Source: s3://data.kl3m.ai/documents/govinfo/USCOURTS/USCOURTS-casd-3_05-cv-00823/USCOURTS-casd-3_05-cv-00823-4/pdf.json

Nature of Suit Code: 850
Nature of Suit: Securities, Commodities, Exchange
Cause of Action: 15:78m(a) Securities Exchange Act

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1

The two groups of investment partnerships are referred to as “TPG” and “LGP,” but

the Court refers to them (and their related entities and individuals) collectively as the

“Partnership Defendants.” These include: Texas Pacific Group, Inc., TPG Advisors III, TPG

Partners III, L.P., TPG Parallel III, L.P., TPG Dutch Parallel III, C.V., TPG Investors III, L.P.,

FOF Partners III, L.P., FOF Partners III-B, L.P., David Bonderman, Jonathan Coslet, James

Coulter, William Price, Leonard Green & Partners, L.P., Green Equity Investors III, L.P., John

Baumer, John Danhakl, Jonathan Sokoloff, and Peter Nolan. The LGP Defendants filed this

motion for clarification, and the TPG Defendants joined it. 

Baumer, Coslet, Danhakl, and Price had relationships both with their respective

investment partnerships and to the Petco corporation because they served on Petco’s Board of

Directors. The Court these four individuals dismissed without prejudice. [Docket Nos. 60 &

61]

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UNITED STATES DISTRICT COURT

SOUTHERN DISTRICT OF CALIFORNIA

In re PETCO ANIMAL SUPPLIES INC.

SECURITIES LITIGATION,

CASE NO. 05-CV-0823-H (RBB)

ORDER DENYING MOTION

FOR CLARIFICATION

[Docket Nos. 62 & 63]

On August 1, 2006, the Court denied in part and granted in part motions to dismiss

this class action securities case. [Docket No. 60] The Court sustained the Consolidated

Complaint as to Defendant Petco (and several officers) on one theory of fraud; however,

the Court dismissed the Partnership Defendants1

 for failure to plead sufficient facts to show

their involvement in the alleged fraud. The Court dismissed without prejudice and

permitted Lead Plaintiff until September 1, 2006 to file a First Amended Consolidated

Case 3:05-cv-00823-H-RBB Document 82 Filed 11/13/06 Page 1 of 7
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Complaint. The Partnership Defendants have now filed a motion to clarify that in the event

Lead Plaintiff choose not to amend the complaint within the time specified by the August

2006 Order, the dismissal will be with prejudice pursuant to the discovery stay of the

Private Securities Litigation Reform Act (“PSLRA”).

Initially, the Court ordered the motion submitted on the briefs. Civil Local Rule

7.1(d)(1). After further consideration, however, the Court convened a telephonic

conference on November 8, 2006 to discuss the legal issue. Dan Drosman, Esq. appeared

for Lead Plaintiff; Eric Waxman, Esq. appeared for the LGP Defendants; Tim Pestotnik,

Esq. appeared for the LGP Defendants; and Peter Benzian, Esq. appeared for the Petco

Defendants. Having carefully considered the arguments of both sides and for the reasons

stated below, the Court DENIES the motion for clarification.

I. Procedural History

Initially, several plaintiffs filed securities class actions against Petco Animal

Supplies, Inc. after its April 15, 2005 announcement that it had discovered an accounting

error relative to certain under-accrued expenses in its distribution operations. The parties

then stipulated to have the several actions consolidated and to select a Lead Plaintiff and

Lead Counsel. 

In October 2005, Lead Plaintiff filed a Consolidated Complaint against two

categories of defendants: first, the Petco corporation and certain executives and officers,

and second, the Partnership Defendants, who had once owned Petco. The Consolidated

Complaint alleged that the defendants had violated the federal securities laws by issuing

false and misleading statements and by engaging in insider trading at artificially-inflated

prices. The Class Period began on August 18, 2004.

In January and February 2006, all defendants filed motions to dismiss for failure to

state a claim for relief. Fed. R. Civ. P. 12(b)(6). Pursuant to the Private Securities

Litigation Reform Act, the filing of those motions to dismiss automatically stayed all

discovery pending resolution of the motion. 15 U.S.C. § 78u-4(b)(3)(B); Medhekar v.

Case 3:05-cv-00823-H-RBB Document 82 Filed 11/13/06 Page 2 of 7
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The stay of discovery provision states:

In any private action arising under this chapter, all discovery and other

proceedings shall be stayed during the pendency of any motion to dismiss,

unless the court finds upon the motion of any party that particularized discovery

is necessary to preserve evidence or to prevent undue prejudice to that party.

