Opinion
00 CV 0958 (SJ)
June 7, 2002
Lead Counsel for Plaintiffs, Lee S. Shalov, Esq., Ralph M. Stone, Esq., James P. Bonner, Esq., SHALOV STONE BONNER, New York, New York
Attorneys for Defendant, Clifford Thau, Esq., VINSON ELKINS LLP, New York, New York
Adrienne M. Ward, Esq., MORGAN, LEWIS BOCKIUS LLP, New York, New York
KENNETH W. GERVER, Esq., New York, N.Y.
MEMORANDUM AND ORDER
Plaintiffs Myrna Rombach, Kevin Burdick, Jay Brosz, Eugene Bell, Dennis Bryan, Kenneth Hall, and Golfway Developments (Thunder Bay) Inc. ("Plaintiffs"), individual stockholders in Family Golf Centers, Inc., brought the above-captioned lawsuit, on behalf of themselves and all others similarly situated, for violations of various securities laws and regulations. Currently before the Court are the Motions to Dismiss of Defendants Dominic Chang, Krishnan P. Thampi, and Jeffrey C. Key ("Individual Defendants"), Defendant Jefferies Company ("Defendant Jefferies"), and Defendant Prudential Securities Inc. ("Defendant Prudential") (collectively, "Underwriter Defendants"). For the reasons set forth below, all three motions by Defendants are granted and the case is dismissed.
BACKGROUND
The Individual Defendants were officers of Family Golf Centers, Inc. ("FGCI" or "the Company"), a Delaware corporation that operated a nation-wide chain of golf centers. FGCI first began operating golf centers in 1992 and operated 119 facilities by the end of 1998. (Individual Defs.' Mot. Dismiss at 4.) FGCI stock was publicly traded through the securities markets and made public filings with the Securities and Exchange Commission. On July 23, 1998, the company conducted a Secondary Offering of FGCI shares. Also in 1998, the Company acquired other large operators of golf driving ranges in the United States and Canada, namely MetroGolf Inc., in January, Eagle Quest Golf Centers, Inc., in April, and Golden Bear Golf Centers, Inc., in July. (Compl. ¶¶ 23.)
The Individual Defendants assert different dates for the acquisition of Eagle Quest and MetroGolf, based on FGCI's filings with the Securities and Exchange Commission. (Individual Defs.' Mot. Dismiss at 35 n. 27.) However, the Court finds that a difference of a few weeks does not affect its analysis.
Defendants Jefferies and Prudential were underwriters of the July 23, 1998 Secondary Offering of FGCI shares.
Plaintiffs allege that each of the Defendants made materially false and misleading statements that caused the price of FGCI shares to trade at artificially inflated prices between May 12, 1998 and August 12, 1999 (the "Class Period"), and that these misstatements and omissions caused damages to each of the Plaintiffs and to other shareholders of the Company. (Compl. ¶¶ 5, 20.) Specifically, Plaintiffs allege that Defendants "made representations as to the Company's growth and future profitability that defendants knew to be based on erroneous and overstated assumptions, or they recklessly disregarded numerous facts in their possession, and not publicly available, that undermined their public statements of optimism." (Compl. ¶ 23.)
Plaintiffs initially included FGCI as a Defendant, but did not name it as a party in the Amended Complaint, because the Company voluntarily filed for bankruptcy. The Amended Complaint is brought against all Defendants for alleged violations of Section 11 of the Securities Act, 15 U.S.C. § 77k ("Section 11"); against the Underwriter Defendants for alleged violations of Section 12(a)(2) of the Securities Act, 15 U.S.C. § 771(a)(2) ("Section 12(a)(2)"); and against the Individual Defendants for alleged violations of Section 15 of the Securities Act, 15 U.S.C. § 77o ("Section 15") and Sections 10(b) and 20(a) of the Exchange Act, 15 U.S.C. § 78j(b) and 78t(a) (respectively, "§ 10(b)" and "§ 20(a)").
The Individual Defendants seek dismissal of the Amended Complaint, pursuant to Rule 12(b)(6) and Rule 9(b) of the Federal Rules of Civil Procedure Rule ("Rule 12(b)(6)" and "Rule 9(b)" respectively), and the Private Securities Litigation Reform Act of 1995, Pub.L. No. 104-67 (1995) ("the PSLRA"). Defendants Jefferies and Prudential filed separate Motions to Dismiss, on the grounds that Plaintiffs' claims against them under Sections 11 and 12(a)(2) are barred by the statute of limitations, and that the Amended Complaint fails to identify material misrepresentations or omissions in the Prospectus for which Defendants would be liable.
DISCUSSION
I. Standard for Motion to Dismiss
A motion to dismiss for failure to state a claim under Rule 12(b)(6) of the Federal Rules of Civil Procedure should be granted only when "it appears beyond doubt that the plaintiff can prove no set of facts in support of his claim which would entitle him to relief." Green v. Maraio, 722 F.2d 1013, 1015-16 (2d Cir. 1983) (quoting Conley v. Gibson, 355 U.S. 41, 45-46 (1957)). The court must accept as true all material facts well-pleaded in the complaint and must make all reasonable inferences in the light most favorable to the plaintiff. Jackson Nat'l Life Ins. Co. v. Merrill Lynch Co., 32 F.3d 697, 699-700 (2d Cir. 1994). "In considering a motion to dismiss for failure to state a claim under Fed.R.Civ.P. 12(b)(6), a district court must limit itself to facts stated in the complaint or in documents attached to the complaint as exhibits or incorporated in the complaint by reference." Kramer v. Time Warner, Inc., 937 F.2d 767, 773 (2d Cir. 1991) (holding that a district court's consideration of documents that were filed with the SEC and were the basis of the misrepresentations or omissions alleged in a securities fraud case was appropriate: "Were courts to refrain from considering such documents, complaints that quoted only selected and misleading portions of such documents could not be dismissed under Rule 12(b)(6) even though they would be doomed to failure."). See also Rothman v. Gregor, 220 F.3d 81, 88 (2d Cir. 2000).
