Opinion
CIVIL ACTION NO. 1:06-CV-1151-ODE.
July 18, 2007
ORDER
This civil case is before the Court on Defendants' Motions to Dismiss [#49, 62] and Lead Plaintiff's Motion to Amend the Amended Complaint [#69]. Defendants contend that Plaintiffs have failed to plead their securities fraud claims against Defendants in accordance with the strict pleading requirements imposed by the Private Securities Litigation Reform Act of 1995 ("PSLRA"), 15 U.S.C §§ 78u- 4, 78u-5. Most compellingly, Defendants argue that Plaintiffs have failed to plead scienter with respect to Defendants individually in accordance with the PSLRA and the United States Supreme Court's recent decision in Tellabs, Inc. v. Makor Issues Rights, Ltd., ___ S.Ct. ___, 2007 WL 1773208 (June 21, 2007). For the following reasons, the Court DISMISSES as moot Defendants' first Motion to Dismiss [#49], GRANTS Defendants' second Motion to Dismiss [#62] and DENIES Lead Plaintiff's Motion to Amend the Amended Complaint [#69].
I. Factual and Procedural Background
Home Depot, Inc. ("Home Depot," "Defendant Home Depot") is a Delaware corporation with its principal place of business in Atlanta, Georgia. Home Depot operates over two thousand stores that sell building materials, home improvement, lawn and garden products, and a variety of installation services.
Robert L. Nardelli ("Nardelli," "Defendant Nardelli") was President and Chief Executive Officer ("CEO") of Home Depot from December 2000 through January 2007, and was Chairman of the Board at Home Depot from 2002 until his resignation. Defendant Carol B. Tomé ("Tomé," "Defendant Tomé") has been Executive Vice President and Chief Financial Officer ("CFO") of Home Depot since May 2001. Larry M. Mercer ("Mercer," "Defendant Mercer") was Home Depot's Executive Vice President of Store Operations during the class period, until he left the company in August 2002. Kenneth G. Langone ("Langone," "Defendant Langone"), a co-founder of Home Depot and a member of the company's Board of Directors, served as Home Depot's "Lead Director" throughout the class period. He was also a member of several Board of Directors' committees during the class period, including the Executive Committee and the Nominating and Corporate Governance Committee. Langone also served on the Audit Committee for fiscal year 2004. It is unclear whether he served on the Audit Committee throughout the class period. Berry R. Cox ("Cox," "Defendant Cox") was a member of Home Depot's Board of Directors from 1978 until 2005. From the beginning of the class period until August 2002, Cox served as the Chairman of Home Depot's Audit Committee. John L. Clendenin ("Clendenin," "Defendant Clendenin") succeeded Cox as Chairman of Home Depot's Audit Committee, filling that role from August 2002 through the end of the class period.
Plaintiffs, who are current or former Home Depot shareholders, filed five related putative class action complaints against Defendants in July 2006 alleging violations of federal securities laws by Defendants. In the complaints, Plaintiffs define the members of the putative class as all persons or entities that purchased Home Depot Stock between May 29, 2001, and February 22, 2005. Plaintiffs filed two separate Motions to Consolidate, To Be Appointed Lead Plaintiff, and for Approval of Lead Plaintiff's Selection of Lead Counsel [#10, 11] on July 11, 2006. On September 26, 2006, the Court preliminarily appointed Bucks County Retirement Board as Lead Plaintiff in these cases. Lead Plaintiff Bucks County Retirement Board is an institutional investor that transacted in Home Depot securities during the class period. As Lead Plaintiff, Bucks County Retirement Board filed an Amended Class Action Complaint [#57] on November 13, 2006.
Plaintiffs allege that, during the class period, Defendants artificially inflated Home Depot's financial results by implementing a company-wide scheme to process billions of dollars of fraudulent return-to-vendor ("RTV") chargebacks. Plaintiffs describe the fraudulent RTV chargeback scheme as follows.
According to Plaintiffs, prior to and during the class period, Home Depot entered into vendor agreements with the vendors of the products it sold in its retail stores. These vendor agreements provided for Home Depot to receive a credit or "chargeback" from the vendor when products supplied by the vendor were damaged or defective. This type of chargeback is commonly referred to as a "RTV chargeback" in the retail industry.
