Coates v. Heartland Wireless Communications, Inc.

• Decision Date: 08 July 1999
• Docket Number: No. Civ.A. 398CV0452-D.,Civ.A. 398CV0452-D.
• Citation: 55 F.Supp.2d 628
• Parties: Robert COATES, et al., Plaintiffs, v. HEARTLAND WIRELESS COMMUNICATIONS, INC., et al., Defendants.
• Court: U.S. District Court — Northern District of Texas

55 F.Supp.2d 628

Robert COATES, et al., Plaintiffs, v. HEARTLAND WIRELESS COMMUNICATIONS, INC., et al., Defendants.

No. Civ.A. 398CV0452-D.

United States District Court, N.D. Texas, Dallas Division.

July 8, 1999.

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Roger F. Claxton & Robert J. Hill of Claxton & Hill, Dallas, TX, for plaintiffs.

Ralph I. Miller, Penny P. Reid, and Robert R. Summerhays of Weil Gotshal & Manges LLP, Dallas, TX, Joseph S. Allerhand of Weil Gotshal & Manges LLP, New York City, for defendants.

FITZWATER, District Judge.

In a prior opinion in this case, Coates v. Heartland Wireless Communications, Inc., 26 F.Supp.2d 910 (N.D.Tex.1998) ("Coates I"), the court granted defendants' motion to dismiss, holding in relevant part that plaintiffs had failed adequately to plead scienter, id. at 918-922, but granting them leave to replead. Id. at 923. Plaintiffs have filed their first amended complaint ("amended complaint"), and the individual defendants move anew to dismiss, contending inter alia that plaintiffs have again failed to plead scienter in the manner required by the Private Securities Litigation Reform Act of 1995 ("PSLRA"), 15 U.S.C. § 78u-4. The court agrees that plaintiffs have not pleaded specific facts that support a strong inference that defendants acted with scienter, and therefore grants defendants' motion to dismiss. For the reasons explained below, however, it holds that plaintiffs should be given another opportunity to plead in conformity with the PSLRA and Fed.R.Civ.P. 9(b).

I

This is a fraud-on-the-market case that follows the March 20, 1997 public announcement of Heartland Wireless Communications, Inc. ("Heartland"), now bankrupt, to write down its subscriber base by approximately 25% and to take a number of charges, including one for $5.2 million for bad debt expense and reserve for uncollectible accounts receivable. Plaintiffs argue that most if not all of these writeoffs and charges should have been taken no later than September 30, 1996, and that Heartland should have disclosed the necessity for the writeoffs, or the circumstances that led to them, no later than November 14, 1996, when Heartland announced third quarter 1996 results, or by February 7, 1997, when Heartland's Board of Directors discussed the company's financial condition at a Board meeting.

Heartland owned and operated wireless cable television systems, primarily in small to mid-size markets in the central United States that were not served by hardwired cable providers. It commenced operations in 1993 and made its initial public offering in 1994. Although Heartland had several competitors, it was considered during the relevant period to be the largest and most successful wireless company based on reported subscriber base.

Plaintiffs Robert Coates ("Coates") and Management Insights, Inc. ("MII") sue Heartland, David E. Webb ("Webb"), L. Allen Wheeler, John R. Bailey ("Bailey"), Alvin H. Lane ("Lane"), John A. Sprague ("Sprague"), and J.R. Holland, Jr. (collectively, the "individual defendants"), who are present or former Heartland officers and/or directors. Coates and MII contend that Heartland and the individual defendants are liable for violating § 10(b) of the Securities Exchange Act of 1934 (the "Exchange Act"), 15 U.S.C. § 78j(b), and Securities and Exchange Commission Rule 10b-5, 17 C.F.R. § 240.10b-5 (1998), promulgated thereunder. They maintain that defendants engaged in a scheme to defraud beginning no later than November 14, 1996 and ending on March 20, 1997, to induce purchases of Heartland stock at artificially inflated prices.¹ Plaintiffs allege that all the individual defendants except Lane are also liable under § 20(a) of the Exchange Act, 15 U.S.C. § 78t(a), as controlling persons. Coates and MII posit that defendants concealed from the investing public and the market the truth about Heartland's subscriber base and accounts receivable by intentionally misrepresenting and failing to disclose the actual growth and prospects of Heartland, the value of its assets, and its financial condition. Plaintiffs aver that defendants concealed the truth and failed to disclose it in a November 14, 1996 press release, third quarter 1996 Form 10-Q, December 1996 note exchange offering prospectus, January 22, 1997 announcement, February 1997 note exchange offering prospectus, and 1996 Form 10-K.

