Rombach v. Chang

• Decision Date: 20 January 2004
• Docket Number: Docket No. 02-7907(L).,Docket No. 02-7933(XAP).
• Citation: 355 F.3d 164
• Parties: Myrna ROMBACH, on behalf of herself and all others similarly situated, Kevin Burdick, Jay Brosz, Eugene Bell, Dennis Bryan, Kenneth Hall, and Golfway Developments (Thunder Bay) Inc., on behalf of themselves and all others similarly situated, Plaintiffs-Appellants-Cross-Appellees, v. Dominic CHANG, Krishnan P. Thampi, Jeffrey C. Key, and Prudential Securities, Inc., Defendants-Appellees, Jeffries & Co., Defendant-Appellee-Cross-Appellant.
• Court: U.S. Court of Appeals — Second Circuit

355 F.3d 164

Myrna ROMBACH, on behalf of herself and all others similarly situated, Kevin Burdick, Jay Brosz, Eugene Bell, Dennis Bryan, Kenneth Hall, and Golfway Developments (Thunder Bay) Inc., on behalf of themselves and all others similarly situated, Plaintiffs-Appellants-Cross-Appellees, v. Dominic CHANG, Krishnan P. Thampi, Jeffrey C. Key, and Prudential Securities, Inc., Defendants-Appellees Jeffries & Co., Defendant-Appellee-Cross-Appellant.

Docket No. 02-7907(L).

Docket No. 02-7933(XAP).

United States Court of Appeals, Second Circuit.

Argued: January 30, 2003.

Decided: January 20, 2004.

Appeal from the United States District Court for the Eastern District of New York, Sterling Johnson, Jr., J.

COPYRIGHT MATERIAL OMITTED

Ralph M. Stone, Shalov Stone & Bonner LLP, New York, NY (John F. Carroll, Jr. on brief), for Plaintiffs-Appellants-Cross-Appellees.

Clifford Thau, Vinson & Elkins, LLP, New York, NY, for Defendants-Appellees.

Lisa Klein Wager, Morgan, Lewis & Bockius LLP, New York, NY (Adrienne M. Ward, on brief), for Defendant-Appellee-Cross-Appellant.

Before: JACOBS, CALABRESI, SOTOMAYOR, Circuit Judges.

JACOBS, Circuit Judge.

This putative securities class action is brought by investors who purchased stock in Family Golf Centers, Inc. ("Family Golf"), a now-bankrupt company that was in the business of acquiring and operating golf courses. Defendants were certain officers of the company and the underwriters of a secondary offering that was used in part to finance the acquisitions. Plaintiffs appeal from a judgment entered in the United Stated District Court for the Eastern District of New York (Johnson, J.) on July 31, 2002, dismissing their action with prejudice for failure to state a claim under Fed.R.Civ.P. 12(b)(6), failure to plead fraud with sufficient particularity under Fed.R.Civ.P. 9(b), and failure to state a claim under the Private Securities Litigation Reform Act of 1995 ("PSLRA"), 15 U.S.C. § 78u-4 (2000).

This appeal presents an issue of first impression in this Circuit: whether the heightened pleading standard of Rule 9(b) of the Federal Rules of Civil Procedure applies to claims brought under Section 11 and Section 12(a)(2) of the Securities Act. We conclude that Rule 9(b) applies when the claim sounds in fraud.

BACKGROUND

Family Golf, a publicly traded company since 1994, was a leading consolidator of golf centers; in 1998, it operated 119 golf facilities nationwide. Defendant Dominic Chang was chief executive officer, chairman of the board, and the largest stockholder; defendant Krishnan Thampi was president, chief operating officer, assistant secretary, treasurer, and a director; and defendant Jeffrey Key was chief financial officer (collectively, the "individual defendants").

By 1998, the company adopted a growth strategy of acquiring large golf course operators with multiple locations. Three such acquisitions were made that year: MetroGolf in January; Eagle Quest in June; and Golden Bear in July. In connection with the financing of these acquisitions, Family Golf conducted a secondary public offering on July 23, 1998. Defendants Jeffries & Company, Inc. and Prudential Securities, Inc. (collectively, the "underwriters") were underwriters and managers of the secondary offering. In the course of these transactions, Family Golf and its underwriters made several optimistic public statements that claimed success in the integration of newly-acquired facilities.

In February and March 1999, Family Golf announced lower than expected earnings and revenue for the fourth quarter of 1998, and its stock price soon plummeted by more than 43 percent. On August 12, 1999, it announced a net loss of six cents per share for the second quarter of 1999, and disclosed that it was in default on a number of financial obligations. The company filed for bankruptcy protection on May 4, 2000.