A. Particularity in Pleading
The Individual Defendants assert that Plaintiffs' Amended Complaint fails to plead fraud with particularity as required by Rule 9(b) and the PSLRA. Rule 9(b) requires that allegations of fraud must state the circumstances of the alleged fraud with particularity. Fed.R.Civ.P. 9(b). "Specifically, the complaint must: (1) specify the statements that the plaintiff contends were fraudulent, (2) identify the speaker, (3) state where and when the statements were made, and (4) explain why the statements were fraudulent." Mills v. Polar Molecular Corp., 12 F.3d 1170, 1175 (2d Cir. 1993). Additionally, the PSLRA requires that allegations of misrepresentation or omissions of material fact must specify the statement alleged to be misleading, the reason why the statement was misleading, and the facts that form the basis for the belief that the statement is misleading. 15 U.S.C. § 78u-4(b)(1).
B. Scienter
In order to make out a claim for securities fraud, Plaintiffs must allege that Defendants acted with scienter. Novak v. Kasaks, 216 F.3d 300, 314 (2d Cir.), cert. denied, Kasaks v. Novak, 531 U.S. 1012 (2000). To plead scienter, plaintiffs must allege with particularity facts giving rise to a strong inference of fraudulent intent. Id 216 F.3d at 307; Acito v. IMCERA Group, Inc., 47 F.3d 47, 52 (2d Cir. 1995). The PSLRA also requires that "the complaint shall, with respect to each act or omission alleged to violate [the Securities Laws], 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 Second Circuit has allowed plaintiffs to demonstrate such a strong inference either by showing strong circumstantial evidence of either conscious misbehavior or recklessness, or by showing that the defendants had both motive and opportunity to commit fraud. See Rothman, 220 F.3d at 90.
C. Application of the Pleading Requirements to Plaintiffs' claims
Plaintiffs' Fourth Cause of Action, claiming that the Individual Defendants violated § 10(b) of the Exchange Act, clearly alleges fraudulent behavior (Compl. ¶ 96) and is subject to the particularity requirements of Rule 9(b) and the PSLRA. The Individual Defendants contend that since Plaintiffs' Section 11 claims allege fraudulent activity, they also should be held to the particularized pleading requirements of Rule 9(b). (Individual Defs.' Mot. Dismiss at 6.) However, the Amended Complaint asserts that these claims do not sound in fraud. (Compl. ¶¶ 71, 81, 90.) The Second Circuit has not specifically addressed this situation, and other circuit courts are split on the issue. The Third, Fifth, and Ninth Circuits have distinguished between allegations of fraud and negligence, and have applied Rule 9(b)'s requirements to Section 11 and Section 12(a)(2) actions that allege fraud. See e.g. Shapiro v. UJB Fin. Corp., 964 F.2d 272, 288 (3d Cir.) (requiring particularized pleading where "[a]s we have noted, the complaint is devoid of allegations that defendants acted negligently in violating §§ 11 and 12(2). Instead, it brims with references to defendants' intentional and reckless misrepresentation of material facts."), cert. denied, UJB Fin. Corp. v. Shapiro, 506 U.S. 934 (1992); Melder v. Morris, 27 F.3d 1097, 1100 n. 6 (5th Cir. 1994) ("When 1933 Securities Act claims are grounded in fraud rather than negligence as they clearly are here, Rule 9(b) applies."); In re Stac Elec. Sec. Litig., 89 F.3d 1399, 1404-05 (9th Cir. 1996) ("We now clarify that the particularity requirements of Rule 9(b) apply to claims brought under Section 11 when, as here, they are grounded in fraud."). Some district courts within the Second Circuit have also applied Rule 9(b) to Section 11 and Section 12(a)(2) claims that sound in fraud. See e.g. In re Ultrafem Inc. Sec. Litig., 91 F. Supp.2d 678, 690 (S.D.N.Y. 2000); Schoenhaut v. American Sensors, Inc., 986 F. Supp. 785, 795 (S.D.N.Y. 1997).
This Court finds that the Amended Complaint bases its Section 11 claims against the Individual Defendants on allegations of fraud, notwithstanding Plaintiffs' assertion that this claim "does not sound in fraud." (Compl. ¶ 71.) Plaintiffs' First Cause of Action repeats and realleges the allegations contained in the Amended Complaint. (Compl. ¶ 70.) Plaintiffs specifically allege that Defendants violated Section 11 by producing and disseminating the allegedly "inaccurate and misleading" Registration Statement for the July 23, 1998 secondary public offering of FGCI stock. (Compl. ¶¶ 72-73.) The Amended Complaint further alleges that the Statement contained false statements of material fact and omitted other facts necessary to make the statements not misleading, and that Plaintiffs relied on these statements to their detriment. (Compl. ¶¶ 72, 77, 78.) Those claims "are classic fraud allegations, that is, allegations of misrepresentations and omissions made with intent to defraud upon which plaintiffs relied." In re Ultrafem, 91 F. Supp.2d at 691 ("By merely disavowing any allegations that would make Rule 9(b) applicable to Securities Act claims and without specifying the allegations that would support a negligence cause of action, plaintiffs essentially request that the Court parse their allegations to find a negligence claim."). Plaintiffs do not assert any claim of negligence on the part of the Individual Defendants, nor do they specify any basis for such a claim. Accordingly, this Court finds that the First Cause of Action against the Individual Defendants sounds in fraud, and is thus subject to the particularity in pleading requirement of Rule 9(b).
