Lovelace v. Software Spectrum Inc.

Citation78 F.3d 1015
Decision Date02 April 1996
Docket NumberNo. 95-10338,95-10338
Parties, Fed. Sec. L. Rep. P 99,100, 34 Fed.R.Serv.3d 730, 44 Fed. R. Evid. Serv. 252 Rebecca LOVELACE, individually and on behalf of all those similarly situated; Ira Newman, individually and on behalf of all those similarly situated, Plaintiffs-Appellants, v. SOFTWARE SPECTRUM INC; Judy O. Sims, Defendants-Appellees. Gerald KLEIN, individually and on behalf of all those similarly situated, Plaintiff-Appellant, v. SOFTWARE SPECTRUM INC.; Judy O. Sims, Defendants-Appellees.
CourtUnited States Courts of Appeals. United States Court of Appeals (5th Circuit)

Roger F. Claxton, Robert James Hill, Kilgore & Kilgore, Dallas, TX, Steven J. Toll, Andrew N. Friedman, Cohen, Milstein, Hausfeld & Toll, Washington, DC, Stuart Hubert Savett, Robert P. Frutkin, Savett, Frutkin, Podell & Ryan, Philadelphia, PA, for Lovelace, Newman and Klein.

Morris Harrell, Timothy W. Mountz, Cynthia B. Asensio, Locke Purnell Rain Harrell, P.C., Dallas, TX, for Software Spectrum, Inc. and Sims.

Appeal from the United States District Court for the Northern District of Texas.

Before JONES, EMILIO M. GARZA and BENAVIDES, Circuit Judges.

EMILIO M. GARZA, Circuit Judge:

Plaintiffs Rebecca Lovelace, Ira Newman, and Gerald Klein, individually and on behalf of all those similarly situated, appeal the district court's judgment dismissing with prejudice their securities fraud claims against Defendants Software Spectrum, Inc., and Judy Sims. We affirm.

I

Software Spectrum is a publicly traded Texas corporation engaged in the resale of microcomputer business software. Sims is the chief executive officer of the corporation and chairman of the board of directors. Lovelace, Newman, and Klein purchased shares of Software Spectrum between October 1993 and May 1994. Software Spectrum's stock price fell sharply after the corporation announced disappointing financial results for the quarter ending December 31, 1993. Lovelace and Newman filed suit against Software Spectrum and Sims, alleging securities fraud. Software Spectrum's stock price fell sharply again after the corporation announced that publication of its financial results for the fiscal year ending March 31, 1994, would be delayed due to a change in auditors. Klein then filed suit against Software Spectrum and Sims, also alleging securities fraud. Software Spectrum and Sims filed motions to dismiss both suits for failure to plead fraud with particularity, pursuant to FED.R.CIV.P. 9(b), and for failure to state a claim upon which relief can be granted, pursuant to FED.R.CIV.P. 12(b)(6). After consolidating the suits, the district court entered an order dismissing the claims without prejudice for failure to plead fraud with particularity, finding specifically that Plaintiffs failed to sufficiently plead the scienter element of their securities fraud claims. The order allowed the Plaintiffs twenty days to replead their claims. After the twenty-day period passed without the Plaintiffs repleading their claims, the district court entered judgment dismissing the claims with prejudice. Plaintiffs filed a timely notice of appeal.

II

Plaintiffs argue that the district court erred in dismissing their claims for failure to plead fraud with particularity. In a pleading alleging fraud, a plaintiff must state the circumstances constituting fraud with particularity. FED.R.CIV.P. 9(b). We treat a dismissal for failure to plead fraud with particularity under Rule 9(b) as a dismissal for failure to state a claim upon which relief can be granted. Shushany v. Allwaste, Inc., 992 F.2d 517, 520 (5th Cir.1993). Therefore, we review the district court's dismissal de novo, as we review a dismissal under Rule 12(b)(6), accepting the complaint's well-pleaded factual allegations as true. Guidry v. Bank of LaPlace, 954 F.2d 278, 281 (5th Cir.1992).

