Opinion ID: 751831
Heading Depth: 2
Heading Rank: 5

Heading: Necessity of Particularity

Text: 49 The district court found that the complaint did not satisfy Federal Rule of Civil Procedure 9(b). It stated only that the complaint fails to plead particularized facts demonstrating that the statements made by the Merisel defendants were false when made. The order cites In re GlenFed, Inc. Sec. Litig., 42 F.3d 1541 (9th Cir.1994) (en banc) (GlenFed I ), which relied on Rule 9(b), and at the hearing on the motion the district court stated: The motion to dismiss is granted with prejudice, and see what the court of appeals has to say about GlenFed. 50 Federal Rule of Civil Procedure 9(b) requires that [i]n all averments of fraud or mistake, the circumstances constituting fraud or mistake shall be stated with particularity. Malice, intent, knowledge, and other condition of mind of a person may be averred generally. The rule applies to actions brought under the federal securities laws. GlenFed I, 42 F.3d at 1545. To satisfy Rule 9(b), 51 a plaintiff must set forth more than the neutral facts necessary to identify the transaction. The plaintiff must set forth what is false or misleading about a statement, and why it is false. In other words, the plaintiff must set forth an explanation as to why the statement or omission complained of was false or misleading. 52 GlenFed I, 42 F.3d at 1548.
53 GlenFed I sets out a useful hypothetical for determining whether the complaint alleged a false statement that was both false when uttered and false when the plaintiff-shareholders discovered the truth: 54 [A] plaintiff might allege that he bought a house from defendant, that defendant assured him that it was in perfect shape, and that in fact the house turned out to be built on landfill, or in a highly irradiated area; plaintiff could simply set forth these facts (presumably along with time and place), allege scienter in conclusory fashion, and be in compliance with Rule 9(b). We agree that such a pleading would satisfy the rule. Since in perfect shape and built on landfill are at least arguably inconsistent, plaintiff would have set forth the most central circumstance constituting fraud--namely, that what defendant said was false. Notably, the statement would have been just as false when defendant uttered it as when plaintiff discovered the truth. 55 Id. Here, the shareholders argue that they have satisfied this test. The complaint alleges that they purchased Merisel's stock, and that Merisel assured them (through its financial statements, its own positive statements, and optimistic projections mirrored in analysts' reports) that Merisel was in good shape due to its acquisition of Computerland, its reorganization overseas, and its positive sales figures. In fact, the Computerland acquisition had plunged Merisel deep into debt, its overseas operations continued to lose money, and it was improperly recognizing revenue from shipments of unordered goods and goods shipped on consignment to keep up the appearance of high sales; as a result, its second quarter earnings for 1994 were disastrously low. Merisel's stock plummeted in value. Merisel's assurances took place at specified times during the class period, and the defendants knew they were false. Merisel's financial house, in other words, was built on a landfill. Because falseness is clear from the facts that had existed all along and were later revealed, id. at 1549, the complaint meets GlenFed I 's requirements on this skeletal analysis, Warshaw, 74 F.3d at 960 (setting forth a similar brief analysis). 56 In Fecht, we applied the rule that a complaint must contain allegations that fraudulent statements were false when made, and found the complaint satisfied Rule 9(b). 70 F.3d at 1083-84. Applying Fecht 's analysis here, the complaint alleges that the positive statements about the Computerland acquisition were false when made, because in truth the purchase created a debt that Merisel could not support. To ensure that a stock offering would ease its debt burden, Merisel misrepresented the state of its overseas operations and its overall prospects to stock analysts, who passed that misinformation on to the market. To keep its annual and quarterly reports positive, Merisel engaged, with Deloitte's help, in deceptive accounting practices. For purposes of Rule 9(b), allegations of specific problems undermining a defendant's optimistic claims suffice to explain how the claims are false. Id. at 1083. 57 In addition, the complaint alleges that Merisel decided to cancel the stock offering very shortly after optimistic statements were made (three weeks before June 7). This shortness of time is circumstantial evidence that the optimistic statements were false when made. Id. The circumstantial evidence mounts with the allegations that the need for the proceeds from a stock offering was great, and that company officials sold their stock at inflated prices while Merisel expressed optimism for the future. See id. at 1084. 58 We hold that the complaint adequately alleged the falsity of the statements.
