In re K-Tel Intern., Inc. Securities Litigation

• Decision Date: 07 August 2002
• Docket Number: No. 00-3210.,00-3210.
• Citation: 300 F.3d 881
• Parties: In re: K-TEL INTERNATIONAL, INC. SECURITIES LITIGATION Pasquale Migliaccio; Creative Care Corporation; Glen Reudolph; Morton Kahn; David Rea; Henry Werres; Claude Seymour; Igal Mammon; Neil Litton, Dr.; Jerry Booth; Joseph Erlich; Gary Ewin; Tim Murchison; Stanford D. Williams; Rev. R.G. Moore; Murray N. Johnson; Elizabeth Alpert; Arthur Alves; Societe Financiere Privee and Ravi Anand, on behalf of themselves and all others similarly situated, Appellants, v. K-tel International, Inc.; Philip Kives; Lawrence Kives, Appellees, Securities and Exchange Commission, Amicus on Behalf of Appellants.
• Court: U.S. Court of Appeals — Eighth Circuit

300 F.3d 881

In re: K-TEL INTERNATIONAL, INC. SECURITIES LITIGATION Pasquale Migliaccio; Creative Care Corporation; Glen Reudolph; Morton Kahn; David Rea; Henry Werres; Claude Seymour; Igal Mammon; Neil Litton, Dr.; Jerry Booth; Joseph Erlich; Gary Ewin; Tim Murchison; Stanford D. Williams; Rev. R.G. Moore; Murray N. Johnson; Elizabeth Alpert; Arthur Alves; Societe Financiere Privee and Ravi Anand, on behalf of themselves and all others similarly situated, Appellants, v. K-tel International, Inc.; Philip Kives; Lawrence Kives, Appellees Securities and Exchange Commission, Amicus on Behalf of Appellants.

No. 00-3210.

United States Court of Appeals, Eighth Circuit.

Submitted: October 17, 2001.

Filed: August 7, 2002.

Rehearing and Rehearing En Banc Denied: October 2, 2002.^*

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John Halebian, argued, New York, NY (Richard A. Lockride, Gregg M. Fishbein and Scott A. Kamber, on the brief), for appellant.

Luis De La Torre, argued, Washington, D.C., for appellants

Jonathan J. Lerner, argued, New York, NY (Lea Haber Kuck, Jacob Hollinger and Karl L. Cambronne, on the brief), for appellee.

Before WOLLMAN,¹ Chief Judge, MURPHY, and RILEY, Circuit Judges.

RILEY, Circuit Judge.

The appellants appeal the district court's² dismissal of their complaint and denial of their motion to amend. The appellants allege the appellees committed securities fraud in violation of section 10(b) of the Securities Exchange Act of 1934 (the Exchange Act), 15 U.S.C. § 78j(b), and related Securities and Exchange Commission (SEC) Rule 10b-5 by failing to make certain accounting adjustments in compliance with Generally Accepted Accounting Principles (GAAP) and by failing to make a timely disclosure regarding a NASDAQ delisting letter. The district court dismissed the complaint for failure to allege the accounting violations with the requisite particularity under Fed.R.Civ.P. 9(b) and for failure to plead facts "giving rise to a strong inference that the defendant[s] acted with the required state of mind" as dictated by the Private Securities Litigation Reform Act (the Reform Act), 15 U.S.C. § 78u-4(b)(2). In re K-tel Int'l, Inc. Sec. Litig., 107 F.Supp.2d 994 (D.Minn.2000). We affirm the district court's well reasoned opinion.

I. BACKGROUND

K-tel International, Inc. (K-tel) through certain of its current and former officers and directors, Philip Kives, Lawrence Kieves,³ David Weiner, Corey Fischer, and Jeffrey Koblick (defendants and appellees), markets and distributes entertainment and consumer products, including pre-recorded music compilations. During the relevant time period, K-tel common stock was publicly traded on the NASDAQ National Market System (NMS). The appellants constitute a class of those who acquired K-tel common stock between May 8, 1998, and 11:36 a.m. on November 17, 1998 (the Class). The Class alleged that during the class period they suffered damages as a result of violations by K-tel of the anti-fraud provisions of federal securities laws. 15 U.S.C. § 78(b); 17 C.F.R. § 240.10b-5 (1995).

On May 5, 1998, K-tel announced the financial results for the quarter ending March 31, 1998, which reported a decline in sales and income. On May 8, 1998, K-tel filed with the SEC its Form 10-Q for the quarter ending March 31, 1998 (the March 10-Q), echoing the negative information previously disclosed. The March 10-Q represented net tangible assets in excess of $4 million. During the period from May 5, 1998, to June 9, 1998, K-tel's share price dropped from $33.94 to $11.25.

On October 13, 1998, after an extension of time requested by K-tel, the company filed Form 10-K, an annual report filed with the SEC, for K-tel's fiscal year ending June 30, 1998. In the June 10-K, Ktel disclosed a shareholders' equity of $3,774,000, thereby representing K-tel was $226,000 below the $4 million net tangible asset minimum requirement for continued listing on NASDAQ.

