Pr Diamonds, Inc. v. Chandler

• Decision Date: 03 March 2004
• Docket Number: No. 02-3921.,02-3921.
• Citation: 364 F.3d 671
• Parties: PR DIAMONDS, INC., et al., Plaintiffs-Appellants, v. John P. CHANDLER, et al., Defendants-Appellees.
• Court: U.S. Court of Appeals — Sixth Circuit

364 F.3d 671

PR DIAMONDS, INC., et al., Plaintiffs-Appellants, v. John P. CHANDLER, et al., Defendants-Appellees.

No. 02-3921.

United States Court of Appeals, Sixth Circuit.

Argued December 12, 2003.

Decided and Filed March 3, 2004.^*

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Richard S. Wayne (briefed), William R. Jacobs (argued), Strauss & Troy, Cincinnati, OH, for Plaintiffs-Appellants.

Robert A. Pitcairn, Jr. (argued and briefed), Katz, Teller, Brant & Hild, Cincinnati, OH, Robert N. Hochman (argued and briefed), Jeffrey R. Tone (briefed), Jeffrey C. Sharer (briefed), Sidley, Austin, Brown & Wood, Chicago, IL, Stephen J. Butler, Thompson Hine, Cincinnati, OH, James H. Ham, III, Baker & Daniels, Indianapolis, IN, for Defendants-Appellees.

Before: COLE and CLAY, Circuit Judges; QUIST, District Judge.^**

OPINION

QUIST, District Judge.

Plaintiffs-appellants in this securities fraud case are investors in the stock of Intrenet, Inc. ("Intrenet" and the "Company"). Defendants-appellees are two Intrenet officers (the "Individual Defendants") and Intrenet's outside auditor, Arthur Andersen LLP ("Andersen"). Plaintiffs' amended consolidated class action complaint (the "Complaint") alleged that the Individual Defendants and Andersen committed securities fraud in violation of Section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b), and Rule 10b-5 promulgated by the Securities and Exchange Commission (the "SEC"), 17 C.F.R. § 240.10b-5. In addition, Plaintiffs alleged that the Individual Defendants were liable as control persons under Section 20(a) of the Securities Exchange Act of 1934, 15 U.S.C. § 78t(a). The district court dismissed the Section 10(b) and Rule 10b-5 claims for lack of specific allegations giving rise to a strong inference of scienter, and later granted judgment on the pleadings on the Section 20(a) claim for failure to state a predicate securities fraud claim against the Company. Plaintiffs now appeal the district court's decisions. For the reasons set forth below, we affirm.

I. Background

Intrenet was an Indiana corporation with its executive offices and principal place of business in Milford, Ohio. The Company operated as a holding company for four truckload carrier subsidiaries (Roadrunner Trucking, Inc., Roadrunner Distribution Services, Inc., Eck Miller Transportation Corp., and Advanced Distribution System, Inc.) and a brokerage logistics operation (INET Logistics, Inc.). Intrenet's consolidated financial statements included all five of these subsidiaries. A publicly-held company, Intrenet was registered with the Securities Exchange Commission and its stock traded on the NASDAQ National Market System. Formed in 1983, Intrenet was once one of the largest public flatbed carriers in North America.

The two Individual Defendants, John P. Chandler and Eric C. Jackson, were Intrenet officers and directors. Chandler was President and Chief Executive Officer since June 12, 2000. Prior to that time, Chandler was, at all relevant times, Executive Vice President and Chief Operating Officer of the Company. Throughout the class period asserted in this action, Chandler was also a director of Intrenet. Jackson was Chairman of Intrenet's Board of Directors from June 12, 2000, to December 19, 2000. Prior to his appointment as Chairman of the Board, Jackson was President and Chief Executive Officer. Jackson was also a director of the Company since 1993. Defendant Arthur Andersen LLP served as Intrenet's outside auditor. In that capacity, Andersen audited the Company's financial statements for the years ending December 31, 1998, and December 31, 1999.

The alleged 20-month class period begins with an Intrenet press release issued on February 19, 1999, reporting the Company's financial results for the fourth quarter and year ending December 31, 1998. Intrenet issued additional financial statements and press releases over the course of the class period. The class period ends with Intrenet's press release dated October 13, 2000, in which the Company announced that it was conducting a review of the accuracy of its financial statements, focusing on the Advanced Distribution System ("ADS") subsidiary. The press release stated that pending the completion of the review, Intrenet's 1998 and 1999 year-end financial statements should not be relied upon, and that the Company expected to reduce its net income by approximately $1.3 million. NASDAQ trading in Intrenet stock was halted on that same day, never to resume. On October 18, 2000, Intrenet issued another press release indicating that the internal audit showed $1.3 million in unrecorded expenses at ADS which could result in restatements of Intrenet's 1998, 1999, and first and second quarter 2000 financial statements. The press release also stated that the individual believed to be responsible for the accounting issues was no longer with the Company.

