The opinion of the court was delivered by: Arthur J. Schwab United States District Judge
Pending before the Court is Defendants' Motion to Dismiss the Second Amended Class Action Complaint ("SAC"), Docket No. 73. For the reasons discussed below, the Motion is granted in its entirety and Plaintiffs' complaint is dismissed with prejudice.
IT Group, Inc. ("ITG" or "the Company"), was a Delaware corporation headquartered in Monroeville, Pennsylvania, whose primary business was providing environmental remediation services to commercial customers and federal government agencies. In November 1996, Defendant The Carlyle Group ("Carlyle"), a private merchant bank located in Washington, D.C., invested some $45 million in ITG, acquiring more than 46,0000 shares of convertible preferred stock and 1.2 million shares of common stock, giving it approximately 25% of the voting power of the Company. As holder of the preferred stock, Carlyle was paid an annual stock dividend of $6.36 million, regardless of the performance of IT Group and regardless of the value of ITG stock to open-market investors.
By virtue of its position as principal holder of the convertible preferred stock, Carlyle had the right to elect one fewer than the majority of directors and to vote with the common shareholders on the election of other directors. Carlyle was thereby able to install one of its managing directors, Defendant Daniel D'Aniello, as Company chairman, and named four other members of the ITG Board of Directors -- Defendants Philip Dolan, Martin Gibson, Robert F. Pugliese, and James David Watkins. Although Defendant Francis J. Harvey had no formal affiliation with Carlyle, he served on two other boards at Carlyle-controlled companies and served on the ITG Board "at Carlyle's behest." (SAC, ¶ 85.) Other directors were Defendants James C. McGill and Richard W. Pogue. Anthony J. DeLuca served as President and Chief Executive Officer ("CEO"); Defendant Harry J. Soose was Senior Vice President and Chief Financial Officer.*fn2
Soon after Carlyle took control of the Company, ITG embarked on an aggressive plan of growth and diversification through acquisition. Between 1997 and 2000, the Company acquired eleven domestic and international companies, many of which had been competitors in the environmental remediation field. To finance these acquisitions, ITG took the following steps:
* In February through June 1998, in connection with its acquisition of OHM Corporation, ITG obtained a $240 million credit facility which was later refinanced to consist of an eight-year $228 million amortizing term loan and a six-year, $185 million revolving credit facility.
* In December 1998, when acquiring Fluor Daniel GTI, Inc., the Company borrowed $20 million in cash from Fluor Daniel and financed the remaining $51.4 million of purchase and transaction costs using cash on hand and its revolving credit facility.
* To finance its acquisitions of Roche Limited Consulting Services and EFM Group in the spring of 1999 and to refinance existing indebtedness in the revolving credit facility, ITG issued $225 million of ten-year senior subordinated notes for net proceeds of $216 million.
The acquisitions and diversification boosted ITG revenues from $400 million in 1996 to approximately $1.4 billion in 2000. However, by the spring of 2000, the Board of Directors realized that the Company's strategy of "growth by acquisition" had failed for a number of reasons:
* the increase in revenue, although significant, was not sufficient to offset the debt which financed the acquisitions;
* ITG had difficulty managing the diversity of the acquired companies and the businesses they performed, in part because of turnover among key personnel in those companies;
* several of the acquired entities did not perform as well as expected; * the Company did not realize the anticipated cost-savings and other efficiencies expected from consolidation of the acquired businesses, in part because of poor management; and
* the general economic slowdown of the late 1990s. (SAC, ¶ 87.*fn3
The Board of Directors re-focused its attention on debt reduction, recognizing that ITG was having increased difficulty meeting the financial covenants associated with its bank loans. On March 8, 2000, ITG obtained an additional $100 million, seven-year term loan ("Term C Loan") from its lending banks in an attempt to resolve its liquidity problems. Although described as a means to support "seasonal business pattern working capital requirements," Plaintiffs allege that, in reality, the Term C Loan was merely a temporary solution to the Company's massive liquidity problems which Defendants concealed from investors.