On the other hand, Plaintiffs' Sections 11 and 12(a)(2) allegations against the Underwriter Defendants do state claims of negligence. In the First and Second Causes of Action, the Amended Complaint specifically alleges that the Underwriter Defendants owed a duty to investors to make reasonable and diligent investigation of the statements contained in the Registration Statement and the Prospectus, and are liable to Plaintiffs for breach of that duty. (Compl. ¶¶ 74, 84.) Accordingly, the Court finds that these claims sound in negligence rather than fraud, and thus are not subject to the particularized pleading requirements for actions sounding in fraud. See In re Ultrafem, 91 F. Supp.2d at 691. The Court addresses the claims against the Underwriter Defendants on the merits at page 27, infra.
II. The Individual Defendants' Statements.
Applying the Rule 9(b) standard, the Court finds that Plaintiffs fail to plead fraud with particularity on their § 10(b) and Section 11 claims asserted against the Individual Defendants in the First and Fourth Causes of Action. Plaintiffs allege that "defendants made representations as to the Company's growth and future profitability that defendants knew to be based on erroneous and overstated assumptions, or they recklessly disregarded numerous facts in their possession, and not publicly available, that undermined their public statements of optimism." (Compl. ¶ 23.) However, in order to maintain this action, Plaintiffs must state with particularity the specific facts in support of their belief that these statements were false when made. Plaintiffs fail to meet this standard.
A. Statements Regarding the New Acquisitions
Most of the statements attributed directly to Defendants are general statements of optimism that are protected by the "bespeaks caution" doctrine and the PSLRA. The "bespeaks caution" doctrine protects forward-looking statements which "reflect hope, adequately tinged with caution, and [where] the total mix of information available to the market cannot reasonably be found to be misleading." San Leandro Emergency Med. Group Profit Sharing Plan v. Philip Morris Companies, Inc., 75 F.3d 801, 811 (2d Cir. 1996) "[M]isguided optimism is not a cause of action, and does not support an inference of fraud." Shields v. Citytrust Bancorp., 25 F.3d 1124, 1129 (2d Cir. 1994) (rejecting the legitimacy of "alleging fraud by hindsight"). See also Rothman, 220 F.3d at 90 ("Generally, poor business judgment is not actionable under section 10(b). . . . The fact that management's optimism about a prosperous future turned out to be unwarranted is not circumstantial evidence of conscious fraudulent behavior or recklessness.") Examples of such puffery are Defendant Chang's May 12, 1998 announcement that recent acquisitions have "firmly established Family Golf Centers as a leader in family-oriented recreation" (Compl. ¶ 40), or the description of the acquisition of Golden Bear Golf Centers as "a unique opportunity" (Compl. ¶ 44). Defendants' statements mixing optimism and caution include a November 5, 1998 press release quoting Defendant Thampi's statement that "we are well underway with the integration of the recently acquired sites," and Defendant Chang's remark that "I am extremely pleased with this quarter's results. We have been working hard to integrate Eagle Quest . . . and the Golden Bear facilities." (Compl. ¶ 57.) The second quarter report for the 1998 fiscal year announced, on August 13, 1998, that "[w]e are very pleased with our results this quarter," followed immediately by the acknowledgment that "[t]he results of the four Eagle Quest centers were significantly impacted by their shortage of working capital and lack of quality [equipment], which we have begun to remedy quickly." (Compl. ¶ 49.)
It should also be noted that both statements were made prior to the acquisition of the Eagle Quest and Golden Bear facilities, and therefore before Defendants could possibly have known that their positive outlook was unmerited.
Plaintiffs allege that "During the October 13, 1998 presentation, defendants continued to emphasize and overstate the purported revenues to be earned at various acquired golf center sites. . . . Defendants also spoke in highly optimistic terms about the integration of newly acquired sites, without disclosing that numerous integration problems were preventing these sites from contributing to the Company's bottom line." (Compl. ¶ 56.) Yet the statements identified by Plaintiffs specifically mentioned the shortage of capital and equipment (Compl. ¶ 49) and the ongoing attempts to-integrate the new facilities (Compl. ¶ 57). Plaintiffs assert that these statements by the Individual Defendants were materially false and misleading because they did not go far enough to disclose "various operational problems at recently acquired sites." (Compl. ¶ 50.)
Plaintiffs do identify several negative trends or circumstances which they contend undermined Defendants' generally optimistic statements of future growth and of which they allege Defendants should have been aware during the Class Period. However, these allegations do not demonstrate the falsity of any of the statements attributed to Defendants. For example, Plaintiffs allege that Defendants had knowledge of "historical experience with acquired sites" (Compl. ¶ 24(a)), but do not specify what that experience was. The Amended Complaint also alleges that FGCI's system of classifying golf centers as "Class 1" or "Class 2" properties, with the classification based on the number of tees and the proximity to major metropolitan areas (Compl. ¶ 27), improperly classified some sites (Compl. ¶ 24(b)), but does not indicate which ones. Further, Plaintiffs assert that the Individual Defendants "knew or recklessly disregarded . . . . significant problems" with construction, regulation, and integration of new properties (Compl. ¶ 24(c)), problems that Defendants also generally acknowledged in their statements, as shown above. Plaintiffs do not indicate the nature of these operational problems in any more detail than Defendant Chang's cautionary statement that the Eagle Quest sites "were significantly impacted by their shortage of working capital and lack of quality [equipment]." (Compl. ¶ 49.)