Defendants moved to dismiss plaintiffs' complaint. The court granted the motion, holding inter alia that the PSLRA codified a ban on group pleading, Coates I, 26 F.Supp.2d at 916, and that plaintiffs had failed adequately to plead scienter, id. at 918-922.² Plaintiffs have filed an amended complaint, and the individual defendants move to dismiss. They maintain that plaintiffs have again failed to plead scienter in the manner that the PSLRA requires, and that plaintiffs are relying impermissibly on group pleading.³

II

The court begins by addressing a threshold procedural question. Although defendants move to dismiss on the ground that plaintiffs have failed to plead scienter in accordance with the PSLRA, the court's conclusion that the amended complaint does not adequately plead scienter is based on constituent reasons that defendants did not present in their motion. This court may dismiss a case for failure to state a claim⁴ even if it does so based on arguments that defendants did not themselves raise. See Guthrie v. Tifco Indus., 941 F.2d 374, 379 (5th Cir.1991) (citing 5A Charles Alan Wright & Arthur R. Miller, Federal Practice and Procedure § 1357, at 301 (2d ed.1990)); Foreman v. Dallas County, Tex., 990 F.Supp. 505, 510 (N.D.Tex.1998) (three-judge court). "Even if a party does not make a formal motion, the court on its own initiative may note the inadequacy of the complaint and dismiss it for failure to state a claim as long as the procedure employed is fair." Wright & Miller, supra § 1357, at 301 (footnote omitted). The court concludes that because defendants move to dismiss on the ground that plaintiffs have failed adequately to plead scienter, the court may analyze plaintiffs' complaint on its own initiative and dismiss for reasons defendants did not give.

To ensure that this procedure is fair to plaintiffs, the court will permit them to replead in an attempt to conform to the requirements of the PSLRA and Rule 9(b). The court does not suggest that it would abuse its discretion or commit legal error by dismissing for failure to state a claim without permitting a plaintiff to replead. In the present case, however, the court is dismissing based on a pleading deficiency rather than on the ground that, beyond doubt, plaintiffs can plead no set of facts that would entitled them to relief. It is also relying on several reasons that, while related to a ground on which defendants seek dismissal, it has raised sua sponte. Although PSLRA dismissals will always be based on a pleading defect, and in all cases in which the court raises dismissal on its own initiative it will be considering arguments that no party has presented, in the present action it is the combination of these two factors, applied to the specific facts of this case, that supports allowing plaintiffs another opportunity to amend.

III

Defendants maintain that plaintiffs' amended complaint fails to plead scienter — "a mental state embracing intent to deceive, manipulate, or defraud"⁵ — in the manner that the PSLRA requires.

The PSLRA obligates a plaintiff to "state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind." 15 U.S.C. § 78u-4(b)(2). To plead scienter in conformity with Rule 9(b), a plaintiff "must set forth specific facts to support an inference of fraud." Lovelace v. Software Spectrum Inc., 78 F.3d 1015, 1018 (5th Cir. 1996) (citing Tuchman v. DSC Communications Corp., 14 F.3d 1061, 1068 (5th Cir. 1994)). "`Courts have uniformly held inadequate a complaint's general averment of the defendant's "knowledge" of material falsity unless the complaint also sets forth specific facts that make it reasonable to believe that defendant knew that a statement was false or misleading.'" Maldonado v. Dominguez, 137 F.3d 1, 9 (1st Cir. 1998) (quoting Greenstone v. Cambex Corp., 975 F.2d 22, 25 (1st Cir.1992)). A plaintiff may not rely on boilerplate or conclusory allegations to satisfy its pleading obligations. See Tuchman, 14 F.3d at 1067 (holding that plaintiff must plead specific facts, not conclusory allegations); In re Burlington Coat Factory Sec. Litig., 114 F.3d 1410, 1418 (3d Cir.1997) (concluding that boilerplate and conclusory allegations will not suffice); Gross v. Summa Four, Inc., 93 F.3d 987, 991 (1st Cir.1996) (stating that Rule 9(b) sets demanding standard and general averments of defendant's knowledge are not enough); Lovelace, 78 F.3d at 1018 (holding that it is insufficient merely to allege that defendant had fraudulent intent). The PSLRA pleading standard (adopted in some circuit courts even before enactment of the PSLRA) requires that the specific facts alleged in the complaint must give rise to a strong inference of fraudulent intent. See 15 U.S.C. § 78u4(b)(2); Burlington, 114 F.3d at 1418; Suna v. Bailey Corp., 107 F.3d 64, 68 (1st Cir.1997); Chill v. General Elec. Co., 101 F.3d 263, 267 (2d Cir.1996). When a complaint fails to plead scienter in conformity with the PSLRA, dismissal is required. Lirette v. Shiva Corp., 27 F.Supp.2d 268, 275 (D.Mass.1998) (citing 15 U.S.C. § 78u4(b)(3)(A)).

IV

A

Plaintiffs first plead scienter based on conscious behavior and/or severe recklessness. The supporting allegations are contained principally in ¶ 15 of the amended complaint under the rubric, "defendant's conscious behavior and/or severe recklessness."⁶

In ¶ 15 plaintiffs allege:

[Heartland] and the Individual Defendants acted with scienter. They made a conscious decision to keep from the investing public adverse material facts known to them as described...