Kowal v. MCI Communications Corp.

• Decision Date: 01 March 1994
• Docket Number: No. 92-7127,92-7127
• Parties: , 62 USLW 2624, Fed. Sec. L. Rep. P 98,101, 28 Fed.R.Serv.3d 100 Charles KOWAL, et al., Appellants, v. MCI COMMUNICATIONS CORPORATION, et al., Appellees.
• Court: U.S. Court of Appeals — District of Columbia Circuit

Page 1271

16 F.3d 1271

305 U.S.App.D.C. 60, 62 USLW 2624, Fed.

Sec. L. Rep. P 98,101,

28 Fed.R.Serv.3d 100

Charles KOWAL, et al., Appellants, v. MCI COMMUNICATIONS CORPORATION, et al., Appellees.

No. 92-7127.

United States Court of Appeals, District of Columbia Circuit.

Argued Oct. 19, 1993.

Decided March 1, 1994.

Appeal from the United States District Court for the District of Columbia.

Steven G. Schulman, New York City, argued the cause for appellants. With him on the briefs were Herbert E. Milstein and Steven J. Toll, Washington, DC.

William O. Bittman, Washington, DC, argued the cause for appellees. With him on the brief were Frederic T. Spindel and John R. Erickson, Washington, DC.

Before EDWARDS, BUCKLEY, and SENTELLE, Circuit Judges.

Opinion for the Court filed by Circuit Judge SENTELLE.

SENTELLE, Circuit Judge:

This is an appeal from a judgment of the district court for the District of Columbia dismissing a complaint under the Securities Exchange Act of 1934 and Rule 10b-5 for failure to plead fraud with sufficient particularity and for failure to state a claim upon which relief could be granted. Plaintiff-appellants, who claim to be members of a class of individuals who purchased MCI common stock from January 30, 1990 to November 15, 1990, sued defendant-appellees MCI Communications Corp. ("MCI") and several of its directors and officers. The complaint alleged that during the putative class period, MCI made statements of optimism and projections of future financial performance which were false and misleading because the company failed to disclose certain competitive pressures and the negative impact that MCI's merger with Telecom U.S.A. would have on its future financial performance. Plaintiffs claimed that MCI's projections of future financial performance lacked a reasonable basis when made because the company knowingly or recklessly disregarded the impact these factors would have on the accuracy of its projections. Because the complaint failed to satisfy FED.R.CIV.P. 9(b) and 12(b)(6), the district court properly ordered dismissal and did not abuse its discretion in denying leave to amend. We therefore affirm.

I. BACKGROUND

We accept as true the following facts set out in plaintiffs' complaint for the purposes of this appeal. See Schuler v. United States, 617 F.2d 605, 608 (D.C.Cir.1979). Defendant-appellee MCI is a Delaware corporation with its headquarters in Washington, D.C. The company is publicly-held. Its shares trade over-the-counter on the NASDAQ's National Market System. During the putative class period, MCI operated as the second-largest provider of long-distance telephone service in the United States. At that time, American Telephone and Telegraph Co. ("AT & T") controlled 64-70 percent of the long-distance market, compared to MCI's 13-15 percent share. Telecom U.S.A. ("Telecom") was the nation's fourth largest long-distance provider until April 8, 1990, when MCI agreed to merge with the company by acquiring all outstanding shares of its stock at a total price of $1.25 billion. To finance the transaction, MCI borrowed approximately $1 billion from a bank group, increasing its debt to equity ratio of 1.12-to-1 on December 31, 1989 to 1.56-to-1 on September 30, 1990. The merger between MCI and Telecom was completed in August, 1991.

For the past decade, MCI has reported nearly uninterrupted improvement in its revenues, earnings, and earnings per share. This solid historical performance was capped with record earnings and a 20% increase in revenues in 1989. The company continued to report year-to-year gains in its first quarter ended March 31, 1990; its second quarter ended June 30, 1990; and its third quarter ended September 30, 1990. However, after the stock market closed on November 15, 1990, MCI announced that it was consolidating its seven regional divisions into four, that it was restructuring operations and could reduce its workforce 6% nationwide in the following six months to reduce expenses, and that it expected revenue growth in the fourth quarter to be "flat" compared to the prior quarter if existing trends continued. The company also acknowledged that restructuring and merger costs would constrain growth in the next several quarters, and that AT & T's aggressive marketing was eroding its market share gains in the residential and small-to-medium sized business markets. The day following the announcement, the price per share of the company's common stock dropped from $29.99 per share to $22.62 at the close of trading.