B. Projections regarding future earnings
Plaintiffs allege that Defendants also made false or misleading statements regarding projections of future earnings. However, the only projections Plaintiffs identify and attribute directly to Defendants are found in an exhibit attached to the Amended Complaint of a slide or handout allegedly used during "road shows" to promote investment in FGCI stock. (Compl., Ex. B.) The Amended Complaint specifically alleges that it was used during a presentation at a BancAmerica Robertson Stephens consumer investment conference on October 13, 1998. (Compl. ¶ 55.) This slide is unclear on its face as to whether the figures represent actual historical revenues generated or projections for future earnings. The Amended Complaint asserts that it was based on projected future revenues. (Compl. ¶ 28.) The slide indicates revenues of $2.3 million for Class I golf centers and $1.2 million for Class II golf centers. The document does not indicate what year the projections are for. Plaintiffs attack this slide as including "overstated projections" with "no basis in historical fact." (Compl. ¶ 28.) However, the only basis for this belief is the recitation of economic data for four identified Class II facilities, which Plaintiffs allege, but do not support, as being "representative of typical FGCI sites." (Compl. ¶ 29.) Plaintiffs do not indicate their source of information on these supposedly representative facilities. Nor is there any link provided between the actual and projected revenues for these four facilities, that would buttress Plaintiffs' claims that the projections were false or misleading.
The most credible of Plaintiffs' allegations regarding undisclosed financial problems involve the "undisclosed liquidity crisis." (Compl. ¶ 33.) Plaintiffs allege that by September 1998, "the Company had stopped making timely payments to such golf equipment suppliers as Calloway and Ping, and to advertising-related vendors, insurers and landlords. The Company's delays resulted in dunning, and vendors even threatened to cease and in fact did cease to make shipments of merchandise and other goods and/or services." (Compl. ¶ 34.) However, the Amended Complaint fails to plead specific facts regarding the length of the delays in remittance of payments, the reach of this alleged problem among vendors, and the extent of the impact on FGCI's financial standing.
The Amended Complaint alleges that the Company's liquidity crisis resulted in FGCI's failure to purchase a completion bond authorized by the City of Denver for a golf facility near the Denver airport (Compl. ¶ 35), the decision not to re-open a Florida facility damaged during a hurricane (Compl. ¶ 36) or to undertake capital improvements at the Encino/Balboa site (Compl. ¶ 38), and a reduction in spending on other capital improvements and advertising ( Id.). However, Plaintiffs fail to provide any support for their belief that these actions were the result of the alleged liquidity crisis, rather than rational cost-saving or profit-maximizing strategies by management.
Further, Plaintiffs allege that the Company under-reported revenues and receipts to landlords and municipalities and that subsequent audits led to additional payments to lessors who assessed rents based on such receipts. (Compl. ¶ 39.) Plaintiffs also contend that FGCI failed to make timely payments for other costs, including rent, taxes, and insurance policies. Plaintiffs allege that some insurance policies were cancelled, but do not identify which policies. The Amended Complaint does specifically state that "internal Seattle Department of Parks and Recreation records confirm that the City of Seattle was alarmed by FGCI's failure to renew insurance." (Compl. ¶ 37.) However, Plaintiffs do not allege that Defendants had knowledge of this internal city document.
In sum, the Court finds that Plaintiffs' allegations do not sufficiently explain how any of the statements attributed to Defendants are false or misleading. See Mills, 12 F.3d at 1175.
C. Analysts' Statements
While Plaintiffs identify specific positive statements regarding the strength of FGCI's stock, these statements were issued by outside analysts, not by the Individual Defendants. Plaintiffs assert that these reports were "based on specific information provided by the Company," and thus should be attributed to the Individual Defendants (Compl. ¶ 41.) In order to hold corporate directors responsible for misleading information disseminated through analysts' reports, plaintiffs must show that the officials either (1) "intentionally fostered a mistaken belief concerning a material fact" that was incorporated into reports; or (2) adopted or placed their "imprimatur" on the reports. Novak v. Kasaks, 216 F.3d at 31.
Plaintiffs point to several analysts reports which they allege were based on information provided by the individual Defendants, including (1) a May 15, 1998 report by Everen Securities that included earnings estimates that Plaintiffs claim were based on information "furnished to the respective analysts by defendants Key and Thampi" (Compl. ¶ 41); (2) a Jefferies Co. report of August 6, 1998 that was allegedly "[b]ased on specific detailed information provided by defendants, including defendant Key, to the purported authors of this report" (Compl. ¶ 48); (3) BancAmerica Robertson Stephens' August 4, 1998 report which allegedly provided "detailed information concerning FGCI's acquisitions that had been relayed to them by defendants Key and Thampi in conference calls and other conferences with defendants" (Compl. ¶ 52); (4) an October 7, 1998 report issued by Everen Securities, Inc. allegedly "based on defendant Key's and others' detailed guidance" (Compl. ¶ 54); and (5) a November 6, 1998 report by BancAmerica Robertson Stephens which allegedly "included detailed information provided by defendants" (Compl. ¶ 58).
