|
|
|||
WILLIAM F. ALDERMAN (State Bar No. 47381)
JOHN KANBERG (State Bar No. 113156)
TANYA HERRERA (State Bar No. 177790)
ORRICK, HERRINGTON & SUTCLIFFE LLP
Old Federal Reserve Bank Building
400 Sansome Street
San Francisco, CA 94111
Telephone: (415) 392-1122
TOWER C. SNOW, JR. (State Bar No. 58342)
DAVID M. FURBUSH (State Bar No. 83447)
BROBECK, PHLEGER & HARRISON LLP
Spear Street Tower, One Market
San Francisco, CA 94105
Telephone: (415) 442-0900
Attorneys for Defendants
Lynn C. Fritz, John H. Johung,
Dennis L. Pelino, Stephen M.
Mattessich, Carsten S. Andersen
and Fritz Companies, Inc.
UNITED STATES DISTRICT COURT
NORTHERN DISTRICT OF CALIFORNIA
| SUSAN POLK, Trustee for the F. Felix
Polk, a Psychological Corporation Profit Sharing Plan, SAMUEL WEISS, VIC SHACKELFORD, E.M. LAWRENCE LIMITED FROZEN RETIREMENT TRUST dated September 1, 1992, GEORGE LEVENSON, and IRVING ROSENZWEIG, On Behalf of Themselves and All Others Similarly Situated, Plaintiffs, vs. LYNN C. FRITZ, JOHN H. JOHUNG,
Defendants. _____________________________________ In re FRITZ COMPANIES SECURITIES
|
)
) ) ) ) ) ) ) ) ) ) ) ) ) ) ) ) ) ) ) ) ) ) ) ) ) ) |
Master File No. C 96-2712 MHP
DEFENDANTS' MOTION TO
[Fed.R.Civ.Procedure 9(b) and
Date: September 12, 1997
|
II. PLAINTIFFS DO NOT APPROACH THE STANDARDS FOR IDENTIFYING ANY STATEMENT THAT WAS ALLEGEDLY FALSE WHEN MADE
A. Plaintiffs' "Bloated Complaint" Is Facially DefectiveIII. PLAINTIFFS' COMPLAINT REFUTES ANY INFERENCE OF SCIENTERB. Plaintiffs Plead No Facts Establishing That Any Statement By Defendants Was False When Made
1. Plaintiffs Have No Claim Based On the Fully Disclosed, And Never Misrepresented, Challenges Posed By the Intertrans MergerC. Plaintiffs Cannot Pursue A Fraud Claim Based On The Hope That "Evidentiary Support Will Likely Exist"2. The Undisputed "Truth On The Market" Bars Plaintiffs' Hindsight Attack On Fritz's Estimated Merger Expenses And Bad Debt Reserve
3. The Restatement Of Fritz's Estimated Merger Expenses And Bad Debt Reserve Does Not Retrospectively Create An Actionable Misstatement
A. Plaintiffs' "Motive And Opportunity" Allegations Cannot Support A Fraud ClaimIV. CONCLUSION1. Fritz's Alleged "Scheme" To Increase RevenuesB. Plaintiffs' Allegations of Accounting Misstatements Do Not Give Rise To An Inference of Scienter2. Fritz's Cash Acquisitions
3. The Conspicuously Missing Stock Sales
4. Bogus Bonus Plan
C. KPMG's Unqualified Audit and Supportive Management Letters are Fatal to Plaintiffs' Fraud Claims
Acito v. Imcera Group, Inc.,
47 F.3d 47 (2d Cir. 1995)
Adam v. Silicon Valley Bancshares,
1994 WL 619300 (N.D.Cal. Feb. 8, 1994)
In re Apple Computer Sec. Litig.,
886 F.2d 1109 (9th Cir. 1989),
cert. denied, 496 U.S. 943 (1996)
Chill v. General Electric,
101 F.3d 263 (2d Cir. 1996)
In re Cirrus Logic Sec. Litig.,
946 F.Supp. 1446 (N.D. Cal. 1996)
In re Clearly Canadian Sec. Litig.,
875 F.Supp. 1410 (N.D.Cal. 1995)
In re Conner Peripherals, Inc. Sec. Litig.,
[1996 Tr. Binder] Fed. Sec. L. Rep. (CCH)
¶ 99,021 (N.D. Cal. Jan. 18, 1996)
In re Cypress Semiconductor, Inc. Sec. Litig.,
[1992 Tr. Binder] Fed. Sec. L.Rep. (CCH)
¶ 97,060 (N.D. Cal. Sept. 23, 1992)
Ferber v. Travelers Corp.,
785 F.Supp. 1101 (D. Conn. 1991)
In re Glenfed, Inc. Sec. Litig.,
42 F.3d 1541 (9th Cir. 1994)
Glickman v. Alexander & Alexander Services, Inc.,
[1996 Tr. Binder] Fed.Sec.L.Rep. (CCH)
¶ 99,101 (S.D.N.Y. Feb. 29, 1996)
Grossman v. Texas Commerce Bancshares,
[1995 Tr. Binder] Fed.Sec.L.Rep. (CCH),
¶ 98,964 (S.D.N.Y. Sept. 15, 1995)
Hockey v. Medhekar,
[Current Tr. Binder] Fed.Sec.L.Rep. (CCH)
¶ 99,465 (N.D. Cal. Apr. 15, 1997)
Hollinger v. Titan Capital Corp.,
914 F.2d 1564 (9th Cir. 1990)
cert. denied, 499 U.S. 976 (1991)
In re ISSI Sec. Litig., No. 95-CV-4471 (MHP)
Kaplan v. Rose,
49 F.3d 1363 (9th Cir. 1994), cert. denied,
116 S. Ct. 58 (1995)
Lovelace v. Software Spectrum, Inc.,
78 F.3d 1015 (5th Cir. 1996)
Mathews v. Centex Telemanagement, Inc.,
[1994 Tr. Binder] Fed. Sec. L.Rep. (CCH)
¶ 98,440 (N.D. Cal. June 8, 1994)
Myles v. Midcom Communications, Inc.,
No. C96-6140, slip op. (W.D. Wash. Nov. 19, 1996)
Padnes v. Scios Nova, Inc.,
1996 WL 539711 (N.D.Cal. Sept. 8, 1996)
In re Ross Systems Sec. Litig.,
[1994 Tr. Binder] Fed.Sec.L.Rep.