Late in 2000, ITG agreed with its lenders that in 2001, it would divest itself of "certain non-core assets and implement other measures in order to reduce debt and raise capital." (SAC, ¶ 95.) Plaintiffs contend that as another example of the Company's "general pattern of obfuscation," this divestiture plan extended not only to passive assets such as real estate, but to businesses which had just been acquired in the preceding three or four years.
Despite the ever-increasing liquidity crisis, ITG maintained a public relations campaign designed to reassure the investing public about the Company's stability and bright future. At the same time, a number of allegedly deceptive accounting and managerial practices (discussed in more detail below) were implemented at the direction of Defendants DeLuca and Soose. By September 2001, the Company's line of credit was almost depleted and it was having difficulty meeting its loan covenants. As a result, it was forced to renegotiate the terms of its loans.
On November 13, 2001, Defendant DeLuca announced his resignation as President and CEO; he was replaced by Mr. Harvey. According to Plaintiffs, Mr. Harvey had actually become Mr. DeLuca's de facto superior at the May 2001 Board of Directors meeting when he was named vice chairman of ITG. Plaintiffs claim that Carlyle required Mr. DeLuca's ouster "due to the [Company's] severe financial situation." (SAC, ¶¶ 86, 98.)
By December 7, 2001, even the questionable accounting practices instituted by Messrs. DeLuca and Soose were not sufficient to keep ITG afloat and it was forced to admit to its lenders that without an emergency loan of $35 million, it would be bankrupt by January 4, 2002. The lenders refused to advance more funds; Carlyle refused to invest additional monies. Although ITG immediately retained workout and restructuring specialists, the Company acknowledged at a second meeting with the banks on December 18, 2001, that its liquidity and leverage problems prevented it from obtaining new contracts with its largest customer, the federal government. On December 27, 2001, the Company publicly announced to investors that a bankruptcy filing could be expected. On January 16, 2002, just three weeks later, ITG filed for bankruptcy protection under Chapter 11 of the U.S. Bankruptcy Code.*fn4
On May 31, 2002, Plaintiff Thomas L. Payne filed a class action suit in the United States District Court for the District of Nevada , alleging that Defendants DeLuca and Soose had issued public statements which failed to disclose the magnitude of the Company's financial difficulties and perpetrated a fraudulent scheme to artificially inflate the price of ITG's shares. (Complaint, ¶ 4.) Mr. Payne brought suit "behalf of all other persons or entities who purchased or acquired [ITG] common stock during the Class Period and were damaged thereby." (Id., ¶ 17.) The Class Period was defined as February 24, 2000, through January 15, 2002.
On October 4, 2002, Mr. Payne, Sid Archinal, Gary H. Karesh, Jo Ann Karesh, Belca D. Swanson and Merle K. Swanson were approved by the District Court in Nevada as Lead Plaintiffs. Based on the relationship of this suit to Staro Asset Management LLC v. DeLuca et al., CA No. 02-886, already pending in this Court, the parties stipulated to a transfer of the action to this District.
Plaintiffs then filed an Amended Complaint on February 28, 2003 (Docket No. 26), adding the Board members and The Carlyle Group as Defendants. Defendants moved to dismiss the Amended Complaint on June 9, 2003 (Docket No. 38), which the parties continued to brief until June 10, 2004, adding evidence and argument as information emerged from the Company's bankruptcy proceedings in the U.S. District Court for the District of Delaware.
On December 16, 2004, the Court issued a Memorandum Opinion, granting the motion to dismiss for failure of Plaintiffs to allege scienter with the particularity required by the Private Securities Litigation Reform Act ("Reform Act" or "PSLRA"), 15 U.S.C. § 78u et seq. However, the dismissal was without prejudice and Plaintiffs were directed to file a Second Amended Class Action Complaint. (Docket No. 68.) Defendants moved to dismiss the Second Amended Complaint on May 27, 2005.
C. Jurisdiction and Venue
This Court has jurisdiction pursuant to 28 U.S.C. § 1331 and 1337, Section 27 of the Securities Exchange Act of 1934 ("the 1934 Act.") Plaintiffs claim that Defendants violated Sections 10(b) and 20 (a) of the 1934 Act, 15 U.S.C. §§ 78j(b), 78(n) and 78t(a) and Rule 10b-5, 17 C.F.R. § 240.10b-5, promulgated thereunder by the Securities and Exchange Commission ("SEC.") Venue is appropriate in this District pursuant to 15 U.S.C. § 78aa and 28 U.S.C. § 1391(b) inasmuch as many of the acts giving rise to the violations alleged herein occurred in this District.
