Court Opinion

ID: 9495180
Source: CourtListenerOpinion
Date Created: 2023-08-05 15:56:32.209701+00
Date Added: 2024-06-11T17:56:51.917142
License: Public Domain

BYE, Circuit Judge,
dissenting.
Public investors rely on companies like Aexiom to report material information accurately. Perverting that information, by ahegedly fudging earnings or otherwise, effectively undermines the operation of the federal securities laws and cuts against-the very principles upon which the stock market’s strength and success depend. Here, the plaintiffs contend Aexiom’s Registration Statement/Prospectus (the “Prospectus”) was false and misleading in three material respects. Because each of the three alleged materially misleading statements and omissions in the Prospectus states a claim under § 11 of the Securities Act of 1933,1 respectfully dissent.
I. Employee Benefit Reserves Issue
In the Complaint, plaintiffs allege that
Contrary to GAAP, Aexiom improperly accounted for its reserve for employee benefits to inflate the Company’s earnings in the Registration Statement/Prospectus by reversing $2.3 million previously accrued and failing to adequately accrue for liabilities which were probable and the amount which Aexiom could reasonably estimate. This caused the Company’s EPS to be overstated by $0.02. In addition, Acxiom’s Prospectus was misleading and violated § 11, because it failed to disclose that Aexiom was only able to make its first quarter numbers by reversing $2.3 million of its employee benefits accrual.
Complaint ¶ 38. I agree with the majority that plaintiffs assert two distinct theories under the employee benefit reserves issue: (1) Aexiom improperly reversed $2.3 million of its employee benefit reserves, in violation of Generally Accepted Accounting Principles (GAAP); and (2) Aexiom failed to disclose this reversal in its Prospectus.
As to the first theory, the majority concludes that plaintiffs’ failure to challenge the Form 10-Q as violative of GAAP necessarily precludes them from stating a §11 claim based upon non-compliance with GAAP. Even assuming that plaintiffs’ § 11 claim rises or falls on this basis, I believe plaintiffs have adequately challenged the information contained in the Form 10-Q.
In the Complaint, plaintiffs allege that, in order for Aexiom to have met its first quarter numbers, Aexiom overstated its earnings and reported them in the narrative section of the Prospectus. Aexiom achieved those inflated results, plaintiffs allege, by improperly reversing $2.3 million of its employee benefits which had already, accrued. Of course, plaintiffs learned of the $2.3 million reversal from the Form 10-Q. By alleging the $2.3 million reversal was improper (because it was contrary to GAAP), plaintiffs necessarily contend the information contained in the *710Form 10-Q violates GAAP. The plaintiffs have more than adequately challenged the information contained in the 10-Q and have not pleaded themselves out of court. To dismiss plaintiffs’ claim because they fail to state the magic words that Acxiom’s “Form 10-Q violates GAAP” is improper and inconsistent with the liberal pleading requirements of Fed.R.Civ.P. 8(a)(2). See Hishon v. King & Spalding, 467 U.S. 69, 73, 104 S.Ct. 2229, 81 L.Ed.2d 59 (1984) (“A court may dismiss a complaint only if it is clear that no relief could be granted under any set of facts that could be proved consistent with the allegations.”).
As to the second theory, the majority observes that materiality is a question of fact. Yet it proceeds to decide, as a matter of law, that Acxiom’s overstatement of its earnings by two percent would not have significantly altered the total mix of information available to a reasonable investor. The majority concludes plaintiffs have faded to state a § 11 claim because the alleged non-disclosure was immaterial as a matter of law. I disagree.
To be actionable under the federal securities laws, misrepresentations or omissions must be material. See Parnes v. Gateway 2000, Inc., 122 F.3d 539, 546 (8th Cir.1997). For an omission to be material, there must be “ ‘a substantial likelihood that the disclosure of the omitted fact would have been viewed by the reasonable investor as having significantly altered the ‘total mix’ of information made available.’ ” Id. (quoting Basic Inc. v. Levinson, 485 U.S. 224, 231-32, 108 S.Ct. 978, 99 L.Ed.2d 194 (1988)). In this case, plaintiffs point out that, without the reversal, Acxiom’s net income would have fallen by $1.5 million to $14.2 million. If earnings per share were adjusted downward to reflect this change, they would have come in at sixteen cents per share, two cents lower than the expected earnings estimate. Thus, plaintiffs allege Acxiom inflated its earnings by two percent in order to hide its failure to meet analysts’ consensus earnings, effectively ensuring a successful secondary offering.
