Opinion ID: 783853
Heading Depth: 4
Heading Rank: 5

Heading: The August 9, 1999, Form 10-Q

Text: 97 The August 9, 1999, Form 10-Q did not recklessly violate generally accepted accounting principles (GAAP), and therefore we hold that the plaintiff failed to state a claim regarding this filing. The plaintiff contends that Champion's second quarter Form 10-Q recklessly violated GAAP because Champion was required by those accounting principles to accrue at least $18 million as a loss on the outstanding loans and volume discounts owed by Parker Homes to Champion. He further avers that the footnote disclosure that Champion did make was insufficient under GAAP. The district court dismissed this claim because it insufficiently alleged scienter, because the court found that Champion was not required to accrue the loss in the second quarter, and because the footnote disclosure satisfied GAAP. 98 Plaintiff bases his argument on Financial Accounting Standard (FAS) No. 5, which requires a company to accrue an estimated loss if two conditions are met: 99 a. Information available prior to the issuance of the financial statements indicates that it is probable that an asset had been impaired or a liability had been incurred at the date of the financial statements. It is implicit in this condition that it must be probable that one or more future events will occur confirming the fact of the loss. 100 b. The amount of the loss can be reasonably estimated. 101 J.A. at 60. The date of the financial statements is the last day of the accounting period for which the financial statements are presented, which in this case was the end of the second quarter: July 3, 1999. Plaintiff's argument is that, given the probability of Parker Homes's bankruptcy and defendants' knowledge thereof prior to July 3, 1999, Champion was required to accrue at least $18 million in probable losses due to Parker Homes's bankruptcy on its second quarter Form 10-Q released on August 9, 1999. 102 In order for us to judge the merits of the plaintiff's claim, we need to be able to answer two questions with regard to probability. First, we need to know what the word probable means in FAS No. 5. In other words, we need to know how probable the contingency needs to be for a company to be required to accrue a loss in the financial statements. There is no guidance in the record on how to answer this question. Second, we need to know how probable Parker Homes's bankruptcy actually was, a contingency that is hard to assess after the fact. 16 103 It is difficult now, in retrospect, to assert that these probabilities were such that it was reckless for the defendants to decide not to disclose more information or to accrue the $18 million loss in the second quarter of 1999. It is certainly a plausible inference that it was reckless. But the opposite is also a plausible inference — that defendants thought they had avoided the bankruptcy, were not sure if they would be able to purchase Parker Homes's assets in the bankruptcy proceedings, and in general were not aware of the economic downturn that was about to hit the manufactured housing market. After the Holding Companies declared bankruptcy on June 28, 1999, Champion engaged in discussions with GE Partners and Ardhouse to continue to provide funding to Parker Homes. These discussions resulted in a Letter of Intent on July 15, 1999, in which GE Partners and Champion agreed to provide the funding. Pursuant to this Letter of Intent, Champion made an unsecured loan of $350,000 to Parker Homes on July 16, 1999. Furthermore, as Ted Parker alleged in his complaint against GE Partners and Ardhouse, 104 At the time such bankruptcy proceedings were filed, T. Parker had conducted telephone negotiations with senior management at GE [Partners] to help structure a continued operating plan for [Parker Homes]. T. Parker had agree to transfer ... a significant portion of his stock in [Parker Homes] to the Defendants and Champion for their input of additional capital into [Parker Homes], which would have allowed the continued operation of [Parker Homes]. T. Parker and Champion believed that such an agreement was in place and then learned the next day that the Defendants had unnecessarily and with improper motivation placed [Parker Homes] into bankruptcy. 105 J.A. at 106. It is at least plausible based on these facts that the defendants had good reason to believe that the loans to Parker Homes were not impaired because they had come to an agreement whereby Parker Homes would be able to avoid Chapter 11. It also appears implausible that defendants would have continued to advance unsecured loans of $2.25 million 17 and $350,000 to Parker Homes if they had known that Parker Homes was going to file a Chapter 11 petition. 