Home Depot's vendor agreements differed with each vendor. However, Plaintiffs allege that Home Depot's vendor agreements commonly included "destroy-in-field" provisions that allowed Home Depot to process certain RTV chargebacks for defective or damaged merchandise at each Home Depot store. Specifically, the destroy-in-field provisions in the vendor agreements authorized each Home Depot store to destroy a certain amount of damaged or defective merchandise at the store without returning the merchandise to the vendor as proof of the product's damaged or defective status. According to the terms of the destroy-in-field provisions, vendors then reimbursed Home Depot for damaged or defective merchandise destroyed at the store level.
The destroy-in-field provisions in many vendor agreements related to the total value of the merchandise destroyed. For example, some vendors allotted a certain dollar amount per month to Home Depot for defective products. The vendor would allow Home Depot to destroy as many defective products as added up to the allotted value each month, and Home Depot would be reimbursed for the defective merchandise. Other vendors allowed Home Depot to destroy an unlimited number of defective small items (for example, those under $25.00 in value) in the field without returning the defective items to the vendor.
Plaintiffs allege that Defendants abused this RTV chargeback system. Plaintiffs assert that Defendants had a practice of requiring their retail stores to claim the maximum amount allowable from each vendor under each vendor's destroy-in-field provision, regardless of whether the merchandise Defendants received from that vendor was actually defective or whether the merchandise had been lost or stolen. According to Plaintiffs, Defendants' fraudulent RTV chargeback practices inflated sales figures, which in turn inflated Home Depot's overall financial performance figures.
Plaintiffs contend that during the class period Defendants' fraudulent RTV chargeback practices enabled Defendant Home Depot to meet or exceed the earnings targets set for it by industry analysts. Plaintiffs assert that the fraud was pervasive within Home Depot, that the individual Defendants knew about the fraud, and that Defendants issued false and misleading statements regarding Home Depot's financial performance and condition that relied upon the fraudulently inflated earnings figures. Plaintiffs allege that this resulted in artificially inflated stock prices and misled investors such as Plaintiffs, who purchased stock during the period in which the allegedly fraudulent RTV chargebacks were ongoing.
Based on these allegations, Plaintiffs assert two causes of action in the Amended Complaint. First, Plaintiffs claim that all Defendants violated section 10(b) of the Exchange Act, 15 U.S.C. § 78j(b), and Rule 10b-5 promulgated thereunder by carrying out a plan, scheme and course of conduct that was intended to and did deceive the investing public, artificially inflated the price of Home Depot securities, and caused Plaintiffs to purchase those securities at artificially inflated prices. Second, Plaintiffs assert that the individual Defendants violated section 20(a) of the Exchange Act, 15 U.S.C. § 78t(a), because they were controlling persons at Home Depot who knew about the fraudulent RTV chargeback scheme and aided and abetted the company's violation of section 10(b) of the Exchange Act, 15 U.S.C. § 78j(b), and Rule 10b-5 promulgated thereunder.
II. Defendants' First Motion to Dismiss [#49]
Defendants filed their first Motion to Dismiss [#49] on October 11, 2006. On November 13, 2006, Plaintiffs filed the Amended Class Action Complaint [#57]. Defendants filed their second Motion to Dismiss [#62] on December 13, 2006. In Defendants' second Motion to Dismiss, Defendants assert that Plaintiffs' Amended Class Action Complaint is an attempt to cure conceded deficiencies in the original complaints. Nonetheless, Defendants direct the arguments in the second Motion to Dismiss towards Plaintiffs' Amended Class Action Complaint.
The Court finds that Defendants have acceded to Plaintiffs' filing of the Amended Class Action Complaint. Consequently, Plaintiffs' Amended Class Action Complaint supersedes the original complaints. The Court DISMISSES as moot Defendants' first Motion to Dismiss [#49] addressing the original complaints.
III. Defendants' Second Motion to Dismiss [#62]
In their second Motion to Dismiss, Defendants argue that Plaintiffs' amended complaint fails to state a claim under Federal Rule of Civil Procedure 12(b)(6) and in accordance with the heightened pleading standards of the PSLRA.
