Rothman v. Gregor, Docket No. 00-7005

CourtU.S. Court of Appeals — Second Circuit
Writing for the CourtJON O. NEWMAN
Citation220 F.3d 81
Parties(2nd Cir. 2000) JOEL ROTHMAN, individually and on behalf of all others similarly situated; ISAAC AUGENSTEIN, on behalf of himself and all other similarly situated; RUEBEN ADVANI, individually and on behalf of all others similarly situated; WILLIAM KELLMAN, individually and on behalf of all other similarly situated; CATHY ANDERSON, on behalf of herself and all others similarly situated; PETER J. PROCE, individually and on behalf of all others similarly situated; JERRY HOEHNEN, individually and on behalf of all others similarly situated; BLAISE RODON, on behalf of himself and all other similarly situated; MOSHE MOSBACHER, on behalf of himself and all others similarly situated, Consolidated-Plaintiffs-Appellants, CHANI HERZOG, individually and on behalf of all others similarly situated, Plaintiff-Appellant, v. ANDREW GREGOR, Consolidated-Defendant-Appellee, GT INTERACTIVE SOFTWARE CORPORATION; RONALD CHAIMOWITZ; JOSEPH J. CAYRE; ARTHUR ANDERSEN, LLP, Defendants-Appellees
Docket NumberDocket No. 00-7005
Decision Date11 July 2000

Page 81

220 F.3d 81 (2nd Cir. 2000)
JOEL ROTHMAN, individually and on behalf of all others similarly situated; ISAAC AUGENSTEIN, on behalf of himself and all other similarly situated; RUEBEN ADVANI, individually and on behalf of all others similarly situated; WILLIAM KELLMAN, individually and on behalf of all other similarly situated; CATHY ANDERSON, on behalf of herself and all others similarly situated; PETER J. PROCE, individually and on behalf of all others similarly situated; JERRY HOEHNEN, individually and on behalf of all others similarly situated; BLAISE RODON, on behalf of himself and all other similarly situated; MOSHE MOSBACHER, on behalf of himself and all others similarly situated, Consolidated-Plaintiffs-Appellants,
CHANI HERZOG, individually and on behalf of all others similarly situated, Plaintiff-Appellant,
v.
ANDREW GREGOR, Consolidated-Defendant-Appellee,
GT INTERACTIVE SOFTWARE CORPORATION; RONALD CHAIMOWITZ; JOSEPH J. CAYRE; ARTHUR ANDERSEN, LLP, Defendants-Appellees.
Docket No. 00-7005
UNITED STATES COURT OF APPEALS FOR THE SECOND CIRCUIT
Argued June 8, 2000
Decided July 11, 2000

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Copyrighted Material Omitted

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Copyrighted Material Omitted

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Ira M. Press, New York, N.Y. (Jeffrey H. Squire, Andrea Bierstein, Kirby, McInerney & Squire, New York, N.Y.; Lionel Z. Glancy, Los Angeles, CA, on the brief) for plaintiffs-appellants.

Michael S. Oberman, New York, N.Y. (Alan R. Friedman, Andrew J. Maloney, Kramer Levin Naftalis & Frankel, New York, N.Y., on the brief), for defendants-appellees GT Interactive Software, Ronald Chaimowitz, Joseph Cayre and Andrew Gregor.

James J. Sabella, New York, N.Y. (James D. Zirin, Jennifer A. DeMarrais, Brown & Wood, New York, N.Y., on the brief), for defendant-appellee Arthur Andersen.

Before: OAKES, NEWMAN, and STRAUB, Circuit Judges.

JON O. NEWMAN, Circuit Judge.