In addition, a few of the analysts' reports themselves cited sources at the Company, including (1) a May 12, 1998 report by CIBC Oppenheimer indicating that its "buy" recommendation was "based on management's stated goals" (Compl. ¶ 41); (2) a September 30, 1998 report by Jefferies Co. which stated that "[mlanagement has given us further comfort in-our earnings estimate of $0.27 per share for the period" (Compl. ¶ 53); (3) an October 7, 1998 report by Everen Securities claiming that "[t]he company also indicated that the integration of the newly acquired Eagle Quest and Golden Bear locations are on track" (Compl. ¶ 54); and (4) a November 6, 1998 report by BancAmerica Robertson Stephens which indicated that "[w]e view the strong profitability improvements reported during Q3 as an indication that the company's integration efforts are on track" (Compl. ¶ 58).
Not one of these allegations meets the requirements of Rule 9(b) or the PSLRA. Although the Amended Complaint identifies the individuals it believes to be responsible for some of the alleged statements to the analysts, it does not indicate when and where these statements were made, nor does it specify particular statements that Plaintiffs contend are fraudulent, nor explain why they are fraudulent. See Mills, 12 F.3d at 1175. Plaintiffs' assertion that "[t]hese remarks by their specific nature (and their timing) came directly from defendants" (Compl. ¶ 52) is too vague to meet their burden under the PSLRA of demonstrating the basis for their belief as to the origin of the statements or the extent to which the statements were misleading at the time they were made. See 15 U.S.C. § 78u-4(b)(1). Accordingly, the Amended Complaint does not sufficiently allege that the analysts' "buy" recommendations or any fraudulent or misleading statements were attributable to Defendants. Nor do Plaintiffs allege that the Individual Defendants reviewed, adopted, or controlled the content of these reports. See Pilarczyk v. Morrison Knudsen Corp., 965 F. Supp. 311, 320 (N.D.N.Y. 1997) (finding analysts' reports not attributable to defendants where "plaintiffs failed to allege what information defendants supplied to the analysts, who supplied it, or how defendants may have controlled the contents of the reports.")
D. Scienter
In addition to their failure to plead fraud with particularity by demonstrating material omissions or misrepresentations, Plaintiffs also fail to plead scienter. The Amended Complaint makes several allegations that Defendants "knew or recklessly disregarded" information that would make their statements of optimism false or misleading (Compl. ¶¶ 24-25, 28, 98. See also ¶¶ 23, 56, 64, 96, 101). However, Plaintiffs have not raised a strong inference of intent to defraud, because they have neither sufficiently alleged that Defendants had the motive and opportunity to commit fraud, nor demonstrated conscious recklessness. See Rothman, 220 F.3d at 90. Plaintiffs allege that "[t]he purpose and effect of said scheme was: (i) to conceal adverse material facts concerning the business, financial condition, performance, and prospects of the Company; (ii) to artificially inflate and maintain the market price of FGCI common stock; and (iii) to cause plaintiffs and the other members of the Class to purchase FGCI common stock at artificially inflated prices." (Compl. ¶ 97). Plaintiffs also indicate that Defendants' actions were taken in an effort "to complete a previously arranged corporate acquisition of EagleQuest and to retire debt," and to "minimize the number of shares used by the Company" in these transactions. (Compl. ¶¶ 98(v)-(vi).) However, these steps are part of the officers' and directors' financial responsibilities to the Company. Plaintiffs do not allege that the Individual Defendants were motivated by any personal expectation of increased compensation, insider trading, or fees from analysts or underwriters. The Second Circuit has ruled that "in some circumstances, the artificial inflation of stock prices in the acquisition context may sometimes be sufficient for securities fraud scienter. . . . Whether sufficient motive could be shown solely by an allegation of a high stock price artificially maintained in the context [of] one impending acquisition might well depend on the particular circumstances of the case." Rothman, 220 F.3d at 93-94. However, this case is not one of those circumstances. Here, Plaintiffs do not allege any other factors that would impute such a motive to Defendants. At any rate, most of the statements alleged in the Amended Complaint were made after the acquisition of the additional facilities.
Nor does the Amended Complaint offer specific allegations of recklessness. The Complaint alleges that the Individual Defendants' positions as senior executives would have provided each of them with "the access and ability to receive and obtain information concerning the numerous material problems outlined above which adversely impacted the Company's operations at all relevant times." (Compl. ¶ 98(i).) Plaintiffs argue, in essence, that by virtue of their positions and access to monthly and quarterly internal reports, operations meetings, and the e-mail system, the Individual Defendants had received knowledge of FGCI's business performance and financial circumstances that indicated that "the Company's public statements were false, misleading and lacking in reasonable basis when made and were inflating the market price of FGCI stock." (Compl. ¶ 98(iii).) As discussed above, Plaintiffs have failed to allege facts supporting their claims that these statements were false or misleading when made. Accordingly, none of Plaintiffs allegations provide the kind of circumstantial evidence that would indicate conscious fraudulent behavior or recklessness. See Shields, 25 F.3d at 1129 (affirming the district court's dismissal of the complaint where the plaintiff paired factual statements of the company's financial problems with conclusory allegations of fraudulent intent. "This technique is sufficient to allege that the defendants were wrong; but misguided optimism is not a cause of action, and does not support an inference of fraud. We have rejected the legitimacy of `alleging fraud by hindsight.'")
