In re Adams Golf, Inc. Securities Litigation

• Decision Date: 10 December 2001
• Docket Number: No. 99-371-RRM.,99-371-RRM.
• Citation: 176 F.Supp.2d 216
• Parties: In re ADAMS GOLF, INC. SECURITIES LITIGATION.
• Court: U.S. District Court — District of Delaware

Page 216

176 F.Supp.2d 216

In re ADAMS GOLF, INC. SECURITIES LITIGATION.

No. 99-371-RRM.

United States District Court, D. Delaware.

December 10, 2001.

COPYRIGHT MATERIAL OMITTED

Joseph A. Rosenthal and Carmella P. Keener, Rosenthal, Monhait, Gross & Goddess, P.A., Wilmington, Delaware; Todd S. Collins and Jacob A. Goldberg, Berger & Montague, P.C., Philadelphia, Pennsylvania; Donald B. Lewis, Law Offices of Donald B. Lewis, Bala Cynwyd, Pennsylvania; Jeffrey P. Bates, Abrahams, Lowenstein, Bushman & Kauffman, P.C., Philadelphia, Pennsylvania; and Kurt Olsen, The Olsen Law Firm, Washington, D.C.; counsel for F. Kenneth Shockley, M.D., David Shockley, John M. and Sandra M. Morrash, and Patricia Clement.

Kevin G. Abrams and J. Travis Lester, Richards, Layton & Finger, Wilmington, Delaware; Daniel J. Tyukody, Jr., Paul R. Bessette, James A. Lico, and Ted F. Angus, Brobeck, Phleger & Harrison LLP, San Francisco, California; counsel for Adams Golf Inc., B.H. (Barney) Adams, Richard H. Murtland, Darl P. Hatfield, Paul F. Brown, Jr., Roland E. Casati, Finis F. Conner, and Stephen R. Patchin.

Robert K. Payson and John E. James, Potter Anderson & Corroon LLP, Wilmington, Delaware; Robert Cusumano, Karen Cestari, and Vivian Lee Brady, Simpson Thacher & Bartlett, New York City; counsel for Lehman Brothers Holdings, Inc., Banc of America Securities LLC, and Ferris Baker Watts Incorporated.

OPINION

McKELVIE, District Judge.

This is a securities case. Plaintiffs F. Kenneth Shockley, M.D., David Shockley, John M. Morrash, Sandra M. Morrash, and Patricia Clement are the lead plaintiffs of an uncertified class consisting of shareholders who purchased shares of Adams Golf, Inc. common stock in, or traceable to, its July 1998 Initial Public Offering ("IPO"). Each lead plaintiff purchased at least part of his or her Adams Golf stock within twenty-five days of the effective date of the of the Registration Statement and the Prospectus that were filed prior to the IPO. There are two groups of defendants. One is composed of parties related to Adams Golf (the "Adams Golf defendants"), and the other composed of the underwriters of the company's IPO (the "Underwriter defendants").

The Adams Golf defendants include the following parties. Defendant Adams Golf, Inc. is a Delaware corporation with its principal executive offices in Wilmington, Delaware. Adams Golf designs, manufactures and markets golf clubs. Defendant B.H. Adams, the founder of Adams Golf, is an officer and director of the company. Defendants Darl P. Hatfield and Richard H. Murtland are officers of the company. Defendants Paul R. Brown, Jr., Ronald E. Casati, Finis F. Conner, and Stephen R. Patchin are directors of the company.

The Underwriter defendants include Lehman Brothers Holdings Inc., Banc of America Securities LLC, and Ferris Baker Watts, Incorporated, the lead underwriters for the IPO.

In their consolidated and amended class action complaint, plaintiffs assert claims pursuant to Sections 11, 12 and 15 of the Securities Act of 1933 ("the '33 Act"), 15 U.S.C. §§ 77k, 77l(a)(2) and 77o, which allege that, in connection with the IPO, defendants wrongfully prepared, signed or caused Adams Golf to issue a Registration Statement and an incorporated Prospectus that were materially false and misleading. Specifically, plaintiffs contend that the defendants failed to disclose that Adams Golf's profits and revenues were severely threatened by extensive distribution of Adams Golf's products to unauthorized retailers. That is, the defendants failed to disclose the existence of what the plaintiffs term a "gray market" for Adams Golf products.

Plaintiffs further contend that defendants failed to disclose that an industry-wide oversupply of retail inventory had weakened sales for at least a full quarter prior to the offering. Plaintiffs argue that certain portions of the Registration Statement and Prospectus were materially misleading with regard to the gray market and oversupply conditions. Plaintiffs allege that as the market learned of these conditions, the per share price of Adams Golf stock dropped from a high of $18.875 to $3.75.