On November 19, nine shareholders filed this lawsuit as a class action in the United States District Court for the District of Columbia, alleging that MCI and its management had engaged in securities fraud. See Kowal v. MCI Communications Corp., No. 90-2862 (D.D.C. filed Nov. 19, 1991). On February 19, an amended complaint was filed by fourteen named plaintiffs, asserting claims against MCI and two of its senior officers under Section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. Sec. 78j(b) (1988), and Rule 10b-5 thereunder, 17 C.F.R. Sec. 240.10b-5 (1993) (collectively "Rule 10b-5"). The complaint alleged that between January 30, 1990 and November 15, 1990, MCI made certain optimistic statements and projections of future earnings, revenues and sales which were false and misleading, thereby artificially inflating the price of MCI common shares. The principal statements that the complaint alleged to be actionable under Rule 10b-5 included the following:

. On January 30, 1990, then-Chief Financial Officer Daniel F. Akerson told the Dow Jones Newswire that MCI expected revenues to increase between 20-30% in 1990, and expected traffic volume to increase by more than 25%. On January 31, Akerson told The Washington Times that the company was "very optimistic about our industry and our ability to take market share," and that MCI expected to gain an additional 2% of the long-distance market in 1990.

. On February 21, 1990, Akerson and Burt C. Roberts, MCI's President and Chief Executive Officer, told Reuters that MCI's growth in 1990 would outpace the industry, and that they anticipated revenues of about $8 billion and earnings growth of about 30% in 1990. Roberts further stated that the company could win as much as 20% of the long-distance market in five years. Akerson further stated that MCI expected revenue growth of 22-25% in 1990, and earnings in the range of $2.85-$3.15 per share for the year.

. On March 28, 1990, MCI released its Annual Report to Stockholders for the year ended December 31, 1989. The Report stated that the company expected to double revenues within four years, and that the company was "equipped with every tool we need ... to duplicate our success in the 1980s [and] ... to go well beyond." In the MD & A section of the Annual Report, the company reported that it expected continued growth in the residential and business market segments.

. On April 9, 1990, Roberts stated in an interview reported on the newswires that the Telecom merger was "very exciting," and that "combining [MCI and Telecom's] strengths will benefit shareholders, customers and employees alike." Roberts described the merger as a strategically important move which gave MCI an immediate 1 1/2% gain in market share, and further stated that the cost of the merger would have no effect on the company's ability to fund growth, since the company expected to pay off the resulting debt within a couple of years.

. On April 18, 1990, in a conference call with securities analysts, Akerson stated that MCI expected sequential quarterly revenue growth of 5-6 1/2%, and earnings of $0.64-$0.68 per share. Akerson further stated that 1990 earnings were expected to be at the high end of the $2.85-$3.05 per share range, and that second half earnings per quarter would be $0.80-$0.90 per share.

. On May 2, 1990, during a presentation to the New York Society of Securities Analysts, Akerson stated that MCI's volume would grow 25-30%, that MCI expected near-term growth twice that of the industry, and that it continued to anticipate earnings per share of approximately $3.00 for 1990.

. At the May 7, 1990 annual meeting, MCI's decision to declare a dividend was described as "an expression of the company's financial strength," "a vote of confidence in its long-term prospects," and a sign of MCI's "fundamental strength."

. On August 29, 1990, MCI stated in a meeting with analysts that the company expected revenue growth of approximately 15-20%, or twice that of the industry.

. On October 18, 1990, MCI's current Chief Financial Officer O. Gene Gabbard stated that taking market share from AT & T was not "any tougher right now, and maybe even a little easier than it was earlier this year or last fall."

Appellants contend that MCI's statements regarding its future prospects were false and misleading because the company did not disclose the following "facts":

. that MCI's competitive position was deteriorating due to a shift from pricing to marketing in the industry;

. that MCI's operating margins were facing increasing pressure as the company was forced to respond to competitors' intensive marketing campaigns with dramatic increases in its own sales and marketing outlays;

. that MCI's increased expenditures on sales and marketing were inadequate to maintain its prior revenue and market share growth rate, particularly in the residential and general business markets;

. that the debt from the Telecom acquisition combined with MCI's large debt from its rapid expansion created a very heavy debt load that deprived the company of badly needed funds for sales and marketing;

. that the difficulty in integrating Telecom's workforce was seriously interfering with MCI's sales and marketing efforts, especially in the general business sector, and was impairing the company's ability to obtain new customers and retain old ones;

. that Telecom's customers were confused and concerned about the MCI...