Lee v. Ernst & Young, Llp, 01-1369.

• Decision Date: 18 June 2002
• Docket Number: No. 01-1369.,01-1369.
• Citation: 294 F.3d 969
• Parties: Jong E. LEE; Heide Sue Casavan; Darcie Molitor; Whitney McFarlin; George E. Faue; Patricia E. Faue; Janice McQuiston; Randolph G. Sunder; Phillip Thomas; Linda Grady; Mathias Faue; Desiree Swan; Ranjit C. Desai; Priyam R. Desai; Herbert A. Beron; Gordon E. Bennett; C. William Brown, Dr., Trustee on behalf of C. William Brown, M.D.P/S Trust, dtd 4/1/85; Charles Fisher; Judith Anne Jacobson; Ann M. Ritz; Joseph Cooper, Plaintiffs-Appellants, v. ERNST & YOUNG, LLP, Defendant-Appellee. Summit Medical Systems, Inc., Defendant. Securities and Exchange Commission, Amicus on Behalf of Appellant.
• Court: U.S. Court of Appeals — Eighth Circuit

294 F.3d 969

Jong E. LEE; Heide Sue Casavan; Darcie Molitor; Whitney McFarlin; George E. Faue; Patricia E. Faue; Janice McQuiston; Randolph G. Sunder; Phillip Thomas; Linda Grady; Mathias Faue; Desiree Swan; Ranjit C. Desai; Priyam R. Desai; Herbert A. Beron; Gordon E. Bennett; C. William Brown, Dr., Trustee on behalf of C. William Brown, M.D.P/S Trust, dtd 4/1/85; Charles Fisher; Judith Anne Jacobson; Ann M. Ritz; Joseph Cooper, Plaintiffs-Appellants, v. ERNST & YOUNG, LLP, Defendant-Appellee Summit Medical Systems, Inc., Defendant.

Securities and Exchange Commission, Amicus on Behalf of Appellant.

No. 01-1369.

United States Court of Appeals, Eighth Circuit.

Submitted: October 17, 2001.

Filed: June 18, 2002.

Gregg M. Fishbein, argued, Minneapolis, MN (Richard A. Lockridge, Minneapolis, Stanley M. Grossman and Patrick V. Dahlstrom, New York, Karen L. Morris and Patrick F. Morris, Wilmington, DE, on the brief), for appellant.

Luis De La Torre, argued amicus curiae, Special Counsel, for Securities Exchange Com'n, Washington, DC (David M. Becker, General Counsel, Jacob H. Stillman, Solicitor, Eric Summergrad, Deputy Solicitor, Mark Pennington, Asst. General Counsel, SEC, Washington, DC, on the brief), for appellants.

Bruce M. Cormier, argued, Washington, DC (William P. Hammer, Jr., New York City, Stanley J. Parzen, Michele Odorozzi, Chicago, IL, Timothy D. Kelly, Wendy A. Snyder, Minneapolis, MN, on the brief), for appellee.

Before McMILLIAN, FAGG and BEAM, Circuit Judges.

McMILLIAN, Circuit Judge.

This appeal arises from consolidated securities fraud lawsuits filed against Summit Medical Systems, Inc. ("Summit"), Summit's officers and directors, and Summit's public accountant-independent auditor, Ernst & Young ("E & Y") (collectively "defendants") by Summit shareholders ("plaintiffs") in the United States District Court for the District of Minnesota. Following the entry of final judgment, plaintiffs appeal from orders of the district court resulting in the dismissal, pursuant to Fed.R.Civ.P. 12(b)(6), of their claim against E & Y for allegedly violating § 11 of the Securities Act of 1933 ("the 1933 Act"), 15 U.S.C. § 77k,¹ by making materially false and misleading statements and omissions in Summit's registration statement filed with the Securities and Exchange Commission ("SEC") in connection with Summit's initial public offering in August 1995. See Joint Appendix, Vol. I, at 65-66 (Count III of the Amended and Consolidated Class Action Complaint (hereinafter "the first amended complaint")). For reversal, plaintiffs argue that the district court (1) erred in holding as a matter of law that standing to bring the § 11 claim exists only for those plaintiffs who acquired their stock in the initial public offering, In re Summit Med. Sys., Inc., Sec. Litig., 10 F.Supp.2d 1068, 1070 (D.Minn. 1998) (In re Summit), and (2) abused its discretion in denying their request to have a named plaintiff, Whitney McFarlin, appointed as a lead plaintiff after the statutory sixty-day period for requesting such appointments had expired. See Joint Appendix, Vol. II, at 554-55 (Transcript of Proceedings (Nov. 20, 1998)). For the reasons discussed below, we reverse the district court's holding on the § 11 standing issue, decline to address the lead plaintiff appointment issue, and remand the case to the district court for further proceedings consistent with this opinion.

Jurisdiction was proper in the district court based upon 28 U.S.C. § 1331. Jurisdiction is proper in this court based upon 28 U.S.C. § 1291. The notice of appeal was timely filed pursuant to Fed. R.App. P. 4(a).

