Source: https://casetext.com/case/tuchman-v-dsc-communications-corp
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Tuchman v. DSC Communications Corp., 14 F.3d 1061 | Casetext Search + Citator
Tuchman v. DSC Communications Corp.
Sec. & Exch. Comm'n v. Blackburn
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17 C.F.R. § 240.10b-5. To state a claim for securities fraud in violation of section 10(b) and Rule 10b-5, a…
Full title:BRUCE H. TUCHMAN, ON BEHALF OF HIMSELF AND ALL OTHERS SIMILARLY SITUATED…
Date published: Feb 25, 1994
14 F.3d 1061 (5th Cir. 1994)
holding that motive to inflate stock price and value of defendants investments was insufficient to establish scienter under Rule 9(b)
Summary of this case from Flaherty & Crumrine Preferred Income Fund, Inc. v. TXU Corp.
W.D. Masterson, III, Kilgore Kilgore, Inc., Dallas, TX, Samuel P. Spore, Miles M. Tepper, Schoengold Sporn, New York City, for plaintiffs-appellants.
E. Russell Nunnally, Sally Christine Helppie, Johnson Gibbs, Dallas, TX, Michael J. Chepiga, Nancy Mallory, Peter J. Beshar, Simpson, Thacher Bartlett, New York City, for defendants-appellees.
Before GOLDBERG and JOLLY, Circuit Judges.
Judge Barksdale heard oral argument in this case, but disqualified himself before the decision was entered. Accordingly, this case is decided by a quorum. See 28 U.S.C. § 46(d).
In this appeal, we must determine whether the district court properly dismissed the appellants' securities fraud claims against DSC Communications Corporation ("DSC") and several other individual defendants. The district court dismissed the appellants' claims without prejudice. 818 F. Supp. 971. The court first held that the appellants' federal securities fraud claims failed to state a claim upon which relief could be granted because the complaint did not adequately allege scienter. The court also concluded that the appellants failed to plead their federal securities fraud claims with sufficient particularity. Having dismissed the federal claims, the district court then denied a pending motion for class certification as moot and declined to exercise jurisdiction over the supplemental state law claims. After a careful review of the complaint, we affirm the judgment of the district court.
On July 11, 1991, only one day after Perpiglia completed his testimony before Congress, appellant Bruce Tuchman filed a class action securities fraud complaint against DSC and several individual defendants. Tuchman sought to represent the class of all shareholders who purchased DSC stock between February 7, 1991 — the date of DSC's 1990 Annual Report — and July 9, 1991. Several other strikingly similar complaints were filed within the next few days. These suits were consolidated with Tuchman's suit. A consolidated class action complaint was then filed, amending the appellants' previous complaints and extending the class period to October 30, 1991 — the day before DSC announced its third quarter results for 1991. The consolidated complaint alleged that the defendants violated § 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b), and Rule 10b-5 promulgated thereunder, 17 C.F.R. § 240.10b-5. This complaint also raised state common law fraud and negligent misrepresentation claims.
The individual defendants are James L. Donald, chairman of the board, chief executive officer, and president of DSC; Gunnar J. Korpinen, senior vice president of DSC's Technology Group until May of 1991; Frank F. Perpiglia, DSC's vice president of corporate planning until May of 1991 when he assumed many of Korpinen's duties; David M. Holland, DSC's senior vice president for North American sales and marketing; Gerald F. Montry, DSC's senior vice president and chief financial officer; and Kenneth R. Vines, DSC's vice president and controller.
DSC announced losses of $25.7 million on revenues of $116.9 million for the second quarter of 1991 and losses of $78.8 million on revenues of $97.6 million for the third quarter of 1991.
15 U.S.C. § 78j(b). Rule 10b-5 provides, in pertinent part, as follows:
The consolidated complaint, despite its length, is not a model of specificity. Pleaded almost entirely on information and belief, it states that the defendants made "proud and optimistic portrayal[s] of DSC's current and projected business, marketing, technological and financial achievements" despite the fact that DSC was "badly lagging behind its competitors in terms of new product development, product quality, cost containment, and product sales." The plaintiffs charge that the defendants thus contrived a "scheme to foster the illusion that DSC was in the forefront of the industry in terms of product quality and innovation, had the ability to meet the demands of its customers in the rapidly changing technological environment, would continue to attract business, generate substantial revenues and positive earnings, would at least maintain, if not increase, gross profit margins, and would be able to attract sufficient financing to maintain and develop a competitive product line."
