Arazie v. Mullane

• Citation: 2 F.3d 1456
• Decision Date: 17 August 1993
• Docket Number: No. 92-3667,92-3667
• Parties: Fed. Sec. L. Rep. P 97,708, 26 Fed.R.Serv.3d 873 David ARAZIE, Paul Karinsky, William Klein, et al., Plaintiffs-Appellants, v. Robert E. MULLANE, Paul J. Johnson, William E. Chandler, et al., Defendants-Appellees.
• Court: United States Courts of Appeals. United States Court of Appeals (7th Circuit)

Page 1456

2 F.3d 1456

Fed. Sec. L. Rep. P 97,708, 26 Fed.R.Serv.3d 873

David ARAZIE, Paul Karinsky, William Klein, et al Plaintiffs-Appellants, v. Robert E. MULLANE, Paul J. Johnson, William E. Chandler, et al., Defendants-Appellees.

No. 92-3667.

United States Court of Appeals Seventh Circuit.

Argued June 1, 1993.

Decided Aug. 17, 1993.

Henry A. Brachtl, Goodkind, Labaton & Rudoff, Jeffrey Squire, Kaufman, Malchman & Kirby, New York City, Terry Rose Saunders, Susman, Saunders & Buehler, Marvin A. Miller, Patrick E. Cafferty, Miller, Faucher, Chertow, Cafferty & Wexler, Chicago, IL, Mark C. Gardy, Lee Squitieri, argued, Abbey & Ellis, New York City, Michael D. Craig, Schiffrin & Craig, Buffalo Grove, IL, for plaintiffs-appellants.

Barbara S. Steiner, Jerold S. Solovy, William D. Heinz, argued, C. John Koch, Patricia A. Bronte, Norman M. Hirsch, Jenner & Block, Chicago, IL, for all other defendants-appellees.

Dennis J. Block, Joseph S. Allerhand, Darla C. Stuckey, Weil, Gotshal & Manges, New York City, for Bally Mfg. Corp.

Before BAUER, Chief Judge, CUMMINGS and MANION, Circuit Judges.

BAUER, Chief Judge.

In this appeal we consider whether the district court properly denied the plaintiffs' motion to amend their complaint. The court concluded that the proposed amended pleading failed to cure the defects which led to the dismissal of the original complaint. We affirm.

I. Facts

The plaintiffs, David Arazie, Paul Karinsky, William Klein, Ann Klein, Aldo Mirizzi, Lawrence Moss, Florence Moss, Kevin O'Sullivan, Jeffrey Starr, and Arthur Yorkes ("the stockholders" or "the plaintiffs"), purchased stock in defendant Bally Manufacturing Corporation between February 24, 1990 and October 11, 1990 ("the class period"). The stockholders brought this action against Robert E. Mullane, Paul J. Johnson, Patrick L. O'Malley, William E. Chandler, Roger N. Keesee, and Bally Manufacturing Corporation alleging that the defendants made fraudulent statements about Bally's financial status during the class period. They allege that Bally and some of its officers and directors (the other name defendants) (collectively "Bally") painted an unjustifiably rosy picture of Bally's financial health. In fact, they contend, the defendants' painting was so exuberant, it amounted to fraud in violation of the federal securities laws. The complaint alleged a cause of action under sections 10(b) and 20(a) of the Securities Exchange Act of 1934, 15 U.S.C. Sec. 78j(b) & 78t(a), and the SEC's Rule 10(b)(5), 17 C.F.R. 240.10b-5. According to the stockholders, the defendants' fraudulent misstatements artificially increased the prices the stockholders paid for their Bally stock. See Basic, Inc. v. Levinson, 485 U.S. 224, 241-44, 108 S.Ct. 978, 988-90, 99 L.Ed.2d 194 (1988) (discussing fraud-on-the-market theory); Wielgos v. Commonwealth Edison Co., 892 F.2d 509, 510 (7th Cir.1989) (same).

The district court dismissed the first complaint because the statements that the plaintiffs complained of fall within the safe harbor for predictive, forward-looking statements provided by Exchange Act Rule 3b-6. 17 C.F.R. Sec. 240.3b-6. The plaintiffs argued that these statements were not protected by Rule 3b-6 because they lacked a reasonable basis in fact. The court found that the plaintiffs failed to satisfy the requirements of Fed.R.Civ.P. 9(b) that fraud be pleaded with particularity. "Because only a fraction of financial deteriorations reflects fraud, plaintiffs may not proffer the different financial statements and rest. Investors must point to some facts suggesting that the difference is attributable to fraud." DiLeo v. Ernst & Young, 901 F.2d 624, 628 (7th Cir.), cert. denied, 498 U.S. 941, 111 S.Ct. 347, 112 L.Ed.2d 312 (1990). We require plaintiffs in securities cases to plead the circumstances showing fraud in detail--the "who, what, where, when, and how." Id. at 636 Plaintiffs must provide enough information about the underlying facts to allow us to distinguish their claims from those of disgruntled investors. The district court ruled that the plaintiffs failed to allege specific facts showing Bally's public predictions were fraudulent. It dismissed the first complaint. In re Bally Mfg. Sec. Litig., 141 F.R.D. 262 (N.D.Ill.1992).

