Vosgerichian v. Commodore Intern.

• Decision Date: 21 September 1994
• Docket Number: Civ. A. No. 92-4867.
• Citation: 862 F. Supp. 1371
• Parties: Glen VOSGERICHIAN, on behalf of himself and all others similarly situated, v. COMMODORE INTERNATIONAL, Irving Gould, Medhi R. Ali, Ronald B. Alexander and Arthur Andersen & Co.
• Court: U.S. District Court — Eastern District of Pennsylvania

862 F. Supp. 1371

Glen VOSGERICHIAN, on behalf of himself and all others similarly situated, v. COMMODORE INTERNATIONAL, Irving Gould, Medhi R. Ali, Ronald B. Alexander and Arthur Andersen & Co.

Civ. A. No. 92-4867.

United States District Court, E.D. Pennsylvania.

September 21, 1994.

John F. Innelli, Michael J. Molder, Philadelphia, PA, for plaintiff.

Bennett G. Picker, Ellen Rosen Rogoff, Philadelphia, PA, Fredric W. Yerman, Phillip A. Geraci, Andrew J. Melnick, New York City, for Commodore defendants.

Arthur Makadon, Mark S. Stewart, Laurie Martin, Philadelphia, PA, for Arthur Andersen & Co.

MEMORANDUM

DITTER, District Judge.

In this case, plaintiff alleged that defendants violated sections 10(b) and 20(a) of the Securities and Exchange Act of 1934, 15 U.S.C. §§ 78j(b), 78t(a) (1981), and Securities and Exchange Commission Rule 10b-5, 17 C.F.R. § 240.10b-5 (1988). Commodore International along with the individual defendants (together, "the Commodore defendants") and Arthur Andersen & Co. ("AA") each filed a motion to dismiss the complaint for failure to state a claim pursuant to Federal Rule of Civil Procedure 12(b)(6). The Commodore defendants submitted an appendix of exhibits with their motion.

I concluded that because the Commodore defendants had submitted material extraneous to the pleadings and because plaintiff had had "a reasonable opportunity to present pertinent material" himself, defendants' motions should be treated as motions for summary judgment.¹ I entered summary judgment in favor of AA and partial summary judgment in favor of the Commodore defendants. I did not, however, give plaintiff prior notice of my intention to treat the motions to dismiss as motions for summary judgment, 832 F.Supp. 909.

Plaintiff filed a motion for reconsideration, arguing that I erred in converting defendants' motions to dismiss into motions for summary judgment without providing plaintiff the requisite notice and opportunity for discovery. Plaintiff asks that I vacate my prior order and deny defendants' motions to dismiss.

FACTS.

Commodore manufactured personal computers and other high technology products. Through the 1980s Commodore prospered, but in 1989, the company's sales began to fall off and net income decreased sharply, particularly in Europe. Plaintiff charges that the Commodore defendants, with the help of their auditor, Andersen, intentionally misled shareholders about the company's financial health. Plaintiff and the other shareholders who purchased Commodore stock between July 1, 1990, and August 19, 1992, were allegedly damaged as a result of having relied on defendants' misrepresentations. Plaintiff specifically alleges the following:

A. THE GAAP VIOLATIONS

1. The Litigation Settlement

The first element of defendants' alleged course of fraud involved Commodore's financial reporting practices. In 1991, Commodore settled a lawsuit with its former president for $9.2 million. In its FY91 third-quarter financial statement, Commodore termed this settlement an "extraordinary item." Because generally accepted accounting principles ("GAAP") reserve the term "extraordinary item" for expenses more unusual than litigation, plaintiff charges that the Commodore defendants, with Andersen's acquiescence, knowingly violated GAAP. Moreover, Andersen, by issuing a "clean" or unqualified opinion for Commodore's statement, allegedly violated generally accepted auditing standards ("GAAS") as well.²

In addition, the Commodore defendants are charged with fraud due to their use of the "extraordinary item" in two different ways. In the third-quarter of FY91, Commodore reported its net income as $10.6 million "before extraordinary item," making its income seem higher than the $1.4 million it actually was after payment of the settlement. The next year, however, in comparing its current income to the prior year's, Commodore called the FY91 third-quarter income "$1.4 million ... after extraordinary charge," which, plaintiff contends, was intended to make the actual drop in net income from FY91 to FY92 seem smaller.

2. The Undisclosed Obligation to Prudential

Second, plaintiff alleges that Commodore failed to disclose in its financial statements an obligation, allegedly incurred in 1987, to buy back warrants for stock it had conveyed to Prudential Insurance Company in 1987, in connection with a $60 million loan. Commodore does not dispute that this obligation was never disclosed; rather, it maintains it never had such an obligation.

