In re Adams Golf Inc. Securities Litigation

• Decision Date: 25 August 2004
• Docket Number: No. 03-3945.,03-3945.
• Citation: 381 F.3d 267
• Parties: In re: ADAMS GOLF, INC. SECURITIES LITIGATION F. Kenneth Shockley, M.D.; David Shockley; Todd Tonore; Zane Bianacci; Patricia Craus; Terry Linville; Larry Price; Federated National Insurance Company, on behalf of all others similarly situated, Appellants.
• Court: U.S. Court of Appeals — Third Circuit

381 F.3d 267

In re: ADAMS GOLF, INC. SECURITIES LITIGATION F. Kenneth Shockley, M.D.; David Shockley; Todd Tonore; Zane Bianacci; Patricia Craus; Terry Linville; Larry Price; Federated National Insurance Company, on behalf of all others similarly situated, Appellants.

No. 03-3945.

United States Court of Appeals, Third Circuit.

Argued May 25, 2004.

Filed August 25, 2004.

Appeal from the United States District Court for the District of Delaware, Kent Jordan, J.

COPYRIGHT MATERIAL OMITTED

COPYRIGHT MATERIAL OMITTED

Elizabeth W. Fox, Todd S. Collins [Argued], Berger & Montague, Philadelphia, PA, for Appellants.

Kevin G. Abrams, Richards, Layton & Finger, Wilmington, DE, Michael J. Biles, Jennifer R. Brannen, Jesse Z. Weiss, Paul R. Bessette [Argued], Kevin G. Abrams, Akin, Gump, Strauss, Hauer & Feld, Austin, TX, for Appellees Adams Golf Inc., B.H. Adams, Richard H. Murtland, Darl P. Hatfield, Paul F. Brown, Jr. Roland E. Casati, Finis F. Conner, and Stephen R. Patchin.

Robert K. Payson, Potter, Anderson & Corroon, Wilmington, DE, Michael J. Chepiga [Argued], Simpson, Thacher & Bartlett, New York, NY, for Appellees Lehman Bros. Holdings, Banc of America Securities LLC, and Ferris Baker Watts.

Before SCIRICA, Chief Judge, RENDELL and ALARCÓN,^* Circuit Judges.

RENDELL, Circuit Judge.

In this securities case, plaintiff-shareholders brought an action under the Securities Act of 1933 against Adams Golf, Inc., a manufacturer of golf equipment, and certain of its officers and underwriters. The plaintiffs contended that the Company's registration statement and prospectus contained materially false or misleading statements in violation of sections 11, 12(a)(2), and 15 of the Securities Act. Among other things, Adams Golf's public offering materials indicated that the Company sold its golf equipment exclusively to authorized retailers and that the golf industry was flourishing. In their complaint, the plaintiffs alleged that Adams Golf omitted information contrary to these representations, i.e., that unauthorized retailers were selling Adams Golf's golf clubs, and that retailers industry-wide were carrying an oversupply of golf equipment. Finding that neither the unauthorized retail nor the oversupply allegations stated a claim upon which relief could be granted, the District Court dismissed the action under Fed.R.Civ.P. 12(b)(6). In re Adams Golf, Inc. Sec. Litig., 176 F.Supp.2d 216 (D.Del. 2001). For the reasons that follow, we will affirm in part and reverse in part.

I

A

When Barney Adams founded Adams Golf in 1987, the Company was a golfing components supplier and a contract manufacturer. Over the years, it grew to become a designer and manufacturer of its own custom-fit golf clubs. After having much success by introducing a high-end golf club, called Tight Lies, the Company offered its shares to the public. On July 10, 1998, an Initial Public Offering ("IPO") of 5,575,000 shares of the Company's common stock was made at $16 per share accompanied by the requisite registration statement and prospectus.¹

In their complaint, the plaintiffs contend that the defendants misrepresented and omitted material facts in the registration statement and prospectus. First, the plaintiffs argue that the defendants failed to disclose that its revenues were artificially inflated by a "gray market" distribution of Adams Golf golf clubs. Second, the plaintiffs argue that the defendants failed to disclose the existence of an industry-wide oversupply of golf equipment. The facts with respect to these two sets of allegations will be explored in more detail.

Adams Golf sold its golf clubs only to authorized dealers. As its registration statement explained:

To preserve the integrity of its image and reputation, the Company limits its distribution to retailers that market premium quality golf equipment and provide a high level of customer service and technical expertise.... The Company believes its selective retail distribution helps its retailers to maintain profitable margins and maximize sales of Adams' products.

The registration statement made clear that, as part of its limited distribution arrangement, the Company "does not sell its products through price sensitive general discount warehouses, department stores or membership clubs."

