Rahman ex rel. Situated v. Kid Brands, Inc.

• Citation: 736 F.3d 237
• Decision Date: 08 October 2013
• Docket Number: No. 12–4257.,12–4257.
• Parties: Shah RAHMAN, Individually and On Behalf of All Others Similarly Situated, Appellant v. KID BRANDS, INC.; Bruce G. Crain; Guy A. Paglinco; Raphael Benaroya.
• Court: United States Courts of Appeals. United States Court of Appeals (3rd Circuit)

736 F.3d 237

Shah RAHMAN, Individually and On Behalf of All Others Similarly Situated, Appellant

v.KID BRANDS, INC.; Bruce G. Crain; Guy A. Paglinco; Raphael Benaroya.

No. 12–4257.

United States Court of Appeals,Third Circuit.

Submitted under Third Circuit

LAR 34.1(a) Oct. 8, 2013.

Filed: Nov. 15, 2013.

David A.P. Brower, Brower Piven, Kim E. Miller, Kahn Swick & Foti, New York, NY, Jeffrey W. Hermann, Cohn, Lifland, Pearlman, Herrman & Knopf, Saddle Brook, NJ, Lewis S. Kahn, Madisonville, LA, for Appellant.

Robert J. Del Tufo, Skadden, Arps, Slate, Meagher & Flom, Newark, NJ, Jay B. Kasner, Christopher R. Gette, Rachel J. Barnett, Matthew S. Barkan, Andrew Muscato, Skadden, Arps, Slater, Meagher & Flom, New York, NY, for Appellees Kid Brands, Inc. and Raphael Benaroya.

Eric B. Fisher, Dickstein Shapiro, New York, NY, Jeffrey Rhodes, Dickstein Shapiro, Washington, DC, Stefano V. Calogero, Wildels, Marx, Lane & Mittendorf, Madison, NJ, for Appellee, Bruce G. Crain.

Rebecca Brazzano, C. Dennis Southard, IV, David A. Wilson, Thompson Hine, Washington, DC, for Appellee, Guy A. Paglinco.

BEFORE: FUENTES, GREENBERG, and BARRY, Circuit Judges.

OPINION OF THE COURT

GREENBERG, Circuit Judge.

I. INTRODUCTION

Shah Rahman, now the appellant, brought this federal securities class action on March 22, 2011, against defendant Kid Brands, Inc., a New Jersey corporation, and against the individual defendants, Bruce G. Crain, Guy A. Paglinco, and Raphael Benaroya, officers of Kid Brands (collectively with Kid Brands “appellees”). Kid Brands is in the business of importing inexpensive infant furniture and products for the purpose of ultimate resale to consumers. The complaint alleged that defendants, now appellees, violated (1) Section 10(b) of the Securities Exchange Act (the “Exchange Act”) and SEC Rule 10b–5 and (2) and Section 20(a) of the Exchange Act. In particular, the complaint alleged that defendants misled investors by artificially inflating Kid Brands stock price by issuing deceptive public financial reports and press releases dealing with Kid Brands' compliance with customs laws and overall financial performance. The putative class included Rahman and all others similarly situated who purchased or obtained Kid Brands common stock between March 26, 2010, and August 16, 2011, inclusive (the “class period”).

Subsequently, Rahman filed a first amended complaint (“FAC”) which the District Court dismissed without prejudice on defendants' motion, on March 8, 2012, in an order that permitted Rahman to file an amended complaint within 60 days. Rahman v. Kid Brands, Inc., Civ. No. 11–1624, 2012 WL 762311 (D.N.J. Mar. 8, 2012). On May 7, 2012, Rahman timely filed a second amended complaint (“SAC”) alleging that, in addition to customs violations, defendants failed to disclose product recalls, safety violations, and illegal staffing practices affecting Kid Brands. Nevertheless, Rahman's brief focuses almost exclusively on the customs violations and makes only passing reference to the other issues. On October 17, 2012, on defendants' motion the District Court dismissed the SAC with prejudice because it did not satisfy the heightened scienter pleading standard required by the Private Securities Litigation Reform Act (“PSLRA”), 15 U.S.C. § 78u–4(b)(2). In its opinion the Court explained that “upon a holistic consideration of the relabeling allegations contained in the SAC, the Court finds that a reasonable person would not deem the inference of scienter at least as strong as any opposing inference.” J.A. at 28. On November 14, 2012, Rahman filed a timely notice of appeal.

Kid Brands operates through four wholly owned subsidiaries: Kids Line, LLC, Sassy, Inc., LaJobi, Inc., and CoCaLo, Inc.¹ Kid Brands primarily imports the inexpensive furniture in which it deals from China for ultimate resale to the public. Kid Brands is a substantial business as its net sales in 2010 were $276,000,000. Under “anti-dumping” laws, Kid Brands is subject to duties that the United States imposes beyond those ordinarily assessed to discourage the importation of some products at very low cost. During the class period, Crain was the president and chief executive officer of Kid Brands and served on its board of directors, and Paglinco was its vice president and chief financial officer. Paglinco retained both positions after the close of the class period. In September 2011, after the close of the class period, Benaroya, previously an outside director, was appointed interim chief executive officer.