106 Additionally, when it did become clear that the loans and discount money were impaired — after Parker Homes was put into bankruptcy — Champion did take the proper steps under GAAP. Since the bankruptcy occurred after the closing of the second quarter on July 3, 1999, and the defendants ostensibly had good reasons to think — at least until after July 3 — that they would be able to prevent Parker Homes's bankruptcy, they were arguably not required to accrue the loss during the second quarter. Instead, Champion followed the instructions in GAAP and FAS No. 5 which provide that, if information becomes available indicating that it is probable that an asset became impaired after the date of the financial statements — July 3, 1999 — but before the statements were filed on August 9, 1999, the financial statements should disclose the nature and estimated amount of the loss, but the loss should not be accrued in those financial statements. This is what Champion did in its August 9, 1999, Form 10-Q, footnote 11. 107 Both outcomes in this situation — bankruptcy or avoidance of bankruptcy — appear to be somewhat probable, and FAS No. 5 does not specify the level of probability required to accrue a loss. Given two fairly plausible explanations of the facts, we find it difficult to say that plaintiff's facts give rise to a strong inference of scienter, that plaintiff's explanation is the most plausible of competing inferences. Vencor, 251 F.3d at 553. We also find it difficult to say that, given the level of knowledge that defendants had of Parker Homes's financial situation, Champion's actions in not accruing the $18 million loss in the second quarter of 1999 were an extreme departure from the standards of ordinary care. Mansbach, 598 F.2d at 1025. 108 Plaintiff's reliance on the similarities between the passage of the Balanced Budget Act in Vencor and Parker Homes's bankruptcy in this case is misplaced. In Vencor, the passage of the Balanced Budget Act was a contingency outside the defendants' control that was virtually certain to have a negative impact on the defendants. See 251 F.3d at 556-58. Therefore, we held that there was a strong inference that defendants were reckless when they released favorable earnings projections after they knew that the Balanced Budget Act was going to have a negative impact on those earnings, and did not give adequate disclaimers about the possible effects of the Act. Id. at 566. In this case, the contingency that could have a negative impact on defendants was not outside defendants' control, and it appears at least plausible that defendants reasonably believed that they had prevented that contingency from taking place. Vencor is also distinguishable from the present case in that there is no indication in the present case that the defendants profited from their allegedly misleading statements. Unlike the defendants in Vencor, there is no allegation in the present case that the defendants undertook any insider trading — or any other means to profit — that might have led them to attempt to conceal Parker Homes's bankruptcy during this period. Cf. Vencor, 251 F.3d at 558. 109 In short, we do not believe that the plaintiff has pleaded sufficient facts to give rise to the strong inference of scienter that is required under the PSLRA. See 15 U.S.C. § 78u-4(b)(2). The evidence does not show that defendants acted with an extreme disregard for the standard of ordinary care in making these statements. See Mansbach, 598 F.2d at 1025. 110 E. The District Court Did Not Err in Denying Plaintiff's Motion for Leave to File the SASC 18 111 The district court moreover did not err in denying the plaintiff's motion for leave to file the SASC. The district court denied plaintiff leave to file the SASC on two grounds. First, the district court held that the amendments provided in the SASC were futile. Second, the district court held that allowing the repeated filing of amended complaints would frustrate the purpose of the PSLRA. 112 As a general matter, leave to amend should be freely given when justice so requires. Fed.R.Civ.P. 15(a). And [i]n the securities litigation context, leave to amend is particularly appropriate where the complaint does not allege fraud with particularity. Morse, 290 F.3d at 800. Denial of leave to amend may nonetheless be appropriate where there is `undue delay, bad faith or dilatory motive on the part of the movant, repeated failure to cure deficiencies by amendments previously allowed, undue prejudice to the opposing party by virtue of allowance of the amendment, futility of the amendment, etc.' Id. (quoting Foman v. Davis, 371 U.S. 178, 182, 83 S.Ct. 227, 9 L.Ed.2d 222 (1962)). 