McFarland v. Memorex Corp.

• Decision Date: 12 February 1980
• Docket Number: C-79-2926-WAI.,No. C-79-2007-WAI,C-79-2007-WAI
• Citation: 493 F. Supp. 631
• Parties: Craig T. McFARLAND, Trustee for Capital Growth Trust, on behalf of himself and all others similarly situated, Plaintiff, v. MEMOREX CORPORATION et al., Defendants. Craig T. McFARLAND, Trustee for Capital Growth Trust, on behalf of himself and all others similarly situated, Plaintiff, v. LEHMAN BROTHERS KUHN LOEB, INC., et al., Defendants.
• Court: U.S. District Court — Northern District of California

493 F. Supp. 631

Craig T. McFARLAND, Trustee for Capital Growth Trust, on behalf of himself and all others similarly situated, Plaintiff, v. MEMOREX CORPORATION et al., Defendants.

Craig T. McFARLAND, Trustee for Capital Growth Trust, on behalf of himself and all others similarly situated, Plaintiff, v. LEHMAN BROTHERS KUHN LOEB, INC., et al., Defendants.

No. C-79-2007-WAI, C-79-2926-WAI.

United States District Court, N. D. California.

February 12, 1980.

COPYRIGHT MATERIAL OMITTED

David B. Gold argued, Paul F. Bennett, George Donaldson, David L. Braverman, San Francisco, Cal., for plaintiff.

Lawrence Calof, J. Michael Brennan argued, Samuel O. Pruitt, Jr., Gibson, Dunn & Crutcher, Los Angeles, Cal., for defendant Memorex Corp. et al.

Graham B. Moody argued, Boake Christensen, Philip R. Rotner, Stephen C. Garavito, McCutchen, Doyle, Brown & Enersen, San Francisco, Cal., for defendant Deloitte, Haskins & Sells.

W. Reece Bader, Richard E. Levine, Orrick, Herrington, Rowley & Sutcliffe, San Francisco, Cal., for defendants BankAmerica Foundation, California First Bank, and Bank of California, N. A.

E. Judge Elderkin, Vincent Paul Finigan, Donald W. Brown, Brobeck, Phleger & Harrison, San Francisco, Cal., for defendant Wells Fargo Bank, N. A.

Edmund T. King, II, Lawrence A. Hobel, Severson, Werson, Berke & Melchior, San Francisco, Cal., for defendant Crocker Nat. Bank.

Charles A. Legge, Robert J. Stumpf, Bronson, Bronson & McKinnon, San Francisco, Cal., for defendants Aetna Cas. and Sur. Co. and General Elec. Credit Corp.

James J. Hagen argued, Simpson, Thacher & Bartlett, New York City, Douglas M. Schwab, Heller, Ehrman, White & McAuliffe, San Francisco, Cal., for defendants Lehman Brothers Kuhn Loeb, Inc., and Blyth Eastman Dillon & Co., Inc.

MEMORANDUM OF DECISION

INGRAM, District Judge.

In two actions brought on behalf of a class and consolidated by order of this Court, plaintiff has charged defendants with violating virtually every section of the Securities Act of 1933 and the Securities Exchange Act of 1934 that can be violated and with committing additional common law and state statutory offenses. Defendants have moved to dismiss on numerous grounds. The questions have been briefed and argued, and this Court now concludes that the motions must be granted for the reasons discussed herein.

Plaintiff alleges causes of action under sections 11, 12, 15 and 17 of the Securities Act of 1933, 15 U.S.C. ?? 77k, 77l, 77o & 77q (1976), sections 10(b), 18(a) and 20 of the Securities Exchange Act of 1934, 15 U.S.C. ?? 78j(b), 78r(a) & 78t (1976), and Rule 10b-5 of the Rules and Regulations adopted by the Securities and Exchange Commission under the Securities Exchange Act of 1934, 17 C.F.R. ? 240.10b-5 (1979). In his pendent claims, plaintiff alleges fraud, deceit, negligent misrepresentation, negligence, professional malpractice and breach of fiduciary duty.¹ First Amended Complaint ?? 1, 13 (filed Aug. 8, 1979) (hereinafter referred to as "complaint").²

The suits arise out of the offer and sale of 1,269,536 shares of common stock of Memorex Corporation under both a registration statement, filed with the Securities and Exchange Commission on July 24, 1978, and a prospectus, dated and effective August 9, 1978.³

There are 42 named defendants in C-79-2007-WAI, and 103 named defendants in C-79-2926-WAI. The defendants can be divided into five categories:

(1) Memorex Corporation, the issuer of the common stock;

(2) the Underwriters;⁴ (3) 24 individuals who were officers or directors of Memorex Corporation, or both, at the time of the stock offering;

(4) Deloitte, Haskins & Sells, independent certified public accountants, identified in the prospectus at page 6 as having examined and certified Memorex's Consolidated Statements of Operations for each of the four years ending December 31, 1977; and

(5) 14 individuals and entities who sold warrants to purchase 519,536 shares of common stock of Memorex to the underwriters prior to the August 9, 1978, offering.