II. STANDARD OF REVIEW -- MOTION TO DISMISS
Unlike a typical civil matter, a securities fraud action is subject to a pyramid of requirements in order to withstand a motion to dismiss for failure to state a claim upon which relief can be granted. The base of the pyramid is established by Federal Rule of Civil Procedure 12(b)(6), which in general requires the court to accept all well-pleaded allegations in the complaint as true and to draw all reasonable inferences in favor of the non-moving party. . . . Dismissal under Rule 12(b)(6) is not appropriate unless it appears beyond doubt that plaintiff can prove no set of facts in support of his claim which would entitle him to relief.
In re Rockefeller Ctr. Props., Inc. Secs. Litig., 311 F.3d 198, 215 (3d Cir. 2002) (internal citations omitted.)
The inquiry under Rule 12(b)(6) "is not whether plaintiffs will ultimately prevail in a trial on the merits, but whether they should be afforded an opportunity to offer evidence in support of their claims." In re Rockefeller Ctr., id. The court is not required, however, to credit "bald assertions or legal conclusions," nor may "legal conclusions draped in the guise of factual allegations . . . benefit from the presumption of truthfulness." Id. at 216.
As a general matter under Rule 12(b)(6), a court may not consider matters extraneous to the pleadings without treating the motion as one for summary judgment and giving all parties reasonable opportunity to present materials pertinent to such a motion under Rule 56. An exception is made, however, for a "document integral to or explicitly relied upon in the complaint," and it has been long established that "a court may consider an undisputedly authentic document that a defendant attaches as an exhibit to a motion to dismiss if the plaintiff's claims are based on the document." In re Burlington Coat Factory Sec. Litig., 114 F.3d 1410, 1426 (3d Cir. 1997) (internal citations omitted.) In securities fraud actions, it is equally well-established that a court may consider public filings such as quarterly and annual reports filed with the SEC.*fn5 Oran v. Stafford, 226 F.3d 275, 289 (3d Cir. 2000).
In such a case, the court must also apply Rule 9(b), requiring that "in all averments of fraud, . . . the circumstances constituting fraud . . . shall be stated with particularity." Fed.R.Civ.P. 9(b). As the Third Circuit Court of Appeals has repeatedly held, "this particularity requirement has been rigorously applied in securities fraud cases." In re Rockefeller Ctr., 311 F.3d at 216, citing In re Burlington, 114 F.3d at 1417. Although Rule 9(b) does not demand that a plaintiff present every material detail of the fraud such as date, location, and time, plaintiffs must use "'alternative means of injecting precision and some measure of substantiation into their allegations of fraud.'" In re Rockefeller Ctr., id., quoting In re Nice Sys. Ltd. Secs. Litig., 135 F. Supp.2d 551, 577 (D. N.J. 2001). The heightened pleading standard of Rule 9(b) "gives defendants notice of the claims against them, provides an increased measure of protection for their reputations, and reduces the number of frivolous suits brought solely to extract settlements." In re Burlington, 114 F.3d at 1418.
At the top of pyramid, the Reform Act adds a further requirement, i.e., that "the complaint shall, with respect to each act or omission alleged to violate this title, . . . state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind." 15 U.S.C. § 78u-4(b)(2). Courts have interpreted this language to mean that while under Rule 9(b) malice, intent, knowledge, and other mental states may be averred generally in suits claiming fraud, the Reform Act requires more than vague or unspecific allegations concerning each defendant's state of mind at the time in question. In re Rockefeller Ctr., 311 F.3d at 224. Heightened particularity also applies to statements which are alleged to have been misleading or false, requiring the plaintiff to state with regard to each such statement "the reason or reasons why the statement is misleading, and, if an allegation regarding the statement or omission is made on information and belief, the complaint shall state with particularity all facts on which that belief is formed." 15 U.S.C. § 78u-4(b)(1). "If a complaint fails to comply with the PSLRA's pleading requirements, dismissal is mandatory." GSC Partners CDO Fund v. Washington, 368 F.3d 228, 237 (3d Cir. 2004), citing 15 U.S.C. § 78u-4(b)(3)(A).