¶ 98,363 (N.D.Cal. July 21, 1994)
San Leandro Emergency Med. Group v. Phillip Morris Co.,
75 F.3d 801 (2d Cir. 1996)
In re Seagate Technology II Sec. Litig.,
[1990 Tr. Binder] Fed.Sec.L.Rep. (CCH)
¶ 95,427 (N.D.Cal. June 19, 1990),
aff'd 98 F.3d 1346 (9th Cir. 1996)
In re Silicon Graphics, Inc. Sec. Litig.,
[Current Tr. Binder] Fed.Sec.L.Rep. (CCH)
¶ 99,468 (N.D. Cal. May 23, 1997)
In re Software Toolworks, Inc. Sec. Litig.,
50 F.3d 615 (9th Cir. 1994),
cert. denied, sub nom.
Montgomery Securities v. Dannenberg,
116 S. Ct. 274 (1995)
Stack v. Lobo,
1995 WL 241448
(N.D.Cal. Apr. 20, 1995)
Thor Power Tool Co. v. Commissioner,
439 U.S. 522 (1979)
Wool v. Tandem Computers, Inc.,
818 F.2d 1433 (9th Cir. 1987)
In re Worlds of Wonder Sec. Litig.,
35 F.3d 1407 (9th Cir. 1994),
cert. denied, 116 S. Ct. 185 (1995) and
cert. denied, 116 S. Ct. 277 (1995)
Zeid v. Kimberly,
No. 96-20136 SW, slip op.
(N.D. Cal. May 5, 1997)
Private Securities Litigation Reform Act of 1995,
15 U.S.C. §§77z-1, et seq.
Section 21D (b)(1)(B)
Section 21D (b)(2)
Section 21D (b)(3)(B)
Section 21E (c)(1)(B)
Qualitative Characteristics of Accounting Information,
Statement of Concepts No. 2 (Fin. Acct. Standards Bd. 1980)
Prior Period Adjustments,
Statement of Standards No. 16
(Fin. Acct. Standards Bd. 1977)
Disclosure of Accounting Policies,
Accounting Principles Board Opinion No. 22 (1972)
TO PLAINTIFFS AND THEIR ATTORNEYS OF RECORD:
PLEASE TAKE NOTICE that at 10:30 a.m. on Friday, September 12,
1997, or as soon thereafter as the matter may be heard in the above-entitled
Courtroom of the Honorable Marilyn Hall Patel, the defendants will and
hereby do move for an Order dismissing the Second Amended Complaint herein
pursuant to the Private Securities Litigation Reform Act of 1995 (the "SRA")
and Federal Rules of Civil Procedure 12(b) and 9(b). The defendants' motion
is based on this Notice of Motion and Supporting Memorandum of Points and
Authorities, the accompanying Declaration of Tanya Herrera ("Herrera Decl.")
and Appendix of Authorities, as well as the pleadings on file herein and
such other matters as may be judicially noticed or come before the Court
at the hearing on this matter.
Instead, plaintiffs simply point to Fritz's voluntary restatement of certain expenses following its May 1995 merger with the Intertrans Company and conclude -- without a glimmer of factual support -- that "Fritz adopted the Intertrans accounting system for much of Fritz's business despite knowing that when combined with Fritz's inadequate internal controls and its decision to terminate many key Intertrans employees, the Intertrans accounting system would not provide accounting information that was sufficiently reliable for Fritz's financial reporting purposes." Compl. ¶ 34. Incredibly, plaintiffs' fraud theory proposes that the core Fritz management team -- which did not sell any stock during the entire 11 month class period -- plotted against its own strategic and economic self-interest.
While the defects in this pleading are obvious and abundant, of greatest significance is the now-apparent reason for this failure:
Not For Lack Of Opportunity. Immediately after Fritz's July 24, 1996 stock price drop, plaintiffs' counsel filed three state securities fraud complaints against these defendants in San Francisco Superior Court. Those actions were dismissed with prejudice, by two different judges, on defendants' initial demurrers.1/ Plaintiffs have since twice amended their pleading in this Court. As this Court has previously noted, "[s]ince the complaints herein are drafted by experienced counsel who have had ample opportunity and instruction to amend," it is clear that the defects in plaintiffs' Second Amended Complaint cannot be cured. In re Seagate Technology II Sec. Litig., [1990 Tr. Binder] Fed.Sec.L.Rep. (CCH) ¶ 95,427 at 97,159 n. 1 (N.D.Cal. June 19, 1990) (dismissing fraud allegations without leave to amend), aff'd 98 F.3d 1346 (9th Cir. 1996).
Certainly Not For Lack Of Discovery. By first filing their securities fraud claims in state court, and thereby circumventing the discovery stay of SRA § 21D (b)(3)(B), plaintiffs have obtained thousands of documents from Fritz's outside auditors, KPMG Peat Marwick ("KPMG"), as well as several securities analysts and the Company's bankers. Ironically, while plaintiffs' most recent amendment was intended to incorporate the fruits of this discovery, the KPMG documents that are referenced in their Second Amended Complaint now preclude any inference of wrongdoing. Mathews v. Centex Telemanagement, Inc., [1994 Tr. Binder] Fed. Sec. L.Rep. (CCH) ¶ 98,440 at 91,038 (N.D. Cal. June 8, 1994) (rejecting scienter allegations where "defendants also conferred with and relied in good faith on their outside auditors"). Thus, while plaintiffs have obtained discovery to which they were not entitled in this Court, they still have not approached this Court's standards for pleading fraud.