15 U.S.C. § 78u-4(b)(3)(B).

3

The Court denied the motion to dismiss as to the five Petco executives who were

alleged to have been involved. The Court granted the motion as to four other Petco executives

(Frederick Major, Keith Martin, Janet Mitchell, and William Woodard) because the facts did

not indicate their involvement in or knowledge of the alleged wrongdoing. 

As noted, four of the individual had overlapping duties to Petco and their respective

Partnerships, but the Court dismissed without prejudice the Consolidated Complaint as to all

outside directors.

Finally, the Court dismissed the allegations of fraud relative to its business strategy,

operational problems (including an inadequate distribution infrastructure, an ineffective

program to re-model the stores, and an error in accounting for tenant improvement allowances)

as to all named Defendants.

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United States Dist. Ct., 99 F.3d 325, 327 (9th Cir. 1996) (per curiam).2

The motions to dismiss were briefed and argued, and on August 1, 2006, the Court

issued its decision. The Court denied the motion by Petco and some of its executives as to

the allegations concerning an accounting impropriety, specifically, an alleged practice to

defer the recording of incurred distribution expenses in order to make quarterly earnings

goals.3

 The Court held that Lead Plaintiff had stated a claim, with factual allegations

sufficient to demonstrate a strong inference of scienter by some of the Petco Defendants. 

Those Petco Defendants have answered the Consolidated Complaint and the Magistrate

Judge has scheduled an Early Neutral Evaluation Conference for November 11, 2006. 

The Court, however, agreed with the Partnership Defendants that the Consolidated

Complaint failed to state a claim against them on either a theory of primary liability or as

control persons. The Partnership Defendants had owned and managed Petco from 2000 to

2002, at which time they became majority shareholders. By the time the Class Period 

began in August 2004; however, the Partnership Defendants had sold most of their shares. 

After October 2004, the Partnership Defendants did not own any Petco common stock,

though two individuals connected to the Partnerships continued to serve as outside

directors. The Court found no basis for holding a former majority shareholder liable for

corporate fraud. 

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The Court granted Lead Plaintiff leave to amend to attempt to cure the deficiencies,

and permitted it until September 1, 2006 to file such an amended complaint. That date has

now passed, and Lead Plaintiff has stated that it does not intend, at this time, to amend.

Lead Plaintiff has served subpoenas on the Partnership Defendants to produce

various documents. Lead Plaintiff is seeking the discovery against these former parties

under the rules that apply to non-parties.

The Partnership Defendants ask the Court to clarify its August 2006 Order to

dismiss them with prejudice now that Lead Plaintiff has chosen not to amend the complaint

within the time set by the Court.

II. Discussion

The Partnership Defendants contend that Lead Plaintiff is circumventing the

discovery stay by leaving them “in a state of limbo without the finality they deserve after

prevailing on their Motions to Dismiss.” LGP’s Br. at 3 (“If the Court were to permit

Plaintiffs to discover their way into a viable securities claim against the dismissed

defendants, the PSLRA discovery stay would become meaningless and the Congressional

intent of the statute vitiated[.]” (quoting In re American Online Time Warner, Inc. Sec. and

ERISA Litig., 2004 U.S. Dist. LEXIS 16017, at * 2 (S.D.N.Y. Aug. 11, 2004). They cite a

statement from a Ninth Circuit decision that the discovery stay in the PSLRA shows that

“Congress clearly intended that complaints in these securities actions should stand or fall

based on the actual knowledge of the plaintiffs rather than information produced by the

defendants after the action has been filed.” Medhekar, 99 F.3d at 326. The Partnership

Defendants argue that plaintiffs “should not be able to begin discovery while maintaining

that they have a right to later amend their complaint against the dismissed defendants.” 

LGP’s Br. at 5. They further reason “that having failed sufficiently to plead a claim against

[the Partnership Defendants], Plaintiffs are precluded by the PSLRA from seeking

discovery until they amend their Complaint and survive a further motion to dismiss.” 

LGP’s Reply Br. at 1. 

/ / / / /

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The Court denies the motion because there is no pending motion to dismiss, thus the

language of the discovery stay provision itself does not apply. See In re Lernout &

Hauspie Sec. Litig., 214 F. Supp. 2d 100, 104-09 (D. Mass. 2002) (when some but not all

defendants had filed motions to dismiss, the PSLRA did not require a discovery stay but

district court imposed restrictions on discovery pending resolution of that motion). The

PSLRA states that discovery is stayed while a motion to dismiss is pending. The decisions

in which courts have enforced this provision have involved situations in which the district

court had not yet resolved a first or second motion to dismiss, or where a party had asked

the district court to reconsider its ruling. E.g., In re Salomon Analyst AT&T Litig., 373 F.