Plaintiff paints his allegations with a broad brush. No effort is made to set forth each defendant's precise wrongdoing and potential liability. Plaintiff alleges that "each defendant committed the statutory and common law violations alleged in this complaint, directly or indirectly," Complaint ? 3, and further, that "each defendant is sued both individually and as a co-conspirator and as an aider and abettor," id. ? 4. In addition, he alleges that "all the allegations made in this complaint are made upon information and belief." Id. ? 5(b). Finally, to cement the links between the defendants, plaintiff alleges that "the above listed defendant officers and directors of Memorex and the Selling Warrant Holders were individually and collectively at all times herein mentioned controlling persons of Memorex. Each of the defendants herein referred to, including Memorex, acted as agent for each." Id. ? 6(g).⁵

This complaint sounds entirely in fraud. Complaint ?? A, 1, 8, 9, 10, 11, 13. As will be discussed below in greater detail, plaintiff has assumed a greater burden with respect to both pleading and proof than had he merely alleged a violation, for example, of section 11 of the 1933 Act.⁶

A careful reading of the complaint reveals that the alleged misdeeds are all detailed in paragraph 10, which reads:

All or part of said statements and omissions were contained in, among other documents, the Prospectus and Registration Statement signed and filed by the defendants with the Securities and Exchange Commission effective August 9, 1978, and prepared with the participation, acquiescence, encouragement or assistance of the defendants, and each of them.

(a) The defendants misrepresented the financial condition, net earnings, assets and net worth of Memorex by means of, inter alia:

(1) Failing to disclose and thereby misrepresenting manufacturing cost variances;

(2) Failing to disclose and thereby misrepresenting costs associated with the manufacture of new products;

(3) Failing to properly account for and thereby misrepresenting cost increases involved in the company's decentralization of facilities;

(4) Failing to properly account for and thereby misrepresenting the effective tax rate applicable to the earnings of the company; and

(5) Failing to disclose and thereby misrepresenting the company's sales revenues;

(b) In addition to the foregoing, the defendants attempted to conceal the company's materially poor and disappointing operating results for the third quarter ended September 29, 1978, by failing to properly account in prior periods for known increased expenses and costs.

(c) The defendants misrepresented that the audited financial statements used in the Registration Statement and the Prospectus fairly presented the financial condition and operating results of Memorex.

No other allegations of impropriety are specified in the complaint.

Defendants have moved to dismiss the complaint under Fed.R.Civ.P. 12(b)(6) for failing to state a claim upon which relief can be granted, and under Fed.R.Civ.P. 9(b) for failing to state the circumstances constituting fraud with particularity.

RULE 9(b)

Because this complaint sounds entirely in fraud, it is held to a higher standard of pleading specificity than that of Fed.R. Civ.P. 8. Rule 9(b) provides:

In all averments of fraud or mistake, the circumstances constituting fraud or mistake shall be stated with particularity. Malice, intent, knowledge, and other condition of mind of a person may be averred generally.

The defendants argue persuasively that the charging allegations of the complaint, as set forth in paragraph 10, do not meet the Rule 9(b) standards.

The commentators have discussed at length the policy reasons underlying the rigorous standards of Rule 9(b). "Allegations of fraud or mistake frequently are advanced only for their nuisance or settlement value and with little hope that they will be successful." 5 C. Wright & A. Miller, Federal Practice and Procedure ? 1296 at 399-400 (1969). See also 2A J. Moore, Federal Practice ? 9.03 (2d rev. ed. 1979). In Temple v. Haft, 73 F.R.D. 49, 52 (D.Del. 1976), the court noted, "A primary purpose of Rule 9(b) is to prevent injury to the reputations of potential defendants from irresponsible, improvident, and cavalier allegations of fraud . . . Particularity in the complaint is also required to minimize the number of unfounded `strike suits'." See also Lewis v. Black, 74 F.R.D. 1 (E.D.N. Y.1975); cases cited in Temple v. Haft, supra, 73 F.R.D. at 52.

The defendants argue that, while they have been charged with serious misdeeds, they are unable to determine what these are. A reading of paragraph 10 leaves this Court only with additional questions: what manufacturing cost variances? what costs associated with the manufacture of new products? what costs associated with decentralization? what discrepancies in the effective tax applicable to the company's earnings?⁷ how were sales revenues misrepresented? which costs should have been accounted for in prior periods? in what manner do the audited financial statements misrepresent the financial condition of Memorex?

Plaintiff responds that the defendants have fair notice of the charges directed against them. He concedes that much of the "detail" of his complaint comes from an article that appeared in the Wall Street Journal on October 18, 1978.⁸ That article quoted Memorex officials regarding earnings pressures.

Plaintiff argues essentially that, since Memorex itself announced that it experienced costs respecting decentralization and new products, and the like, it cannot claim in good faith that the complaint lacks detail. Indeed, plaintiff suggested in argument that he can provide detail only after discovery has begun.⁹ This "detail following discovery" rationale has been firmly rejected by the courts:

A complaint alleging fraud should be filed only after a wrong is reasonably believed to have occurred; it should

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