To carry out this alleged scheme, the plaintiffs claim that the defendants portrayed DSC to the public as "an industry leader in research and development, product innovation, manufacturing and marketing of sophisticated telecommunications switching equipment and systems of the highest quality, efficiency, and reliability, and as enjoying wide and growing customer acceptance of and satisfaction with its products." The plaintiffs also assert that the defendants depicted DSC "as being financially sound, having substantial assets (including inventory and receivables), and expecting long-term growth in its revenues, gross profit margins, earnings, and market share, while characterizing disappointing results and/or unfulfilled expectations in those areas as being merely temporary, and resulting primarily from general `current economic conditions', `economic uncertainties', and, more particularly, `delays' in its customers' purchasing decisions."
(c) Customers were not delaying purchasing decisions, but were in fact cancelling orders for, returning DSC products and/or maintaining or even increasing their purchasing levels of comparable equipment — but from vendors other than DSC;
Consolidated Complaint ¶ 25.
The remainder of the consolidated complaint compares statements culled from DSC's public statements to the allegations contained in paragraph 25. The complaint concludes that DSC's public disclosures included misstatements and omissions of material facts. These alleged misstatements and omissions fall into three general categories: (1) the quality, reliability, and competitiveness of DSC and its products; (2) DSC's marketing position and growth prospects; and (3) DSC's financial position. A few examples from each category will suffice.
Other allegations in the consolidated complaint simply quote from DSC's public statements and conclusorily assert that they are false or misleading. Such allegations fall far short of adequately pleading securities fraud.
As to DSC's marketing position and growth prospects, the plaintiffs maintain that the following excerpt from DSC's 1990 annual report is materially false and misleading: "The company continued to be profitable, but not to the level that was originally planned. This was due to a number of factors, including the impact of current economic conditions, which led to the delay of certain customer purchase decisions. . . . We expect these factors are only temporary obstacles to our continued profitable growth." The plaintiffs assert that DSC's economic downturn was in fact caused by the company's unfavorable product mix and a loss of competitiveness.
After the consolidated complaint was filed, the defendants moved to dismiss the plaintiffs' claims under Fed.R.Civ.P. 12(b)(6) for failure to state a claim for which relief can be granted and under Fed.R.Civ.P. 9(b) for failure to plead fraud with particularity. The district court granted the defendants' motion on both grounds: The court first concluded that the plaintiffs had failed to state claim upon which relief could be granted because they had not pleaded any facts "to establish that any misstatements or omissions which may have been made were made with scienter." 818 F. Supp. at 976. The court also found that the plaintiffs had "failed to state their securities fraud claim with particularity." Id. at 977. The district court then denied a pending motion for class certification, declined to exercise jurisdiction over the remaining state law claims, and dismissed the plaintiffs' claims without prejudice. Contending that their securities fraud claims were adequately pleaded, plaintiffs appeal.
The plaintiffs' consolidated complaint contains three basic sets of claims: federal securities fraud claims, state common law fraud claims, and state common law negligent misrepresentation claims. The district court dismissed the federal securities fraud claims and declined to exercise jurisdiction over the remaining state law claims. We now examine the district court's dismissal of the plaintiffs' federal securities fraud claims.
Since there was no class certification, we treat this case as one brought by the named plaintiffs individually. Kaplan v. Utilicorp United, Inc., 9 F.3d 405, 407 (5th Cir. 1993).
To establish a federal securities fraud claim under § 10(b) of the Securities Exchange Act and Rule 10b-5, the plaintiffs must show "(1) a misstatement or an omission (2) of material fact (3) made with scienter (4) on which the plaintiff relied (5) that proximately caused [the plaintiff's] injury." Cyrak v. Lemon, 919 F.2d 320, 325 (5th Cir. 1990); Schlesinger v. Herzog, 2 F.3d 135, 139 (5th Cir. 1993).