Normally, in deciding a motion to dismiss for failure to state a claim, courts must limit their inquiry to the facts stated in the complaint and the documents either attached to or incorporated in the complaint. However, courts may also consider matters of which they may take judicial notice. See FED.R.EVID. 201(f) ("Judicial notice may be taken at any stage of the proceeding."). The Second Circuit has held that a district court deciding a motion to dismiss a securities fraud action may take judicial notice of the contents of documents filed with the Securities Exchange Commission. Kramer v. Time Warner Inc., 937 F.2d 767, 774 (2nd Cir.1991). We find this approach persuasive, and accordingly we adopt the following rule: When deciding a motion to dismiss a claim for securities fraud on the pleadings, a court may consider the contents of relevant public disclosure documents which (1) are required to be filed with the SEC, and (2) are actually filed with the SEC. Such documents should be considered only for the purpose of determining what statements the documents contain, not to prove the truth of the documents' contents. See Hennessy v. Penril Datacomm Networks, Inc., 69 F.3d 1344, 1354-55 (7th Cir.1995) (holding that the district court properly refused to take judicial notice of a corporation's Form 10-K to determine a fact in dispute--the number of corporate employees). 1

Plaintiffs' complaint alleges that Software Spectrum and Sims violated § 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b), and Rule 10b-5 promulgated thereunder, 17 C.F.R. § 240.10b-5, and that Sims violated § 20(a) of the Securities Exchange Act of 1934, 15 U.S.C. § 78t(a). To establish a claim for securities fraud under these provisions, a plaintiff must prove (1) a misstatement or omission (2) of a material fact (3) made with scienter (4) on which the plaintiff relied (5) that proximately caused the plaintiff's injury. Cyrak v. Lemon, 919 F.2d 320, 325 (5th Cir.1990). Scienter is defined as "a mental state embracing intent to deceive, manipulate, or defraud." Ernst & Ernst v. Hochfelder, 425 U.S. 185, 193 n. 12, 96 S.Ct. 1375, 1381 n. 12, 47 L.Ed.2d 668 (1976). 2

A plaintiff will not survive a Rule 9(b) motion to dismiss on the pleadings by simply alleging that a defendant had fraudulent intent. In order to adequately plead scienter, a plaintiff must set forth specific facts to support an inference of fraud. Tuchman v. DSC Communications Corp., 14 F.3d 1061, 1068 (5th Cir.1994). Alleged facts are sufficient to support such an inference if they either (1) show a defendant's motive to commit securities fraud, or (2) identify circumstances that indicate conscious behavior on the part of the defendant. Id.

Plaintiffs allege that Defendants knew, but did not disclose, that Software Spectrum's earnings were materially affected by financial incentives from its suppliers based on product sales goals. Plaintiffs allege that the Defendants knew prior to the fiscal quarter beginning October 1, 1994, but did not disclose, that earnings for that quarter would suffer due to a failure to meet product sales goals in the previous quarter. Plaintiffs further allege that Defendants stated Software Spectrum's earnings for the first nine months of 1994 in a manner inconsistent with generally accepted accounting principles, and that Defendants changed auditors because their former auditors insisted that credits be removed and earnings restated. We must determine whether these allegations suffice to indicate conscious behavior on the part of Defendants. 3

A number of our recent cases have addressed the degree of particularity with which a plaintiff must plead a securities fraud claim in order to identify conscious behavior on the part of the defendant. In Tuchman, shareholders brought an action for securities fraud against the corporation and its officers. In an attempt to identify circumstances that indicate conscious behavior on the part of the defendants, the Tuchman plaintiffs alleged that corporate officers made contradictory statements regarding the corporation's commitment to quality, the adequacy of the testing of corporate software, the reasons for corporate telephone network outages, and the reasons for the corporation's economic downturn. 14 F.3d at 1069. We found these allegations inadequate to indicate conscious behavior on the part of the defendants, noting that "the complaint contains no assertion of any fact that makes it reasonable to believe that the defendants knew that any of their statements were materially false or misleading when made." Id. We thus upheld a Rule 9(b) dismissal on the pleadings for failure to adequately plead scienter. Id. at 1068-70.

In Melder v. Morris, 27 F.3d 1097 (5th Cir.1994), shareholders brought an action for securities fraud against the corporation and its officers, directors, accountants, and underwriters. The Melder plaintiffs attempted to establish scienter by alleging that the corporation's officers, directors, accountants, and underwriters entered into a conspiracy to inflate the price of the corporation's stock. Id. at 1102. We found these allegations insufficient to indicate the defendants' motive to commit securities fraud, and we also found them insufficient to identify circumstances that indicate conscious behavior by the defendants. Id. at 1102-04. We thus upheld a Rule 9(b) dismissal on the pleadings for failure to adequately plead scienter. Id. at 1100-04. In so holding, we noted that rote conclusory allegations that the defendants "knowingly did this" or "recklessly did that" fail to meet the heightened pleading requirements of Rule 9(b). Id. at 1104.

In the present case, Plaintiffs' first allegation claims that Defendants knew, but did not disclose, that Software Spectrum's earnings were materially affected by financial incentives from its suppliers based on product sales goals. As required by law, Software Spectrum filed its 1991 and 1992 prospectuses with the SEC. Both of these documents contain a paragraph, under the general heading "Risk Factors," titled "Reliance on Rebates, Marketing Funds and Volume...

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