Rhodes v. Omega Research, Inc.

• Decision Date: 01 March 1999
• Docket Number: No. 98-0174-CIV.,98-0174-CIV.
• Citation: 38 F.Supp.2d 1353
• Parties: Richard M. RHODES, individually and on behalf of all others similarly situated, Plaintiffs, v. OMEGA RESEARCH, INC.; William R. Cruz; Ralph L. Cruz; Bancboston Robertson Stephens; Lehman Brothers; and Hambrecht & Quist Defendants.
• Court: U.S. District Court — Southern District of Florida

38 F.Supp.2d 1353

Richard M. RHODES, individually and on behalf of all others similarly situated, Plaintiffs, v. OMEGA RESEARCH, INC.; William R. Cruz; Ralph L. Cruz; Bancboston Robertson Stephens; Lehman Brothers; and Hambrecht & Quist Defendants.

No. 98-0174-CIV.

United States District Court, S.D. Florida.

March 1, 1999.

Michael Pucillo, Wendy H. Zoberman, Burt & Pucillo, LLP, W. Palm Beach, FL, Andrew Barroway, Schiffrin, Craig & Barroway, LLP, Bala Cynwyd, PA, Ralph Stone, Esq., Shalov, Stone & Bonner, New York City, for Plaintiffs.

Eugene E. Stearns, Richard B. Jackson, Stearns, Weaver, Miller, Weissler, Alhadeff & Sitteron, P.A., Miami, FL, for Defendants William R. Cruz, Ralph L. Cruz and Omega Research, Inc.

Hilarie Bass, Greenberg, Traurig, P.A., Miami, FL, Sara Brody, Stephen M. Kanster, Amy M. McNamer, Brobeck Phleger & Harrison, LLP, San Francisco, CA, for BancBoston Robertson Stephens, Lehman Brothers and Hambrecht & Quist.

ORDER GRANTING IN PART AND DENYING IN PART MOTIONS TO DISMISS

LENARD, District Judge.

THIS CAUSE is before the Court on two motions to dismiss the Amended Complaint, filed by (1) Defendants Omega Research, Inc., William R. Cruz, and Ralph L. Cruz ("Omega Defendants"), on August 18, 1998; and (2) Defendants BancBoston Robertson Stephens, Lehman Brothers, and Hambrecht & Quist ("Underwriters"), on July 1, 1998. The Court having considered the motions, the responses and the record in this case, finds as follows.

I. Introduction

In the Amended Complaint, Plaintiffs allege in Count I that all Defendants violated section 11 of the Securities Act of 1933, 15 U.S.C. §§ 77k and 77o (1994) ("Securities Act"); in Count II that all Defendants violated section 12(A)(2) of the Securities Act; and in Count III that individual Defendants violated section 15 of the Securities Act.

Omega Research, Inc. was founded by Ralph L. Cruz and William R. Cruz in 1982, and is headquartered in Miami, Florida. It designs and sells investment analysis computer software. One of Omega's products, TradeStation, pioneered the concept of allowing investors to use a personal computer to create investment models which, among other things, allow for the automation of investment strategies in various markets. Omega also manufactures other computer-based statistical modeling products, including OptionStation and SuperCharts. These products are used by individual investors, so-called "day traders," and by institutional investors. These products are also sold and marketed under licencing agreements with other companies, notably with Dow Jones Markets, under various names, including "Dow Jones TradeStation." The licencing agreement with Dow Jones extends at least until the year 2002, and constitutes a major source of current and expected revenue for Omega.

In September, 1997, Omega undertook an initial public offering. The Registration Statement and Prospectus ("Prospectus") filed in connection with the initial public offering of Omega's common stock was declared effective by the Securities and Exchange Commission on September 30, 1997. In the offering, Omega sold 2,758,108 shares of common stock and William R. Cruz and Ralph L. Cruz, then the only beneficial shareholders of Omega, sold a total of 1,166,892 shares. The shares sold for $11 per share and the offering was fully subscribed.

The Prospectus filed in conjunction with the offering and attached to the Amended Complaint is a detailed and thorough document, replete with cautionary warnings describing the high degree of risk involved with this business. The introductory paragraph describes the planned offering and states, "The Company will not receive any of the proceeds from the sale of the shares being sold by the Selling Shareholders."¹ Then, in bold type, the first page announces:

"The Common Stock offered hereby involves a high degree of risk. See `Risk Factors' beginning on page 7."

(Prospectus at 1.) Beginning on page seven, the Prospectus outlines numerous risk factors involved in any decision to invest in Omega. Among the most important were: (1) the company's short history and lack of track record; (2) dependence on few products appealing only to a small group of potential customers; (3) the interdependence of Omega's products with other computer software products, including the underlying computer operating system and potential problems within the Windows operating system; (4) the difficulty in predicting revenue streams because of market elasticity of demand; (5) the company's liberal return policy, which could generate negative revenue and impact sales; (6) the dependence of ongoing licencing agreements, notably with Dow Jones, for future revenue; (7) the problems associated with recent growth, including various staffing issues and the potential for customer service problems; (8) the risk of competition, including the risk that low barriers to entry in the market could lead to future competition; (9) risks of defects in current or future products; and, not coincidentally (10) the risk of litigation. These risks are only a few of those outlined in great detail.