The plaintiffs filed a motion to clarify the judgment to indicate whether they had leave to amend the complaint, or, in the alternative, to vacate the judgment under Fed.R.Civ.P. 60(b) and grant leave to amend under Rule 15(a). Plaintiffs filed a proposed amended complaint. Count one of the amended complaint alleged a cause of action under sections 10(b) and 20(a) of the Securities Exchange Act of 1934, 15 U.S.C. Sec. 78j(b) & 78t(a), and the SEC's Rule 10(b)(5), 17 C.F.R. 240.10b-5; count two alleged common law fraud and deceit; count three alleged common law negligent misrepresentation. The court clarified its judgment, indicating that it did not grant leave to amend, and further denied the motion to vacate and leave to amend. In re Bally Mfg. Sec. Litig., 144 F.R.D. 78 (N.D.Ill.1992). The court found that the amended complaint also failed to satisfy the requirements of Rule 9(b). The plaintiffs appeal the district court's denial of their motion to amend.

We review the facts alleged in the amended complaint to determine whether the district court's finding that it fails to satisfy the requirements of Rule 9(b) is correct. See Proposed Second Consolidated Amended & Supplemental Class Action Complaint, Appellants' Appendix at 230 ("Amended Complaint").

Bally's primary operations, fitness centers and casino hotels, require substantial capital investment. During 1987, 1988, and 1989, Bally invested heavily in property, equipment, and new acquisitions--to the tune of more than $800 million. In re Bally, 141 F.R.D. at 264. These investments were highly leveraged. By the end of 1989, Bally's $1.77 billion debt reflected 75% of its capitalization. In September 1990, Bally's stock price dropped precipitously after the firm announced it would not pay scheduled debt payments and dividends. The stockholders allege that during the class period, Bally's stock prices were kept artificially high by false statements and material omissions in Bally's public statements and SEC filings about its financial status. Amended Complaint at p 80. The statements, according to the stockholders, failed to disclose an imminent cash crunch which threatened Bally's viability as a going concern. Amended Complaint at p 1.

The complaint catalogues Bally's public statements between February and October 1990, and compares these statements to some of Bally's internal memoranda. Bally's internal memos and "reasonable projections" (based on data released in Bally's public statements), the stockholders argue, show that Bally's public statements were fraudulent because they omitted material facts. The allegedly fraudulent statements fall roughly into four categories. The first group concerned Bally's use of cash from its New Jersey casino subsidiary. The plaintiffs claim that the manner in which Bally obtained cash from this subsidiary should have been disclosed because it revealed Bally's desperate liquidity problems. The second group of statements concerned Bally's general failure to disclose what plaintiffs term a "looming liquidity crisis," particularly with regard to Bally's offer to swap debt instruments for common stock. The plaintiffs argue that Bally misleadingly portrayed the swap as a plan to "increase shareholder value." Amended Complaint at p 47. They contend Bally should have announced that the swap was designed to cure severe liquidity problems. The failure to reveal the "true" nature of the swap made Bally's predictions of its future performance fraudulent. These problems, they believe, should have been disclosed. The third group of statements concerned the general success and competitiveness of Bally's casino and fitness center operations. Plaintiffs argue that Bally understated the effect of new entrants in the casino market and overstated the revenues its casinos and fitness centers would generate. The final group of statements concerned a range of topics, and are grouped together because they were issued in the weeks just prior to the drop in Bally's stock. We will review each group of statements, and the plaintiffs' allegations that certain internal documents contradict these statements and predictions about Bally's financial health.

A. Cash from New Jersey Casinos

Bally announced its fourth quarter and year-end financial figures for 1989 on February 23, 1990. The stockholders highlight the following statement issued by Bally and quote Chairman of the Board and CEO, defendant Robert Mullane, who announced the figures:

[W]e are well positioned to meet the needs of our markets as we move into the '90s.... Despite the recent decline of gaming industry stocks, I feel our previously reported strong cash flow position of approximately $7.00 per share after interest and taxes will reflect favorably on the company's long-term financial and stock market performance.

Amended Complaint at p 38. Shortly after the year-end financial figures were released, in March 1990, Mullane told Crain's Chicago Business, that "[Bally] is a good business that's not being sold well on Wall Street.... I've done a very poor job of selling the company[,] .... We're going to start some selling. We have to. We have a better company than we've been showing." Id. at p 39. These statements were misleading according to the stockholders because they did not disclose Bally's reliance on cash it received from its New Jersey casino subsidiary. This infusion, the stockholders claim, revealed Bally's weak financial position. They allege that Bally's position was so weak that it was willing to risk violating New Jersey's casino regulations.

To understand the basis for this accusation, we must briefly review the history of Bally's New Jersey casino operations. New Jersey...