438 F.3d 256 (3rd Cir. 2006), 04-3716, In re Suprema Specialties, Inc. Securities Litigation

Docket Nº:04-3716, 04-3755.
Citation:438 F.3d 256
Party Name:In re: SUPREMA SPECIALTIES, INC. SECURITIES LITIGATION Teachers' Retirement System of Louisiana, Appellant Special Situations Fund, III, L.P.; Special Situations Cayman Fund, L.P., Appellants.
Case Date:February 23, 2006
Court:United States Courts of Appeals, Court of Appeals for the Third Circuit
 
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438 F.3d 256 (3rd Cir. 2006)

In re: SUPREMA SPECIALTIES, INC. SECURITIES LITIGATION

Teachers' Retirement System of Louisiana, Appellant

Special Situations Fund, III, L.P.; Special Situations Cayman Fund, L.P., Appellants.

Nos. 04-3716, 04-3755.

United States Court of Appeals, Third Circuit

Feb. 23, 2006

Argued Sept. 14, 2005.

On Appeal from the United States District Court for the District of New Jersey, D.C. Nos. 02-cv-00168, 02-cv-03099, District Judge: Honorable William H. Walls

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Daniel L. Berger (Argued), J. Erik Sandstedt, Bernstein, Litowitz, Berger & Grossman, LLP, New York, NY, for Appellant Teachers' Retirement System of Louisiana.

Lawrence M. Rolnick (Argued), Lowenstein Sandler P.C., Roseland, NJ, Marc B. Kramer (Argued), Short Hills, NJ, for Appellants Special Situations Fund, III, L.P. and Special Situations Cayman Fund, L.P.

Phillip A. Geraci (Argued), Frederic W. Yerman, Kaye Scholer, New York, NY, Diane J. O'Neil, Mendes & Mount, Newark, NJ, Michael T. Conway, Lazare, Potter, Giacovas & Kranjac, New York, NY, for Appellees Mark Cocchiola and Marco Cocchiola.

Nancy E. Delaney (Argued), T. Barry Kingham, Dora Straus, Curtis, Mallet-Prevost, Colt & Mosle, LLP, New York, NY, for Appellee Steven Venechanos.

William J. Snipes (Argued), Sullivan & Cromwell, LLP, New York, NY, Charles J. Benjamin, Jr., McCarter & English, LLP, Newark, NJ, for Appellees Rudolph Acosta, Paul DeSocia, and Barry Rutcofsky.

Ira G. Greenberg (Argued), Edwards, Angell, Palmer & Dodge, New York, NY, for Appellee BDO Seidman, LLP.

Robert L. Hickok (Argued), Pepper Hamilton LLP, Philadelphia, PA, for Appellees Roth Capital Partners, LLC, Janney Montgomery Scott, LLC, and Pacific Growth Equities, Inc.

Thomas B. Lewis, Stark & Stark, Princeton, NJ, for Appellee Oberweis.net.

Anthony P. La Rocco, Kirkpatrick & Lockhart Nicholson Graham LLP, Newark, NJ, Keith A. Ketterling, Stoll Stoll Berne Lokting & Shlachter PC, Portland, OR, for Appellee Paulson Investment Company, Inc.

Robert A. Assuncao, DLA Piper Rudnick Gray Cary U.S. LLP, Edison, NJ, for Appellee Westminster Securities Corp.

Nooshin Namazi (Argued), Kevin J. O'Malley, Nicoletti Hornig Campise & Sweeney, New York, NY, for Appellee Westport Resources Investment Services, Inc.

Before: SLOVITER, BARRY, and SMITH, Circuit Judges.

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OPINION

SLOVITER, Circuit Judge

Table of Contents

I. A. The Rise and Fall of Suprema ................................ 264

B. The Secondary Offerings ..................................... 266

C. Procedural History .......................................... 267

II. A. Section 11 and Section 12(a)(2) Claims ...................... 269

B. Section 10(b) Claims ........................................ 275

1. The Officers ........................................... 277

a) Motive and Opportunity .............................. 277

b) Circumstantial Evidence of Misconduct ............... 278

  1. The Auditor ............................................ 279

  2. The Outside Directors .................................. 281

  3. The 2000 and 2001 Underwriters ......................... 282

C. Section 18 Claims ........................................... 283

D. Section 15 and Section 20(

  1. Claims ......................... 284

    E. Pendent State law claims .................................... 286

    III. Conclusion ....................................................... 286

    At the center of this securities fraud action is Suprema Specialties, Inc. ("Suprema"), a now-defunct company that presented itself as a producer and distributor of all natural gourmet Italian cheeses. Over a two-year period, Suprema reported wildly successful growth in its sales and receivables, thereby enticing lenders to increase its credit line and luring investors to the purchase of its stock. In truth, Suprema had fabricated millions of dollars in cheese sales and engaged in other fraudulent schemes that ultimately led to the company's dissolution in bankruptcy. Government investigations resulted in four individuals connected to Suprema's schemes pleading guilty to federal charges of, inter alia, conspiracy to commit securities fraud. Those individuals have admitted that a number of Suprema's public statements regarding its finances and the nature of its business were untrue.