Supp. 2d 252, 254-56 (S.D.N.Y. 2005) (defendants’ motion for reconsideration to consider

intervening Circuit authority that might compel district court to dismiss defendants was still

pending); Powers v. Eichen, 961 F. Supp. 233, 236 (S.D. Cal. 1997) (Battaglia, Magistrate

Judge) (defendants’ motion for reconsideration pending). Here, the Lead Plaintiff has

stated a securities law claim against Petco and various executives. The Consolidated

Complaint has been sustained as to the alleged accounting fraud, and the Lead Plaintiff is

now relieved of the PSLRA stay and may properly seek discovery to support its theory. 

But the Partnership Defendants further contend that the “spirit” of the discovery stay

will be violated unless the Court dismisses them with prejudice. They contend that the

Lead Plaintiff must choose to amend its complaint against the Partnership Defendants

based upon the information currently possessed or accept a dismissal with prejudice. The

Partnership Defendants refer to the legislative history of the PSLRA in which Congress

stated it wanted to protect potential targets of frivolous securities lawsuits from the expense

and burden of “fishing expeditions” by precluding discovery until a district court had

sustained the sufficiency of the allegations. See e.g., Medhekar, 99 F.3d at 328 (reviewing

legislative history). 

The Court has carefully considered the Partnership Defendants’ argument in this

regard but concludes that they are not entitled to the relief they seek. Controlling Ninth

Circuit authority instructs the district courts that “[d]ismissal with prejudice . . . is not

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appropriate unless it is clear . . . that the complaint could not be saved by amendment.” 

Eminence Capital, LLC v. Aspeon, Inc., 316 F.3d 1048, 1052 (9th Cir. 2003) (per curiam).

The Court has not reached that conclusion as to the Partnership Defendants thus the Court

cannot dismiss them with prejudice at this stage. 

As the Partnership Defendants note, the Lead Plaintiff is seeking discovery from

entities for which they have not stated a claim for relief, and this circumstance presents an

interesting legal issue. Yet it cannot be said that Lead Plaintiff is “circumventing” the

discovery stay. The Partnership Defendants, like any other as yet unknown potential

defendant, are protected by the discovery rules that limit the types of discovery that can be

pursued against a non-party. As noted, the Lead Plaintiff is issuing subpoenas to the

Partnership Defendants as non-parties under the procedures of Rule 45 of the Federal Rules

of Civil Procedure. In the event that Lead Plaintiff discovers evidence that would prompt it

to seek leave to amend its complaint to add further factual allegations against the

Partnership Defendants (or some other individual), it would be required to seek leave of

court within the time frame set by the scheduling order and explain why it had not done so

within the time set by the Court’s August 1, 2006 Order. Cf. Fed. R. Civ. P. 41(b)

(involuntary dismissal). That process is not unfairly prejudicial to the Partnership

Defendants. Cf. Eminence, 316 F.3d at 1052-53 (district court must explain reason to

dismiss complaint without leave to amend, and prejudice to defendant carries most weight). 

Conversely, if the Court were to dismiss the Partnerships with prejudice, it could lead to a

piecemeal appeal process or require a motion for relief from judgment. This scenario is

more cumbersome. Under either scenario, the Lead Plaintiff could continue to seek

discovery from the Partnership Defendants as non-parties. Thus, the effect on the

Partnership Defendants is the same. Cf. Med. Imaging Ctrs. of Am. v. Lichtenstein, 917 F.

Supp. 717, 720 (S.D. Cal. 1996). Having considered the competing interests in the current

posture of the case, the Court is not persuaded by the Partn ership Defendants’ argument

that the PSLRA entitles them to immediate dismissal with prejudice. Accordingly, the

Court denies their motion for clarification.

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CONCLUSION

Upon due consideration of the parties' memoranda and exhibits, a review of the

record, and for the reasons set forth above the Court DENIES the motion for clarification

filed by the LGP Defendants and joined by the TPG Defendants. [Docket Nos. 62 & 63]

IT IS SO ORDERED.

DATED: November 13, 2006

MARILYN L. HUFF, District Judge

UNITED STATES DISTRICT COURT

cc: all counsel of record

Case 3:05-cv-00823-H-RBB Document 82 Filed 11/13/06 Page 7 of 7