This appeal concerns a securities fraud claim against a seller of computer software for misrepresenting its income by failing to expense royalty advances after it became clear that the capitalized value of these advances was significantly overstated. Joel Rothman, representing a plaintiff class, appeals from the December 6, 1999, judgment of the District Court of the Southern District of New York (David Edelstein, Judge), dismissing with prejudice plaintiffs' claims against Defendant-Appellees GT Interactive Software Corp. ("GT") and its officers, and Arthur Andersen LLP ("Anderson"). We conclude that the complaint meets the pleading requirements for a securities fraud action against GT and its officers. We also conclude that the District Court properly dismissed the claim against Andersen for failure to sufficiently plead scienter. We therefore affirm in part, reverse in part, and remand.

Background

The Second Amended Complaint ("Complaint") alleges or incorporates the following facts. GT, a Delaware corporation headquartered in New York, publishes and merchandises interactive entertainment, educational, and consumer software. Defendant-Appellee Ronald Chaimowitz is president, chief executive officer, and a director of GT. Defendant-Appellee Joseph J. Cayre is chairman of the board of directors of GT. Defendant-Appellee Andrew Gregor is vice-president of finance and chief financial officer of GT. Defendant-Appellee Andersen, an international accounting and consulting firm, has been GT's outside auditor since some time prior to December 1995. Plaintiff-Appellants represent a class of persons who purchased GT securities from December 15, 1995, through December 12, 1997 (the "GT Class Period"), and from February 4, 1996, through December 12, 1997 (the "Andersen Class Period").

GT commenced its operations in 1993. During the GT Class Period, GT developed many software titles each year by contracting with small, independent software developers and underwriting their development costs in large part by paying them the royalty payments they expected to earn in advance of any sales. For "front-line" software titles, GT advanced on average $ 750,000 to $ 1 million in royalties per title and paid $ 4-5 million to well-known developers. In its agreements with some

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software developers, GT defined the term "front-line" as a "'computer program so technically and aesthetically advanced that it can be marketed and sold to end users in the price range for new releases in its class.'" GT claimed to have released five front-line titles in 1994, twenty-four in 1995, and 67 in 1996. Under generally accepted accounting principles ("GAAP") concerning royalty prepayments, all costs incurred to "'establish technological feasibility of a computer software product to be sold, leased or otherwise marketed are search and development costs,'" and therefore "should be charged to expenses when incurred." GT's accounting policy for royalty advances during the relevant period, however, provided:

Royalty advances represent the unamortized elements of prepayments to third party licensors of software products for the right to manufacture and/or distribute their products under various licensing agreements. Such advances are amortized to cost of goods sold in accordance with the individual agreements.

Date Capitalized
                EarningsSEC Filing Royalty
                AnnouncedDate Advances Net Income
                1996
                quarter 1 4/30/96 5/14/96 $ 21,280,000$ 5,100,000
                quarter 2 8/1/96 8/14/96 $ 29,577,000$ 2,140,000
                quarter 3 11/4/9611/14/96 $ 57,357,000$ 3,757,000
                quarter 4 2/10/97 3/31/97 $ 69,202,000$ 4,393,000
                
1997
                quarter 1 5/5/97 5/15/97 $ 70,344,000$ 4,554,000
                quarter 2 8/7/97 8/14/97 $ 83,591,000$ 4,469,000
                quarter 3 11/3/9711/14/97 $ 87,542,000$ 8,526,000
                

Future realization of royalty advances is assessed quarterly by management and charged to expense if it is not likely that the amounts will be recovered through sales of the related product.

The Complaint states that until January 1, 1998, GT accounted for most of the royalty advances as assets in its financial disclosure statements, even though, the Complaint continues, the "great majority" of software titles for which GT advanced royalties during the Class Period "either failed commercially or underperformed expectations in the marketplace." This was done, the Complaint alleges, in order to artificially inflate GT's reported earnings throughout the Class Period.

To support this general allegation, the Complaint states or incorporates by reference several categories of information and specific allegations, including the following.

(a) Financial Statements. The Complaint sets forth the following summary of GT's financial statements in its SEC filings:

GT spent $ 27.8 million on royalty advances in the first nine months of 1996, and $ 18.3 million in the first nine months of 1997.