    The plaintiffs-appellants here are two institutional investors, Special Situations Fund, III, L.P., and Special Situations Fund Cayman, L.P. (collectively, the "SSF Plaintiffs"), and the Teachers' Retirement System of Louisiana (referred to as "Lead Class Plaintiff" because it held that status in the consolidated class actions before the District Court). SSF Plaintiffs and Lead Class Plaintiff brought separate actions for damages against Suprema's former officers and directors, its auditor, and several investment firms that served as underwriters in two public stock offerings through which plaintiffs claim to have acquired Suprema stock. Plaintiffs asserted claims for relief under Sections 11, 12(a)(2), and 15 of the Securities Act of 1933 (the "Securities Act"), and Sections 10(b), 18, and 20 of the Securities and Exchange Act of 1934 (the "Exchange Act"), along with fraud and misrepresentation claims under state law. On defendants' motions, the United States District Court for the District of New Jersey dismissed all claims pursuant to Rules 9(b) and 12(b)(6) of the Federal Rules of Civil Procedure, as well as provisions of the Private Securities Litigation Reform Act ("PSLRA"). Among the important issues presented on appeal is whether the District Court properly applied the "sounds in fraud" doctrine in dismissing the claims asserted under Section 11 and Section 12(a)(2) despite plaintiffs'

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    efforts to ground their Securities Act claims in negligence and to plead them separately in the complaints from their fraud-based claims. We will reverse the District Court's orders dismissing the claims under Sections 11, 12(a)(2), and 15 of the Securities Act and Section 10(b) of the Exchange Act as to some of the defendants, and we will affirm as to the dismissal of the remaining counts. We will remand as to the state law claims.

    I.

    In setting forth the underlying facts, we accept as true the well-pleaded allegations in plaintiffs' second amended complaints and consider the documents incorporated by reference therein. See Cal. Pub. Employees Ret. Sys. v. Chubb Corp., 394 F.3d 126, 134 (3d Cir. 2004) (herein after "CALPERS").

    A. The Rise and Fall of Suprema

    Suprema was founded as a New York non-public corporation in 1983. It became a publicly traded company in 1991 and was listed on the NASDAQ (trading under the symbol "CHEZ") in 1993. Suprema had its corporate headquarters, along with a processing plant, in Paterson, New Jersey, and it operated three wholly-owned subsidiaries, at which it manufactured and processed cheese, in Manteca, California; Ogdensburg, New York; and Blackfoot, Idaho. Suprema's business was divided between two product lines: "hard cheese," which included imported and domestically produced parmesan and romano, and "soft-cheese," which included domestically produced mozzarella, ricotta, and provolone.

    Defendant-Appellee Mark Cocchiola was a founder of Suprema and acted as the company's Executive Vice-President, CEO, and Chairman of the Board of Directors. Defendant-Appellee Steven Venechanos was the company's CFO and Secretary, and also a member of the Board of Directors during the Class Period. (Cocchiola and Venechanos will be referred to collectively as the "Officers.") Defendants-Appellees Marco Cocchiola (Mark Cocchiola's father), Rudolph Acosta, Jr., Paul DeSocio, and Barry Rutcofsky (collectively, the "Outside Directors") were members of the Board of Directors. (We will refer to Mark Cocchiola simply as "Cocchiola" and to Marco Cocchiola by his full name.) Marco Cocchiola was also Suprema's Operations Manager. Acosta, DeSocio, and Rutcofsky were members of the Board's Audit Committee. Defendant-Appellee BDO Seidman, LLP ("BDO") was Suprema's auditor throughout the class period.

    In 2000 and 2001, Suprema reported dramatic growth in sales and receivables, which it attributed primarily to growth in sales of its domestically manufactured hard cheeses. Suprema's net sales for fiscal year 2000 increased to $278.4 million, reflecting a 58% increase over fiscal year 1999, and for fiscal year 2001, increased to $420.3 million, or 51% over fiscal year 2000. In its hard cheese business alone, Suprema reported 400% growth in revenue between fiscal year 1999 and the end of fiscal year 2001. Its receivables were reported to have grown from $36 million at the end of fiscal year 1999 to $101.8 million by the end of fiscal year 2001. During this same period, industry wide growth in sales was only approximately 9% per year. In September 2001, Fortune Magazine named Suprema the twenty-third fastest growing small company in the United States, and shortly thereafter Forbes Magazine ranked it as the twenty-second best small company. Between the fourth quarter of 1998 and the fourth quarter of 2000, the company's average share price more than doubled.

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    State and federal investigations subsequently revealed that Suprema's explosive growth was an illusion- the product of a fraudulent scheme involving so-called round-trip sales or circular transactions associated with the hard cheese side of its business. The round-trip sales scheme was one in which...

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