Surely Not For Lack Of Guidance. This Court and numerous others have made clear the requirements for identifying alleged misstatements, for supporting an inference of fraud, and for establishing "motive and opportunity." It is no mystery that plaintiffs cannot, as they have attempted here, simply rely on later events to support the claimed falsity of earlier statements: "Instead, a plaintiff must set forth not only why a given statement was false or misleading, but why it was false or misleading when made." Padnes v. Scios Nova, Inc., 1996 WL 539711*4 (N.D.Cal. Sept. 8, 1996). In the absence of specific factual allegations establishing a misstatement and a strong inference of scienter, "the court can only conclude that plaintiffs' allegations are based purely on speculation and conclusions drawn from hindsight." Zeid v. Kimberly, No. 96-20136 SW, slip op. at 23 (N.D.Cal. May 5, 1997).
It is now inescapable that there is a single, irrefutable explanation for why experienced counsel with every opportunity and procedural advantage have nonetheless profoundly failed to state any section 10(b) claim: this simply is not a fraud case.
In May 1995, pursuant to the Fritz Companies, Inc. and Intertrans Corporation Joint Merger Proxy and Prospectus (the "Proxy") (Herrera Decl. Ex. B and Compl. ¶ 34), Fritz merged with the Texas-based Intertrans Company. Because the newly-combined Company then changed to a May 31 fiscal year-end (from a calendar year), Fritz issued a Form 10-K for the January-May, 1995 five month "transition period" (Herrera Decl. Ex. C and Compl. ¶ 44). This Form 10-K, which was filed August 28, 1995 and begins the alleged class period, included a charge for merger-related expenses of nearly $30 million. The Proxy made clear that this expense "may be increased" and could not be finally determined "until the operational and transition plans are completed." Proxy p. 22.
Fritz's financial statements for the transition period were the subject of an unqualified audit by KPMG. All the financial reporting that is now at issue was first scrutinized by the Fritz audit committee, comprised of two esteemed bank regulators: outside directors and non-defendants James Gilleran (former Superintendent of the California State Banking Department) and Preston Martin (former Vice Chairman of the Board of Governors of the Federal Reserve Board). Throughout the class period, and with respect to the many complex accounting issues raised by an international merger, the Company consulted with its independent auditors. Indeed, the KPMG work papers addressing the issues of merger expense, bad debt reserve and accounting controls have all been produced to plaintiffs.
On July 24, 1996, Fritz reported that it was restating its expenses
for the third quarter (ending February 28 and originally reported April
2, 1996) and would take additional merger and charges totalling $11 million.
The Company announced that "we underestimated final costs related to the
full integration of our two companies" and that "[w]e also erred in adopting
the Intertrans accounting system, as it has proven inadequate, especially
given our rapid growth." (Herrera Decl. Ex. D and Compl. ¶ 77). Within
a week, plaintiffs' counsel herein filed five state and federal complaints
alleging securities fraud. The present Second Amended Complaint is the
last that remains.
"Plaintiffs were required to explain why the statement or omission complained of was false or misleading when made. Glenfed, 42 F.3d at 1549. In addition, the time, place and nature of the allegedly fraudulent activities must have been pleaded with specificity. Kaplan v. Rose, 49 F.3d 1363, 1370 (9th Cir. 1994), cert. denied, 116 S. Ct. 58 (1995) (citing Wool v. Tandem Computers, Inc., 818 F.2d 1433, 1439 (9th Cir. 1987))."Id. Acknowledging that these requirements impose a formidable burden on class action securities plaintiffs -- especially in the absence of discovery -- this Court nonetheless concluded that it could not ignore "the clear mandate of the SRA and pre-Reform Act Ninth Circuit case law which requires that plaintiffs plead facts specifying why a particular statement was false and misleading when made. SRA § 21D (b)(1)(B); Glenfed, 42 F.3d at 1448-49." Id. at 97,081-82. In this case, plaintiffs' twice-amended complaint fails every meaningful pleading test. Most of plaintiffs' allegations simply recite unchallenged corporate announcements or non-actionable statements outside the class period. None of these allegations attempts to explain -- notwithstanding plaintiffs' access to KPMG's documents -- why accounting estimates of merger and bad debt expenses were "untrue or misleading when made." Glenfed, 42 F.3d at 1549 (emphasis original). Moreover, as this Court and others have recently ruled, plaintiffs cannot proceed with any federal securities class action when the "Basis of Allegations" for all claimed wrongdoing is simply the "belie[f] that after reasonable opportunity for discovery, substantial evidentiary support will likely exist. . . " Compl. ¶ 125; see Alliance at 97,081.2/
Even with respect to plaintiffs' alleged "misstatements" during the class period, the vast majority are no more than cursory references to Fritz press releases announcing the acquisition of local freight-forwarding operations. See Compl. ¶¶ 46, 47, 48, 49, 57, 58, 59, 60, 66, 71, 74 (Herrera Decl. Ex. E). As to each of these innocuous announcements, plaintiffs repeat the same boilerplate allegations:
¶ 52. An October 2, 1995 announcement by the Fritz Board of a 2-for-1 stock split.Plaintiffs do not attempt to identify how any of these statements could possibly constitute an actionable misrepresentation attributable to any defendant5/. Thus, before it is possible to apply the Glenfed or Securities Reform Act pleading standards to this Complaint, virtually all of its "fraud" allegations simply evaporate. Because this Court has repeatedly warned that such complaints "are an unwelcome and wholly unnecessary strain on defendants and on the court system," Conner at 94,000 (quoting Glenfed, 42 F.3d at 1554), plaintiffs' insistence on proceeding with these facially defective allegations can only be viewed as a concession of their inability to plead any actionable fraud claim.¶ 53. An October 3, 1990, San Francisco Chronicle article concerning Fritz's success, without attribution to any defendant.
¶ 72. A May 7, 1996, Los Angeles Times article listing Fritz among its "Best Performing Companies in California."4/.