Background

Summit is a corporation headquartered in Minneapolis, Minnesota, which provides "clinical outcomes" medical database software and related products and services. According to the first amended complaint, 2.5 million shares of Summit common stock began trading publicly on August 4, 1995, at $9.00 per share. Following the initial public offering, the Summit stock price increased even though no profit was shown by Summit. A secondary public offering was made in June 1996. At the end of 1996, the Summit stock price began to decline, and it eventually fell below the price at which the stock was initially offered to the public. On March 3, 1997, Summit publicly disclosed that it had been improperly recognizing revenues. Following an investigation, Summit announced that it planned to restate its financial results dating back to 1994. On April 4, 1997, Summit filed revised statements with the SEC showing the total revenues for the years 1994 and 1995, and the first nine months of 1996, to be $5.6 million less than originally reported, representing an 11% cumulative shortfall. See In re Summit, 10 F.Supp.2d at 1069.

Following Summit's public disclosures, numerous lawsuits were brought against defendants, resulting in the present consolidated action. See Joint Appendix, Vol. I, at 1-8 (magistrate judge's order consolidating complaints, appointing lead plaintiffs, and approving lead counsel, pursuant to the Private Securities Litigation Reform Act of 1995 ("PSLRA"), 15 U.S.C. § 78u-4(a)). On August 25, 1997, the lead plaintiffs in this consolidated case filed the first amended complaint. See id. at 17-77. In their factual allegations, plaintiffs averred that Summit initially filed a draft registration statement and prospectus with the SEC on June 21, 1995, that Summit thereafter filed several amendments to its draft registration statement and prospectus, and that Summit filed its final registration statement and prospectus on August 7, 1995. See id. at 36. (Hereinafter "the registration statement" refers to the final version filed by Summit on August 7, 1995.) According to the first amended complaint, the registration statement identified E & Y as an "expert" which had audited and certified Summit's financial statements, and it set forth E & Y's opinion that Summit's consolidated financial statements "presented fairly, in all material respects, the consolidated financial position of [Summit] for the 1993 and 1994 fiscal years, and the results of [Summit's] consolidated operations and its consolidated cash flows for 1992, 1993, and 1994, `in conformity with generally accepted accounting principles [ ("GAAP") ].'" Id. at 36-37.² In Count III of the first amended complaint, plaintiffs asserted that, because of Summit's premature recognition of revenue in violation of GAAP and Summit's own publicly-stated revenue recognition policies, the registration statement contained materially false and misleading statements and omissions regarding Summit's actual financial status and accounting practices from as early as 1994. See id. at 65. In their prayer for relief, plaintiffs sought, among other things, monetary damages, attorneys' fees, and their costs of litigation. Whitney McFarlin, though not a lead plaintiff, was identified in the first amended complaint as a named plaintiff. See id. at 20.

Defendants, including E & Y, moved to dismiss the first amended complaint on several grounds. The district court granted in part and denied in part defendants' motion to dismiss. In re Summit, 10 F.Supp.2d at 1071. As to the § 11 claim against E & Y, the district court held, as a matter of law, that only those plaintiffs who purchased their stock in the Summit initial public offering had standing to sue. See id. at 1070. In support of this holding, the district court relied upon Gustafson v. Alloyd Co., 513 U.S. 561, 115 S.Ct. 1061, 131 L.Ed.2d 1 (1995) (Gustafson) (holding that aftermarket purchasers of securities did not have a claim under § 12(2) of the 1933 Act³). The district court explained that the 1933 Act must be read as a whole and that, based upon the shared legislative history and legislative intent behind § 11 and § 12(2) of the 1933 Act, "the standing principles announced in Gustafson apply equally to Section 11 and 12 claims." In re Summit, 10 F. Supp.2d at 1071 (citing In re WRT Energy Sec. Litig., No. 96-CIV 3611, 1997 WL 576023, at *5 (S.D.N.Y. Sept. 15, 1997) (dismissing, for lack of standing, a § 11 claim brought by aftermarket purchasers of securities, based upon interpretation and application of Gustafson)). The district court dismissed the § 11 claim of all the named plaintiffs except for two (one of whom was McFarlin) who appeared to have acquired their stock in Summit's August 1995 initial public offering. Id. As to the other plaintiffs, the district court dismissed their § 11 claim without prejudice and with leave to replead the § 11 claim to establish standing consistent with the district court's interpretation of the statute. Id.⁴

Plaintiffs subsequently filed a Second Amended and Consolidated Class Action Complaint ("the second amended complaint"), see Joint Appendix, Vol. II, at 352-403, which again included under Count III a § 11 claim against E & Y and others. This time, however, it was brought by the two plaintiffs who appeared to have purchased their Summit shares in the August 1995 initial public offering, on behalf of the members of the class who had purchased their Summit shares in the initial public offering. See id. at 399-400. E & Y moved to dismiss the § 11 claim in the second amended complaint, and the district court scheduled a hearing. At the hearing, held on November 20, 1998, plaintiffs acknowledged that McFarlin was the only named plaintiff who had purchased stock in Summit's August 1995 initial public offering, and they asked to have McFarlin appointed a lead plaintiff. The district court orally denied plaintiffs' request on the ground that it would be inconsistent with the PSLRA to appoint McFarlin as a lead plaintiff at that point in the litigation. See Joint Appendix, Vol. II, at 554-55 (Transcript of Proceedings) ("That, in my view, both contravenes the words of the 60-day designation, and in fact contravenes the strongly expressed spirit of Congress inherent in the passage of the [PSLRA]."). Thereafter,...