Federal Rule of Civil Procedure 12(b)(6) empowers the Court to grant a defendant's motion to dismiss when the pleadings fail to state a claim upon which relief can be granted. In support of their second Motion to Dismiss, Defendants filed a Notice of Supplemental Authority [#77] with the Court regarding the Supreme Court's recent decision in Bell Atlantic Corp. v. Twombly, ___ U.S. ___, 127 S.Ct. 1955 (2007). The Court agrees with Defendants that Twombly is relevant to the Court's decision in this case. Specifically, the Supreme Court in Twombly heightened the pleading standard for complaints attacked by a Rule 12(b)(6) motion to dismiss. See Twombly, 127 S. Ct. at 1964-65. The post-Twombly standard of review on a Rule 12(b)(6) motion is as follows.
When considering a defendant's motion to dismiss, the Court accepts the plaintiff's allegations as true, Hishon v. King Spalding, 467 U.S. 69, 73 (1984), and construes the complaint in the plaintiff's favor, Duke v. Cleland, 5 F.3d 1399, 1402 (11th Cir. 1993). To survive a motion to dismiss, a complaint need not contain "detailed factual allegations." Twombly, 127 S.Ct. at 1964. However, the factual allegations "must be enough to raise a right to relief above the speculative level." Id. at 1965. "[A] plaintiff's obligation to provide the `grounds' of his `entitle[ment] to relief' requires more than labels and conclusions, and a formulaic recitation of the elements of a cause of action will not do." Id. at 1964-65.
In their Motion to Dismiss, Defendants set forth six grounds upon which they argue the complaint should be dismissed: (1) failure to allege specific facts establishing a strong inference that any defendant acted with scienter; (2) failure to plead fraud with the particularity required by the Reform Act and by Federal Rule of Civil Procedure 9(b); (3) the alleged misstatements are immaterial as a matter of law; (4) failure to adequately allege that the challenged statements were false when made; (5) failure to allege facts establishing that the alleged fraud proximately caused the alleged losses; and (6) the control person allegations fail because they are derivative of Plaintiff's flawed primary claims. Because the Court finds that Plaintiffs' complaint fails to state a claim on the basis of scienter alone, the Court will address only the scienter argument of the six arguments asserted by Defendants in their second Motion to Dismiss.
A. Scienter
Count I of the Amended Complaint alleges that all Defendants violated Section 10(b) of the Securities and Exchange Act of 1934 and S.E.C. Rule 10b-5 promulgated thereunder. To establish liability under § 10(b) and Rule 10b-5, a PSLRA plaintiff must prove that the defendant acted with scienter, "a mental state embracing intent to deceive, manipulate, or defraud." Enrst Ernst v. Hochfelder, 425 U.S. 185, 193 (1976).
Defendants argue that the complaint fails to raise the strong inference of scienter required for claims under § 10(b) and Rule 10b-5 as to any defendant to this action. Defendants aver that Plaintiffs fail to plead specific facts suggesting a nexus between the fraudulent RTV chargebacks allegedly occurring at the individual store level and the senior management and director Defendants. Specifically, the complaint refers to "management" and unidentified "home office" employees but fails to allege that improper RTV chargebacks were communicated up the corporate chain of command to the individually-named Defendants or any other members of senior management who were responsible for preparing the public statements Plaintiffs have alleged contained false and misleading information.
Defendants argue that Plaintiffs' attempt to raise an inference of scienter (i.e. that the fraudulent RTV chargebacks were of such magnitude and duration and so pervasive that Defendants knew or should have known about them) is likewise unsupported by specific facts in the pleadings. Instead, according to Defendants, Plaintiffs attempt to raise an inference of scienter with "a series of anecdotal reports alleging improper RTV charges at certain stores cobbled together from interviews of a handful of former employees and quotations from newspaper reports." Def.'s Mem. in Supp. of their Mot. to Dismiss at 24.
In addition to attacking Plaintiffs' complaint in its entirety, Defendants also question specific documents submitted by Plaintiffs and allege that they fail to raise a strong inference of scienter. Specifically, Defendants challenge the "Mercer Memo" and several Home Depot internal memoranda and documents that Plaintiffs allege were circulated by Defendants between 2001 and 2004.
