228 F.3d 154 (2nd Cir. 2000), 99-7904, Ganino v Citizens Utilities Co.
|Docket Nº:||Docket No. 99-7904|
|Citation:||228 F.3d 154|
|Party Name:||JOSEPH A. GANINO, ROBERT E. CREIGHTON, LOUISE A. CREIGHTON, WILLIAM J. FRAY, THE ESTATE OF NORMAN GARAND, THE GARAND FAMILY PARNTERSHIP, A. JOHN KALIL, REZA NAJAFZADEH, JEFFREY T. NORTON, REBECCA L. NORTON, JOHN NORTON, MATTHEW NORTON, LAURA NORTON, ALICE M. TOBIN AND BRANTLEY H. TUDOR, individually and on behalf of a class of persons similarly sit|
|Case Date:||September 06, 2000|
|Court:||United States Courts of Appeals, Court of Appeals for the Second Circuit|
Argued: April 10, 2000
As Amended Sept. 11, 2000
Appellants appealed from a judgment of the United States District Court for the District of Connecticut (Warren W. Eginton, Senior Judge) dismissing the complaint for failure to state a claim.
Reversed in part, vacated in part, and remanded.
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ANDREW M. SCHATZ (Jeffrey S. Nobel, Andrew S. Turret, on the brief), Schatz & Nobel, PC, Connecticut, for Appellants.
GEORGE A. ZIMMERMAN (W.H. Ramsay Lewis, Shoshanah V. Asnis, on the brief), Skadden, Arps, Slate, Meagher & Flom, LLP, New York, for Appellee.
Before: NEWMAN, KEARSE, AND KATZMANN, Circuit Judges.
KATZMANN, Circuit Judge:
The plaintiffs-appellants appeal from a final judgment of the United States District Court for the District of Connecticut (Warren W. Eginton, Senior Judge), granting the defendants-appellees' motion to dismiss the Second Amended Complaint (the "Complaint") for failure to state a claim under Sections 10(b)1 and 20(a)2 of the Securities Exchange Act of 1934 (the "Exchange Act"), 15 U.S.C. §§ 78j(b) & 78t(a), and Rule 10b-53 promulgated thereunder, 17 C.F.R. § 240.10b-5. The district court held: (1) the misrepresentations regarding certain payments amounting
to 1.7% of total annual revenue were immaterial as a matter of law; (2) the lack of share price movement following the release of corrective information was evidence of immateriality; and (3) the Complaint was defective as to one or more of the other elements of a Rule 10b-5 suit. For the reasons that follow, we reverse in part, vacate in part, and remand with instructions.
A. Factual Background
The plaintiffs in this action purchased or acquired the common stock of Citizens Utilities Company ("Citizens" or the "Company"), the corporate defendant, between May 7, 1996 and August 7, 1997 (the "Class Period"). [JA 260 ¶ 1] Alleging that Citizens' share price was fraudulently inflated during the Class Period, the plaintiffs seek to represent the class of all purchasers of Citizens common stock during the Class Period in this action against Citizens and three of its senior officers. [JA 262-63 ¶¶ 8-9; JA 265 ¶ 11] The following allegations are drawn from their Complaint, which we accept as true for purposes of this appeal.
Citizens is a publicly traded communications and public services company. [JA 262 ¶ 8] As of 1995, Citizens had reported over fifty consecutive years of increased revenue, earnings, and earnings per share, a fact which it emphasized in its public comments. Id. [JA 269 ¶ 22; JA 280 ¶ 33] In 1995, however, Citizens would not receive approximately $38 million in revenue from Pacific Bell. [JA 296-97 ¶ 60d] In order to continue to report increased earnings, the Company had to find another source of revenue. [Id.]
That replacement source was Hungarian Telephone & Cable Corporation ("HTCC"), a U.S. company which provides telephone services in Hungary under telecommunications concessions from the Hungarian government. [JA 268-69 ¶ 20] The concession contracts require HTCC to meet certain construction milestones. [JA 268 ¶ 20b] Failure to do so would subject HTCC to fines, reduction of its exclusivity period, or abrogation of the contracts. [JA 269 ¶ 20c-d] Unprofitable since its inception, HTCC by 1995 lacked the necessary funds to satisfy its contractual requirements and began looking for a source of financing. [JA 269 ¶ 21] Beginning in May 1995, HTCC and Citizens (through a wholly owned subsidiary of Citizens) entered into a series of agreements under which Citizens agreed in 1995 to make and/or guarantee loans to HTCC. In consideration for these loans and guarantees, Citizens received substantial fees (the "Financial Support Fees" or the "Fees"), consisting primarily of HTCC stock and options. [JA 270-71 ¶ 23] In addition, Citizens also provided management consulting services to HTCC. Id. ¶ 23. [JA 272 ¶ 24c]
1. Allegations of Material Misrepresentations
Although Citizens earned and received approximately $10.1 million in Financial Support Fees from HTCC in 1995, Citizens, according to the Complaint, fraudulently recognized this sum as 1996 first and second quarter income without proper disclosure. [JA 281 ¶ 34(f), 284 ¶ 36(f)] Because Citizens' 1995 annual financial statement ("1995 Form 10-K") filed with the Securities and Exchange Commission (the "SEC") stated that Citizens "ha[d] been compensated for . . . guarantees and financial support [to HTCC]," investors were allegedly misled into believing that the $10.1 million booked in 1996 was new income, unrelated to the 1995 HTCC loan and guarantee transactions. [JA 276 ¶ 26, 283 ¶ 37] See 15 U.S.C. § 78m(a)(2) (requiring quarterly and annual financial reports to be filed with the SEC); 17 C.F.R. § 240.13a-13(a).