III. APPLICABLE LAW -- COUNT I
A. Count I -- Violation of Section 10(b) of the Securities Exchange Act
In Count I of the Second Amended Complaint, Plaintiffs allege that each Individual Defendant violated Section 10(b) of the 1934 Act. In particular, Plaintiffs allege:
At all relevant times, the Defendants, individually and in concert, directly and indirectly, . . . engaged and participated in a continuous course of conduct whereby they knowingly and/or recklessly made and/or failed to correct public representations which were or had become materially false and misleading regarding [ITG's] financial results and operations. This continuous course of conduct resulted in the Defendants causing [ITG] to publish public statements which they knew, or were reckless in not knowing, were materially false and misleading, in order to artificially inflate the market price of [ITG] stock and which operated as a fraud and deceit upon the members of the Class.
The Individual Defendants are liable as direct participants in and as a controlling persons [sic] of the wrongs complained herein. By virtue of their positions of control and authority as officers and directors of [ITG] the Individual Defendants were able to and did, directly or indirectly, control the content of the aforesaid statements relating to the Company, and/or the failure [sic] to correct those statements in timely fashion once they knew or were reckless in not knowing that those statements were no longer true or accurate. The Individual Defendants caused or controlled the preparation and/or issuance of public statements and the failure to correct such public statements containing misstatements and omissions of material facts as alleged herein. (SAC, ¶¶ 483-484.)
Section 10(b) of the Securities Exchange Act of 1934 makes it unlawful "to use or employ, in connection with the purchase or sale of any security registered on a national securities exchange . . . any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the Commission may prescribe as necessary or appropriate in the public interest or for the protection of investors." 15 U.S.C. § 78j(b). Among the rules and regulations promulgated under Section 10(b), Rule 10b-5 provides:
It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce, or of the mails or of any facility of any national securities exchange,
(a) To employ any device, scheme, or artifice to defraud,. . .
(b) To make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading, or
(c) To engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person, in connection with the purchase or sale of any security.
In a securities fraud action brought pursuant to Section 10(b) and Rule 10b-5, the basic elements to be alleged by a plaintiff are: (1) a material misrepresentation or omission by the defendant; (2) scienter, i.e., a wrongful state of mind on the part of the defendant; (3) in connection with the purchase or sale of a security; (4) reliance, often referred to in fraud-on-the-market cases as "transaction causation;" (5) economic loss; and (6) "loss causation," i.e., a causal connection between the material misrepresentation and the loss. Dura Pharmaceuticals, Inc. v. Broudo, 554 U.S. 336, 125 S.Ct. 1627, 1631 (2005).
Before we address the question of whether the Second Amended Complaint satisfies each of these elements, we digress to consider two bodies of law which pertain to the allegations therein, the fraud-on-the-market doctrine, and legal theories which may provide some protection for statements which might otherwise be actionable as fraudulent misrepresentations or omissions.
Under traditional securities fraud analysis, the plaintiff was required to prove that he purchased or sold securities in reliance on the defendant's misrepresentations, i.e., that he was aware of and directly misled by a specific representation. See Semerenko v. Cendant Corp., 223 F.3d 165, 178 (3d Cir. 2000). In recent years, however, courts have applied a "fraud-on-the-market" doctrine to the sale and purchase of securities traded on an efficient open market*fn6 where face-to-face transactions are rare. See Basic, Inc. v. Levinson, 485 U.S. 224, 241-243 (1988); Semerenko, id. Under this theory, a plaintiff is entitled to three presumptions: (1) the market price of the security incorporated the alleged misrepresentations (or omissions), (2) the plaintiff relied on the market price as an indicator of the security's value, and (3) the plaintiff acted reasonably in relying on the security's market price. Semerenko, 223 F.3d at 179; Basic, Inc., 485 U.S. at 248-249.*fn7 In short, plaintiffs relying on a fraud-on-the-market theory are alleging that the defendants' misleading statements "caused injury, . . . not through the plaintiffs' direct reliance upon them, but by dint of the statements' inflating effect on the market price of the security purchased." Shaw v. Digital Equip. Corp., 82 F.3d 1194, 1218 (1st Cir. 1996). In the Third Circuit, an efficient market is defined as one in which "information important to reasonable investors . . . is immediately incorporated into stock prices." In re Burlington, 114 F.3d at 1425 (citation omitted.)