(b) Sales. According to domestic sales figures for all of GT's software titles released during the GT Class Period, as reported by PC Data, a market research firm, 64 percent of GT's products realized less than $ 250,000 in sales during the two year period covering calender years 1996 and 1997. From 1995 through 1996, between 56 and sixty-seven percent of GT's titles realized less than $ 100,000 in sales. Most of GT's sales of a software product are realized during the first year that the product was commercially available. The Complaint provides the names and sales figures for several front-line titles released

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between November 1995 and March 1997 that GT allegedly failed to "write down to net realizable value on a timely basis."

According to GT's 1996 Form 10K, GT's annual net sales amounted to $ 234,461 in 1995 and to $ 365,490 in 1996. A September 13, 1997, report by an analyst at Oppenheimer & Co. calculated that, because of GT's operating and sales costs, GT needed to realize nearly $ 4 in sales to recoup every $ 1 of the royalties it prepaid.

(c) Stock Transactions. In December 1995, GT made an initial public offering ("IPO") of 10 million shares, including 5.5 million that the company offered and 4.5 million that the selling stockholders tendered, at $ 14 per share, from which it realized $ 71,885,000. GT's prospectus, dated December 14, 1995, reported that as of December 6, 1995, Defendant-Appellee Cayre beneficially owned 16,094,907 shares of GT common stock, and Defendant-Appellee Chaimowitz beneficially owned 804,582 shares of GT common stock. In connection with the IPO, Cayre sold 1,494,720 of those shares at $ 14 per share for approximately $ 20,000,000. During the Class Periods, Chaimowitz sold at least 70,000 of his shares for an aggregate value of $ 1,615,000. In February 1997, Chaimowitz purchased 6,000 shares of GT stock.

In June and July 1996, GT used its stock to acquire three companies: FormGen Corp. for 1,030,000 GT shares, Wizard Works Group for 2,350,000 GT shares, and Humongous Entertainment, Inc. for 3,458,000 GT shares. During October 1997, GT acquired SingleTrac Entertainment Tech for $ 5.4 million in cash and 700,000 shares of stock valued at $ 7.2 million, for a total value of $ 12.6 million.

(d) Lawsuits. On November 28, 1995, GT entered into an agreement with Scavenger, Inc. to develop four software games, and advanced $ 2.5 million in royalties to Scavenger. In September 1997, Scavenger filed a breach of contract suit in New York Supreme Court, claiming that GT had deliberately withheld further payments in December 1996 and, as a result, Scavenger had ceased business operations in January 1997. In what the Appellants refer to as GT's cross-complaint, GT claimed that Scavenger had breached the contract in 1996, and that GT subsequently terminated the agreement in March 1997, because Scavenger never delivered two of the games and the two games it did deliver did not satisfy the requirements of the agreement.

On December 4, 1997, GT filed suit against Smith Engineering, a software developer, for breach of contract. GT alleged that notwithstanding royalty advances from GT totaling $ 645,000 over two and a half...

