Wells v. HBO & Co.

• Decision Date: 29 October 1992
• Docket Number: Civ. A. No. 1:87-CV-657-JTC.
• Citation: 813 F. Supp. 1561
• Parties: Rosalind WELLS, Plaintiff, v. HBO & COMPANY, Defendant.
• Court: U.S. District Court — Northern District of Georgia

813 F. Supp. 1561

Rosalind WELLS, Plaintiff, v. HBO & COMPANY, Defendant.

Civ. A. No. 1:87-CV-657-JTC.

United States District Court, N.D. Georgia, Atlanta Division.

October 29, 1992.

Edward Lupo Savell, Savell & Williams, Atlanta, GA, Joseph H. Weiss, Office of Joseph H. Weiss, Jules Brody, Mark Levine, Stull Stull & Brody, New York City, for plaintiff.

Richard M. Kirby, Gregory Russell Hanthorn, Jones Day Reavis & Pogue, Atlanta, GA, Robert E. Zimet, Skadden Arps Slate, Meagher & Flom, New York City, for defendant.

ORDER

CAMP, District Judge.

This action is before the court on four motions by plaintiff: 1) a motion to file a first amendment to the complaint # 51-1, 2) a motion to add defendants # 51-2; 3) an unopposed motion to file this amendment under seal # 52-1; and 4) a motion to compel testimony.

This is a class action brought by the plaintiff on behalf of the buyers of HBO common stock during the class period, March 29, 1985 through April 20, 1986. This case was transferred from the Eastern District of New York in 1987. There was a nearly four-year stay on discovery on substantive issues pending class certification, which this Court did on April 17, 1991.

Plaintiff's existing complaint alleges that HBO unlawfully inflated its earnings, and hence its stock value, by the accounting and disclosure methods it used with respect to a practice called "discounting". Both sides agree that discounting is a lawful practice. It allows a party who is to receive future periodic payments under a contract to sell the contract and its future stream of revenues for a discounted lump sum. Here, HBO sold its contracts to service hospital computer software for a lump sum.

The original controversy arose over the fact that HBO counted this lump sum as current income. This practice made its income for the current period higher, and for the later periods when it would have earned a steady stream of income correspondingly lower. Plaintiffs contend HBO should have treated this as a financing arrangement, borrowing money against future revenue, which would have made its current income lower. The existing complaint charges defendant with violating Section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. §§ 78j(b) and 78n, and SEC rule 10b-5, 17 C.F.R. § 240.10b-5.

Plaintiff points in her existing complaint to a number of specific statements that HBO made during the class period that she believes were false and misleading. On March 29, 1985, the start of the class period, HBO filed a form 10-K with the Securities and Exchange Commission. Complaint ¶ 14. This form included by reference HBO's 1985 annual report covering the 1984 calendar year. Id. at ¶ 15. This annual report stated that "HBO's accounting for revenue and income recognition is conservative ... Income accounting is also conservative." Id. The report provided figures for HBO's net income, service and fee revenue, earnings per share, and declared cash dividends, and provided rates of increase for these figures. Id. at ¶ 16. The annual report also stated:

We believe that growth rates in earnings per share of 25% to 30% can be achieved during 1985 and subsequent years. This growth rate is somewhat in excess of the industry's overall growth rate. However, it reflects the rapidly expanding product lines of the new HBO & Company.

Id. at ¶ 17. Notes to the report stated that HBO recognized revenue from service agreements "monthly, as billed, over the life of the agreement, beginning at the system installation date or in full on the date the contract is discounted." Id. at ¶ 18.

HBO also filed quarterly disclosure forms during 1985 describing revenue from service agreements, and another 10-K form in March, 1986. Id. at ¶¶ 19-22. The 1986 annual report incorporated in this 10-K form continued to describe revenues from discounting agreements. Id. at ¶ 23.

The class period ends April 20, 1986, the day before HBO announced it would stop discounting long-term service agreements. Id. at ¶ 24. In making this announcement, HBO stated that because it no longer would discount contracts, its earnings would be "sharply lower for the current year than in preceding years, and substantial volatility in earnings may be expected in the future." Id. at ¶ 24. Plaintiff alleges the price of HBO's common shares declined materially after HBO announced its change in revenue recognition policy.