Prior to the IPO, however, Adams Golf had learned that Tight Lies golf clubs were being sold by Costco, a discount warehouse. On June 9, 1998, one month before the registration statement's effective date, the Company issued a press release in which it acknowledged that an unauthorized dealer was selling its signature product. Indeed, the plaintiffs alleged that prior to the IPO, Costco possessed over 5,000 Tight Lies clubs in its inventory. In the press release, Adams Golf stated it was "concerned" about Costco's sale of the golf clubs "because Costco [was] not an authorized distributor." Concerned enough that, according to the press release, Adams Golf initiated legal proceedings, by filing a bill of discovery against Costco, to determine "whether Costco's claims that they had properly acquired Adams' Tight Lies fairway woods for resale were accurate." The plaintiffs further alleged that the unauthorized distribution was not limited to Costco and included "sales by other unauthorized discount retailers and international gray market distributors."

This unauthorized inventory created a "gray market," according to the plaintiffs. The complaint defines "gray market" to simply refer to "the unauthorized distribution of the Company's products to discount retailers." The complaint sets out the several ostensible consequences of this gray market. The plaintiffs alleged that the Company initially experienced a rise in sales as products were diverted to the unauthorized distributors. According to their complaint, "[t]he short-term income generated by sales to the gray market also skewed the Company's overall financial appearance, creating the false impression of heightened sales and profitability at the time of the IPO, according to the historical financial statements contained in the Registration Statement and the Prospectus." Seeking a better deal, consumers bought their Tight Lies clubs from cheaper, unauthorized sources. With their sales diminished, authorized dealers then reduced their orders for Adams Golf equipment. In time, the ultimate result for the Company was an overall drop in revenue.

About five months after the IPO, on January 7, 1999, Adams Golf issued a press release anticipating disappointing fourth quarter 1998 results. The Company stated that sales would continue to suffer as a result of the "gray market distribution of its products to a membership warehouse club." Further, according to the plaintiffs' complaint, Adams Golf acknowledged, in its Form 10-K filed in March of 1999, that despite its best efforts, a membership warehouse club had possession of its golf clubs, and that the Company "does not believe that the gray marketing of its product can be totally eliminated."

The complaint also states that by omitting any mention of an industry-wide glut of golf equipment carried by retailers, certain passages in Adams Golf's registration statement were materially misleading. Specifically, the plaintiffs refer to the statement that "[t]he Company believes its prompt delivery of products enables its retail accounts to maintain smaller quantities of inventory than may be required with other golf equipment manufacturers." Further, the plaintiffs argue that forward-looking statements contained in the offering materials, including the belief that "a number of trends are likely to increase the demand for Adams' products" painted too rosy a picture of the golf industry, particularly in light of the problem of retail over-supply.²

The record indicates that oversupply did eventually come to adversely affect Adams Golf's bottom line. Indeed, the first quarter report for 1999 indicated that the Company had suffered disappointing financial results, partly owing to an "oversupply of inventory at the retail level, a condition that weakened club sales industry wide over the last 12 months, [and] has resulted in substantial reductions in retailer purchases."

B

The District Court granted the defendants' motion to dismiss for failure to state a claim upon which relief may be granted. Adams Golf, 176 F.Supp.2d at 238. The Court ruled as to both the gray market and the retail oversupply claims that Adams Golf's registration statement contained neither false, nor misleading statements nor any material omissions. In response, the plaintiffs filed a motion to amend its complaint pursuant to Fed. R.Civ.P. 59(e) and 15, which the District Court denied in a subsequent order. The plaintiffs timely appealed both rulings of the District Court. We have jurisdiction to consider this appeal pursuant to 28 U.S.C. § 1291.

II

This Court reviews Rule 12(b)(6) dismissals de novo, accepting all well-pleaded allegations as true and drawing all reasonable inferences in favor of plaintiffs. Anthony v. Council, 316 F.3d 412, 416 (3d Cir.2003). We may not affirm unless we are certain that no relief could be granted under any set of facts which could be proven. Id. The District Court concluded that the plaintiffs' complaint was insufficient to state a claim against the defendants under sections 11 and 12(a)(2) of the 1933 Act.³

The 1933 Act creates federal duties, particularly involving registration and disclosure, in connection with the public offering of securities. Sections 11 and 12(a)(2) impose civil liability for the making of materially false or misleading statements in registration statements and prospectuses. See 15 U.S.C. §§ 77k, 77l (a)(2). In particular, section 11 involves material misstatements or omissions in registration statements, while section 12(a)(2) involves prospectuses and other solicitation materials.

To state a claim under section 11, plaintiffs must allege that they purchased securities...