Scienter is a crucial element of the securities fraud claims in this case. Scienter must be shown because not every misstatement or omission in a corporation's disclosures gives rise to a Rule 10b-5 claim. The Supreme Court has defined scienter to be "a mental state embracing intent to deceive, manipulate, or defraud." Ernst Ernst v. Hochfelder, 425 U.S. 185, 193 n. 12, 96 S.Ct. 1375, 1381 n. 12, 47 L.Ed.2d 668 (1976). We have held that the scienter element of a federal securities fraud claim may be satisfied by
Shushany v. Allwaste, Inc., 992 F.2d 517, 521 (5th Cir. 1993) (quoting Broad v. Rockwell Int'l Corp., 642 F.2d 929, 961-62 (5th Cir.) (en banc), cert. denied, 454 U.S. 965, 102 S.Ct. 506, 70 L.Ed.2d 380 (1981)); Akin v. Q-L Invest. Inc., 959 F.2d 521, 526 n. 2. (5th Cir. 1992). As we shall show below, it was necessary that the plaintiffs adequately plead scienter to survive a motion to dismiss.
We review the dismissal of the plaintiffs' federal securities fraud claims on the pleadings de novo, employing the same standard as the district court. Shushany, 992 F.2d at 520. Accordingly, we will accept as true the well-pleaded factual allegations of the consolidated complaint and any reasonable inferences to be drawn from them. Id. In order to avoid dismissal for failure to state a claim, however, "`a plaintiff must plead specific facts, not mere conclusory allegations . . . .'" Guidry v. Bank of LaPlace, 954 F.2d 278, 281 (5th Cir. 1992) (citation omitted). We will thus not accept as true conclusory allegations or unwarranted deductions of fact.
Typically, a plaintiff's complaint must contain a "short and plain statement of the claim showing that the pleader is entitled to relief." Fed.R.Civ.P. 8(a)(2). In other words, a plaintiff must simply allege all of the elements of a right to recover against a defendant. To prevail on a motion to dismiss an ordinary claim under Fed.R.Civ.P. 12(b)(6), a defendant must show that "the plaintiff can prove no set of facts in support of his claim which would entitle him to relief." Conley v. Gibson, 355 U.S. 41, 45-46, 78 S.Ct. 99, 102, 2 L.Ed.2d 80 (1957). However, the first sentence of Federal Rule of Civil Procedure 9(b) imposes a heightened level of pleading for fraud claims: "In all averments of fraud or mistake, the circumstances constituting fraud or mistake shall be stated with particularity." This requirement applies to federal securities fraud claims. Whalen v. Carter, 954 F.2d 1087, 1097 (5th Cir. 1992). In securities fraud suits, this heightened pleading standard provides defendants with fair notice of the plaintiffs' claims, protects defendants from harm to their reputation and goodwill, reduces the number of strike suits, and prevents plaintiffs from filing baseless claims and then attempting to discover unknown wrongs. Shushany, 992 F.2d at 521; Cosmas v. Hassett, 886 F.2d 8, 11 (2d Cir. 1989).
The particularity demanded by Rule 9(b) necessarily differs with the facts of each case. Guidry, 954 F.2d at 288. Thus, it is not especially useful to "articulate the requirements of Rule 9(b) in great detail." Id. Nevertheless, we have recently stated that Rule 9(b) requires the plaintiff to allege "the particulars of `time, place, and contents of the false representations, as well as the identity of the person making the misrepresentation and what [that person] obtained thereby.'" Tel-Phonic Services, Inc. v. TBS Int'l, Inc., 975 F.2d 1134, 1139 (5th Cir. 1992) (citation omitted).