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  • In re Cardinal Health Inc. Securities Litigations, No. C2-04-575.
    • United States
    • U.S. District Court — Southern District of Ohio
    • April 12, 2006
    ..."the portion of stockholdings sold," "the change in volume of insider sales," "and the number of insiders selling." See Rothman v. Gregor, 220 F.3d 81, 94 (2d Cir.2000) (citing Oxford Health Plans, 187 F.R.D. 133, 140 (S.D.N.Y.1999)) ($78 million profit from sale of 1.2 million shares durin......
  • In re Worldcom, Inc. Securities Litigation, No. 02 Civ. 3288(DLC).
    • United States
    • United States District Courts. 2nd Circuit. United States District Courts. 2nd Circuit. Southern District of New York
    • May 19, 2003
    ...SEC, and documents that the plaintiffs either possessed or knew about and upon which they relied in bringing the suit. Rothman v. Gregor, 220 F.3d 81, 88 (2d Cir.2000) (citations omitted); Cortec Indus., Inc. v. Sum Holding L.P., 949 F.2d 42, 47-48 (2d Cir.1991). The court need not credit g......
  • In re Weight Watchers Int'l Inc., 19cv2005
    • United States
    • United States District Courts. 2nd Circuit. United States District Courts. 2nd Circuit. Southern District of New York
    • November 30, 2020
    ...214.) "Insider sales have been found unusual based on a variety of factors, including the amount of profit from sales." Rothman v. Gregor, 220 F.3d 81, 94 (2d Cir. 2000).Courts in the Second Circuit have found that stock sales are not indicative of scienter when they are more than two month......
  • Renco Grp., Inc. v. Wilmington Trust, Nat'l Ass'n (In re Magnesium Corp. of Am.), Case No. 01–14312 (MKV) (Jointly Administered)
    • United States
    • United States Bankruptcy Courts. Second Circuit. U.S. Bankruptcy Court — Southern District of New York
    • March 30, 2018
    ...of which judicial notice may be taken. See Grant v. County of Erie , 542 Fed. Appx. 21, 23 (2d Cir. 2013) (citing Rothman v. Gregor , 220 F.3d 81, 88 (2d Cir. 2000) ). "A document is integral to the complaint ‘where the complaint relies heavily upon its terms and effect.’ " Goel v. Bunge, L......
  • Request a trial to view additional results
1111 cases
  • In re Cardinal Health Inc. Securities Litigations, No. C2-04-575.
    • United States
    • U.S. District Court — Southern District of Ohio
    • April 12, 2006
    ..."the portion of stockholdings sold," "the change in volume of insider sales," "and the number of insiders selling." See Rothman v. Gregor, 220 F.3d 81, 94 (2d Cir.2000) (citing Oxford Health Plans, 187 F.R.D. 133, 140 (S.D.N.Y.1999)) ($78 million profit from sale of 1.2 million shares durin......
  • In re Worldcom, Inc. Securities Litigation, No. 02 Civ. 3288(DLC).
    • United States
    • United States District Courts. 2nd Circuit. United States District Courts. 2nd Circuit. Southern District of New York
    • May 19, 2003
    ...SEC, and documents that the plaintiffs either possessed or knew about and upon which they relied in bringing the suit. Rothman v. Gregor, 220 F.3d 81, 88 (2d Cir.2000) (citations omitted); Cortec Indus., Inc. v. Sum Holding L.P., 949 F.2d 42, 47-48 (2d Cir.1991). The court need not credit g......
  • In re Weight Watchers Int'l Inc., 19cv2005
    • United States
    • United States District Courts. 2nd Circuit. United States District Courts. 2nd Circuit. Southern District of New York
    • November 30, 2020
    ...214.) "Insider sales have been found unusual based on a variety of factors, including the amount of profit from sales." Rothman v. Gregor, 220 F.3d 81, 94 (2d Cir. 2000).Courts in the Second Circuit have found that stock sales are not indicative of scienter when they are more than two month......
  • Renco Grp., Inc. v. Wilmington Trust, Nat'l Ass'n (In re Magnesium Corp. of Am.), Case No. 01–14312 (MKV) (Jointly Administered)
    • United States
    • United States Bankruptcy Courts. Second Circuit. U.S. Bankruptcy Court — Southern District of New York
    • March 30, 2018
    ...of which judicial notice may be taken. See Grant v. County of Erie , 542 Fed. Appx. 21, 23 (2d Cir. 2013) (citing Rothman v. Gregor , 220 F.3d 81, 88 (2d Cir. 2000) ). "A document is integral to the complaint ‘where the complaint relies heavily upon its terms and effect.’ " Goel v. Bunge, L......
  • Request a trial to view additional results
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