On October 19, 1998, the National Association of Securities Dealers (the NASD) notified K-tel that K-tel's net tangible assets, based upon the June 10-K, had fallen below the $4 million minimum level necessary for continued listing. K-tel made no public announcement at this time of either its receipt of the October 19, 1998 delisting letter or its request for a hearing and temporary extension of time to meet the net tangible asset requirement. However, on November 3 and November 10, K-tel made public announcements regarding a partnership with Playboy Online for an online music store and another partnership arrangement with Microsoft.

On November 16, 1998, K-tel filed its Form 10-Q for the quarter ending September 30, 1998 (September 10-Q). The September 10-Q included information regarding negative financial results and also the receipt of the October 19, 1998 NASD letter. K-tel was not actually delisted as a result of the October 19, 1998 NASD letter.

A series of common stock transactions by individual defendants occurred during the class period. Specifically, almost 2.7 million shares of K-tel common stock were sold by four individual defendants between May 8, 1998, and June 9, 1998.⁴ From June 9, 1998 to November 17, 1998, there were only two other transactions by the individual defendants: on November 13, 1998, Koblick purchased 27,200 shares through the exercise of stock options, and on November 17, 1998, the day after filing the September 10-Q, Fischer sold 15,000 shares. The Class alleged the individual defendants received over $41 million from the sales of K-tel common stock during the class period.

In its three-count amended complaint, the Class alleged violations of section 10(b) of the Exchange Act and Rule 10b-5 based upon the omission of material adverse information and the knowing or reckless dissemination of false statements (Count I); violations by the individual defendants of section 20(a) of the Exchange Act based upon their alleged wrongful conduct (Count II); and violations by the individual defendants of section 20A of the Exchange Act based upon their sales of common stock (Count III). In Counts II and III, the Class raised claims against individual defendants Kives, Kieves, and Koblick. On appeal the Class does not challenge the district court's dismissal of these two counts.

The Class alleged that a continuous fraudulent scheme in combination with large stock trades by some of the individual defendants gave rise to the securities law violations in Count I. As alleged, the scheme was characterized by two circumstances. First, the Class alleged two accounting violations gleaned from K-tel's SEC filings. The Class asserts K-tel knew in March 1998 of a $1.498 million loss due to the poor performance of a subsidiary and K-tel was required by GAAP to write-off the assets of the subsidiary in its March 10-Q filing, filed May 8, 1998. K-tel wrote down assets in that amount by March 1999. Additionally, the Class alleged K-tel failed to disclose future losses of $1.8 million related to the subsidiary, also in violation of GAAP. The Class alleged such overstating of assets in the March 10-Q and the later June 10-K is a violation of GAAP and is evidence of fraud and scienter because K-tel's inclusion of the overstated assets concealed its inability to comply with the minimum necessary tangible net asset requirement for continued listing on the NMS.

Second, the Class alleged K-tel's failure to disclose publicly the October 19, 1998 NASD letter is evidence of fraudulent intent. The Class alleged K-tel's failure to disclose the letter in the four-week period after it was received was a material omission because during the period K-tel was involved in press releases extolling the company's business including, inter alia, new partnerships with Playboy Online and Microsoft.

The district court granted K-tel's motion to dismiss all claims pursuant to Rules 9(b) and 12(b)(6) of the Federal Rules of Civil Procedure, and 15 U.S.C. § 78u-4(b)(2), finding the amended complaint failed to allege with sufficient particularity either material misrepresentations or facts giving rise to a strong inference of scienter. Further, the district court denied leave to amend the complaint again and entered judgment for K-tel and the individual defendants.

II. DISCUSSION

The Exchange Act § 10(b) and related rules prohibit "the use of any `manipulative or deceptive device or contrivance' in connection with the purchase or sale of a security." Alpern v. UtiliCorp United, Inc., 84 F.3d 1525, 1533 (8th Cir.1996) (quoting 15 U.S.C. § 78j(b) and Herman & MacLean v. Huddleston, 459 U.S. 375, 382, 103 S.Ct. 683, 74 L.Ed.2d 548 (1983)); see also In re Navarre Corp. Sec. Litig., 299 F.3d 735, 2002 WL 1760458, slip op. at 8 (8th Cir.2002). Rule 10b-5 provides that it is unlawful:

for any person, directly or indirectly ...

(a) To employ any device, scheme, or artifice to defraud,

(b) To make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading, or

(c) To engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person, in connection with the purchase or sale of any security.

17 C.F.R. § 240.10b-5 (1995).

In order to proceed on claims brought pursuant to section 10(b) and Rule 10b-5, the Class is required to show four elements: (1) misrepresentations or omissions of material fact or acts that operated as a fraud or deceit in violation of the rule; (2) causation, often analyzed in terms of materiality and reliance; (3) scienter on the part of the defendants; and (4) economic harm caused by the fraudulent activity occurring in connection with the purchase and sale of a security. See 17 C.F.R. § 240.10b-5; In re Navarre Corp., 299 F.3d 735, 2002 WL 1760458, slip op. at 9. Alpern, 84 F.3d...