What the Amended Complaint makes clear is that the early optimism of both the Individual Defendants and the outside analysts was misplaced. Defendants began to reassess the initially optimistic outlook later in the Class Period. On February 16, 1999, FGCI announced reported earnings significantly below expectations. Defendant Chang stated that "[w]hile we remain optimistic that most of the underperforming sites, will, in the future, perform at levels comparable to our core golf centers, it is clear that more than likely they will continue to underperform in the near-term." (Compl. ¶ 59.) On March 11, 1999, Defendant Thampi indicated that "[w]hile we are disappointed at the contribution of many of the more recently acquired sites this quarter, we are likewise working hard to complete the integration of the Eagle Quest, Golden Bear, MetroGolf and other sites acquired mostly during the second half of last year." (Compl. ¶ 60.) Plaintiffs argue that these acknowledgments of financial problems came too little, too late. However, the Court finds that these statements, first made just five months after the last acquisition, adequately and timely disclosed the problems that FGCI was having in integrating the newly-acquired sites into its operation and increasing their profitability. Thus, these statements are not false or misleading, but honest assessments of the increasingly more pessimistic outlook of the Company's directors regarding the Company's financial health, combined with optimistic projections for future profitability. In fact, Plaintiffs acknowledge that these announcements caused an immediate decline in FGCI's stock prices. (Compl. ¶ 59.)
The Court finds that the Amended Complaint does not plead the elements of fraud or scienter for § 10(b) or Section 11 claims against the Individual Defendants with sufficient particularity. Accordingly, these claims against Defendants Chang, Thampi, and Key are dismissed.
III. Remaining Claims-Against the Individual Defendants
Plaintiffs' remaining claims, the Third and Fifth Causes of Action, allege violations of Section 15 of the Securities Act and § 20(a) of the Exchange Act. These provisions hold control persons secondarily liable for violations of Section 11 of the Securities Act and § 10(b) of the Exchange Act. In order to find secondary liability, plaintiffs must show a primary violation by the controlled person whom the controlling persons control. SEC v. First Jersey Securities. Inc., 101 F.3d 1450, 1472 (2d Cir. 1996). See also SEC v. Savoy Indus., Inc., 587 F.2d 1149, 1171 n. 50 (D.C. Cir. 1978) ("Section 15 of the Securities Act of 1933, 15 U.S.C. § 77o (1976), provides expressly for secondary liability of control persons only where the controlled person is liable under section 11 or 12 of the Securities Act of 1933."). Where Section 11 and § 10(b) claims are dismissed for failing to state a claim, the Section 15 and § 20(a) claims must be dismissed as well. See Shields, 25 F.3d at 1132 ("[B]ecause we find that the primary violation asserted by Shields is not adequately pleaded and therefore properly dismissed by the district court, we also find no error in the district court's dismissal of the claims of secondary liability under § 20."). See also In re Symbol Technologies Class Action Litig., 950 F. Supp. 1237, 1246 (E.D.N.Y. 1997) ("If there is no § 10(b) securities fraud claim, there can be no related claim under § 20."); Hinerfeld v. United Auto Group, 1998 WL 397852, *8 (S.D.N.Y. 1998) ("Because the causes of action under Sections 11 and 12(a)(2) of the Securities Act are dismissed, there can be no control person liability under Section 15."). Since the Court has found that Plaintiffs have failed to plead their § 10(b) and Section 11 claims against the Individual Defendants with the particularity required by Rule 9(b), those Defendants may not be he held secondarily liable under § 20(a) or Section 15 for the same conduct. Accordingly, those claims are also dismissed against Defendants Chang, Thampi, and Key.
IV. The Underwriter Defendants' Statute of Limitations Defense
Plaintiffs added the Underwriter Defendants and the Sections 11 and 12(a)(2) claims for the first time in their Amended Complaint filed July 14, 2000. Defendant Jefferies moves to dismiss the Amended Complaint, alleging that Plaintiffs' claims against it under Sections 11 and 12(a)(2) are barred by the statute of limitations set forth in Section 13 of the Securities Act, and, alternatively, that the Amended Complaint fails to identify material misrepresentations or omissions in the Prospectus. Defendant Prudential joins this motion. The Court finds that Plaintiffs' allegations against the Underwriter Defendants are timely, but dismisses them for failing to state a claim under the Securities Laws.
The Underwriter Defendants contend that Plaintiffs' claims against them under Sections 11 and 12(a)(2) must be dismissed as untimely, pursuant to Section 13 of the Securities Act, which provides that: "No action shall be maintained to enforce any liability created under section 77k or 771(a)(2) of this title unless brought within one year after the discovery of the untrue statement or the omission, or after such discovery should have been made by the exercise of reasonable diligence." 15 U.S.C. § 77m. Courts in this Circuit have required that claims brought pursuant to Sections 11 and 12(a)(2) "must set forth: (1) the time and circumstances of the discovery of the fraudulent statement; (2) the reasons why it was not discovered earlier (if more than one year has lapsed since the making of the fraudulent statement); and (3) the diligent efforts which plaintiff undertook in making or seeking such discovery." In re Integrated Res. Real Estate Ltd. P'ships Sec. Litig., 815 F. Supp. 620, 631 (S.D.N.Y. 1993). See In re Chaus Sec. Litig., 801 F. Supp. 1257, 1265 (S.D.N.Y. 1992) ("Failure to plead compliance with the statute of limitations requires dismissal.")