Importantly, though, the second sentence of Rule 9(b) relaxes the particularity requirement for conditions of the mind, such as scienter: "Malice, intent, knowledge, and other condition of mind of a person may be averred generally." Although scienter may be "averred generally", case law amply demonstrates that pleading scienter requires more than a simple allegation that a defendant had fraudulent intent. To plead scienter adequately, a plaintiff must set forth specific facts that support an inference of fraud. See Greenstone v. Cambex Corp., 975 F.2d 22, 25 (1st Cir. 1992) ("The courts have uniformly held inadequate a complaint's general averment of the defendant's `knowledge' of material falsity, unless the complaint also sets forth specific facts that makes it reasonable to believe that defendant knew that a statement was materially false or misleading.") (emphasis in original); DiLeo v. Ernst Young, 901 F.2d 624, 629 (7th Cir.) ("Although Rule 9(b) does not require `particularity' with respect to the defendants' mental state, the complaint must still afford a basis for believing that plaintiffs could prove scienter."), cert. denied, 498 U.S. 941, 111 S.Ct. 347, 112 L.Ed.2d 312 (1990); cf. Wexner v. First Manhattan Co., 902 F.2d 169, 172 (2d Cir. 1990) (requiring plaintiffs who allege fraud "to plead the factual basis which gives rise to a `strong inference' of fraudulent intent.") (citation omitted) (emphasis added).
The factual background adequate for an inference of fraudulent intent can be satisfied by alleging facts that show a defendant's motive to commit securities fraud. Where a defendant's motive is not apparent, a plaintiff may adequately plead scienter by identifying circumstances that indicate conscious behavior on the part of the defendant, though the strength of the circumstantial allegations must be correspondingly greater. Beck v. Manufacturers Hanover Trust Co., 820 F.2d 46, 50 (2d Cir. 1987), cert. denied, 484 U.S. 1005, 108 S.Ct. 698, 98 L.Ed.2d 650 (1988), overruled on other grounds, United States v. Indelicato, 865 F.2d 1370 (2d Cir.) (en banc), cert. denied, 493 U.S. 811, 110 S.Ct. 56, 107 L.Ed.2d 24 (1989). If the facts pleaded in a complaint are peculiarly within the opposing party's knowledge, fraud pleadings may be based on information and belief. However, this luxury "must not be mistaken for license to base claims of fraud on speculation and conclusory allegations." Wexner, 902 F.2d at 172.
Consolidated Complaint ¶ 103. This allegation alone does not set out facts sufficient to lead to a proper inference of scienter. As the court below aptly noted:
818 F. Supp. at 976 (quoting Ferber v. Travelers Corp., 785 F. Supp. 1101, 1107 (D.Conn. 1991)).
Similarly, the plaintiffs' charge that Donald and Perpiglia made contradictory statements from one day to the next regarding (1) DSC's responsibility for the telephone network outages and (2) the adequacy of DSC's testing of the software involved in those outages is insufficient to establish securities fraud. Regarding both alleged contradictions, the complaint contains no assertion of any fact that makes it reasonable to believe that the defendants knew that any of their statements were materially false or misleading when made. Again, without such a showing, this portion of the consolidated complaint fails to state a claim for securities fraud.
Conspicuously absent from the plaintiffs' allegations related to the re-negotiated Motorola contract is any statement that the defendants concealed or misrepresented material information relating to that agreement. Although DSC characterized the Motorola contract as a "particular success", the defendants were under no duty to "employ the adjectorial characterization" that the plaintiffs believe is more accurate. Wright v. International Business Machines Corp., 796 F. Supp. 1120, 1126 (N.D.Ill. 1992). The plaintiffs' allegations concerning the Motorola contract do not state a claim for securities fraud.
[t]he securities laws do not put executives of public corporations to the choice of either hiding their mistakes or facing a class-action shareholder suit. In fact, the "fundamental purpose" of the securities laws is just the opposite — "to substitute a philosophy of full disclosure for the policy of caveat emptor and thus to achieve a high standard of business ethics in the securities industry."
Hershfang v. Citicorp, 767 F. Supp. 1251 (S.D.N.Y. 1991) (quoting SEC v. Capital Gains Research Bureau, Inc., 375 U.S. 180, 186, 84 S.Ct. 275, 280, 11 L.Ed.2d 237 (1963)). The district court properly concluded that the plaintiffs failed to adequately plead a 10b-5 claim.
Since the plaintiffs failed to properly allege a violation of the federal securities laws, the plaintiffs' claims against DSC and the individuals defendants were correctly dismissed. Moreover, the district court plainly did not abuse its discretion when it declined to exercise its discretionary jurisdiction over the supplemental state law claims. 28 U.S.C. § 1367(c)(3); Parker Parsley Petroleum Co. v. Dresser Indus., 972 F.2d 580 (5th Cir. 1992).
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