Crowell v. Ionics, Inc., No. CIV.A.03-10393-WGY.
| Decision Date | 03 November 2004 |
| Docket Number | No. CIV.A.03-10393-WGY. |
| Citation | 343 F.Supp.2d 1 |
| Parties | John L. CROWELL, Individually and on Behalf of All Others Similarly Situated, Plaintiffs, v. IONICS, INC., Arthur L. Goldstein, and Daniel M. Kuzmak Defendants. |
| Court | U.S. District Court — District of Massachusetts |
Jason D. Frank, Kimberly C. Nuzum, Testa, Brian E. Pastuszenski, Testa, Hurwitz & Thibeault, LLP, Boston, MA, Christopher F. Robertson, Seyfarth Shaw, LLP, Boston, MA, for Ionics, Inc., Arthur L. Goldstein, Daniel M. Kuzmak, Defendants.
Samuel H. Rudman, Cauley, Geller, Bowman, Coates & Rudman, LLP, Melville, NY, for John L Crowell, Plaintiff.
Thomas G. Shapiro, Shapiro Haber & Urmy LLP, Boston, MA, for Jerome Deckler, John L Crowell, Plaintiffs.
This case involves a federal securities law class action on behalf of all individuals who purchased or acquired the common stock of Ionics, Inc. ("Ionics") between October 25, 2001, and March 14, 2003 (inclusively, the "Class Period"), and were damaged by allegedly materially false or misleading statements that Ionics made regarding its financial situation and operations. Am. Compl. ¶ 9 [Doc. No. 12]. The lead plaintiff, John L. Crowell1 ("Crowell"), seeks certification of the class and, ultimately, damages. Ionics, along with the defendants Arthur L. Goldstein ("Goldstein") and Daniel M. Kuzmak ("Kuzmak") (collectively, "Ionics Defendants"), move to dismiss under Federal Rule of Civil Procedure 12(b)(6), partly on standing grounds, but primarily attacking the legal sufficiency of Crowell's complaint, particularly in light of the heightened pleading requirements under the federal securities laws and under Federal Rule of Civil Procedure 9(b). After a hearing on February 24, 2004, the Court denied the Ionics Defendants' Motion To Dismiss from the bench. This memorandum explains the reasons behind the Court's decision.
A. Facts
The Court takes the facts alleged in Crowell's Complaint as true in considering the Ionics Defendants' Motion to Dismiss. Crowell has attributed the facts alleged to witness or document sources, as this Court has required. Given the heightened pleading requirements in securities fraud cases, the facts must be described in some detail.
Crowell allegedly purchased Ionics common stock during the Class Period at artificially inflated prices, and was damaged thereby. Am. Compl. ¶ 6. Ionics is a Massachusetts corporation with its principal place of business in Watertown, Massachusetts. Id. ¶ 7. Goldstein was at all relevant times Ionics' Chairman and Chief Executive Officer. Id. ¶ 8(a). Kuzmak was at all relevant times Ionics' Chief Financial Officer and Vice President. Id. ¶ 8(b). Crowell has adequately alleged facts suggesting that the class action is an appropriate form for this litigation.
Ionics develops and manufactures systems and provides related services for water treatment, and also produces desalination, water, and wastewater treatment systems and instruments. Id. ¶ 7. Most of its revenues come from long-term sales and construction-type contracts. Id. ¶ 15. According to Crowell, "[t]hese transactions are highly complex and require a highly effective system of internal controls and procedures, among other things, in order to properly recognize contract revenues and costs in the Company's financial statements." Id.
Ionics manages its operations through four business group segments: the equipment business group ("EBG"), the ultrapure water group ("UWG"), the consumer water group ("CWG"), and the instrument business group ("IBG"). Id. ¶ 16. Within these business segments, Ionics has identified certain core product and market sectors, including water desalination/purification equipment and facilities serving general industries and municipalities, and ultrapure water processing systems servicing primarily the microelectronics and power industries. Id.
In 2001, the EBG and the UWG accounted for roughly 67 percent of Ionics' revenues, and that percentage grew to approximately 80 percent near the beginning of the Class Period, due to the December 2001 sale of the company's Aqua Cool Pure Bottled Water Operations in the United States, the United Kingdom, and France ("Aqua Cool"). Id. ¶ 17.2 In other words, the Aqua Cool assets accounted for over 16 percent of the company's 2001 revenues, and comprised the major portion of Ionics' consumer segment revenues and assets both in the United States and abroad. Id. ¶ 18. "At all relevant times, therefore, the [Ionics] defendants were highly motivated to make it appear that EWG and UWG segments were operating profitably." Id.