The Underwriter Defendants allege pleading deficiencies, claiming that Plaintiffs fail to allege the time and circumstances of their discovery of the allegedly false or misleading statements in the Prospectus. The Court finds that Plaintiffs' pleadings, though weak, are sufficient to meet this burden. In the context of their First and Second Causes of Action, Plaintiffs did plead compliance with the statute of limitations, alleging that they "could not have reasonably discovered [the facts upon which this complaint is based] prior to August 11, 1999." (Compl. ¶ 79 see also Compl. ¶ 88). These pleadings, standing alone, would not be sufficient. However, Plaintiffs' earlier recitation in the Amended Complaint, included by reference in each cause of action (Compl. ¶¶ 70, 80), alleges that the August 12, 1999 announcement of the Company's second quarter earnings "shocked the investment community by announcing a net loss in the quarter of $0.06 per share, and that the Company was in default on several of its financial covenants with lenders, placing the Company in imminent danger of bankruptcy." (Compl. ¶ 62.) Plaintiffs allege that they could not have known of the extent of the financial difficulties nor the link to allegedly false or misleading statements in the Prospectus prior to FGCI's August announcement. This announcement "stunned the market, and resulted in further dramatic declines in the Company's stock price." (Compl. ¶ 63.) Plaintiffs have thus sufficiently set forth the timing and the information that led them to conclude that fraud had been perpetrated through the issuance of a false or misleading Prospectus.
Even if the Amended Complaint does not suffer from pleading deficiencies regarding the timing of Plaintiffs' discovery of the allegedly false or misleading Prospectus, the Underwriter Defendants contend that it should be dismissed because Plaintiffs had "inquiry notice" of the facts giving rise to their allegations about the Prospectus as early as February 16 or March 11, 1999. "In the Second Circuit, the statute of limitations for securities fraud claims begins to run when the plaintiff has actual knowledge of the alleged fraud or when the plaintiff is placed on inquiry notice, to wit, when the plaintiff has `knowledge of facts which in the exercise of reasonable diligence should have led to actual knowledge.'" In re Integrated, 815 F. Supp. at 637 (quoting Phillips v. Levie, 593 F.2d 459, 462 (2d Cir. 1979)). The degree of information that triggers inquiry notice must be "sufficient storm warnings" to alert a reasonable person to the probability, not mere possibility, of fraudulent activity. Id., 815 F. Supp. at 639.
The Underwriter Defendants contend that the February and March announcements, the resulting slide in FGCI's stock price, and contemporary media reports were "sufficient `storm warning' to trigger Plaintiffs' duty to inquire." (Underwriter Defs.' Mot. Dismiss at 12.) Courts in the Second Circuit have dismissed complaints where the facts from which knowledge may be imputed are clear from the pleadings and the public disclosures. See Dodds v. Cigna Sec., Inc., 12 F.3d 346, 352 n. 3 (2d Cir. 1993) ("Where . . . the facts needed for determination of when a reasonable investor of ordinary intelligence would have been aware of the existence of fraud can be gleaned from the complaint and papers such as the prospectuses and disclosure forms that are integral to the complaint, resolution of the issue on a motion to dismiss is appropriate."); see also Menowitz v. Brown, 991 F.2d 36, 42 (2d Cir. 1993) (affirming dismissal where district court found that plaintiffs were placed on inquiry notice by SEC filings).
This Court, having drawn all inferences in favor of the Plaintiffs and accepting all factual allegations in the Amended Complaint as true, does not find sufficient evidence in the pleadings and SEC filings that Plaintiffs were on inquiry notice as early as March 1999. The Court finds that the February and March announcements that the Company's financial performance was not living up to expectations were insufficient to alert Plaintiffs to the possibility that they had been deceived by a fraudulent or misleading Prospectus. Thus, the Amended Complaint may not be dismissed on statute of limitations grounds.
V. The Merits of Plaintiffs' Claims against the Underwriter Defendants
In the alternative, the Underwriter Defendants contend that even under the less stringent pleading standard for negligence actions under Sections 11 and 12(a)(2) of the Securities Act, Plaintiffs fail to state a claim for actionable misrepresentations or omissions in the Prospectus. Sections 11 and 12(a)(2) impose liability for material misstatements or omissions in a prospectus and registration statement, respectively. See 15 U.S.C. § 77k(a)(5) and 771(a)(2). The test for materiality under Section 11 is "whether the defendants' representations, taken together and in context, would have misled a reasonable investor." I. Meyer Pincus Assoc., P.C. v. Oppenheimer Co., Inc., 939 F.2d 759, 761 (2d Cir. 1991).
Plaintiffs allege that Defendants distributed and filed a prospectus in connection with the July 23, 1998 secondary public offering which "contained untrue statements of material facts, omitted to state other facts necessary to make the statements made not misleading, and concealed and failed to disclose other material facts." (Compl. ¶ 83.) Specifically, the Amended Complaint alleges that the Prospectus "failed to disclose that the Company was experiencing significant problems integrating recently acquired properties, particularly Eagle Quest and MetroGolf Properties." (Compl. ¶ 46.) Further, the Amended Complaint alleges that the Registration Statement "failed to disclose that the Offering was necessitated by pressure from the Company's lenders and its deteriorating cash position, and it failed to disclose that the integration of recently acquired sites was proceeding poorly and that the company was experiencing operation problems associated with these acquired properties." (Compl. ¶ 72.)