¶ 73. A May 9, 1996 unattributed report concerning a private placement by Fritz.
¶ 76. A May 24, 1996 press release announcing the resignation of Carsten Andersen from the Fritz Board.
The Ninth Circuit mandates that plaintiffs plead contemporaneous facts
or other evidence that could establish an actionable misrepresentation.
Far from meeting this standard, plaintiffs resort to a laundry list of
conclusory allegations that "[t]he Intertrans accounting system was not
integrated", "Fritz failed to adequately reserve for material amounts of
uncollectible accounts receivable", and "Fritz's one-time acquisition charges
of $29.995 million materially understated merger costs (including what
it would cost Fritz to integrate Intertrans into its operations)." Although
this failure is hardly surprising -- considering that the contemporaneous
KPMG work papers establish that every accounting judgment was well-founded
and supported by independent auditors -- it is fatal to these purported
fraud claims.
To the contrary, at the time of the Intertrans merger Fritz unequivocally warned its shareholders of the significant challenges presented by this business combination. In the Fritz-Intertrans Joint Proxy, the Company cautioned that the merger would "present difficult challenges" and that "the combined companies will be more complex and diverse than either Fritz or Intertrans individually". Proxy p. 22 ("Risk Factor" discussion of "Uncertainty as to Future Financial Results"). Indeed, Fritz apprised the market that "the combined companies will need to successfully integrate and streamline existing functions," and that "there can be no assurance that integration will be accomplished smoothly or successfully." Id.
Plaintiffs clearly cannot base a fraud claim on Fritz's "failure to
effectively accomplish the integration of the two companies' operations"
when the Company used these very words in its Proxy to warn of the potential
adverse impact of the Intertrans merger. Id. Nor can plaintiffs
plead a fraud claim that is unsupported by factual allegations establishing
how or why Fritz's estimates of its merger expenses and debt reserves were
"false" when made. As another Northern District court recently held in
rejecting similar fraud claims based upon alleged misstated merger charges
and understated debt reserves, "plaintiffs do not allege any facts showing
that [defendant's] decision to set its reserve for doubtful accounts at
a certain level was not a permissible business judgment." Stack v. Lobo,
1995 WL 241448*4 (N.D.Cal. Apr. 20, 1995).
To the contrary, Fritz's publicly-filed documents establish that the market was well aware that the initial $30 million estimate of Fritz's merger expenses was preliminary and subject to change. The Proxy Statement sent to all Fritz and Intertrans shareholders warned that "it will not be feasible to determine the actual amount of the [merger] charge until the operational and transition plans are completed." See Proxy p. 22 ("Risk Factor" discussion of "Merger Expenses"). Fritz expressly cautioned that the initial calculation of this merger charge "may be increased by unanticipated additional expenses incurred in connection with the Merger," and that "there can be no assurance that Fritz will not incur additional charges in subsequent quarters to reflect costs associated with the Merger." Id. Thus, while plaintiffs now claim that shareholders were misled by a "material understate[ment of] merger costs (including what it would cost Fritz to integrate Intertrans into its operations)," Compl. ¶ 45(e), investors clearly expected that the costs of integrating Intertrans could increase over time.8/
Moreover, the KPMG Management Letter, which followed its unqualified audit of Fritz's financial statements for the transition period, specifically recognized that the Intertrans merger costs and the Company's allowance for bad debt were inherently "accounting estimates":
"Accounting estimates are an integral part of the financial statements prepared by management and are based upon management's current judgments. Certain accounting estimates are particularly sensitive because of their significance to the financial statements and because of the possibility that the future events affecting them may differ markedly from management's current judgments. Following is a summary of significant accounting estimates made in preparation of the 1995 consolidated financial statements:(Herrera Decl. Ex. G and Compl. ¶ 91).In connection with the acquisition of Intertrans Corporation on May 30, 1995, the Company recorded expenses of $3.3 million for transaction costs and $26.7 for other related costs, including: costs of combining operations, costs of eliminating duplicate management information systems and facilities, severance and outplacement of 182 terminated employees, cancellation of certain contractual obligations, write-off of certain aged receivables and other related costs.
The allowance for doubtful accounts represents management's estimate of the accounts receivable that will not be collectible. The level of reserves is based upon management's analysis of the Company's past collection history as well as their consideration of future expected collections and other specific factors."
With full access to the KPMG work papers, plaintiffs have not challenged
the fact that Fritz's revision of these initial "accounting estimates"
was caused by precisely the forewarned "future events." As discussed below,
a restatement does not (as a matter of law or logic) establish that these
original estimates were "false when made"; it simply confirms that a company's
projected merger expenses and bad debt reserves are inherently estimates
that are subject to change. Because plaintiffs do not attempt to establish
that these projections (1) were not actually believed, (2) lacked any reasonable
basis, or (3) were contradicted by undisclosed facts that seriously undermined
their accuracy, In re Apple Computer Sec. Litig., 886 F.2d 1109,
1113-14 (9th Cir. 1989), cert. denied, 496 U.S. 943 (1996), they
cannot serve as the basis for a federal securities fraud claim. See
also Mathews at 91,033 ("Reserves for bad debts are essentially predictions
about the future. The fact that a future prediction turns out to be wrong
does not mean it was fraudulent when made").