113 The district court held that amendment of the CAC with the SASC would be futile because the SASC did not better link the allegations of scienter with any specific misstatements or omissions. We have already stated that the district court erred in so holding. As we stated in Morse, [i]n the securities litigation context, leave to amend is particularly appropriate where the complaint does not allege fraud with particularity. 290 F.3d at 800. However, we nonetheless agree with the district court that the facts alleged in the SASC do not give rise to the strong inference of scienter required under the PSLRA, and therefore are futile. See Morse, 290 F.3d at 800. The additional facts alleged in the SASC strengthen the inference that the defendants had some indication that Parker Homes had surplus inventory and was going through some financial difficulties in the spring of 1999. The SASC also alleges that the defendants knew that Parker Homes's bankruptcy was likely because Ted Parker had sent out notices of default on Parker Homes's sales lot lease agreements, which were Parker Homes's only unencumbered asset. However, as the plaintiff also alleged, the defendants expressly disclosed that they believed there was excess inventory in the market as well as their knowledge that Parker Homes had excess inventory, which the defendants believed to be due to Parker Homes's unique business plan. As the facts alleged by the plaintiff also imply, there is at least a plausible inference that the defendants believed they had averted the Parker Homes bankruptcy. The additional allegations in the SASC thus do not give rise to the strong inference of recklessness required under the PSLRA, and are therefore futile. 114 The district court also correctly held that allowing repeated filing of amended complaints would frustrate the purpose of the PSLRA. To come to this conclusion, the district court first had to decide whether the PSLRA restricts Rule 15(a) of the Federal Rules of Civil Procedure. Rule 15(a) provides that [a] party may amend the party's pleading only by leave of court or by written consent of the adverse party; and leave should be freely given when justice so requires. The PSLRA, on the other hand, states that [i]n any private action arising under this chapter, the court shall, on the motion of any defendant, dismiss the complaint if the [pleading] requirements... are not met. 15 U.S.C. § 78u-4(b)(3)(A). The district court found that the purpose of the PSLRA's heightened pleading requirements and stay of discovery were to prevent harassing strike suits filed the moment a company's stock price falls, and concluded that the PSLRA could not achieve this purpose if plaintiffs were allowed to amend and amend until they got it right. Since the plaintiff failed to meet the pleading requirements, the district court concluded that in order to enforce the purpose of the PSLRA, it must dismiss the CAC with prejudice. 115 Plaintiff cites several district court opinions that allowed for repeated amendments to complaints despite motions to dismiss by the defendants. See In re Livent, Inc. Noteholders Secs. Lit., 174 F.Supp.2d 144, 148 (S.D.N.Y.2001) (third amended complaint); McNamara v. Bre-X Minerals, Ltd., 197 F.Supp.2d 622 (E.D.Tex.2001) (fourth amended complaint); Chu v. Sabratek Corp., 100 F.Supp.2d 827, 844 & n. 14 (N.D.Ill.2000) (sixth amended complaint); In re Southern Pac. Funding Corp. Sec. Lit., 83 F.Supp.2d 1172, 1174 (D.Or.1999) (fourth amended complaint). He also cites a Third Circuit case that allowed amendment despite the PSLRA, even after the final judgment: 116 Although we are reluctant to allow amendment of a pleading at this stage of the proceedings, the plaintiffs were precluded from engaging in discovery in the District Court. Without discovery, plaintiffs had no way to obtain the meeting minutes other than by happenstance. We will not add to the strict discovery restrictions in the Private Securities Litigation Reform Act (PSLRA) by narrowly construing Rule 15 in this case, even at this late stage in the litigation. Given the high burdens the PSLRA placed on plaintiffs, justice and fairness require that the plaintiffs before us be allowed an opportunity to amend their complaint to include allegations relating to the newly discovered Board meeting minutes. 117 Werner v. Werner, 267 F.3d 288, 297 (3d Cir.2001). Werner is the most persuasive authority for requiring the district court to allow an amended pleading. 118 While the Werner opinion had not been issued at the time of the district court's denial of the motion to permit an amended complaint, the district court nonetheless responded to a similar argument by plaintiff: 119 In this case, it appears that plaintiffs are contending that since discovery procedures are not available to them, that a court must be lenient in allowing amendments to pleadings. Contending that Rule 15 permits this, they purposely seek to circumvent the [PSLRA's] strict requirements preventing discovery. But this is precisely the device that Congress intended to be used, i.e., to prevent suits in which a foundation for the suit can not be pleaded. 