59 Merisel argues strongly that the claims of improper revenue recognition are too vague to satisfy Rule 9(b). 60 The complaint alleges that in order to falsify its 1993 third and fourth quarter revenues, Merisel 61 deliberately shipped excessive amounts of product to several of its accounts.... 62 In many instances, Merisel promised the customer that they would not have to pay for the product unless and until they re-sold it. In other instances, Merisel actually shipped merchandise that had not been ordered by the customer. These customers included: Comp. USA, CompuCom, Corporate Software, SoftMart, Egghead Software, P.C. Connection, Microcenter, Software, Etc. 63 The complaint further alleges that GAAP required Merisel to defer revenue recognition on these shipments until payment was received, and that Merisel failed to do so, instead reporting them immediately in order to overstate its revenues. The complaint lists the dollar amounts of overstatements of revenues, net income, and earnings per share for the third and fourth quarters of 1993. As a result of these overshipments, an unprecedented number of returns in the first quarter of 1994 resulted in a declining profit margin; Merisel concealed the high return rate and claimed the profit margin problem was due to price-cutting. Merisel continued this strategy in the first quarter and as a result overstated revenue for the first quarter, also listed as a dollar amount. 64 A company that 'substantially overstate[s] its revenues by reporting consignment transactions as sales ... mak[es] false or misleading statements of material fact.'  In re Worlds of Wonder Sec. Litig., 35 F.3d 1407, 1418 (9th Cir.1994) (quoting Malone v. Microdyne Corp., 26 F.3d 471, 478 (4th Cir.1994)). Nevertheless, Merisel claims the allegations of overstatement are not specific enough, because the Complaint does not allege the time, customer, amount, or other circumstances, of a single wrongful transaction of any type. Merisel cites DiLeo v. Ernst & Young, 901 F.2d 624 (7th Cir.1990), for the proposition that the failure to plead a specific transaction is fatal. 65 In DiLeo, the class plaintiff alleged that a bank burdened with a large number of bad loans did not increase its reserves fast enough. The central allegation was that the defendants, the bank's accountants, knew of this problem before the class members bought the bank's stock. Id. at 626. The complaint did not, however, give any examples of problem loans, or provide any concrete examples, other than stating that additional reserves of at least $600 million were necessary, and that credit losses were understated by approximately 4 billion, while nonperforming loans were materially understated. Id. at 626-27. Holding that even a large column of big numbers need not add up to fraud, the Seventh Circuit affirmed the dismissal of the complaint. Id. at 627. The plaintiffs had not pled the who, what, when, where, and how that would suggest fraud, rather than a business mistake viewed with the benefit of hindsight. Id. at 627-28. 66 In this case, the complaint identified who (eight of Merisel's customers), what (four types of improper revenue recognition), when (last two quarters of 1993 and first quarter of 1994), and where (reported in financial statements). The complaint alleged that Merisel misled by inflating its revenues by specific amounts, and by falsely claiming that its revenue recognition policy was stricter than it really was (how). This is more than fraud by hindsight, and far more specific than DiLeo 's allegations, which did not specify which customer's loans were problems, what was problematic about them, or how the defendant intentionally misled the stockholders. 67 It is not fatal to the complaint that it does not describe in detail a single specific transaction (i.e. shipment) in which Merisel transgressed as above, by customer, amount, and precise method. Comparable precedent does not require greater detail. In Fecht, we found sufficiently particular allegations that newly opened Price Co. stores had low sales volumes, and that nine named stores (three in particular) were losing money. 70 F.3d at 1083 n. 5 & n. 6. We did not require a specific number or a precise time frame. The complaints in GlenFed I and Wells Fargo each alleged specific problems which they allege undermined defendants' optimistic claims, rather than stat[ing] simply that defendants' public statements were false, without explaining how they were false. GlenFed I, 42 F.3d at 1551; Wells Fargo, 12 F.3d at 926-28. Both cases pointed to specific problem loans. Id. Here, the complaint points to specific quarters and specific customers, and provides dollar figures for each quarter. 68 We hold that the complaint meets the particularity requirement of Rule 9(b). Overall, the complaint  'identifies the circumstances of the alleged fraud so that defendants can prepare an adequate answer.'  Warshaw, 74 F.3d at 960 (quoting Kaplan v. Rose, 49 F.3d 1363, 1370 (9th Cir.1994), cert. denied, 516 U.S. 810, 116 S.Ct. 58, 133 L.Ed.2d 21 (1995)). We decline to require that a complaint must allege specific shipments to specific customers at specific times with a specific dollar amount of improperly recognized revenue; we cannot make Rule 9(b) carry more weight than it was meant to bear. GlenFed I, 42 F.3d at 1554. If the shareholders cannot prove any specific instances of excessive revenue recognition with specific customers, they will not prevail on that claim at summary judgment or trial. Because [w]e do not test the evidence at this stage, id. at 1550, the complaint should go forward.