In Glenfed, the Ninth Circuit specifically recognized that accounting judgments, such as "the valuation of assets and the setting of loan loss reserves[,] are based on flexible accounting concepts [that] do not always (or perhaps ever) yield a single correct figure." Glenfed, 42 F.3d at 1549:
"In order to allege the circumstances constituting fraud, plaintiff must set forth facts explaining why the difference between the earlier and the later statements is not merely the difference between two permissible judgments, but rather the result of a falsehood."Id. Because there is inherently a range of permissible accounting judgments (particularly with respect to projected reserves and estimated expenses), the Glenfed court expressly rejected plaintiffs' theory that "later corrective actions on the part of the defendants" establish that a prior accounting judgment was "false" when made. Id. at 1540-41.9/
In this case, Fritz specifically warned that the "actual amount of the merger charge" could not be pre-determined and "may be increased" by events in subsequent quarters. It is undisputed that these unforeseen events included 200 more personnel terminations than were originally planned, see July 24, 1996 Press Release (Herrera Decl. Ex. D and Compl. ¶ 77) -- many of which involved overseas agents responsible for collecting money that was owed to the Company -- which adversely affected both the costs associated with the merger and Fritz's ability to collect its receivables. Revealingly, plaintiffs not only fail to challenge the bases for these original accounting estimates, they cannot allege that the Company's independent auditors disagreed with any financial judgment.10/
When faced with strikingly similar allegations of accounting fraud, trial courts implementing Glenfed have rejected plaintiffs' fallacious presumption based on a voluntary restatement. In Myles v. Midcom Communications, Inc., slip op., No. C96-614D (W.D. Wash. Nov. 19, 1996), plaintiffs alleged that "a central part of Midcom's expansion plan was an efficient, reliable, state-of-the-art accounting system." Id. at 2. Just as in the present case, plaintiffs summarily alleged that this accounting system was known to have "significant problems" and "would require a high level of employee support at a time when defendants were planning to reduce the number of Midcom employees." Id. Ultimately, due to revenue recognition errors made by its accounting system, Midcom was forced to restate its earnings for a quarter, which precipitated a 42% one-day stock price drop. Id. at 3.
In response to plaintiffs' fraud allegations attacking the original revenue report, the Midcom court concluded that the company's subsequent restatement of its earnings was "irrelevant" to the issue of whether the initial statement was actionable:
"[I]n order to adequately plead securities fraud, plaintiff must plead facts showing that the statements were known to be false when made; showing that statements were later corrected is inadequate. See, In re Glenfed, Inc. Securities Litig., 42 F.3d 1541, 1553 (9th Cir. 1994)."Id. at 18. Numerous other courts have similarly emphasized that "while plaintiffs may be correct as a matter of hindsight -- those differences of opinion do not rise to the level of misstatements." Mathews at 91,037; see also Lovelace v. Software Spectrum, 78 F.3d 1015, 1019 (5th Cir. 1996) ("A corporation does not admit that previous SEC filings are misleading every time that it amends or updates language in new filings"). Because the present Complaint contains no facts establishing that Fritz's accounting judgments were false when made, "plaintiffs' allegations are baldly conclusory and thus clearly insufficient" under Ninth Circuit law. Stack v. Lobo, 1995 WL 21448*4.
"[b]elief that after reasonable opportunity for discovery, substantial evidentiary support will likely exist for the[se] allegations. . . ."In response to a virtually identical allegation that "support will likely exist" for claims of fraud, this Court recently ruled that "something more than the current bases for allegations in Complaint ¶ 69 [the corresponding "Basis for Allegations" recital] are needed in order for them to have a viable action." Alliance at 97,084 n. 13. The problems with this non-allegation were addressed by the Court at the hearing during which the Alliance complaint was dismissed:
"Paragraph 69 is sort of like a Red Flag: `We ain't got nothing and we're not going to tell you until we get something', you know, 'then we'll have, after discovery we'll have a basis for it.'Alliance, Transcript of April 11, 1997 Hearing, p. 19 (Herrera Decl. Ex. I).The Court requires, given the tough standards now and the mandate under the Private Securities Litigation Reform Act, that you state the basis for it and where it came from. I mean, otherwise [it's] just information and belief and it doesn't tell us much, and anybody could file one of these."
This conclusion that securities plaintiffs cannot "hold back" the basis for their fraud allegations was reiterated by the Silicon Graphics court. In analyzing a comparable "Basis for Allegations" disclaimer, Judge Smith recognized that "because the sources set forth [including the investigation of counsel and discussions with consultants] do not provide plaintiffs with personal knowledge, the complaint must be based on information and belief -- that is the only alternative. See Wool, 818 F.2d at 1439." Silicon Graphics at 97,130. The SRA now requires that all such information and belief allegations must further "state with particularity all facts upon which that belief is formed." Id.; SRA § 21D(b)(1)(B).
In her ruling, Judge Smith specifically referenced the Congressional
debate on this provision, which highlighted the impact of the proposed
"state all facts" pleading requirement. See, e.g., 141 Cong. Rec.
H2849 (March 8, 1995)(Statement of Rep. Dingell)("You must literally, in
your pleadings, include the names of confidential informants, employees,
competitors, government employees, members of the media, and others who
have provided information leading to the filing of the case."); Silicon
Graphics at 97,131. Because Congress specifically rejected amendments
that would have lowered this pleading standard, Judge Smith properly concluded
that the rule enacted by Congress must now govern. In this case, plaintiffs'
misplaced hope that evidence "will likely exist" -- and their failure to
"state the basis for [allegations of fraud] and where it came from" --
is a further factor that compels dismissal of the present Complaint.
In this case, however, plaintiffs have not only improperly relied upon
"broad allegations that apply to virtually any company," Zeid, slip
op. at 30, they also have inadvertently refuted any "strong inference"
of scienter. The fact that Fritz's management team sold no stock during
the class period betrays the absurdity of plaintiffs' fraud theory that
these defendants first (a) warned of the uncertainty inherent in estimating
the costs of a complex merger, then (b) received assurance from their auditors
that their accounting methodology and internal controls were sound, but
nonetheless (c) intentionally adopted an unreliable accounting statement
that would misstate costs and revenues, and thereby (d) inflicted upon
themselves significant losses in the value of their controlling stock interests.
As Judge Whyte observed when facing similar fraud allegations, "[i]nferences
that people acted in an economically irrational manner should not be indulged
without some explanation." Adam v. Silicon Valley Bancshares, 1994
WL 619300*3 (N.D.Cal. Feb. 8, 1994). Plaintiffs have offered none.