Plaintiffs seek damages from defendants to compensate for the loss in value of their stock. Defendants have moved to dismiss plaintiffs' complaint pursuant to Federal Rules of Civil Procedure 12(b)(6) and 9(b) and the 1995 Private Securities Litigation Reform Act (the "PSLRA") for failure to demonstrate any set of facts that would entitle them to relief.

On January 8, 2001, the court heard oral argument on defendants' pending motions to dismiss. This is the court's decision on the motions to dismiss.

I. FACTUAL BACKGROUND

The court draws the following facts from plaintiffs' consolidated and amended class action complaint and the documents referenced therein.

In 1987, Barney H. Adams founded Adams Golf. Adams initially started the company as a general golfing components supplier and contract manufacturer, but later developed it into a producer of high-end, custom fit golf clubs. In the fall of 1995, Adams introduced the "Tight Lies Original," the lead product in a new line of high-end golf clubs. The Tight Lies Original was an immediate success. In December 1996, Adams added three fairway woods, the Tight Lies Strong 3, Strong 5, and Strong 7. Adams added the Tight Lies Strong 9 to the product line in January 1998. Adams Golf enjoyed rapid sales growth with the Tight Lies clubs. According to the July 9, 1998 Prospectus, the company's sales increased from $1.1 million in 1995 to $36.7 million in 1997. In the first quarter of 1998, Adams Golf recorded net sales of $24.5 million and held a 27% market share in the single fairway woods category.

On July 10, 1998, Adams Golf executed an IPO. According to the company's July 13, 1998, Securities and Exchange Commission ("SEC") Rule 424(b)(4) filing, the IPO was conducted on a firm commitment basis through the underwriter defendants and consisted of six million shares offered at $16.00 per share. On July 10, 1998, the day after the allegedly misleading Registration Statement and Prospectus became effective, the stock traded publicly on the NASDAQ exchange and closed at $18.375. At oral argument, counsel for plaintiffs stated that two of the lead plaintiffs, F. Kenneth Shockley, M.D. and David Shockley ("the Shockley plaintiffs"), purchased their shares directly from the Underwriter defendants during the IPO. The remaining lead plaintiffs ("the non-Shockley plaintiffs") purchased their shares on the public market soon after the IPO.

The amended complaint charges that the defendants misrepresented and omitted material facts in the July 10, 1998, Adams Golf Registration Statement. Plaintiffs contend that the omissions relate to two material subjects. First, plaintiffs allege that defendants failed to disclose that Adams Golf's profits and revenues were artificially inflated by extensive "gray market" distribution of Adams Golf's products to Costco, an unauthorized discount retailer. Second, plaintiffs allegations infer that an industry-wide oversupply of inventory at the retail level existed for at least a full quarter prior to the IPO, that the defendants failed to disclose this allegedly material information, and that this industry-wide oversupply has adversely affected Adams Golfs' profits.

A. Facts Underlying The Allegation of Gray Market Sales Misrepresentation

At some point before the IPO, personnel at Adams Golf learned that certain Tight Lies products were being sold at Costco, an unauthorized discount retailer. According the plaintiffs, these sales resulted in a "gray market" for the Tight Lies golf clubs. The term "gray market" describes a market condition created by the unauthorized sale of products to discounters willing to resell the products at prices substantially lower than those set by authorized retailers. These discounters use the lower prices to draw consumers away from the authorized retailers. When the consumers purchase the products from the discounters, the profit margins for the distributor of the product are reduced. In addition, according to the complaint, gray markets tend to skew the distributor's revenues, causing higher sales in the earlier periods as products filter to discounters through gray market channels and lower sales in later periods as the authorized retailers, losing sales to discounters, order fewer products from the distributor.

On June 9, 1998, one month before the effective date of the Registration Statement, Adams Golf issued a press release explaining that it had filed a Bill of Discovery against Costco. The press release states, "[t]he bill of discovery was filed in order to determine whether Costco's claims that they had properly acquired Adams' Tight Lies fairway woods for resale were accurate.... Adams Golf became concerned when it learned that Costco was selling their Tight Lies fairway woods because Costco is not an authorized distributor." At that time, Costco held over 5,000 Adams Golf clubs in its inventory.

According to the plaintiffs, these gray market sales artificially inflated Adams Golf's sales prior to the IPO and damaged the sales after the IPO by reducing the market price for the clubs. Plaintiffs explain that Costco's gray market sales are only one example of sales by unauthorized discounters and international gray market discounters. The Registration Statement and Prospectus did not specifically refer to the gray market. Rather, it stated that "the Company does not sell its products through price sensitive general discount warehouses, department stores or membership clubs."

On January 7, 1999, Adams Golf disclosed in a company press release that sales results would continue to be adversely affected as a result of "the gray market distribution of its products to a membership warehouse club." In the company's 1998 Form 10-K Report, filed with the SEC in March 1999, the Adams Golf disclosed that:

Despite the Company's...