F.3d at 84; Chill, 101 F.3d at 270. Only where such allegations are coupled with evidence of "corresponding fraudulent intent," Chill, 101 F.3d at 270, might they be sufficient.
While to the average citizen the $28.8 million in assets referred to in the amended complaint would appear to be material, no reasonable person could conclude from the facts alleged in the amended complaint that the three individual defendants, who were respectively the President, the Controller, and Chief Financial Officer, or anyone else in senior management of this $4 billion dollar company, focused on these assets and made a deliberate or reckless decision not to write them off when required.
For example, one of the write-offs that Plaintiffs allege to have been fraudulently deferred was the write-off of $4.2 million in connection with the sale of the company's Grizzly Nature Center. Plaintiffs refer to a September 28, 1999 press report in Billings, Montana, where the park was located, which stated that in July company officials had come to the park and told employees that if a suitable buyer was not found for the park it would be closed. However, there is no reason to believe that senior executives, such as the individual defendants, would have focused their attention on the Grizzly Nature Center, which had revenues of only $1 million, and recognized that when it was sold the company would have to take a $4.2 million write-off. Moreover, even if one assumed that in July 1999, the defendants came to realize that the write-off was required, nothing improper was done since the write-off was made in the financial statements for the third quarter, which ended September 30, 1999. Given the relatively insignificant nature of the Grizzly Nature Center to the total operations of the company, the company would not be expected to make a special announcement of a decision to sell the operation and the possibility that the sale would result in a write-off of some of its book value.
There is similarly no reason to conclude that anyone in senior management focused on the need to write off $6.5 million of contract acquisition costs for food concessions operated at the Great Western Forum and the U.S. Air Arena because new arenas were under construction in these areas and the teams playing in these venues had announced plans to move to the new sites. While the company was obviously aware that these new arenas were under construction and, indeed, announced in its annual report that it had been awarded the concessions contract for the Staples Center, which would effectively replace the Great Western forum, the amended complaint does not contain a single factual allegation that would suggest that anyone in the company focused on the impact that the opening of these new arenas would have on the company's existing concessions. Since the company had a total of $132,818,000 of such acquisition costs on its books, it cannot be assumed that the $6.5 million dollars of such costs associated with these two venues were brought to the attention of senior management.
There is similarly no evidence of fraudulent intent with respect to the largest single write-off referred to in the complaint, the forfeiture of a $10 million non-refundable deposit in connection with the termination of the planned acquisition of Volume Services of America, Inc. ("Volume Services") that the company announced on June 28, 1999. The problem with Plaintiffs's argument that the defendants fraudulently failed to write off the $10 million deposit Ogden paid to Volume Services is that it requires the Court to find that Ogden entered into the acquisition contract knowing that it would be unable to consummate the acquisition and would, therefore, forfeit its $10 million. The amended complaint offers no logical reason why any corporate officer would enter into such a transaction knowing that it would not be consummated. Indeed, the fact that the defendants entered into this contract containing a $10 million forfeiture provision is strong evidence that they did not recognize the problems that were confronting the company that ultimately lead to the abandonment of the spin-off plans and the other actions announced on September 17.
Before turning to the remaining write-offs alleged in the amended complaint to have been fraudulently delayed, it is significant to note that in addition to announcing that it would not be splitting up into two separate corporations and that it expected to report a loss for the third quarter, the company's September press release also announced that R. Richard Albon, the Chairman of the Board of Directors and Chief Executive of the company, had resigned all of his positions and the company had appointed a new chief executive officer. This fact is significant because it suggests that the decision to abandon certain lines of business and to write down other assets was the result of a fresh examination of the company's operations by new management rather than decisions that prior management knew to be necessary but fraudulently deferred.
The clearest examples of such challenged write-offs which the facts suggest resulted from the decision of new management are the write-offs of $2.1 million in connection with the termination of a casino joint venture in South Africa and a $2.5 million write-off in connection with the sale of a casino operation in Aruba. The amended complaint is devoid of any allegation relating to the South Africa casino other than that the write-off occurred in the third quartet of 1999. With respect to the Aruba casino, the complaint alleges only that its operations had been unprofitable in 1998 and 1999. The amended complaint contains no factual allegation that would suggest that, prior to the election of new management, anyone in the company had made a decision to terminate either of these casino projects or had any other reason to believe that the book value of these assets would ultimately be written down.
The final $3 million of allegedly concealed loses referred to in the amended complaint is an amount of loss that the company announced for the third quarter in its Ogden Environmental Services Division. While the amended complaint alleges that the company regularly shifted costs in this division from unprofitable to profitable contracts, even if true, that fact would not have any effect on the total profit or loss for the overall operation of the division. There are no facts alleged to support an inference that the $3 million loss in this division in the third quarter should have been recognized in an earlier period. Thus, there is no conceivable basis for an inference that the company and its principal officers acted with fraudulent intent with respect to this particular loss.
In sum, read in its entirety, the amended complaint does no more than paint a picture of a company run for years by an entrenched and not overly competent management, who when faced with shareholder discontent hired Goldman Sachs to advise them with respect to a plan to split up the company. It appears that as a result of Goldman Sachs' review of the companies operations, management learned that their plans for the company did not make economic sense and that painful changes had to be made in the companies operations. While these facts indicate that the company's management may have been negligent in not recognizing its problems earlier, the amended complaint is totally lacking in factual allegations "giving rise to a strong inference that the defendants acted with [scienter]." See SEC v. Price Waterhouse, 797 F. Supp. 1217, 1240 (S.D.N.Y. 1992). For that reason the complaint is dismissed.
In view of the fact that the amended complaint is the second pleading filed by the plaintiffs in this case and that the plaintiffs' opposition papers do not suggest the existence of any unpleaded fact that might ultimately sustain the complaint, Plaintiffs' application for leave to file an amended complaint is denied.
SO ORDERED.