Ames Dept. Stores Inc. Stock Litigation, In re

• Decision Date: 02 April 1993
• Docket Number: No. 62,D,62
• Citation: 991 F.2d 953
• Parties: Fed. Sec. L. Rep. P 97,410 In re AMES DEPARTMENT STORES INC. STOCK LITIGATION. William STEINER, Nathan Spiro, Florence Spiro, David Minkoff, Goldie Jaroslawicz, Charles W. Collier, Rodney Shields, David Kahn, Sheldon Shore, Samuel H. Title, Violet Klein, Dominick T. Brancato, Anna M. Brancato, on behalf of a putative class of persons similarly situated, Plaintiffs-Appellants, v. AMES DEPARTMENT STORES, INC., Peter B. Hollis, Ralph M. Shulansky, Duane R. Wolter, James A. Harmon, Herbert Gilman, Earl M. Spector, Norman Asher, Arthur F. Loewy, Maurice Segall, Wertheim Schroder & Co. Incorporated, Defendants-Appellees. ocket 92-7304.
• Court: U.S. Court of Appeals — Second Circuit

Page 953

991 F.2d 953

Fed. Sec. L. Rep. P 97,410

In re AMES DEPARTMENT STORES INC. STOCK LITIGATION.

William STEINER, Nathan Spiro, Florence Spiro, David

Minkoff, Goldie Jaroslawicz, Charles W. Collier, Rodney

Shields, David Kahn, Sheldon Shore, Samuel H. Title, Violet

Klein, Dominick T. Brancato, Anna M. Brancato, on behalf of a putative class of persons similarly situated, Plaintiffs-Appellants, v. AMES DEPARTMENT STORES, INC., Peter B. Hollis, Ralph M.

Shulansky, Duane R. Wolter, James A. Harmon, Herbert Gilman,

Earl M. Spector, Norman Asher, Arthur F. Loewy, Maurice

Segall, Wertheim Schroder & Co. Incorporated, Defendants-Appellees.

No. 62, Docket 92-7304.

United States Court of Appeals, Second Circuit.

Argued Sept. 14, 1992.

Decided April 2, 1993.

Edward Labaton, New York City (Lawrence A. Sucharow, Lynda G. Jacobs, Goodkind Labaton Rudoff & Sucharow, Robert S. Schachter, Hillary Sobel, Zwerling, Schachter & Zwerling, Richard A. Fuchs, Koskoff, Koskoff & Bieder, P.C., Bridgeport, CT, of counsel), for plaintiffs-appellants.

Robert I. Harwood, New York City (Wechsler, Skirnick, Harwood, Halebian, Feffer, of counsel), for plaintiffs-appellants Nathan and Florence Spiro.

Bruce Gerstein, New York City (Garwin Bronzaft Gerstein & Fisher, of counsel), for plaintiff-appellant David Minkoff.

Stuart H. Savett, Philadelphia, PA (Savett, Frutkin, Podell & Ryan, P.C., Arnold Levin, Levin, Fishbein, Sedran & Berman, of counsel), for plaintiff-appellant Goldie Jaroslawicz.

Daniel W. Krasner, New York City (Wolf Haldenstein Adler Freeman & Herz, of counsel), for plaintiff-appellant Charles W. Collier.

Richard D. Greenfield, Haverford, PA (Greenfield & Chimicles, of counsel), for plaintiff-appellant Rodney B. Shields.

Stephen D. Oestreich, New York City (Wolf Popper Ross Wolf & Jones), for plaintiff-appellant David Kahn.

Stanley R. Wolfe, Philadelphia, PA (Berger & Montague, of counsel), for plaintiff-appellant Sheldon Shore.

Harvey S. Kronfeld, Philadelphia, PA (Kronfeld, Newberg & Duggan, of counsel), for plaintiff-appellant Samuel H. Title.

Stanley M. Grossman, New York City (Pomerantz, Levy, Haudek, Block & Grossman, of counsel), for plaintiff-appellant Violet Klein.

I. Stephen Rabin, New York City, for plaintiffs-appellants Dominick T. and Anna M. Brancato.

Andrew M. Schatz, Hartford, CT (Jeffery S. Nobel, Schatz & Schatz, Ribicoff & Kotkin, of counsel), for defendants-appellees Peter B. Hollis and Duane R. Wolter.

Ralph G. Elliot, Hartford, CT (Tyler, Cooper & Alcorn, of counsel), for defendants-appellees Ralph M. Shulansky and Herbert Gilman.

Jeffrey B. Rudman, Boston, MA (William H. Paine, J. Kent Wicker, Hale and Dorr; Ralph G. Elliot, Hartford, CT, Tyler, Cooper & Alcorn, of counsel), for defendants-appellees James A. Harmon and Norman B. Asher.

Ralph G. Elliot, Hartford, CT (Tyler, Cooper & Alcorn; Jeffrey B. Rudman, Hale and Dorr, of counsel), for defendant-appellee Earl M. Spector.

Douglas H. Meal, Boston, MA (John R. Baraniak, Jr., Kenneth A. Galton, Ropes & Gray; Peter C. Schwartz, Hartford, CT, Gordon, Muir and Foley, of counsel), for defendants-appellees Arthur F. Loewy and Maurice Segall.

Lewis A. Kaplan, New York City (Jay L. Himes, David Jaroslaw, Donn Zaretsky, Paul, Weiss, Rifkind, Wharton & Garrison, Jacob D. Zeldes, Bridgeport, CT, Zeldes, Needle & Cooper, P.C., of counsel), for defendant-appellee Wertheim Schroder & Co. Inc.