120 The stay of discovery and the heightened pleading standards are separate and distinct, yet complimentary mechanisms. The stay of discovery operates to prevent plaintiffs with baseless claims from squeezing a nuisance settlement from an innocent defendant. The pleading requirement is more than simply a line the plaintiffs must cross to set to discovery; it is the heart of the [PSLRA]. This stringent requirement operates to discourage baseless suits altogether. It evinces Congress's acknowledgment of the burden an allegation of securities fraud places on the innocent defendant even without discovery. The [PSLRA] requires a uniform pleading standard; this standard is meaningless if judges on a case-by-case basis grant leave to amend numerous times. 121 Since Werner was decided, the Third Circuit has specifically endorsed this reasoning, quoting with approval District Judge Reed's reliance upon the district court's opinion in this case: 122 The PSLRA's stay of discovery procedures was intended by Congress to protect innocent defendants from having to pay nuisance settlements in securities fraud actions in which a foundation for the suit cannot be pleaded; rather than lead to the conclusion that plaintiffs should receive more leniency in amending their pleadings, the stay of discovery procedures adopted in conjunction with the heightened pleading standards under the PSLRA is a reflection of the objective of Congress to provide a filter at the earliest stage (the pleading stage) to screen out lawsuits that have no factual basis. [ In re Champion Enters., 145 F.Supp.2d 871] at 874 [(E.D.Mich. 2001)] (quoting Selected Bill Provisions of the Conference Report to H.R. 1058/ § 240, 141 Cong. Rec. § 19152 (daily ed. Dec. 22, 1995)). This objective would be thwarted if, considering the history of this case, plaintiffs were liberally permitted leave to amend again; this is particularly true where, as here, there is a stark absence of any suggestion by the plaintiffs that they have developed any facts since the action was commenced which would, if true, cure the defects in the pleadings under the heightened requirements of the PSLRA. 123 In re NAHC, Inc. Secs. Litig., 306 F.3d 1314, 1332-333 (3d Cir.2002) (quoting In re NAHC, Inc. Secs. Litig., No. 00-4020, 2001 U.S. Dist. LEXIS 16754, at -82 (E.D.Pa. Oct. 17, 2001)). While it is true that the Third Circuit was reviewing its district court's decision only for abuse of discretion, 19 it is clear that it was giving its approval to the district court's legal interpretation of the PSLRA, an interpretation that is subject to de novo review. 124 Plaintiff also contended during oral argument that our recent holding in Morse, 290 F.3d 795, requires a reversal of the district court's decision denying plaintiff further leave to amend his complaint. In Morse we held that, despite the plaintiffs' gamesmanship in failing to amend their complaint, the plaintiffs' actions did not amount to bad faith and the delay alone did not justify denial of leave to amend. 290 F.3d at 800. Additionally, in that case it did not appear that the defendants would be prejudiced by allowing further amendment. Id. at 800-01. Notably however, in Morse there was no discussion of the heightened pleading requirements of the PSLRA, or even of the PSLRA generally. In light of those requirements, we think it is correct to interpret the PSLRA as restricting the ability of plaintiffs to amend their complaint, and thus as limiting the scope of Rule 15(a) of the Federal Rules of Civil Procedure. Morse is also distinguishable from the present case in that there was no finding in that case that amendment would be futile, while in this case allowing the plaintiff to file the SASC would not overcome the inadequacies of the CAC. We therefore find that our holding in Morse does not dispose of the issue at hand. 125 We agree with the district court that the purpose of the PSLRA would be frustrated if district courts were required to allow repeated amendments to complaints filed under the PSLRA. We also agree, although on other grounds, that the proposed amendments in the SASC would be futile. The district court was within its discretion in refusing the plaintiff leave to file the SASC, and in light of our holding that filing of the SASC would be futile — although on alternative grounds than those found by the district court — we AFFIRM the judgment of the district court dismissing this case.