On January 2, 2001, Intrenet announced that effective immediately it and its subsidiary trucking companies would cease operations, lay off most employees, and direct the liquidation of assets. Intrenet said that after a thorough review of the Company's business, industry dynamics, and all available options, it was determined that issues related to fuel prices, driver retention, and the unwillingness of many customers to accept higher rates would preclude the Company from achieving operational profitability in the foreseeable future. Also, Intrenet noted that it lacked adequate capital to execute its business plan. CEO Chandler further stated that the previously announced accounting issues relating to the ADS subsidiary had little impact on the decision to suspend operations and liquidate. On January 19, 2001, Intrenet filed for Chapter 11 bankruptcy protection.

Intrenet stockholder Hirsch Seidman initiated this action in January 2001 in the United States District Court for the Southern District of Ohio. Seidman sued both individually and on behalf of all other similarly situated public investors who purchased Intrenet common stock during the class period (February 19, 1999, through October 13, 2000) and incurred losses when the stock lost value as a result of the October 13, 2000, press release and subsequent collapse of the Company. In June 2001, the district court appointed P.R. Diamonds, Inc. as lead plaintiff. Plaintiffs filed an amended consolidated class action complaint (the "Complaint") on August 17, 2001, to add Andersen as a defendant. Pursuant to this Complaint, Plaintiffs asserted claims under 15 U.S.C. § 78j(b) ("Section 10(b)") and 17 C.F.R. § 240.10b-5 ("Rule 10b-5") against the Individual Defendants and Andersen, as well as claims of "control person" liability under 15 U.S.C. § 78t(a) ("Section 20(a)") against the Individual Defendants.

Plaintiffs' Complaint alleges that Intrenet's financial statements and press releases during the asserted class period contained material misrepresentations and omissions masking the Company's true financial condition, making them false and misleading. According to Plaintiffs, these fraudulent financial statements and press releases inflated the Company's financial results and growth, leading to artificial increases in its stock price. The district court accurately summarized the Complaint's allegations in the following manner:

(1) Intrenet's financial results and growth were artificially inflated;

(2) Although Intrenet represented that its financial statements were prepared in compliance with generally accepted accounting principles ("GAAP"), they were not:

(a) the financial statements failed to reconcile inter-company transactions among Intrenet's five subsidiaries (b) the financial statements failed to record day-to-day operating expenses;

(c) the financial statements failed to account for uncollectible receivables and understated receivable reserves;

(d) the financial statements failed to record an impairment in the value of Intrenet's assets; and

(e) the financial statements failed to fully disclose the significant risks and uncertainties associated with deficiencies in the company's internal control and accounting system; and

(3) Intrenet's financial statements, which incorporated the financial results of its five subsidiaries, artificially inflated the net income and earnings of its ADS subsidiary.

In addition to the aforementioned purported omissions and misrepresentations, the Complaint alleges that Intrenet's public statements included false and misleading language painting an unduly rosy picture of the Company's financial situation. For example, Intrenet claimed it was making "solid strides" and "positive progress" at the time when Plaintiffs allege losses were far in excess of those reported. Intrenet also announced a plan to increase productivity and eliminate expenses and liabilities when Plaintiffs allege it was artificially inflating its earnings.

With respect to the Individual Defendants, the Complaint asserts that as top-level Intrenet executives and control persons, they knew of or recklessly disregarded the alleged misrepresentations and omissions. With respect to Intrenet's outside auditor, the Complaint posits that Andersen issued false and misleading audit reports stating that Intrenet's financial statements fairly represented the Company's financial condition and complied with GAAP. Plaintiffs also allege that Andersen failed to conduct its audits in compliance with generally accepted auditing standards ("GAAS").

On October 10, 2001, the Individual Defendants filed a motion to dismiss Plaintiffs' case under Federal Rules of Civil Procedure 9(b) and 12(b)(6). Andersen filed its motion to dismiss pursuant to Federal Rule of Civil Procedure 12(b)(6) on October 12, 2001. On November 21, 2001, Plaintiffs filed a consolidated memorandum opposing Defendants' motions to dismiss and, in the alternative, requesting leave to amend their Complaint. The...