However, Plaintiffs allegations fail to show that any material statements or omissions attributed to Defendants were, in fact, misleading or false. The Prospectus included optimistic remarks about the Company's acquisition of the new facilities. (Underwriter Defs.' Mot. Dismiss at 16, citing Prospectus at 26). Such statements are protected by traditional "bespeaks caution" doctrine and the safe harbor provided by the PSLRA. The PSLRA added a new section 27A to the Securities Act, which protects such a statement when it "is identified as a forward looking statement, and is accompanied by meaningful cautionary statements identifying important factors that could cause actual results to differ materially from those in the forward looking statement," or if it is immaterial, or if the plaintiff fails to show the defendant's knowledge of falsity. 15 U.S.C. § 77z-2(c)(1)(A)-(B). These statements included substantial cautionary language and specific risk factors. Plaintiffs acknowledge that the Prospectus disclosed that the Company had significant debt and no assurances that cash flow would be sufficient to serve that debt (Pls.' Opp'n Underwriter Defs.' Mot. Dismiss at 21, citing Prospectus at 7); cautioned that there are "no assurances" that successful integration of the new facilities or any other event would occur ( Id. at 22); disclosed that the Company anticipated the need to raise additional capital in order to increase its leverage ( Id., citing Prospectus at 6); and warned that there "can be no assurance that the Company will be able to obtain additional financing" ( Id.). Further, the Prospectus specifically identified "Risk Factors," including the Company's indebtedness, historical evidence that the Eagle Quest and Golden Bear facilities had suffered recent losses, and the lack of assurances that the new facilities "can be readily integrated into the Company's operating structure." (Underwriter Defs.' Mot. Dismiss at 16, citing Prospectus at 5.) The Court finds that these statements clearly indicated the potential risks in investing in FGCI's stock and provide the very same information that Plaintiffs claim was omitted.
Plaintiffs argue that such "generalized risk statements" and "boilerplate disclosures" do not protect Defendants from liability. (Pls.' Opp'n Underwriter Defs.' Mot. at 22.) "Warnings of detriment are insufficient if they are simply a smoke screen to cover a company's internal reasonably informed certainty of detriment." In re Prudential Sec. Inc. Ltd. P'ships Litig., 930 F. Supp. 68, 72-74 (S.D.N.Y. 1996). Plaintiffs contend that the Underwriter Defendants, "in the exercise of reasonable care should have known of the material misstatements and omissions contained in the Prospectus." (Compl. ¶ 74.) However, the Court finds that Plaintiffs' allegations regarding FGCI's negative historical experience with acquired sites and an impending liquidity crisis are not sufficiently indicative of a dire financial situation that would make the optimistic statements contained in the Prospectus false or misleading. Nor do Plaintiffs allege that, at the time of the statements, there was any indication that the new facilities were likely to face integration problems, that cash flow would be insufficient to service the debt within the next year, that the Company would face difficulty in raising additional capital, or any other information that would contradict the optimistic statements in the Prospectus. Plaintiffs acknowledge that FGCI did not file for bankruptcy protection within the year following the 1998 Offering. (Compl. ¶ 63.) See In re Ultrafem, 91 F. Supp.2d at 700 (finding that there was no misrepresentation in the prospectus with respect to liquidity where the issuer filed for bankruptcy after the period during which the prospectus expected to have sufficient cash to operate). Thus, no "reasonable investigation" could have alerted the Underwriter Defendants to the possibility that any material misstatements or omissions existed. Accordingly, there is no showing that, at the time of the Offering, Defendants knew or should have known of any facts that would make the statements or omissions in the Prospectus false or misleading when made. Accordingly, the Court finds that the statements contained in the Prospectus are not actionable. Plaintiffs' claims against the Underwriter Defendants under Sections 11 and 12(a)(2) of the Securities Acts are dismissed.
VI. Opportunity to Re-Plead
Plaintiffs have requested that, in the event the Amended Complaint is found insufficient to maintain their causes of action against Defendants, they be granted leave to amend their complaint pursuant to Rule 15(a) of the Federal Rules of Civil Procedure. (Pls.' Opp'n Individual Defs.' Mot. Dismiss at 11 n. 3; Pls.' Opp'n Underwriter Defs.' Mot. Dismiss at 8 n. 4.) Rule 15 declares that leave to amend "shall be freely given when justice so requires." Fed.R.Civ.P. 15(a). Although leave is entrusted to the discretion of the district court, the Supreme Court has indicated that leave should be given "in the absence of any apparent or declared reason — such as undue delay, bad faith or dilatory motive on the part of the movant, repeated failure to cure deficiencies by amendments previously allowed, undue prejudice to the opposing party by virtue of allowance of the amendment, futility of amendment, etc." Foman v. Davis, 371 U.S. 178, 182 (1962). See also John Hancock Mut. Life Ins. Co. v. Amerford Int'l Corp., 22 F.3d 458, 462 (2d Cir. 1994) (holding that the district court did not abuse its discretion in denying motion for leave to amend, where the court stated its reasons for denying leave to amend); Acito, 47 F.3d at 55 (affirming district court's denial of leave to amend where the additional information offered would not cure the deficiencies noted by the court).
Plaintiffs have given no indication of additional allegations that could cure the pleading deficiencies in the Amended Complaint. Should Plaintiffs wish to attempt such curative efforts, the Court grants Plaintiffs 30 days from the date of this order to submit to the Court their proposed bases for leave to amend the complaint. Plaintiffs are warned that the Court will not entertain a reprise of the conclusory allegations of the Amended Complaint.
CONCLUSION
For the reasons set forth above, Defendants' motions to dismiss are granted and the Amended Complaint is dismissed in its entirety. The Clerk of the Court is directed to leave the action open for 30 days to await receipt of Plaintiffs' proposed bases, if any, for amending the Amended Complaint.