Here, Plaintiffs allege that the market for ITG securities was efficient because:
* the stock was listed and actively traded on the New York Stock Exchange, a highly efficient market;
* ITG's average trading volume during the Class Period was in excess of 96,000 shares and it had market capitalization during the Class Period in excess of $165 million;
* the Company regularly communicated with public investors via established market communication mechanisms, e.g., press releases, communications with the financial press, and periodic conference calls with securities analysts; and
* securities analysts at major brokerage firms made their reports about ITG widely available to brokerage sales personnel and thence to customers.
Plaintiffs contend that the market for ITG securities promptly absorbed current information about the Company -- including the alleged misrepresentations -- and that the information was reflected in the prices at which the stock traded. Therefore, the fraud-on-the-market theory applies to all purchases of ITG securities by members of the Class during the Class Period. (SAC, ¶ 479.)
Defendants do not dispute Plaintiffs' argument that they are entitled to the presumption of reliance in either their Memorandum of Points and Authorities in Support of Defendants' Motion to Dismiss the Second Amended Class Action Complaint (Docket No. 74, "Defs.' Memo.") or their Reply Memorandum in Support of the Motion to Dismiss the Second Amended Class Action Complaint (Docket No. 88.) Therefore, in the analysis which follows, we do not address the element of reliance, the fourth element recognized in Dura.
C. The Reform Act's Statutory Safe Harbor and Related Protections
Defendants do dispute, however, Plaintiffs' contention that the statutory "safe harbor" provided for forward-looking statements does not apply. Because we discuss the applicability of this doctrine throughout our consideration of the alleged material misrepresentations, we set out the general principles of that doctrine as a threshold matter. Also, we discuss briefly the "bespeaks caution" doctrine and the law related to "puffery."
1. The Statutory Safe Harbor
"Concerned about the effect of litigation's specter on corporate disclosure, Congress created in the PSLRA a safe harbor for forward-looking statements." In re Merck & Co. Sec. Litig., 432 F.3d 261, 272 (3d Cir. 2005), citing S. Rep. No. 104-98, at 16, reprinted in 1995 U.S.C.C.A.N. 679, 695. As defined in the Reform Act, a forward-looking statement (written or oral) is one which contains "a projection of revenues, income (including income loss), earnings (including earnings loss) per share, capital expenditures, dividends, capital structure, or other financial items." See In re Advanta Corp. Sec. Litig., 180 F.3d 525, 536 (3d Cir. 1999), quoting 15 U.S.C. § 78u-5(i)(1)(A). A forward-looking statement may also address "the plans and objectives of management for future operations, including plans or objectives relating to the products or services of the issuer." 15 U.S.C. § 78u-5(i)(1)(B).*fn8 Such statements are said to fall within the "statutory safe harbor" of the Reform Act and are not grounds for liability under Section 10(b). In re Advanta, id. By definition, statements which are not forward looking are not entitled to protection of the statutory safe harbor provision. Also explicitly excluded are any forward-looking statements "included in a financial statement prepared in accordance with generally accepted accounting principles." 15 U.S.C. § 78u-5(b)(2)(A).
In order to fall within the safe harbor, a forward-looking statement must be identified as such and "accompanied by meaningful cautionary statements identifying important factors that could cause actual results to differ materially from those in the forward-looking statement." EP Medsystems, Inc. v. EchoCath, Inc., 235 F.3d 865, 872-873 (3d Cir. 2000), quoting 15 U.S.C. § 78u-5(c)(1)(A)(i). Cautionary language must be "extensive yet specific." In re Trump Casino Sec. Litig., 7 F.3d 357, 369 (3d Cir. 1993) (comparing safe harbor cautionary language to that of the bespeaks caution doctrine discussed below.)