On June 26, 2007, Defendants filed a Notice of Supplemental Authority [#78] with the Court in support of the instant motion. In their Notice of Supplemental Authority, Defendants submit that a recent Supreme Court case, Tellabs, Inc. v. Makor Issues Rights, Ltd., ___ S. Ct. ___, 2007 WL 1773208 (June 21, 2007), is controlling in this case.
Tellabs sets forth a new, heightened scienter pleading requirement in PSLRA cases. Prior to Tellabs, it was sufficient for plaintiffs in private securities fraud actions to plead scienter by "alleg[ing] facts from which, if true, a reasonable person could infer that the defendant acted with the required intent." Tellabs, 2007 WL 1773208 at *4 (quoting Makor Issues Rights, Ltd. v. Tellabs, Inc., 437 F.3d 588, 602 (7th Cir. 2006)). However, the Supreme Court concluded that this standard did not capture the stricter pleading standard Congress intended to impose in § 21D(b)(2) of the PSLRA. Id. Consequently, the Supreme Court held in Tellabs that plaintiffs in private securities fraud actions must raise an inference of scienter in their pleadings that is "more than merely plausible or reasonable- it must be cogent and at least as compelling as any opposing inference of non-fraudulent intent." Id. The Tellabs Court explained:
The inference that the defendant acted with scienter need not be irrefutable, i.e. of the `smoking-gun' genre, or even `the most plausible of competing inferences' . . . Yet the inference of scienter must be more than merely `reasonable' or `permissible'-it must be cogent and compelling, thus strong in light of other explanations.Id. at *10. A PSLRA plaintiff "must demonstrate that it is more likely than not that the defendant acted with scienter." Id. at *12 (emphasis in original). A court must consider the complaint in its entirety and plaintiff's allegations collectively to determine whether a cogent and compelling inference of scienter has been pled. Id. at *9-11.
Lead Plaintiff also filed a Notice of Supplemental Authority [#79] regarding Tellabs. Lead Plaintiff asserts that the Amended Complaint meets the scienter pleading standards set out inTellabs. Without giving specific examples, Lead Plaintiff contends that the scienter allegations set forth in the Amended Complaint "are cogent and at least as compelling as any opposing inferences that Defendants have raised." Pl.'s Notice of Supplemental Auth. at 4.
The Court turns now to the allegations in the Amended Complaint to determine whether Plaintiffs have met the standard for pleading scienter set by Tellabs. Plaintiffs have submitted no direct evidence of the defendants' participation in a company-wide RTV scheme and instead Plaintiffs rely on circumstantial evidence intended to raise an inference of scienter on the part of the defendants. The allegations set forth in the Amended Complaint are as follows.
The Amended Complaint relays allegations made by former Home Depot store employees who contend that fraudulent RTV chargebacks were "common place" at Home Depot during the class period and that RTVs were "constantly inflated" in many Home Depot retail stores. See Amended Compl. at ¶¶ 54, 61. At least one former Home Depot employee told Plaintiffs that fraudulent RTV chargebacks were prevalent across stores in multiple states and were so lucrative (between $50,000.00 and $200,000.00 per store per month) that Home Depot management "must have known the practice was occurring." Id. at ¶ 63. One former employee who held the position of "RTV clerk" at three different Home Depot locations told Plaintiffs that "management" set mandatory dollar-value quotas for her for RTV chargebacks even though those quotas could only be met by processing fraudulent RTV chargebacks. Id. at ¶ 67. Two former employees who worked as RTV clerks or assistant RTV clerks told Plaintiffs that their store managers were the ones who asked them to process fraudulent RTV chargebacks. See id. at ¶¶ 67, 77, 78. According to another former Home Depot employee, ten to twenty percent of the RTV chargebacks his store processed per month were "questionable."Id. at ¶ 79.
Plaintiffs allege that Defendants circulated at least two internal memoranda regarding RTV chargebacks. First, Plaintiffs cite an article in the New York Post that reported Defendant Larry Mercer circulated a memo (the "Mercer Memo") to Home Depot's store managers on April 19, 2002. Amended Compl. at ¶ 80. According to the New York Post, the memo discussed "missed RTV dollars" and encouraged store managers to increase RTV chargebacks. Id. at ¶ 81. One Home Depot employee told Plaintiffs that in the months following the distribution of this memo, RTV chargebacks at his store increased by approximately 25%. Id. at ¶ 83. Second, Plaintiffs cite another article in the New York Post that reported that a memo was distributed on February 12, 2004, outlining procedures for collecting chargebacks from suppliers. Id. at ¶ 88. The New York Post article asserted that Home Depot circulated the February 12, 2004 memo to "quell the concerns of several employees who had complained that superiors were pressuring them to participate in the scheme." Id. at ¶ 89.