Moreover, Commodore concedes that in 1989, and 1991, when it did buy back portions of these warrants, it reported these re-purchases in its financial statements as equity transactions. Arthur Andersen does not dispute that it "advised or concurred" with Commodore's decision to do so.

B. CDTV

Plaintiff's second charge in the Commodore defendants' course of fraudulent conduct is that these defendants misrepresented their expectations for CDTV, a new interactive compact disc television system for the home. Plaintiff charges that defendants promised that the product would do far more than it did.

In Commodore's first CDTV press release on April 3, 1991, it introduced its "revolutionary consumer electronics component." Commodore stated that, "During the introductory phase, 50 CDTV multimedia titles will be available, with more than a hundred planned." (Appendix, CDTV Press Release). Also in that release, Nolan Bushnell, general manager of Commodore's Interactive Consumer Products Division, stated:

We believe the CDTV player and interactive multimedia will be to the 1990s what VCRs and videos were to the 1980s. The CDTV system will make our education entertaining and our entertainment educational. If we can change the world through information, then this is the product to do it.

Later that month, Commodore's chairman, Irving Gould, stated: "Commodore's range of products is now being enhanced with the launch of CDTV, an innovative multi-media product which represents a major potential opportunity in the consumer market." (Appendix, FY91 3Q PR and Report.)

At the end of that year, the company's 1991 annual report announced:

CDTV was received with great enthusiasm by industry analysts and retailers. The Electronic Industries Association named it one of the most innovative consumer electronics products of 1991. Popular Science named CDTV one of 1990's "Best of What's New" products for the home.

It continued, "Commodore and other third party developers introduced more than 50 CDTV titles with 100 planned to be available by Christmas 1991," and concluded:

Commodore plans to offer a wide range of CDTV accessory products in fiscal 1992, including keyboard, genlock, and storage and networking devices. In addition, Commodore plans to introduce a new video card that will substantially enhance the color capability of CDTV to over 4 million colors.

Finally, in its 1991 Financial Review, Commodore stated plainly that: "The CDTV, the first CD based interactive multimedia player for consumers, was launched in the fourth quarter of fiscal 1991 and accounted for only a nominal share of sales." (Appendix, 1991 Report.)

Commodore does not contest that CDTV sold slowly. In the spring of 1992, just after the Christmas season, the company cut CDTV's suggested retail price by 20 percent.

C. RELIANCE ON THE SHRINKING EUROPEAN MARKET

The final element of Commodore's alleged fraud is its failure to disclose the extent of the European recession's impact on Commodore's growth in Europe. Commodore concedes it relied heavily on the European computer market. It also concedes that the demand for personal computers in Europe dropped sharply in 1990 and 1991. Plaintiff concedes that the recession was widely recognized and that defendants had no duty to report on Europe's economy in greater detail. What was fraudulent, plaintiff charges, was Commodore's failure to disclose how this recession had actually affected growth, reporting instead that declining revenues were due to "currency fluctuations" and a "weak global economic environment." In particular, plaintiff charges that Commodore's reports of "continuing sales growth of European operations" and its "sustained growth ... despite the significant unfavorable effect of foreign exchange rates" were false. Plaintiff claims it is now evident that the company's high sales volume was due not to continued growth but to Commodore's aggressive price cutting strategy.

DISCUSSION.

A. THE CONVERSION OF MOTIONS TO DISMISS INTO MOTIONS FOR SUMMARY JUDGMENT WAS ERRONEOUS.

The Third Circuit has specifically held that "litigants are entitled to 10 days notice before a Rule 12(b)(6) motion to dismiss may be converted into a Rule 56 motion for summary judgment." Crown Central Petroleum v. Waldman, 634 F.2d 127, 129 (3d Cir.1980). I did not give plaintiff any notice that I intended to rule on defendants' motions to dismiss as motions for summary judgment; therefore, the conversion was improper.

B. PLAINTIFF'S CLAIMS MUST NONETHELESS BE DISMISSED.

1. Consideration of the documents in the appendix was proper in ruling on a motion to dismiss.

Generally, in ruling on a motion to dismiss, a court "may not consider any material other than the pleadings." 2A James W. Moore et al., Moore's Federal Practice ¶ 12.072.-5, at 12-89 (2d ed. 1994). If the court does consider extraneous material, Rule 12(b) requires that the motion to dismiss be converted into a motion for summary judgment and that all parties be given a "reasonable opportunity to present all material made pertinent to such a motion by Rule 56." Fed.R.Civ.Pro. 12(b).

"Material which is submitted as part of the complaint, as well as certain items in the record and the public record," however, may be consulted in deciding a motion to dismiss without treating the motion as one for summary judgment. Pension Benefit Guaranty Corp. v. White Consolidated Industries, 998 F.2d 1192, 1196 (3d Cir.1993); 2A James W. Moore et...