a. May 7, 1996 Announcement of 1996 First Quarter Financial Results and First Quarter Form 10-Q
On May 7, 1996, Citizens publicly announced an after-tax net income of $38.9 million for the first quarter of 1996, up 15% from the corresponding period in 1995. [JA 279-80 ¶ 33] These results were reflected in its 1996 first quarter financial statement ("First Quarter Form 10-Q"). [JA 117 (line item "Net Income"), JA 280 ¶ 33] The defendants
did not disclose that "as much as $6.9 million of the $38.9 million . . . was HTCC related income which was deceptively 'stored' by Citizens" until the first quarter of 1996. [JA 281 ¶ 34f] According to the Complaint, the defendants also concealed the fact that this $6.9 million made up most if not all of the reported 15% increase during the first quarter of 1996. [Id.]
b. August 15, 1996 Press Release and 1996 Second Quarter Form 10-Q
On August 15, 1996, Citizens issued another press release announcing "record . . . profits for the three- and six-month periods ended June 30, 1996," with the second quarter's net income of $46.3 million representing a 10% increase over the comparable period in the preceding year. [JA 281 ¶ 35] Citizens attributed this growth to "continuous above-average growth in volume and profitability in each of its sectors, particularly telecommunications." [JA 281-82 ¶ 35] These results were reflected in its 1996 second quarter financial report ("Second Quarter Form 10-Q"). [JA 129 (line item "Net Income"), JA 282 ¶ 35] The Complaint charges that the August 15, 1996 press release and the 1996 Second Quarter Form 10-Q both failed to disclose that "approximately $10 million of the $85.1 million of reported income for the six months ended June 30, 1996 was HTCC related income" which should have been recognized in 1995. [JA 283 ¶ 36f] The Complaint states that the defendants also concealed the fact that this approximately $10 million accounted for the full 10% increase in income for the first six months of 1996 over the comparable period in 1995. [Id.]
c. Subsequent Financial Statements and Press Releases
The $10.1 million of Financial Support Fees were also reported as part of the year-to-date earnings in Citizens' 1996 Third Quarter Form 10-Q, 1996 Form 10-K, and accompanying press releases. [JA 284-86 ¶¶ 38-41] An additional $11.2 million of Fees were booked in the last quarter of 1996 and reflected in the 1996 year-end statement ("1996 Form 10-K"). [JA 287 ¶ 42f] In total, the Fees at issue added up to approximately $22 million, or 1.7% of Citizens' total revenue for 1996. [JA 146 (line item "Total revenues")] As with the Form 10-Qs for the first two quarters of 1996, the defendants did not disclose in the Third Quarter Form 10-Q, 1996 Form 10-K, and accompanying press releases that the reported income included HTCC Fees earned and received in 1995. [Id.]
On April 30, 1997, Citizens issued a press release announcing lower than expected earnings for the first quarter of 1997. These results were reflected in the Company's 1997 First Quarter Form 10-Q. [JA 287-88 ¶ 43; JA 288 ¶ 44] Neither document attributed the drop in income to the decrease in HTCC Fees. Instead, according to the Complaint, the press release misleadingly focused on rising expenses. [JA 288 ¶ 43] Beginning in or about May 1997, industry analysts began to report weaknesses in Citizens' earnings position. [JA 288-89 ¶¶ 46-47] Their predictions were confirmed by Citizens in August 1997 with the filing of its 1997 Second Quarter Form 10-Q, which also disclosed that the reported income for the first two quarters of 1996 included material income from HTCC. [JA 289 ¶ 48]
d. Other Misrepresentations
The defendants allegedly made other material misrepresentations. According to the Complaint, the defendants failed to disclose that the Fees were non-recurring income, in violation of a Generally Accepted Accounting Principle ("GAAP")4 that
companies report "extraordinary, unusual or infrequently occurring events and transactions." [JA 292 ¶ 53] See generally Accounting Principles Board ("APB") Opinion No. 30, ¶¶ 19-24 (1973) (explaining "Criteria for Extraordinary Items"). The defendants also allegedly concealed Citizens' control over HTCC and in fact, by employing "cost...
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