Remarkably, the majority finds, based on the background portions of the Complaint and Acxiom’s financial statements, that the reserve adjustment was the result of a September 1998 merger that required Acxiom to merge separate employee benefit plans. While this may prove to be true, plaintiffs clearly have alleged the reserve adjustment was aimed at inflating Acxiom’s earnings so that it could meet its expected earnings at the time of the offering. At this preliminary stage of the litigation, we must accept plaintiffs’ allegations as true. See Abels v. Farmers Commodities Corp., 259 F.3d 910, 916 (8th Cir.2001).
The majority ultimately concludes that Acxiom’s failure to disclose the two percent overstatement of earnings is immaterial as a matter of law. It relies on Gateway 2000, which upheld a Rule 12 dismissal because a two percent overstatement of assets by a high-risk/high-yield investment opportunity would not have significantly altered the total mix of information available to a reasonable investor. Here, however, we are not dealing with assets, but rather an overstatement of two percent of earnings. See In re Burlington Coat Factory Sec. Litig., 114 F.3d 1410, 1420 n. 9 (3rd Cir.1997) (explaining that earnings reports are among the pieces of data that investors find most valuable in making their investment decisions).
Moreover, like the Second Circuit, I find the Securities and Exchange Commission’s (SEC) Staff Accounting Bulletin (SAB) No. 99 to be a persuasive guide in evaluating the materiality of an alleged misrepresentation. See Ganino v. Citizens Util. Co., 228 F.3d 154, 163 (2nd Cir.2000) (recogniz*711ing that SAB No. 99 does not carry the force of law, yet is nonetheless persuasive in evaluating the materiality of an alleged misrepresentation). In SAB No. 99, the SEC commented that “[qualitative factors may cause misstatements of quantitatively small amounts to be material,” including “whether the misstatement masks a change in earnings or other trends,” or “the misstatements hides a failure to meet analysts’ consensus expectations for the enterprise.” SAB No. 99, 64 Fed.Reg. 45150, 45152 (1999). This is precisely why the plaintiffs allege Acxiom manipulated its earnings — to meet analysts’ consensus expectations.
Additionally, we must not forget the market’s response to the information considered by the majority to be immaterial as a matter of law. At the time of the offering, Acxiom stock sold at $27 per share, but following the Form 10-Q and the Barron’s article, which disclosed the information, Acxiom stock dropped to $17 per share. See Oran v. Stafford, 226 F.3d 275, 285 (3rd Cir.2000) (suggesting that the materiality of the undisclosed information was confirmed by, among other things, a four percent drop in share prices on September 17, the day The New York Times and The Wall Street Journal reported it).
II. The Allowance for Doubtful Accounts Issue
Plaintiffs allege Acxiom overstated the quarterly earnings reported in the Prospectus by $.01 per share when it decreased its allowance for doubtful accounts from $5.6 million to $5.2 million despite a $30 million increase in accounts receivables and an increase in its “days sales outstanding.” Plaintiffs allege this information is material because it permitted Acxiom to meet analysts’ expectations on the eve of the stock offering.
The majority acknowledges that earnings trends are important to potential investors in a growth company like Acxiom and, therefore, misstating income to meet analysts’ expectations can be significant to a reasonable investor. Ante at 707. The majority, however, proceeds to scrutinize the Complaint, faulting the plaintiffs for not adequately particularizing specific facts, id., despite concluding that plaintiffs are not subject to the heightened pleading requirements of Fed.R.Civ.P. 9(b). Plaintiffs have clearly complied with Rule 8(a)(2) by alleging “AcxLom’s Prospectus was misleading because it failed to disclose that despite a $30 million increase in accounts receivable and an increase in days outstanding, Acxiom decreased its allowance for doubtful accounts from $5.6 million to $5.2 million.” Complaint ¶ 39. This allegation, coupled with the allegation contained in ¶ 42 of the Complaint (alleging quarterly earnings were overstated by $.01 per share due to Acxiom’s failure to record reserves adequately for uncollectible receivables), sufficiently states a claim under § 11. ■
The Supreme Court recently articulated the purpose of Rule 8(a)(2), explaining
a complaint must include only a short and plain statement of the claim showing that the pleader is entitled to relief. Such a statement must simply give the defendant fair notice of what the plaintiffs claim is and the grounds upon which it rests. This simplified notice pleading standard relies on liberal discovery rules and summary judgment motions to define disputed facts and issues and to dispose of unmeritorious claims.