Plaintiffs contend that Defendants distributed at least one internal strategy document regarding the system of fraudulent RTV chargebacks. Plaintiffs submit that a former Home Depot employee told them that in 2001 Home Depot published a "Strategic Operating Plan" that identified a higher number of RTV chargebacks as a way for the company to reduce its "shrink," i.e. lost or stolen inventory, numbers. Id. at ¶¶ 84-85. The same plan estimated that planned "Vendor Income (Rebates)" accounted for 4.5% of the company's gross margins in 2001 and was expected to account for 5.2% of gross margins in 2004. Id. at ¶ 86.
In addition to the aforementioned documents Plaintiffs maintain were distributed at Home Depot, Plaintiffs rely on the allegations made as part of several "whistleblower" actions filed by former Home Depot employees to infer that Defendants knew about and propagated a system of fraudulent RTV chargebacks. For example, Plaintiffs quote extensively from a complaint filed with the U.S. Department of Labor ("DOL") by Michael Davis, a former RTV clerk in a Home Depot store. Plaintiffs emphasize portions of Davis's DOL complaint, such as Davis's allegation that he "was instructed to process false claims, making up quantities and inputting them into the system that were supposed to total a dollar amount just below the amount allowed by the vendor." Id. at ¶ 103. Plaintiffs also emphasize Davis's claim that "[o]n a periodic basis, Company management would circulate memos telling personnel to use RTVs instead of markdowns . . . These memos came from another store, the Atlanta home office, and the Paramus, New Jersey office in some cases setting dollar value store goals, dollar value regional goals and a companywide goal of $59 million." Id. In addition to Michael Davis's DOL complaint, Plaintiffs cite a number of New York Post articles from 2005 and 2006 that reported that other former Home Depot employees were speaking out against Home Depot's RTV chargeback policy. Id. at ¶¶ 104-12, 115-18. At least one employee about whom the New York Post reported claimed that Home Depot had fired him for refusing to process fraudulent RTVs. Id. at ¶ 105. Two employees about whom the New York Post reported claimed that fraudulent RTV chargebacks happened not only at the stores at which they worked, but at other stores as well. See id. at ¶ 106, 111.
Plaintiffs submit that Defendants knew about the RTV fraud and resolved to overhaul the RTV system in the summer of 2003. Plaintiffs quote from a memo from Home Depot to its vendors dated July 1, 2004, entitled "RTV Process Changes." Id. at ¶ 92. In the July 1, 2004 memo, John Campi, Home Depot's Vice President of Global Sourcing and Supply Chain, informed vendors that Home Depot had identified the RTV process as a "critical focus area" and would be implementing changes to ensure "accurate RTV policy execution" in an effort to reduce processing of "disputes." Id. at ¶¶ 92-3. Plaintiffs quote from another memo to vendors, dated November 11, 2004, discussing the new RTV system and assuring vendors it would "reduce time spent investigating/validating chargebacks and processing disputes" and would better enable Home Depot to track the "true defective rate" among products supplied by vendors. Id. at ¶ 95. According to Plaintiffs, the overhauled RTV system was rolled out in October 2004, at which point the abrupt cessation in alleged misconduct resulted in an immediate decline in Home Depot's diluted earnings per share. Id. at ¶ 96.
Plaintiffs aver that, despite the RTV system overhaul, RTV abuses were ongoing over a year later. Plaintiffs cite a September 7, 2006, New York Post article asserting that internal auditors visited Home Depot stores in Washington, D.C., Maryland, Pennsylvania and New York in the summer of 2006 as "part of an ongoing internal investigation into allegations of improper vendor chargebacks." Id. at ¶ 115. The New York Post article reported that "[i]nvestigators interrogated store employees, sometimes up to five hours at a stretch, and carted away documents." Id. According to the New York Post article, a focal point for the investigators "was whether employees had been given a weekly percentage target for RTV claims." Id.