The safe harbor provision does not apply, however, if the statement was made by a natural person (as compared to a business entity) who had "actual knowledge" at the time that the statement was false or misleading. 15 U.S.C. § 78u-5(c)(1)(B)(i). A forward-looking statement made by a business entity is protected unless it was made by or with the approval of an executive officer of that entity who had actual knowledge that the statement was false or misleading. 15 U.S.C. § 78u-5(c)(1)(B)(ii). If a forward-looking statement later proves to be erroneous, there is no duty imposed by the Reform Act to update such a statement. In re Advanta, 180 F.3d at 536; 15 U.S.C.A. § 78u-5(d) ("Nothing in this section shall impose upon any person a duty to update a forward-looking statement.")
In applying the Reform Act safe harbor provision, the court must first look at the statement itself, determine if it is forward-looking, and decide if it is accompanied by adequate cautionary statements or is otherwise immaterial. The second step is to consider whether the plaintiff has adequately alleged that the forward-looking statement, even if accompanied by cautionary language, was made with actual knowledge that the statement was false or misleading. Greebel v. FTP Software, Inc., 194 F.3d 185, 201 (1st Cir. 1999).
2. The "Bespeaks Caution" Doctrine
Enactment of the PSLRA's safe harbor provision did not do away with the judicially created "bespeaks caution" doctrine. EP Medsystems, 235 F.3d at 873. "'[B]espeaks caution' is essentially shorthand for the well-established principle that a statement or omission must be considered in context, so that accompanying statements may render it immaterial as a matter of law." In re Trump Casino, 7 F.3d at 364. The Third Circuit has strictly delineated, however, the type of accompanying language which is sufficient to trigger application of the bespeaks caution doctrine. That language must relate directly to that on which investors claim to have relied. . . . [A] vague or blanket (boilerplate) disclaimer which merely warns the reader that the investment has risks will ordinarily be inadequate to prevent misinformation. To suffice, the cautionary statements must be substantive and tailored to the specific future projections, estimates or opinions . . . which the plaintiffs challenge.
EP Medsystems, 235 F.3d at 873.
Like the safe harbor provision, the bespeaks caution doctrine does not protect forward-looking statements made with actual knowledge of their falsity at the time they are made. In re Trump Casino, 7 F.3d at 368.
A third source of protection for allegedly false or misleading statements is the concept of "puffery." Puffery comes into play when a court is considering the materiality of statements alleged to have been misleading. While materiality determinations are typically reserved for the trier of fact, "complaints alleging securities fraud often contain claims of omissions or misstatements that are obviously so unimportant that courts can rule them immaterial as a matter of law at the pleading stage." In re Burlington, 114 F.3d at 1426.
The Third Circuit has defined puffery as "vague and general statements of optimism . . . understood by reasonable investors as such." In re Advanta, 180 F.3d at 538; In re Burlington, 114 F.3d at 1428, n14. Such "statements of subjective analysis or extrapolations, such as opinions, motives and intentions" or other types of "soft information" are not actionable because investors do not rely on such information in making decisions. In re Advanta, id. at 539; see also Parnes v. Gateway 2000, 122 F.3d 539, 547 (8th Cir. 1997), pointing out that "some statements are so vague and such obvious hyperbole that no reasonable investor would rely upon them."
The context in which optimistic statements are made is critical to the distinction between misrepresentation and puffery. In re Lucent Technologies, Inc. Sec. Litig., CA No. 00-621, 2002 U.S. Dist. LEXIS 11556 at *77 (D. N.J. June 26, 2002). In general, the more the statement diverges from known facts about the entity or the more precise and concrete the statement, the less likely courts have been to dismiss the statement as inactionable puffery. See Southland Sec. Corp. v. INSpire Ins. Solutions Inc., 365 F.3d 353, 372 (5th Cir. 2004).