Before: OAKES, KEARSE and PRATT, Circuit Judges.

OAKES, Senior Circuit Judge:

The 1988 acquisition by Ames Department Stores, Inc. ("Ames") of the discount stores division of the Zayre Corporation ("Zayre") drove Ames into bankruptcy and set off a chain of class action securities lawsuits. This action was filed by common stockholders of Ames who purchased their shares between May 10, 1989 and April 10, 1990, the day after Ames announced that it had suffered catastrophic losses for fiscal year 1990; additional consolidated class action lawsuits have been filed by purchasers of two issuances of debt securities--"reset notes" and convertible debentures--sold in 1989 to finance the acquisition, and Ames's bankruptcy trustee has sued its investment banker and Chief Executive Officer. All of the Ames securities cases have been heard in the District Court for the District of Connecticut, Peter C. Dorsey, Judge. Judge Dorsey dismissed the common stockholders' case under Federal Rule of Civil Procedure 12(b)(6), reasoning that the stockholders had failed to allege a "connection" between the fraud and their stock purchases. We reverse.

BACKGROUND

The stockholders raise claims under §§ 10(b) and 20(a) of the Securities Exchange Act of 1934, 15 U.S.C. §§ 78j(b), 78t(a), and Rule 10b-5, 17 C.F.R. § 240.10b-5 (1992), and under the common law. They allege that seven directors and officers As defendants, the stockholders named Ames's CEO and President Peter B. Hollis; its Board Chairman, James A. Harmon, who also served as chairman and CEO of defendant Wertheim; and directors and/or officers Duane R. Wolter, Ames Executive Vice President and Chief Financial Officer; Earl M. Spector, Executive Vice President, Secretary and member of the Board of Directors; Norman B. Asher, Ames director, member of Ames's audit and executive committees and outside counsel for Ames in connection with the acquisition and the first of the debt offerings; Maurice Segall, an Ames director since the acquisition, member of the Ames audit committee and former CEO of Zayre; Arthur F. Loewy, an Ames director after the acquisition, member of the Ames audit committee and a former Zayre financial officer; and Wertheim, which allegedly acted as investment banker to both Ames and Zayre in their merger negotiations, and as managing underwriter for the two debt offerings issued in connection with the acquisition. Both Hollis and Harmon also allegedly served on Ames' audit and executive committees.

                of Ames and Ames investment banker Wertheim Schroder & Co., Inc.  ("Wertheim") disseminated 32 documents or statements into the market for Ames securities which contained false and misleading statements concerning Ames's financial health, its future profitability, and the success of Ames's integration of the newly-acquired Zayre stores.   The complaint alleges that the defendants learned at specific meetings that Ames's financial situation was deteriorating rapidly, that internal financial and inventory reports were inaccurate and unreliable, and that the integration was failing and draining Ames's profitability.   It further alleges that despite this information, the defendants disseminated, in addition to the prospectuses for the two debt offerings issued to finance the acquisition, false reports, news releases, and other statements painting quite a rosy picture of Ames's profitability and future
                

The district court dismissed the complaint under Federal Rule of Civil Procedure 12(b)(6) on the ground that the false and misleading statements were not made "in connection with" a public offering of Ames's common stock so as to satisfy § 10(b) and Rule 10b-5, but, rather, rested solely upon allegations pertaining to the reset note and debenture prospectuses. The stockholders argue that the district court's conclusion that there was a failure to satisfy the "in connection with" requirement was erroneous as a matter of law, citing Fischman v. Raytheon Mfg. Co., 188 F.2d 783 (2d Cir.1951) (reversing dismissal of common stockholders' § 10(b) complaint based upon misstatements in prospectus offering preferred stock). The stockholders also note that there were at least 25 documents unrelated to Ames's debt offerings which they alleged were misleading, including financial reports filed with the SEC and press releases issued to the general public. Each of these documents, they allege, independently violated Rule 10b-5; and all of them were part of the ongoing scheme to defraud them. None of these other documents was directed to holders or potential purchasers of a specific security; instead, all were directed to the general investing public.

We begin our discussion with a review of the facts as alleged in the stockholders' complaint. For purposes of our review of the 12(b)(6) dismissal, of course, we must take all of the allegations of the complaint as true.

A. BACKGROUND TO THE ACQUISITION

Ames, a successor to a business founded in 1958, was incorporated in Delaware in 1962. A successful discount department store chain, it steadily expanded through the 1960s, '70s and early '80s. By 1970, it had 23 stores and annual sales of about $50 million. By 1985, its annual sales were approximately $300 million. In August, 1985, Ames effectively doubled its size by acquiring the G.C. Murphy chain of 108 discount department stores and 144 variety stores with annual sales of $900 million. By the end of Ames's fiscal year ending January 30, 1988, Ames's annual sales had The Murphy Acquisition itself presented Ames with difficulties, leaving the company less profitable than it had been before and plunging the combined operations' controls into a state of chaos. In early 1988, Ames tried to resolve some of its control problems by hiring Arthur Andersen & Co. to rewrite the company's "computer codes and applications software," including programs matching receipts with purchase orders, organizing the distribution and replenishment system, and affecting the company's general ledger accounts and the preparation of essential financial information. In the second half of 1988, the internal audit department acknowledged that internal financial controls were inadequate, and financial statements for fiscal year 1989 and the quarterly statements for fiscal year 1990 did not conform to basic accounting principles.

grown to more than $2 billion, and it had 342 discount department stores, 146 variety stores, and four distribution centers.

Nonetheless, in October, 1988, Ames acquired the Zayre discount stores. By doing so, Ames announced...