Swierkiewicz v. Sorema N.A., 534 U.S. 506, 122 S.Ct. 992, 998, 152 L.Ed.2d 1 (2002) (internal quotations and citations omitted). In dismissing this claim under Rule 12(b)(6), the majority snubs the spirit *712of the liberal pleading requirements of Rule 8(a).
III. The Allstate Contract Issue
The plaintiffs allege the Allstate contract had been renegotiated in March 1999 for an additional five years, resulting in lower pricing for traditional services performed by Acxiom. They further allege the Allstate contract represented a negative trend for Acxiom in that the price reductions reflected the adverse competitive environment in which it operated. Plaintiffs explained that a disclosure of its significance was required for investors to fully understand the state of Acxiom’s business and worth of its stock. After all, Allstate was Acxiom’s largest client in 1999, representing 10.9% .of its revenues for fiscal year 1999.
The majority agrees with the district court that “[a] company has no duty to disparage its own competitive positions in the market where it has provided accurate hard data from which analysts and investors can draw their own conclusions about the company’s conditions and the value of its stock.” Ante at 708. The plaintiffs allege, however, that Acxiom did not reveal the hard data — the Prospectus omitted any discussion or description of the new contract’s actual impact on first quarter results. The majority then notes the Prospectus made no affirmative representations concerning this contract. But the plaintiffs’ claim with respect to the Allstate contract relates to Acxiom’s failure to disclose, not affirmatively misrepresent, material information.
Moreover, the plaintiffs allege Acxiom was required to describe the details of the Allstate contract because it reflected a negative trend that Acxiom reasonably should have expected to materially impact its revenues and income. 17 C.F.R. § 229.303(a)(3)(ii) requires a registrant to “[djescribe any known trends or uncertainties that have had or that the registrant reasonably expects will have a material favorable or unfavorable impact on net sales or revenues or income from continuing operations.” Here, the plaintiffs allege Acxiom knew the impact of the renegotiated contract with Allstate, at least as it pertained to the first quarter results. They also allege Acxiom knew the renegotiated- contract was reasonably likely to have material effects on its financial condition or results of operation. That is, the Alstate contract “would result in lower pricing for traditional services, and represented a negative trend in that price reductions were reflective of the adverse competitive environment in which Acxiom was working.” Complaint ¶ 25(e)-(f). The majority nonetheless determines that “one individually negotiated contract with a major customer does not establish or even effectively allege a competitive trend .... ” Ante at 708. Granted, this claim relates only to the renegotiated contract with Al-staté, but Alstate was Acxiom’s single largest customer and the renegotiated contract was effective for five years.4 This certainly could have a negative trend in pricing. Even the sophisticated financial analyst who wrote the article in Barron’s noted the renegotiated Alstate contract reflected a more general pricing pressure, *713under which Acxiom “has been straining its balance sheet to keep up with the earnings growth that it’s been promising Wall Street,” and observed further that .“[t]he terms of this contract, ... make it clear that the company’s business with Allstate won’t be as profitable as it had been.” Complaint ¶ 30 (quoting Barron’s article).
Because each of the three alleged materially misleading statements and omissions in the Prospectus states a claim under § 11 of the Securities Act of 1933, I would reverse the judgment of the district court. I respectfully dissent.

. According to the SEC's 1989 release interpreting 17 C.F.R. § 229.303(a)(3)(ii), "[r]e-quired disclosure is based on currently known trends, events, and uncertainties that are reasonably expected to have material effects, such as: A reduction in the registrant's product process; erosion in the registrant's market share; changes in insurance coverage; or the likely non-renewal of a material contract.'' Management's Discussion and Analysis of Financial Condition, Securities Act Release No. 6835, 54 Fed.Reg. 22,427, 22,429 (May 24, 1989) (emphasis added).