The SAC alleges that Kid Brands obscured the origin of its Chinese-manufactured products to reduce import duties and increase profits, and then made misleading statements regarding its financial health. Rahman supported the SAC with statements from six confidential witnesses who had been employees of Kid Brands or its subsidiaries.² Rahman believes that the statements support his contention that defendants engaged in repeated violations of customs laws. He described the witnesses in the SAC as follows:

• CW1: A former LaJobi employee who worked in the outbound shipping department from March 2010–March 2012 and dealt with the products entering and exiting the distribution center.

• CW2: A former LaJobi employee who worked in the recovering and shipping department from June 2011–January 2012 and dealt with inbound and outbound shipments of products.

• CW3: A former LaJobi distribution manager who worked for the company from May 2000–November 2010. CW3 oversaw safety and security at a Cranbury, New Jersey, warehouse and dealt with the packing slips.

• CW4: A former Kid Brands employee who worked in the internal auditing department as a Sarbanes Oxley consultant from March 2004–August 2009 and reviewed the internal financial information for Kid Brands and its subsidiaries.

• CW5: A former LaJobi sales and forecast demand manager who worked at the company from March 2010–April 2011. CW5 had personal knowledge and familiarity with the subsidiary's operations, database and inventory tools.

• CW6: A former Kids Line employee who worked in packaging design from June 2011–March 2012 and whose statements relate to his discharge from that employment.

The immediate event that led to this litigation occurred in December 2010, when U.S. Customs and Border Protection informed Kid Brands that it was conducting a “Focused Assessment” of its import practices and procedures. Following this notification, Kid Brands' board of directors initiated an investigation of Kid Brands' practices and, for that purpose, hired the outside law firm of Skadden, Arps, Slate, Meagher & Flom. Kid Brands, however, did not publicly disclose that it was subject to the Focused Assessment or that it had hired the law firm until after it received a report from the firm. Eventually on March 15, 2011, Kid Brands revealed that LaJobi had violated United States law by misidentifying the manufacturer and shipper of certain products, that it had discharged two LaJobi employees, and that it anticipated needing to pay $7 million in fines and charges to resolve issues largely arising from the Focused Assessment. As might be expected, this information had a negative impact on Kid Brands' stock price. Thus, at the end of the day on March 15, 2011, Kid Brands' stock closed at $6.91 a share, a large drop from its prior day closing price of $9.24. Five months later, on August 15, 2011, Kid Brands filed a federal Form 10–Q for the quarter ending June 30, 2011, in which it indicated that CoCaLo and Kids Line also had evaded custom duties. The next day, August 16, 2011, Kid Brands issued a Form 8–K that estimated its total liabilities to be in excess of $10 million for wrongful practices extending over a period of nearly five years. Kid Brands' stock closed at $4.49 per share on August 15, 2011, at $3.65 the following day, and at $2.97 on August 22, 2011.

II. JURISDICTION AND STANDARD OF REVIEW

The District Court had jurisdiction pursuant to 28 U.S.C. § 1331 and 15 U.S.C. § 78aa and we have jurisdiction pursuant to 28 U.S.C. § 1291. We exercise plenary review of the District Court's order of dismissal pursuant to Fed.R.Civ.P. 12(b)(6). In conducting that review, we accept Rahman's allegations in the SAC as true and review the complaint in its entirety. See Tellabs, Inc. v. Makor Issues & Rights, Ltd., 551 U.S. 308, 322, 127 S.Ct. 2499, 2509, 168 L.Ed.2d 179 (2007). But in this process we recognize that, when alleging a securities fraud cause of action, a plaintiff “must satisfy the heightened pleading rules codified in the PSLRA.” Institutional Investors Grp. v. Avaya, Inc., 564 F.3d 242, 252 (3d Cir.2009).

III. DISCUSSION

The PSLRA established heightened pleading requirements for a plaintiff to meet in order to plead a cause of action successfully in class actions alleging securities fraud. Thus, it requires that a complaint “ ‘state with particularity both the facts constituting the alleged violation, and the facts evidencing scienter, i.e., the defendant's intention ‘to deceive, manipulate, or defraud.’ ” ³Tellabs, 551 U.S. at 313, 127 S.Ct. at 2504. To satisfy the latter requirement, a plaintiff must “ ‘state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind.’ ” Id. at 314, 127 S.Ct. at 2504 (emphasis added) (quoting 15 U.S.C. § 78u–4(b)(2)). In Tellabs, in holding that the investors bringing a securities fraud class action had failed to meet that standard, the Supreme Court explained: “[t]o qualify as ‘strong’ within the intendment of [ 15 U.S.C. § 78u–4(b)(2) ] ... an inference of scienter must be more than merely plausible or reasonable-it must be cogent and at least as compelling as any opposing inference of nonfraudulent intent.” Id. at 314, 127 S.Ct. at 2504–05.

Pursuant to its authority under Section 10(b) of the Exchange Act, the SEC issued Rule 10b–5, which renders it unlawful for any person:

(a) To employ any device, scheme, or...