As this Court recently ruled, only insider trading "in suspicious amounts or at suspicious times is probative of bad faith and scienter." Alliance at 97,083, quoting In re Apple Sec. Litig., 886 F.2d 1109, 1117 (9th Cir. 1989). In Alliance, notwithstanding the fact that all five of the individual defendants sold very significant holdings -- totalling more than half a million shares at the stock's historic high price for proceeds in excess of $31 million -- this Court concluded that "[t]he trading here does not raise an inference of recklessness". Alliance at 97,083. In the present case, plaintiffs concede that all of Andersen's trading occurred during a two-day period, January 22-23, 1996, just after the company's announcement of its second quarter results, Compl. ¶¶ 62-63, and in the middle of Fritz's third quarter, i.e., precisely the "trading window" that refutes any inference of wrongful conduct. Furthermore, the stock selling of a single individual (particularly one with a disproportionately short tenure at the Company) cannot create a motive as to the core Fritz management team. See San Leandro Emergency Med. Group v. Phillip Morris Co., 75 F.3d 801, 814 (2d Cir. 1996) ("the fact that other defendants did not sell their shares . . . undermines plaintiffs' claims regarding motive").15/
Ironically, the genuine significance of plaintiffs' "motive" allegations
is that they flatly refute any possible inference of scienter. Lynn
Fritz is alleged to have owned over 39% of the outstanding stock of the
Fritz Companies. Plaintiffs claim that Fritz, acting with scienter, forced
the Company to adopt an accounting system that he knew could not provide
reliable financial information. Incredibly, plaintiffs then conclude that
Fritz (and the entire management team) knowingly miscalculated certain
expenses -- and then voluntarily restated these expenses -- to their own
great personal detriment and without selling a single share of stock
during the entire 11 month class period. Compl. ¶ 34. In short,
plaintiffs' fraud theory necessarily presumes that the defendants acted
irrationally and, by definition, without motive. See In re Cypress
Semiconductor, Inc. Sec. Litig., [1992 Tr. Binder] Fed. Sec. L.Rep.
(CCH) ¶ 97,060 at 94,697 (N.D. Cal. Sept. 23, 1992)(non-sale of stock
undermines any inference of scienter).
For example, the Ninth Circuit has emphasized that "[t]he mere publication of inaccurate accounting figures, or a failure to follow GAAP, without more, does not establish scienter." In re Software Toolworks, Inc. Sec. Litig., 50 F.3d 615, 627 (9th Cir. 1994), cert. denied, 116 U.S. 274 (1995). Even with respect to section 10(b) claims against auditors, it is clear that an incorrect resolution of accounting issues "is not sufficient to establish scienter." In re Worlds of Wonder Sec. Litig., 35 F.3d 1407, 1426 (9th Cir. 1994). Because the law of this circuit has never permitted fraud claims based upon a mere "misapplication of accounting principles," Software Toolworks, 50 F. 3d at 628, plaintiffs cannot now raise a strong inference of scienter under the SRA simply by pointing to Fritz's voluntary restatement.
In other circuits as well, it is widely recognized that "[a]llegations of a violation of GAAP provisions . . . without corresponding fraudulent intent are not sufficient to state a securities fraud claim." Chill v. General Electric Co., 101 F.3d at 265. In Chill, plaintiffs claimed fraud after the corporate defendant announced it was taking a $350 million charge to its first quarter 1994 earnings to adjust for previously recorded false profits. The Second Circuit rejected this claim, concluding that a restatement did not give rise to a strong inference of scienter or recklessness. Id. at 266; accord Glickman v. Alexander & Alexander Services, Inc. at 94,641 (granting motion to dismiss with prejudice and holding that a restatement of almost $30 million in revenues "does not raise a strong inference of fraud").
Likewise, in Lovelace v. Software Spectrum, Inc., 78 F.3d at
1019, the defendant's outside auditors insisted that it restate its financial
statements to reduce its reported earnings. Ignoring its accountant's warnings
that the company's financial statements violated GAAP, the corporate defendant
simply fired its auditors. Based on this conscious decision to reject the
accounting judgment of its own auditors, a plaintiff class soon alleged
accounting fraud. The Fifth Circuit rejected these allegations, noting
that GAAP is "a term of art encompassing a wide range of acceptable procedures."
Id. at 1019. Rather than simply second-guess an accounting judgment,
plaintiffs had to establish that defendants knew they were "publishing
materially false information, or . . . [were] severely reckless in publishing
such information." Id. at 1020. In this case, of course, plaintiffs
can never premise a fraud claim on the very accounting judgments that were
endorsed by Fritz's outside auditors.
As a threshold matter, Fritz's August 28, 1995 financial statements for the transition period were the subject of an unqualified audit by KPMG. Thus, after a full audit performed in accordance with generally accepted auditing standards, which involved "examining evidence supporting the comments and disclosures in the financial statements," KPMG concluded that the Fritz financial statements fairly presented the Company's financial position in accordance with GAAP. Form 10-K at F-19. Although plaintiffs have excerpted portions of the commentary accompanying the KPMG Management Letter (and neglected to inform the Court that this commentary was provided solely to suggest ideas for further improvement), they have ignored the dispositive fact that KPMG concluded that there were "no matters involving the internal control structure and its operation that we consider to be material weaknesses." Management Letter p. 1; see also November 1, 1995 Letter to Fritz's Audit Committee at 3: "We propose no material corrections of the financial statements."
While plaintiffs have opened the door to this Court's consideration of the KPMG documents that were produced in discovery during their short-lived state court litigation, and which have implicitly been relied upon in the Complaint, these documents are the death knell for plaintiffs' fraud claims. For example, plaintiffs assert that "in connection with Peat's 1996 audit and in April 1997, Fritz was required to record millions of dollars of internal bad debt reserves . . ." Compl. ¶ 93; see also ¶ 100 (claiming that KPMG "insist[ed] on restatement).16/ But it is undeniable that the KPMG work papers "in connection with Peat's 1996 audit" have been provided to plaintiffs and these documents refute plaintiffs' allegation. Because plaintiffs cannot -- consistent with their Rule 11 obligations -- deny the fact that KPMG supported the very accounting judgments that are now challenged, they cannot premise an inference of fraud on the misrepresentation that KPMG "insisted on restatement."