In addition to the information on risk outlined above, the Prospectus contained extensive discussion of the financial position of the company, the proposed use of proceeds from the sale of stock, and explicit disclosures regarding benefits that certain shareholders would receive as a result of the offering. See note 1, supra. These disclosures included a discussion of the "S corporation," distribution of earnings in relation to the relevant Internal Revenue Code provisions (See Prospectus at 15-16), and the explicit disclosure that the revenue generated by the sale would inure to the benefit of the existing shareholders. (See Prospectus 19.)

The public received information about Omega and the initial public offering from sources other than the Prospectus.² (See Am. Compl. ¶¶ 39-47.) Plaintiffs allege, for example, that officers of Omega made "roadshow" presentations, where they projected the image of a dynamic and successful corporation with prospects for increased future revenues and earnings. (Am. Compl. ¶¶ 39-43.) On October 27, 1997, Omega reported its third quarter financial results including earnings of $0.09 cents per share. (Am. Compl. ¶ 41.) Plaintiffs allege that on that same day, October 27, 1997, all three Underwriters — BancAmerica Robertson Stephens,³ Lehman Brothers, and Hambrecht & Quist — issued reports recommending that investors "buy" Omega Research stock, and predicting Omega would earn between $0.06 and $0.07 cents per share in each of the third and fourth quarters of fiscal year 1997. (Am. Compl. ¶ 40.)

Thus the Company appeared to have beaten earnings expectations by $0.02-0.03 cents per share. Thereafter, Plaintiffs allege, the Underwriter Defendants issued so-called "booster shot" reports. Although Plaintiffs reference but do not attach these reports, Underwriter Defendants allegedly predicted earnings between $0.07-$0.08 cents per share for the fourth quarter of fiscal year 1997, and provided generally positive assessments of Omega. (Am. Compl. ¶ 42.)

Plaintiffs infer that this series of predictions was materially misleading. They allege that starting on January 6, 1998, the Underwriter Defendants and Omega separately announced lower earnings estimates. Plaintiffs infer, although do not state explicitly,⁴ that these announcements somehow demonstrate the previous earnings estimates were "materially" misleading. In early January, 1998, Omega announced it expected to earn approximately $0.02 to $0.04 cents per share for the fourth quarter of 1997, and shortly thereafter each of the Underwriter Defendants issued earnings estimates that corresponded to these figures. (Am. Compl. ¶¶ 45-46.) Thus, between the third and fourth quarters of 1997, earnings appear to have dropped between $0.05-0.07 cents per share.

The initial public offer raised, in Plaintiffs' estimate, approximately $46 million. (Am. Compl. 2.) After trading above the initial $11 per share price, the stock price declined.⁵ Less than three weeks after the lowered-earnings announcements, Plaintiffs filed suit on January 28, 1998. On April 23, 1998, discovery was stayed pursuant to the automatic stay provisions of the Private Securities Litigation Reform Act of 1995, 15 U.S.C. § 772(b)(1). An Amended Complaint followed on June 1, 1998, claiming injury on behalf of all persons who purchased Omega stock from October 1, 1997, through January 6, 1998 (the "class period").

In the Amended Complaint, Plaintiffs allege the Prospectus is materially false and misleading because: (1) it does not disclose the trend of decline in market sales (Am. Compl. ¶¶ 14-15, 20-22) and does not disclose technical problems with the company's products (Am. Compl. ¶¶ 15-18, 23-31); (2) it does not disclose that the company's products are not "year 2000 complaint," (Am. Compl. ¶ 32); (3) it does not disclose product return problems (Am. Compl. ¶ 33); (4) it does not disclose product delays (Am. Compl. ¶ 34); (5) it inadequately discloses the Cruz brothers' stake in the offering (Am. Compl. ¶¶ 35-36); and (6) it unreasonably priced the stock during the initial public offering (Am. Compl. ¶ 37). In addition, Plaintiffs allege more broadly that the Prospectus inadequately discloses the risk involved in investing in these securities. (Am. Compl. ¶ 38.) Finally, Plaintiffs allege the "road show" and other reports produced by the Company and the Underwriters materially misled investors. (Am. Compl. ¶¶ 39-43.)

All Defendants now seek to dismiss the Amended Complaint in its entirety, arguing Plaintiffs have failed to state any claim upon which relief may be granted. Fed. R.Civ.P. 12(b)(6).

II. Standard of Review

In evaluating a motion to dismiss, a district court must view the complaint in the light most favorable to the plaintiff. Scheuer v. Rhodes, 416 U.S. 232, 94 S.Ct. 1683, 40 L.Ed.2d 90 (1974). A complaint may not be...