The source of the comment also plays a role in determining if general statements of optimism are actionable. Statements of opinion by top corporate officials may be actionable if they are made without a reasonable basis. Virginia Bankshares, Inc. v. Sandberg, 501 U.S. 1083, 1099 (1991). The Court distinguished such statements from ordinary, unattributed expressions of optimism because such statements "can be materially significant to investors because investors know that these top officials have knowledge and expertise far exceeding that of the ordinary investor." In re Burlington, 114 F.3d at 1428, citing Virginia Bankshares, 501 U.S. at 1090-1091.
"If a statement meets the definition of mere puffery and hence, is immaterial as a matter of law, it is irrelevant whether the statement is forward-looking or made with actual knowledge that it is false." California Pub. Emples. Ret. Sys. v. Chubb Corp., ("CALPERS"), CA No. 00-4285, 2002 U.S. Dist. LEXIS 27189, *34, n13 (D. N.J. June 26, 2002).
We turn now to analysis of each of the critical Dura elements, scienter and the existence of material misrepresentations which proximately caused Plaintiffs' losses.
Normally, analysis of a securities fraud action would begin with a discussion of the statements alleged to be material misrepresentations or omissions by the defendant. However, we begin with the concept of scienter because we conclude that for the second time, Plaintiffs have failed to allege that all but two of the Individual Defendants acted with the wrongful state of mind necessary to state a claim against them under the Reform Act.
The Third Circuit Court of Appeals defines scienter as a mental state embracing intent to deceive, manipulate or defraud, or, at a minimum, highly unreasonable conduct, involving not merely simple, or even excusable negligence, but an extreme departure from the standards of ordinary care, . . . which presents a danger of misleading buyers or sellers that is either known to the defendant or is so obvious that the actor must have been aware of it.
In re IKON Office Solutions, Inc., 277 F.3d 658, 667 (3d Cir. 2002)(citations and internal quotations omitted).
The PSLRA requires a plaintiff, "with respect to each act or omission," to "state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind." GSC Partners, 368 F.3d at 237, quoting 15 U.S.C. § 78u-4(b)(2). A plaintiff may satisfy the "strong inference" requirement in either of two ways: "(a) by alleging facts sufficient to show that defendants had the motive and opportunity to commit fraud, or (b) by alleging facts that constitute strong circumstantial evidence of conscious misbehavior or recklessness." In re Burlington, 114 F.3d at 1418 (internal quotation omitted). As we have previously pointed out in this case, the facts giving rise to a strong inference of scienter must be alleged with particularity, meaning that plaintiffs must plead "the who, what, where, when, and how: the first paragraph of any newspaper story." (Docket No. 68 at 11, quoting DiLeo v. Ernst & Young, 901 F.2d 624, 627 (7th Cir. 1990).)
The Third Circuit has concluded that to the extent the general pleading permitted with respect to mental state established in Rule 9(b) conflicts with the PSLRA's heightened scienter requirements, the PSLRA "supersedes Rule 9(b) as it relates to Rule 10b-5 actions." In re Advanta, 180 F.3d at 531, n5. The appropriate sanction for complaints which fail to meet the PSLRA scienter requirement is dismissal. Id. at 531.
1. Identifying the Individual Defendants
Because scienter must be determined as to each Individual Defendant, we first briefly outline their roles with ITG. Plaintiffs provide the following information about the ten Individual Defendants who are alleged to have violated Section 10(b). Officers are listed first, followed by members of the Board of Directors.
* Anthony DeLuca: Chief Executive Officer, President, and Director of ITG from 1996 when the Company was taken over by Carlyle until he was forced to resign in November 2001. Had been with ITG in senior management positions since March 1990. (SAC, ¶ 40.) The only Individual Defendant identified in the SAC as being a stockholder in ITG. (Id., ¶ 99.)
* Francis J. Harvey: Replaced Mr. DeLuca as Acting CEO and President in November 2001 upon the latter's termination. Director of ITG from 1999 through 2002; was a member of the Board of Directors' executive committee and the compensation committee. Served on the boards of other companies in which Carlyle had major investments. (SAC, ¶ 42.) Elected Vice Chairman of the Board in May 2001. (Id., ¶ 86.)
* Harry J. Soose: Joined ITG in 1991; became Senior Vice President and Chief Financial Officer as of July 1999 and remained in those positions until ITG declared bankruptcy. (SAC, ¶ 41.)