Plaintiff alleges in her original complaint that these filings were false and misleading, and did not present fairly HBO's financial condition and the results of its operations, in four specific respects:

(a) Each of the filings failed to disclose that HBO's revenue and earnings for the respective periods were artificially inflated by revenue recognition policies that were, at best, problematic; that they may have to be discontinued; and that, if discontinued, would result in sharply lower earnings and substantial volatility in earnings;

(b) The 1985 Form 10-K and 1985 Annual Report misrepresented HBO's accounting for revenue and income recognition as conservative;

(c) The 1985 Annual Report failed to disclose that, particularly in view of its questionable revenue recognition policies, HBO did not have a good faith or reasonable basis for its purported belief that growth rates in earnings per share of 25% to 30% can be achieved in future years; and

(d) The 1986 Form 10-K and the 1986 Annual Report failed to disclose that, particularly in view of its questionable revenue recognition policies, HBO did not have a good faith or reasonable basis for its assertion that future payments from systems installed or to be installed pursuant to service agreements provide the Company with a strong revenue base for the future.

Id. at ¶ 26.

Finally, Paragraph 27 of the complaint adds that HBO "knew or should have known throughout the Class Period that its filings did not present fairly the Company's financial position, the results of its operations, and the changes in its financial position for the respective periods."

Now, the plaintiff proposes to add to her 10(b) claim, and add two new state common-law claims. In essence, plaintiff claims that in addition to accounting wrongly for its discounting practice, HBO deferred recognizing expenses incurred in the first quarter of 1985 until the fourth quarter, and failed to note that HBO's new integration with other companies was not going as smoothly as expected. See, e.g., Prop.Amd.Cmplt. at ¶ 48.

The amended complaint cites the same allegedly misleading statements as the original concerning revenues and earnings projections. It adds three Wall Street Journal articles, id. at ¶¶ 24, 27, and 30, and an additional earnings report, id. at ¶ 35, which it contends also were misleading or based on misleading information. The proposed amended complaint, unlike the original, contends that HBO's September, 1985 form 10-Q was misleading because it failed to include information concerning expenses incurred. Id. at ¶ 67(c).

Plaintiff wishes to amend her 10(b) claim to reflect this. Her two proposed common law state claims arise from the same underlying facts as the original and amended complaints, that is, the same statements that allegedly misled buyers concerning discounting reporting methods and expense deferral. The first claim is for negligent misrepresentation, the second for common-law fraud. Plaintiff claims that she only learned of the new facts underlying the supplemented claim recently, upon discovery.

Plaintiff also proposes to add four individuals as defendants in her action. Two, James Napier and John Lawless, each served as president and CEO of HBO during parts of the class period. A third, Walter Huff, was Chairman of the Board of HBO during the class period, and the fourth, Joseph Blesser, was HBO's Controller and Chief Accounting Officer.

With respect to these proposed individual defendants, the proposed amendment adds allegations concerning stock sales made by the added defendants. Id. at ¶ 65. It notes that HBO's 10-Q for the first three quarters of 1985 contained an address to the shareholders signed by Napier, and that Blesser signed the third quarter form 10-Q. All four defendants signed the 1985 10-K. ¶ 36.

DISCUSSION

Rule 15 of the Federal Rules of Civil Procedure allows plaintiffs to amend their complaints after 20 days of service by leave of the court. The Supreme Court has commanded that "leave to amend shall be freely given when justice so requires." Foman v. Davis, 371 U.S. 178, 182, 83 S.Ct. 227, 230, 9 L.Ed.2d 222 (1962); see also Borden, Inc. v. Florida E. Coast Ry. Co., 772 F.2d 750, 757 (11th Cir.1985) ("There is a strong policy embodied in the Federal Rules of Civil Procedure, and Rule 15 particularly, favoring the liberality of amendment."). However, if an amendment would be futile, a court need not allow it. See Foman, 371 U.S. at 182, 83 S.Ct. at 230; Homes by Michelle, Inc. v. Federal Savs. Bank, 733 F.Supp. 1495, 1501 (N.D.Ga. 1990) (court may deny leave if amended complaint subject to dismissal) (citing Pan-Islamic Trade Corp. v. Exxon Corp., 632 F.2d 539, 546 (5th Cir.1980), cert. denied, 454 U.S. 927, 102 S.Ct. 427, 70 L.Ed.2d 236 (1981)).

The defendant argues the amendment would be futile for two reasons. First, it contends that nearly all the additional material in the proposed amended complaint is time barred. Second, with respect only to the state law claims, it contends that the plaintiff cannot show that she relied on defendant's representations, and that under Georgia law reliance is an essential element of her claims.

A. The New 10(b) Allegations

Six years and two months elapsed between the end of the class period and the time plaintiff sought leave to amend her complaint. Unless the proposed amendment "relates back" to the original complaint, see Fed.R.Civ.Proc. 15(c), then plaintiff may encounter statute of limitations problems.

Under Rule 15(c), an amendment relates back to the date of the original...