The plaintiffs purchased or otherwise acquired shares of Family Golf between May 12, 1998 and August 12, 1999 (the "Class Period"); a subclass purchased Family Golf stock in the secondary public offering. The initial complaint was filed in the Eastern District of New York on February 16, 2000, and a Consolidated Amended Class Action Complaint was filed on July 17, 2000.¹ It is alleged that the company's finances had begun deteriorating months before the announcement of bad news and while the company and its underwriters were exuding confidence about its growth; that by September 1998, Family Golf was in a "liquidity crisis" that prevented it from making timely payments to vendors, insurers, and landlords; that the liquidity crisis "had the effect of systematically overstating [Family Golf's] publicly reported income"; and that the individual defendants and underwriters made several misrepresentations and omissions about Family Golf's financial performance and projected income to the effect that the newly-acquired golf facilities would be profitable even though they knew — or recklessly disregarded — that the company was having serious trouble digesting its large new acquisitions.

The complaint focuses most specifically on the following communications: (1) press releases indicating that integration of the new acquisitions was progressing smoothly; (2) a slide (entitled "Facility Economics Comparison") that was used in connection with the secondary offering; (3) analysts' reports (based on information provided by defendants) also noting that integration of the new acquisitions was progressing smoothly; and (4) the registration statement and prospectus for the secondary offering.

Plaintiffs undertake to plead five claims:

(1) That all defendants violated Section 11 of the Securities Act of 1933 ("Securities Act"), 15 U.S.C. § 77k (2000), by disseminating a registration statement for the secondary public offering that contained false and misleading statements and failed to state material facts;²

(2) That the underwriters violated Section 12(a)(2) of the Securities Act, 15 U.S.C. § 77l(a)(2), by soliciting the sale of shares in the secondary public offering based on a prospectus that contained false and misleading statements and failed to state material facts;³

(3) That the individual defendants were "control person[s] at Family Golf by virtue of their positions as directors and/or senior officers," and violated Section 15 of the Securities Act, 15 U.S.C. § 77o, by "having signed the Registration Statement and having otherwise participated in the process which allowed the Offering to be successfully completed";

(4) That the individual defendants violated Section 10(b) of the Exchange Act of 1934 ("Exchange Act"), 15 U.S.C. § 78j(b) (2000), and Rule 10b-5 promulgated thereunder, 17 C.F.R. § 240.10b-5, by "engag[ing] in a plan, scheme and course of conduct, pursuant to which they knowingly and/or recklessly engaged in acts, transactions, practices, and courses of business which operated as a fraud upon plaintiffs and other members of the Class";⁴ and

(5) That the individual defendants are "secondarily liable" as "controlling persons of the Company," pursuant to Section 20(a) of the Exchange Act, 15 U.S.C. § 78t(a), for the violation of Section 10(b).

Defendants moved to dismiss the complaint for failure to state a claim under Fed.R.Civ.P. 12(b)(6), failure to plead fraud with sufficient particularity under Fed.R.Civ.P. 9(b), and failure to state a claim under the PSLRA. The district court (Johnson, J.) granted defendants' motions and dismissed the complaint in its entirety with prejudice.

With regard to the claims against the individual defendants, the court ruled: that plaintiffs "fail to plead fraud with particularity on their § 10(b) and Section 11 claims" because their allegations "do not sufficiently explain how any of the statements attributed to Defendants are false or misleading," Rombach v. Chang, No. 00-CV-0958, 2002 WL 1396986, at *4, *7, 2002 U.S. Dist. LEXIS 15754, at *11-*12, *19 (E.D.N.Y. June 7, 2002); that plaintiffs failed to plead scienter, as required by the PSLRA, id. at *9, 2002 U.S. Dist. LEXIS 15754, at *23; and that as a consequence of those rulings, the "control person" claims pleaded under Section 15 and Section 20(a) — which are predicated on a primary violation of securities law — also fall, id. at *10, 2002 U.S. Dist. LEXIS 15754, at *29-*30.

The court dismissed all claims against the underwriters on the ground that because their "optimistic remarks about [Family Golf's] acquisition of the new facilities" included "substantial cautionary language and specific risk factors," id. at *13, 2002 U.S. Dist. LEXIS 15754, at *37, the statements were "protected by traditional `bespeaks caution' doctrine and the safe harbor provided by the PSLRA," and that therefore the "allegations fail to show that any material statements or omissions attributed to Defendants were, in fact, misleading or false." Id.

Plaintiffs filed a timely notice of appeal to this Court. Defendant Jeffries & Company cross-appealed on the ground that the district court failed to make the Rule 11 findings required by the PSLRA, see 15 U.S.C. § 78u-4(c)(1), and that the district court erred in finding that the claims against the underwriters were not time-barred.

DISCUSSION

This Court "review[s] de novo a district court's dismissal of a complaint pursuant to Rule 12(b)(6), accepting all factual allegations in the complaint as true and drawing all reasonable inferences in the plaintiffs' favor." Ganino v. Citizens Utilities Co., 228 F.3d 154, 161 (2d Cir.2000). "We uphold a dismissal only if it appears beyond doubt that the plaintiff can prove no set of facts in support of his claim which would entitle him to relief." Id. (citation and internal quotation marks omitted). Consideration is limited to the facts alleged in the complaint and any documents attached to the complaint or incorporated by reference. See Kramer v. Time Warner Inc., 937 F.2d 767, 773 (2d Cir.1991).

I

The district court concluded, as to...