In re Craftmatic Securities Litigation

• Decision Date: 27 January 1989
• Docket Number: No. 88-4530.,88-4530.
• Citation: 703 F. Supp. 1175
• Parties: In re CRAFTMATIC SECURITIES LITIGATION.
• Court: U.S. District Court — Eastern District of Pennsylvania

703 F. Supp. 1175

In re CRAFTMATIC SECURITIES LITIGATION.

No. 88-4530.

United States District Court, E.D. Pennsylvania.

January 13, 1989.

As Amended January 27, 1989.

Leonard Barrack, Barrack, Rodos & Bacine Philadelphia, Pa., Richard D. Greenfield, Greenfield & Chimicles, Haverford, Pa., for plaintiffs.

Alan C. Kessler, Mark R. Rosen, Mesirov, Gelman, Jaffe, Cramer & Jamieson, Philadelphia, Pa., for defendants.

Steven R. Waxman, Howard E. Goldberg, George S. Kounoupis, Fox, Rothschild, O'Brien & Frankel, Philadelphia, Pa., for Advest, Inc.

MEMORANDUM OF DECISION

McGLYNN, District Judge.

In this federal securities class action, Defendants Craftmatic/Contours Industries, Inc., Stanley Kraftsow and Carolyn Kraftsow ("Craftmatic Defendants") move to dismiss Counts I, II and III of Plaintiff's Consolidated Amended Complaint ("Complaint") for failure to state a claim upon which relief can be granted, Fed.R.Civ.P. 12(b)(6), and for failure to comply with the pleading requirements of Rule 9(b); to dismiss Plaintiff's pendant state law claim— Count IV—for lack of subject matter jurisdiction, Fed.R.Civ.P. 12(b)(1); or, in the alternative, to strike Plaintiff's legally insufficient averments pursuant to Fed.R.Civ.P. 12(f). Defendant Advest moves to dismiss Count I to the extent that the factual allegations set forth in paragraph 49(d)-(g), (i)-(l) purport to state a claim against Advest upon which relief can be granted; or in the alternative, to strike paragraph 49(d)-(g) and (i)-(l) as immaterial pursuant to Fed.R.Civ.P. 12(f). Advest further moves pursuant to Rule 12(e) for a more definite statement as to Count III of the Complaint. For the reasons stated below, I conclude that:

I) Count I should be dismissed with respect to all defendants for failure to state a claim upon which relief can be granted;

II) Count III should be dismissed with respect to the Craftmatic Defendants for failure to state a claim upon which relief an be granted;

III) Count II should be dismissed with respect to the Craftmatic Defendants for failure to state a claim upon which relief can be granted to the extent it incorporates paragraph 49(a)-(m), (o)-(p) of the Complaint;

IV) Count III should be dismissed with respect to Defendant Advest for failure to state a claim upon which relief can be granted to the extent it incorporates paragraph 49(a)-(m), (o)-(p) of the Complaint; and

V) Counts II and III should be dismissed (with leave to amend) for failure to comply with the "particularity" requirement of Fed.R.Civ.P. 9(b) to the extent they incorporate paragraph 49(q)-(t) of the Complaint.

I. FACTS

In deciding a motion to dismiss for failure to state a claim,

factual allegations of the Complaint are to be accepted as true and the complaint should be dismissed only if it appears to a certainty that no relief could be afforded under any set of facts which could be proved. Reasonable factual inferences will be drawn to aid the pleader.

D.P. Enterprises, Inc. v. Bucks County Community College, 725 F.2d 943, 944 (3d Cir.1984).

Defendant Craftmatic manufactures, markets and distributes the Craftmatic Adjustable Bed, "specifically designed for residential use which purports to have certain features found in hospital beds," and the Contour Chair Lounge, "which purports to be a custom-fitted reclining chair." Cplt. paragraph 7(a). Craftmatic's stock has been traded publicly since March 5, 1986 ("Initial Public Offering"). Cplt. paragraph 7(c). Defendant Stanley Kraftsow served as Chairman of the Board of Directors, President, and Chief Operating Officer of Craftmatic during the class period. Cplt. par. 8. His wife, Defendant Carolyn Kraftsow, is a Director and Secretary of Craftmatic. Cplt. par. 9. Defendant Advest, Inc. is the securities brokerage and investment firm that served as the Company's investment banker, advisor, and the principal underwriter in Craftmatic's initial public offering.

The Plaintiff class is comprised of all persons who purchased Craftmatic common stock during the period March 5, 1986 through June 11, 1987 ("the class period"). In their Complaint, Plaintiffs purport to state three federal causes of action¹ and one state pendant claim², in essence, alleging that Defendants made certain injurious misrepresentations and omissions of material fact in connection with the initial public offering and subsequent trading of Craftmatic stock.