Plaintiffs intend the foregoing allegations to raise an inference that the scheme of RTV chargebacks was so large, pervasive, and longstanding within Home Depot that executives and board members of Home Depot knew about or recklessly disregarded the beneficial effect the fraudulent RTV chargebacks had on Home Depot's financial results. Plaintiffs argue that it would have been impossible for Defendants not to know about a countrywide scheme dating from as early as 1993 that had the effect of inflating individual stores' earnings as much as $1 million per year and inflating Home Depot's operating income by $1 billion per year, or 10% of its operating income. Plaintiffs cite specifically the Mercer Memo (that allegedly discussed "missed RTV dollars" and maximizing opportunities to "boost chargebacks") and the February 12, 2004 memo (allegedly distributed to "quell the concerns of several employees who had complained that superiors were pressuring them to participate in the scheme") as evidence that Defendants knew or should have known that a scheme of fraudulent RTV chargebacks was ongoing. Plaintiffs also argue that the 2004 memos from Home Depot to vendors regarding the impending RTV overhaul and its goals are evidence that Defendants knew about the RTV scheme. Finally, Plaintiffs contend that the 2001 "Strategic Operating Plan" that addressed "Vendor Income (Rebates)" was evidence of Defendants' knowledge of the scheme.
The Court finds that Plaintiffs' allegations with respect to scienter are insufficient according to the standard adopted by the Supreme Court in Tellabs. Although Plaintiffs' allegations, if accepted as true, demonstrate a widespread and pervasive scheme of improper RTV chargebacks, Plaintiffs' allegations are insufficient to show that Defendants had the requisite intent to deceive, manipulate, or defraud. In fact, the Amended Complaint on its face raises several cogent and compelling inferences to the contrary.
For example, it can be inferred from the allegations in the Amended Complaint that once Defendants learned of the RTV scheme in 2003, they acted immediately to correct the fraud. Addressing Plaintiffs' allegations specifically, Plaintiffs allege that the Mercer Memo and the Strategic Operating Plan provide evidence of scienter. However, those documents were circulated by Home Depot in 2001 and 2002 and can plausibly be read as encouraging Home Depot employees to maximize authentic RTV chargebacks and to recapture money Home Depot legitimately was owed by vendors for defective merchandise. Those documents can also be read within the context of the aggressive financial targets Home Depot was setting for its stores during this time period. The Amended Complaint contains a number of statements by former Home Depot employees that the filing of fraudulent RTV chargebacks at the individual store level was necessitated by Home Depot's aggressive financial targeting for the individual stores in the years prior to 2003.
Plaintiffs allege that Defendants resolved to overhaul the RTV system in the summer of 2003. It can be inferred from Plaintiffs' Amended Complaint that the events that allegedly occurred at Home Depot from 2003 to 2006 were the result of Home Depot's discovery of RTV chargeback abuse and a subsequent decision to overhaul the RTV system. For example, the February 12, 2004 memo from Home Depot to its vendors comports with an ongoing overhaul of the RTV system. It is clear from the face of the memo that it was intended to reassure vendors that only authentic RTV chargebacks would be submitted in the future. Michael Davis filed his whistleblower complaint in 2005, but the RTV schemes he describes occurred between 2000 and 2004, either prior to or immediately following Home Depot's overhaul of the RTV system. The internal investigation that Plaintiffs allege occurred at Home Depot stores in September 2006 is likewise consistent with a "clean-up" effort by Home Depot. The fact that RTV fraud continued after Home Depot overhauled the RTV system in late 2004 is unsurprising if the practice of filing fraudulent RTV chargebacks was occurring in as many stores as Plaintiffs allege it was.
Additionally, even if the Court were to accept Plaintiffs' construction of the allegations in the Amended Complaint, the inference of scienter Plaintiffs' construction raises is not cogent and compelling with respect to the individual Defendants. While the Amended Complaint could be read to allege that a large, longstanding and pervasive scheme of RTV chargeback fraud existed at Home Depot, the Amended Complaint does no more than infer that "someone" in the "management" of Home Depot had to know about the scheme. The Eleventh Circuit has held "scienter must be found with respect to each defendant and with respect to each alleged violation of the statute . . . [A] plaintiff, to proceed beyond the pleading stage, must allege facts sufficiently demonstrating each defendant's state of mind regarding his or her alleged violations." Phillips v. Scientific-Atlanta, Inc., 374 F.3d 1015, 1017-18 (11th Cir. 2004) (emphasis added). Even under the most liberal reading of the Amended Complaint, it does not allege facts demonstrating scienter with respect to each defendant in this action.