* Daniel A. D'Aniello: Elected to represent Carlyle on the Board and served as Board Chairman from 1996 through 2002. Had been a managing director of Carlyle since 1987 and served on boards of other companies owned by Carlyle. Member of the executive and compensation committees. (SAC, ¶¶ 45, 79.)
* James C. McGill and Richard W. Pogue: Served as directors during the Class Period; members of the audit review committee. (SAC, ¶¶ 43-44.)
* Martin Gibson and Robert F. Pugliese: Elected by Carlyle to represent its interests on the Board; served as directors throughout the Class Period; members of the audit review committee. (SAC, ¶¶ 47-48.)
* Philip B. Dolan: Represented Carlyle on the Board from 1996 through 2002 and served on the board of one other company affiliated with Carlyle. Was a principal, then managing director, of Carlyle from 1998 through 2002 and a vice president of Carlyle since 1989. Member of the compensation committee. (SAC, ¶ 46.)
* James D. Watkins: Elected to represent Carlyle on the Board from 1996 through 2002 and served on the board of one other company affiliated with Carlyle. Member of the compensation committee. (SAC, ¶ 49.)
2. Motive and Opportunity Method of Satisfying the "Strong Inference" Requirement
In a Complaint comprised of 491 paragraphs and 181 pages, Plaintiffs fail to state whether they are relying on motive and opportunity to establish scienter, on circumstantial evidence, or on a combination of the two. In their Memorandum of Law in Opposition to Defendants' Motion to Dismiss the Second Amended Class Action Complaint (Docket No. 86, "Plfs.' Memo"), Plaintiffs argue that "the distinctive motivational factor in this case" was "prolonging the Company's survival" for two years and that in the SAC, they "clearly allege that IT Group's viability depended on Defendants' scheme to artificially make it appear viable." (Id. at 52-53.)
Under the PSLRA, motive and opportunity must be supported by "facts stated 'with particularity' and those facts must give rise to a 'strong inference' of scienter." In re Advanta, 180 F.3d at 535, quoting 15 U.S.C.A. § 78u-4(b)(2). At least one court has held that the opportunity to commit fraud by controlling dissemination of information to investors may be presumed when the defendants served as the company's senior officers and/or directors. In re Stonepath Group, Inc. Sec. Litig., 397 F. Supp.2d 575, 591 (E.D. Pa. 2005). However, there are no factual allegations*fn9 in the Second Amended Complaint that any Individual Defendant took any particular steps to control the flow of information and neither Defendants nor Plaintiffs address this prong in their briefs. We need not dwell on this question, however, because we conclude that the purported motive -- prolonging the Company's survival -- is insufficient to establish scienter.
In attempting to show scienter from a defendant's motive and opportunity to commit fraud, "motives that are generally possessed by most corporate directors and officers do not suffice; instead, plaintiffs must assert a concrete and personal benefit to the individual defendants resulting from this fraud." GSC Partners, 368 F.3d at 237 (internal quotation omitted.) General motives such as wishing to complete a particular corporate transaction (GSC Partners, id.), the desire to avoid breaching loan covenants or disclosing lack of liquidity (In re Stonepath Group, 397 F. Supp.2d at 592-593), attempting to increase a company's stock value as part of an acquisition strategy (In re Nice Sys., 135 F. Supp.2d at 583-84), or even such personal benefits as increasing one's compensation*fn10 or maintaining continued employment (In re Digital Island Secs. Litig., 357 F.3d 322, 331 (3d Cir. 2004)) are insufficient establish scienter.
Reading the Second Amended Complaint in its entirety, the most one can conclude is that Plaintiffs allege because each Individual Defendant held a position as officer or director, he was therefore motivated to keep the Company afloat. Of course, the goal of every director and officer of a business entity is to assure its longevity and market position, not only for personal motives such as compensation or the prestige of being associated with a successful organization, but also for the more general purposes of attracting investors and achieving the goals of the corporation, including profitability. "Prolonging the company's survival," however, surely falls within those generalized motives which, as Plaintiffs recognize, ...