Likewise, plaintiffs cannot claim that "Fritz management was aware of
the Company's inadequate internal accounting and control systems," Compl.
¶ 91, when the KPMG work papers included an analysis of these controls
that gave the highest "supportive" evaluation to Fritz's systems and concluded
that "the information system at the Company is capable of producing timely
and adequate reports." ("Control Overview Document" at p. 9, Herrera Decl.
Ex. J). Likewise, while plaintiffs rely on a conclusory allegation that
Fritz knowingly mischaracterized unidentified bad debt as merger expenses,
the auditor's September 3, 1996 analysis of "overall reasonableness of
merger expenses" concluded that "[KPMG] agrees with the client classification
as merger and related expenses." ("Restructuring Memo" at p. 8, Herrera
Decl. Ex. J). Because the KPMG documents flatly contradict plaintiffs'
unsupported assertion that the auditors "required" a restatement "in connection
with [their] 1996 audit," plaintiffs cannot transform Fritz's candid reevaluation
of its third quarter expenses into a "scheme to defraud." Mathews
at 91,038 (reliance on outside auditors negates inference of scienter).
Dated: July 2, 1997
| WILLIAM F. ALDERMAN
JOHN KANBERG TANYA HERRERA ORRICK, HERRINGTON & SUTCLIFFE LLP /s/
|
1/ In opposing defendants'
motion to stay these state court actions, the same plaintiff class recognized
that section 10(b)'s scienter requirements, inter alia, rendered
those now-dismissed claims "the more favorable state law causes of action."
Plaintiffs' Mem. in Opp. to Motion to Stay, filed Sept. 26, 1996, at p.
8, Levenson, et al. v. Fritz, S.F. Sup. Ct. No. 979971 (Herrera
Decl. Ex. A).
2/ In light of the
unanimous rulings in Alliance, ¶ 99,465 at 97078-79, In
re Silicon Graphics, Inc. Sec. Litig., [Current Tr. Binder] Fed. Sec.
L. Rep. (CCH) ¶ 99,468 at 97,123 (N.D. Cal. May 23, 1997) and Zeid
v. Kimberly, No. 96-20136 SW, slip op. at 7 (N.D. Cal. May 5,
1997), plaintiffs have presumably abandoned their contention that the SRA
does not apply to the present action, which was initiated in July, 1996.
But see Compl. ¶ 34.
3/ Indeed, in In
re ISSI Sec. Litig., No. 95-CV-4471 (MHP) (N.D. Cal. March 29, 1996),
Conner Peripherals, supra, and Alliance, supra, this
Court provided plaintiffs a roadmap for charting comprehensible factual
assertions and contemporaneous fact that might support a fraud claim. Plaintiffs
have chosen to ignore this guidance.
4/ Not surprisingly,
given the history of abuse that led to enactment of the Securities Reform
Act, most of the public companies identified in the cited article as having
delivered greatest value to their shareholders ("best Performing Companies
in California", Herrera Decl. Ex. E) have also previously been accused
by plaintiffs, following some business reversal, of scheming to defraud
their shareholders. See, e.g., Cisco Systems, Oracle Corp., Cadence
Design, Seagate Technology, Sun Microsystems, Informix (all defendants
in securities class actions, and all listed even higher than Fritz in providing
shareholder return).
5/ Similarly, plaintiffs offer no suggestion as to how the following excerpts from Fritz's August 1995 Form 10-K (Compl. ¶ 44 and Herrera Decl. Ex. C) might support any fraud claim:
A key component of the company's integrated logistics program is its information systems, in which the company has invested substantial management and financial resources.As the Ninth Circuit observed, "[t]he statements are identified and their falseness is alleged, but the reasons for their falsity are not set forth." Glenfed, 42 F.3d at 1552.* * *
The company believes it is a leader in information processing for integrated transportation logistics and that maintaining and strengthening such leadership position will be critical to its continued success. Since 1971, the Company has invested substantial management and financial resources in the development of its information systems.
* * *
In late 1991, the Company introduced the first module of Fritz Logistics Expediting System (FLEX), and advanced information system designed to manage, process and tract international freight transactions. FLEX is an ongoing information research and development project of the Company, and the Company believes that it is the most comprehensive source of information for importers and exporters worldwide for managing the logistics of their global sourcing and distribution activities.
* * *
On May 30, 1995, the Company merged with Intertrans Corporation )(Intertrans); a provider of international air freight and ocean freight forwarding, custom brokerage, and other consulting and transportation services.
6/ Those reports
include: (a) Fritz's August 28, 1995 Form 10-K for the five month "transition
period" ended May 31, 1995, during which Fritz merged with Intertrans and
switched to a May 31 fiscal year-end, see Compl. ¶¶ 44-45
and> Herrera Decl. Ex. C; (b) Fritz's October 1995 press release
and 10-Q Report for its 1st Quarter ended August 31, see Compl.
¶¶ 51, 54-58 and Herrera Decl. Exs. E. and F; (c) Fritz's
January 1996 press release and 10-Q Report for the 2d Quarter ended November
30, 1995, see Compl. ¶¶ 62-64 and Herrera Decl.
Exs. E and F; and (d) Fritz's April 1996 press release and 10-Q Report
for the 3d Quarter ended February 29, 1996. See Compl. ¶¶
68-70 and Herrera Decl. Exs. E and F.