Because Plaintiffs have failed to demonstrate that it is more likely than not that the individual Defendants acted with scienter, the Court GRANTS Defendants' Motion to Dismiss with respect to Plaintiffs' claim that Defendants violated section 10(b) of the Securities and Exchange Act of 1934 and Rule 10b-5 promulgated thereunder.
With respect to Plaintiffs' claim premised upon section 20(a) of the Securities and Exchange Act, 15 U.S.C. § 78t(a), Plaintiffs' failure to state a claim under section 10(b) of that Act precludes Plaintiffs from stating a claim under section 20(a). See In re World Access, Inc., 310 F. Supp. 2d 1281, 1300 (N.D. Ga. 2004) (stating that a plaintiff's section 20(a) claims "are dependent upon a finding that there is a triable issue of fact as to whether a primary violation of securities law has occurred."); see also No. 84 Employer-Teamster Joint Council Pension Trust Fund v. Am. W. Holding Corp., 320 F.3d 920, 945 (9th Cir. 2003) ("In order to prove a prima facie case under Section 20(a), a plaintiff must prove: (1) a primary violation of federal securities law and (2) that the defendant exercised actual power or control over the primary violator." (internal quotations omitted)); Dresner v. Utility.com, Inc., 371 F. Supp. 2d 476, 491 (S.D.N.Y. 2005) ("To allege a proper claim for controlling-person liability, plaintiffs must allege inter alia an underlying securities law violation by the controlled person."). Consequently, the Court DISMISSES Plaintiffs' § 20(a) claim as well.
Because Plaintiffs' claims under §§ 10(b) and 20(a) of the Securities and Exchange Act constitute the entirety of the Amended Complaint, the Court hereby DISMISSES the Amended Complaint in its entirety for failure to state a claim under Federal Rule of Civil Procedure 12(b)(6).
IV. Plaintiff's Motion to Amend the Amended Complaint [#69]
Lead Plaintiff filed a Motion to Amend the Amended Complaint [#69] on March 21, 2007. Lead Plaintiff filed this motion in anticipation of the Court's decision with respect to Defendants' Motion to Dismiss [#62]. In the event that the Court grants Defendants' Motion to Dismiss, Lead Plaintiff asks that the Court grant it leave to amend the Complaint to incorporate newly discovered material facts that are relevant to its allegations and that were not available when Lead Plaintiff filed the Amended Complaint. Lead Plaintiff did not file a proposed amended complaint with its motion.
The new facts that Lead Plaintiff wishes to incorporate into a second amended complaint consist of the following. Lead Plaintiff has obtained a report entitled "July 2004 Shrink Target Store Meeting — Tom Taylor and Mike Lamb" ("the Report"). This report addresses missed RTV dollars at target stores and sets an "RTV target" for each store. Lead Plaintiff asserts that the report shows that income from RTV chargebacks totaled more than ten percent of each target store's overall sales and varied widely among the target stores. Lead Plaintiff argues that this report supports its allegations that RTV chargeback fraud had a significant impact on Home Depot's financial performance and that RTV chargeback fraud was pervasive throughout the company. Lead Plaintiff contends that the fact that the report exists at all is evidence that Defendants tracked RTV rates and knew or should have known that RTV fraud was occurring at the store level.
Lead Plaintiff also wishes to incorporate evidence regarding Defendant Nardelli's resignation from his position as CEO of Home Depot effective January 2, 2007. Lead Plaintiff argues that the timing of Nardelli's departure is suspicious, occurring only six weeks after Lead Plaintiff filed the Amended Complaint and soon after Nardelli admitted to participation in an improper stock option backdating scheme. Plaintiff submits that the timing and abrupt nature of Nardelli's resignation give rise to an inference of scienter as to Nardelli. Lead Plaintiff asserts that Nardelli and other corporate executives, including the individual Defendants, had an interest in lowering the stock acquisition cost so that they could backdate their stock options to the lower stock price and thereby increase the price at which they could later sell the stock options.