In recent years, Ionics has increasingly implemented a "build, own, and operate" ("build-own-operate") strategy whereby the company constructs, owns, operates, and maintains water desalination and purification facilities, among other activities. Id. ¶ 19. During the Class Period, Ionics maintained or initiated investments in at least seven foreign "affiliated" companies under the build-own-operate strategy, including Grupo Empresarial de Mejoramiento Ambiental, S. de R.L. de C.V. — Mexico (the "EDF project") and Desalination Company of Trinidad and Tobago, Ltd. ("Desalcott" or the "Trinidad project"). Id. Ionics has a minority interest in each of the seven known foreign affiliates (50 percent or less), and so does not include affiliate financial statements in its consolidated financial statements. Id.
Ionics conducts a substantial amount of its EBG business through sales of equipment and construction services to companies outside the United States. Id. ¶ 20. In 2001, revenues of over $20 million resulted from such sales, but that number declined to $12 million in 2002.3 Id. Ionics primarily attributed the decline to the completion of the Desalcott construction project in Trinidad. Id. Purportedly, where Ionics has a 20 percent to 50 percent ownership interest in an affiliate, it uses equity basis accounting and makes certain profit eliminations or deferrals on its sales to those affiliates. Id.
On November 5, 2002, Ionics issued a press release announcing that it was restating its financial results for the first two quarters of fiscal year 2002. Id. ¶ 21. The announcement "stunned" the market. Id. Ionics reduced previously reported income by roughly $1,300,000, or over 31 percent, for the six months ending June 30, 2002. Id. The company attributed the restatement to "intercompany transactions between the Company and its French subsidiary that were erroneously recorded at the subsidiary level." Id. (quoting Ionics' press release).
The "intercompany transactions" were in fact unrecorded "project cost overruns," among other things, that Ionics incurred on the EDF project (in Mexico) prior to and during the first two quarters of 2002, but failed to report in its consolidated operating results. Id. ¶ 22. At least $600,000 of the restated costs and expenses related to the EDF project. Id. ¶ 23. Former employees of Ionics France, a French subsidiary that was losing money at the time, state that when Ionics was closing the books for the first quarter of 2002, during April 2002, a dispute arose between Ionics' corporate controller, Anthony DiPaola, and certain officers of Ionics France over the recording of $2,000,000 in EDF cost overruns, which Ionics (through Goldstein and others) directed Ionics France to record. Id. ¶ 23-24. These and other losses (probably from Kuwait) that Ionics sought to shift onto its European subsidiaries totaled an estimated $5,000,000 to $6,000,000. Id. ¶ 26. The Ionics France employees refused to place the costs on Ionics France's books, because the costs related to Ionics' losses from its business segments in Mexico and the United States; in other words those losses were not attributable to Ionics France. Id. ¶ 23. Ionics France's Vice President was fired in April 2002 for refusing to follow Goldstein's orders, and the decision was allegedly made by Goldstein and Ed Cichon ("Cichon"), Ionics' Vice President and head of the BEG. Id. ¶ 25.
Essentially, Ionics was seeking to shift losses from its own books to those of a subsidiary. A former Ionics France employee has stated that the motive for this was to reduce Ionics' tax liabilities arising from a $19,000,000 gain related to the December 2001 sale of Aqua Cool's France operations. Id. ¶ 26. Another former Ionics France employee stated that during the second quarter of 2002, Ionics attempted to falsify tax documents prepared in connection with the Aqua Cool sale, stating the proceeds as a long-term profit rather than a short-term profit after three years. Id.
Thus, as of at least April 2002, the Ionics Defendants knew that Ionics France did not record the costs and expenses associated with the EDF project cost overruns, among others, which the Ionics Defendants had ordered the French subsidiary's controller to record during 2002's first two quarters. Id. ¶ 27. According to Crowell, "Ionics has now restated its financial statements for the first and second quarter of 2002, thereby admitting that those financial statements were materially false and misleading when issued." Id. ¶ 28.4
The aforementioned accounting improprieties were not the only ones in which Ionics is alleged to have engaged. Crowell alleges that during the Class Period, Ionics overstated revenues and profits by millions of dollars by improperly accounting for costs and expenses associated with its long-term equipment and construction contracts. Id. ¶ 29. Ionics shifted "cost overruns" on certain long-term equipment sales contracts and construction projects from unprofitable projects where...
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