The thrust of Plaintiffs' complaint is laid out in paragraph 49³. All but one of the allegations contained in this paragraph involve failures to disclose purported material information, not affirmative representations.

The Craftmatic Defendants group the specific averments contained in paragraph 49 into three categories: 1) those omissions that fail to predict difficulties that might be encountered in the future, see Cplt. paragraph 49(d)-(e), (g), (m), (p)-(t); 2) those that fail to disclose or characterize ineffective management, see Cplt. paragraph 49(a)-(c), (f)-(h), (h)-(l) sic, (n); and 3) those that blur this distinction, see Cplt. paragraph 49(j)-(l).⁴ Craftmatic Defendants' Memorandum in Support of Motion to Dismiss at 8.

II. PREDICTIVE FAILURES

The Craftmatic Defendants contend that plaintiffs have attempted improperly to create a duty to predict future business activities and to convert garden variety claims of corporate mismanagement, which are more properly the subject of litigation under Delaware corporation law, into federal securities claims. Plaintiffs have alleged, in essence, that defendants failed to speculate or accurately predict their future difficulties, and to disclose their own alleged mismanagement. These claims, which transcend the boundaries of disclosure mandated by the federal securities laws, seek to impose liability based upon defendants' failure to peer into the future and predict the events which plaintiffs, with the benefits of perfect hindsight, now claim should have been disclosed.

Motion to Dismiss at 4.

The Craftmatic Defendants subdivide Plaintiffs claims for alleged predictive failures into two categories: those that involve failures to predict future developments, Cplt. paragraph 49(a), (d)-(e), (g), (m), (p), and those that involve the reasonableness of projections actually made, Cplt. paragraph 49(q)-(t).

A. Failure to Predict Future Developments

The Consolidated Amended Complaint, in essence, alleges that certain documents failed to disclose that:

—Craftmatic's advertising and marketing program was based on deceptive and illegal sales practices which would and did result in charges and fines being levied against the company, paragraph 49(a);

—the company's expansion program entailed an unusual and extremely high risk of failure and that the company was gambling with its profitability, paragraph 49(d);

—the company's application of the advertising and marketing strategies of its core business to new product lines would hurt the company's profitability, paragraph 49(e);

—the company required an increasing number of distributorships in uncertain marketing territories and increases in promotional and advertising costs in order to increase sales, paragraph 49(g);

—the company's rate of growth in its core business was not sustainable, paragraph 49(m); and that

—the company's new products were not amenable to being marketed successfully by the same sales techniques developed for its core business, paragraph 49(p).

Each of these omissions involve the failure to predict future events.

Generally, companies are not required to make future-oriented projections, although they are now permitted to do so in some circumstances.

Until the early 1970's, the SEC prohibited companies from including most predictive information in the documents they filed with the SEC.... Courts generally recognized this policy and followed the SEC's lead by holding that failure to disclose predictive information was not actionable under the securities laws....

In 1973, however, the SEC determined that `changes in its present policies with regard to the use of projections would assist in the protection of investors and would be in the public interest.... In 1978 ... the SEC issued a statement encouraging, although not requiring, disclosures of management projections both in filings with the SEC and in general.... Because of the SEC's change in policy, courts have begun to re-examine the position that a company's decision not to disclose predictive information is always immune from scrutiny under the securities laws. As a result of these re-examinations, courts have adopted a variety of approaches to dealing with the problem of undisclosed predictions.

Isquith v. Middle South Utilities, Inc., 847 F.2d 186, 204-205 (5th Cir.), cert. denied. ___ U.S. ___, 109 S.Ct. 310, 102 L.Ed.2d 329 (1988).

The Court of Appeals for the Third Circuit has adopted a case-by-case approach to determine when a duty exists to disclose certain "soft information." Flynn v. Bass Brothers Enterprises, Inc., 744 F.2d 978, 988 (3d Cir.1984). In Flynn, the court rejected its earlier position, articulated in Kohn v. American Metal Climax, Inc., 458 F.2d 255, 265 (3d Cir.), cert. denied, 409 U.S. 874, 93 S.Ct. 120, 34 L.Ed.2d (1972), that "`presentations of future earnings, appraised asset valuations and other hypothetical data' are to be discouraged."

Henceforth, the law is not that asset appraisals are, as a matter of law, immaterial. Rather, in appropriate cases, such information must be disclosed. Courts should ascertain the duty to disclose asset valuations and other soft information on a case by case basis, by weighing the potential aid such information will give a shareholder against the potential harm, such as undue reliance, if the information in released with a proper cautionary note.

Id. at 988.

Although the Court of Appeals concluded that all "soft information" should no longer automatically be considered immaterial, it upheld the District Court's determination in Flynn that certain...