Defendants oppose this motion and argue that to allow Plaintiffs to file another complaint would frustrate the purpose of the PSLRA and would only prolong these "baseless lawsuits." Def.'s Brief in Opp. to Lead Pl.'s Mot. to Amend the Amended Compl. at 7. Defendants submit that the plaintiffs to this action filed six separate but almost identical complaints at the inception of this action. After the Court granted Lead Plaintiff status to Bucks County Retirement Board, Bucks County Retirement Board filed the 290-page Amended Complaint addressed above. Defendants contend that to allow Plaintiffs to continually amend their complaints in this action would frustrate the purpose of the PSLRA, which is to permit the earliest possible dismissal of frivolous securities litigation.
Defendants also argue that amendment of the amended complaint would be futile because Plaintiffs' "newly discovered evidence" will not cure the defects in the pleadings. Defendants address the specific evidence Plaintiffs seek to incorporate into a second amended complaint. First, Defendants contend that Plaintiffs have mischaracterized the Report and that the Report does not actually say what Plaintiffs contend it says. Defendants also address Plaintiffs' insinuations with respect to Defendant Nardelli's departure from Home Depot. Defendants argue that Plaintiffs have not submitted a single fact connecting Nardelli's departure to the allegations made by Plaintiffs in these lawsuits. Defendants also submit that the alleged backdating of stock options by Home Depot executives occurred prior to November 2000 and therefore has no relevance to this action, the class period for which begins in May 2001.
The Court concludes that Lead Plaintiffs' Motion to Amend should be DENIED. First, the Court notes that this would be Lead Plaintiffs' third complaint filed in this action. The Court finds that Lead Plaintiffs have had ample opportunity to amend and correct their pleadings pursuant to Federal Rule of Civil Procedure 15(a).
Second, Lead Plaintiffs have failed to attach a proposed amended complaint to their motion to amend, contrary to customary practice in this court.
Third, the Court has reviewed the newly-discovered evidence upon which Lead Plaintiffs seek to base new allegations in a second amended complaint. The Court concludes that allegations based on the newly-discovered evidence would not alter the Court's conclusion regarding Plaintiffs' failure to plead scienter in accordance with the PSLRA. Specifically, the Report, like the Mercer Memo and the Strategic Operating Plan, can plausibly be read as encouraging Home Depot employees to maximize authentic RTV chargebacks and to recapture money Home Depot legitimately was owed by vendors for defective merchandise. Consequently, the Report does not strengthen or weaken the inference of scienter Plaintiffs attempt to raise in their complaint. Lead Plaintiffs' allegations with respect to Defendant Nardelli's resignation as CEO of Home Depot are no more than mere speculation. The facts about the stock option backdating scheme and Nardelli's involvement in it cannot be connected to the facts alleged regarding the RTV chargeback scheme in any plausible way. Additionally, the Court finds nothing suspicious about the timing of Nardelli's resignation in relation to the timing of the filing of the Amended Complaint. The original complaint in this action was filed on May 12, 2006, nearly seven months prior to Nardelli's resignation. The fact that the Amended Complaint was filed on November 13, 2006, less than two months prior to Nardelli's resignation, does not raise any inference that Nardelli's resignation was connected to Lead Plaintiffs' filing of the Amended Complaint. Any new allegations based on the Report or related to Nardelli's resignation would not improve the allegations in the Amended Complaint such that Lead Plaintiffs could plead successfully that the individual Defendants acted with scienter.
For the foregoing reasons, the Court DENIES Plaintiffs' Motion to Amend the Amended Complaint [#69].
V. Conclusion
For the foregoing reasons, Defendants' First Motion to Dismiss [#49] is DISMISSED as moot. Defendants' Second Motion to Dismiss [#62] is GRANTED. Plaintiffs' Amended Complaint is hereby dismissed in its entirety. Lead Plaintiff's Motion to Amend the Amended Complaint [#69] is DENIED. The Clerk is directed to enter judgment in Defendants' favor, with costs taxed to Plaintiffs.
SO ORDERED.