7/ For the same
reasons, plaintiffs cannot premise any claim on the alleged omission of
a disclosure that "Fritz's program to grow revenues to over #1 billion
by rapid fire acquisitions had and would continue to adversely impact Fritz's
margins and freight yields." See, e.g., Compl. ¶¶ 54(k),
66(k), 70(l). The Complaint is not only devoid of allegations as to the
existence (much less announcement) of any such revenue "program," it fails
to suggest any facts that could possibly have given rise to a duty on the
part of Fritz to announce that its business strategy "had and would continue"
to fail.
8/ In fact, as plaintiffs
acknowledge, when Fritz first announced that it planned to take a charge
in the range of $25-28 million in connection with its merger expenses,
it publicly characterized this figure as "relatively low." Compl. ¶
37. In light of the Company's simultaneous warning that this figure was
subject to revision, the subsequent announcement of additional merger expenses
were obviously forewarned.
9/ This range of permissible judgments under the governing accounting standards is further reflected in FASB Statement of Concepts No. 2:
"Those who are unfamiliar with the nature of accounting are often surprised at the number of choices that accountants are required to make. Yet choices arise at every turn. . . There are some who seem to harbor the hope that somewhere waiting to be discovered there is a comprehensive scoring system that can provide the universal criterion for making accounting choices. Unfortunately, neither the Board nor anyone else has such a system at the present time, and there is little probability that one will be forthcoming in the foreseeable future."Qualitative Characteristics of Accounting Information, Statement of Concepts No. 2, ¶¶ 8, 10 (Fin. Acct. Standards Bd. 1980) (Herrera Decl. Ex. H).
10/ FASB Statement
of Concepts No. 16 (upon which plaintiffs selectively rely) further betrays
their elliptical argument that a restatement "confirms" an accounting irregularity.
Compl ¶ 100. In reality, FASB specifically distinguishes between accounting
"mistakes" and "[i]n contrast, a change in accounting estimates [which]
results from new information or improved judgment. Thus an error is distinguishable
from a change in estimate." Prior Period Adjustments, Statement of Standards
No. 16, ¶ 41 (Fin. Acct. Standards Bd. 1977) (Herrera Decl. Ex. H).
11/ Under the Save
Harbor provisions of the Reform Act, section 10(b) claims based upon "forward-looking
statements" require proof of the defendant's actual knowledge that the
statement was false or misleading. SRA § 21E (c)(1)(B). In this case,
plaintiffs allege a series of "failed forecasts": the alleged failure to
warn that "the Intertrans Accounting system would not be integrated,"
Compl. ¶ 45(a); that Fritz's initial acquisition charge "materially
understated merger costs (including what it would cost Fritz to integrate
Intertrans into its operations)," id. ¶ 45(e); and that Fritz
"failed to include at least $4.7 million in necessary bad debt reserves."
Id. ¶ 45(f). Plaintiffs do not challenged the observation in
KPMG's Management Letter that the reporting of these merger costs and debt
reserves inherently reflected "accounting estimates" that were subject
to "future events affecting them [that] may differ markedly from management's
[original] judgment." (Herrera Decl. Ex. G). As mentioned above, however,
the present motion to dismiss does not depend upon which of these states
of mid requirement(s) governs plaintiffs' fraud allegations. While their
Complaint offers no facts to support a knowing misrepresentation on the
part of any defendant, it also fails to suggest facts that could support
a strong inference of recklessness. Because plaintiffs do not -- and cannot
-- satisfy any formulation of the scienter pleading test, this motion will
assume, arguendo, the recklessness standard of Hollinger v. Titan
Capital Corp., 914 F.2d 1564, 1569 (9th Cir. 1990) (en banc),
cert. denied, 499 U.S. 976 (1991)(requiring "not mere simple or
even inexcusable negligence," but rather an "extreme departure" that presents
a danger of deception that is "either known to the defendant or so obvious
that the actors must have been aware of it").
12/ Indeed, in
this case it is undisputed that following the class period and the restatement
of Fritz's expenses, the Company still reported unchallenged revenues in
excess of $1 billion for fiscal 1996. Thus, plaintiffs' attempt to transform
a public company's essential survival instinct into a "strong inference"
of wrongdoing is unsupported by both the facts and the law.
13/ Moreover, the
fact that Fritz has made more than 40 acquisitions of local providers throughout
the world since 1990 only underscores the complexity of the Company's integration
efforts and accounting judgments. As the Midcom court observed under
similar circumstances, "if the allegations about [the company's accounting
system] are true -- i.e., that the system was flawed -- then this
suggests an innocent explanation for the accounting errors." Midcom,
slip op. at 19.
14/ In its recent
dismissal of plaintiffs' fraud allegations in Alliance, this Court
rejected the very same allegation that defendants were motivated to commit
fraud in order to increase the stock price: "such a 'motive' is insufficient
to support recklessness, let alone actual knowledge". Alliance at
97,084 n. 12.
15/ Nor do Andersen's
sales show any suspicious pattern of dumping stock prior to a "bad news"
announcement -- the classic model for drawing an inference of scienter.
Here (as shown by plaintiffs' own chart, Compl. p. 5), Andersen's sales
during the January 1996 "window" were followed by consistently higher prices
for Fritz's stock throughout the succeeding months. It was not until May
1996, after Andersen had left the Company and after Fritz's announcement
of third quarter results, that the stock price began to slide below that
at which Andersen sold.
16/ As this Court recently observed, documents that are referred to in a complaint and whose authenticity is not disputed may be considered in the context of a motion to dismiss pursuant to Rule 12(b)(6). Alliance at 97,077; see also Padnes v. Scios Nova *9 (permitting consideration, on a motion to dismiss, of documents available to plaintiffs that refute "sweeping allegations" of fraud); Silicon Graphics at 97,127 (permitting consideration of documents that were not cited in plaintiffs' complaint, but which were the source of allegations therein: "Plaintiffs cannot preclude consideration [of the non-referenced documents] by artful pleading"). In this case, the KPMG audit work papers that plaintiffs have allegedly relied upon not only compel the dismissal of this Complaint, but also preclude any viable amendment.
13 Aug 1997