question of the doctrine's validity because the complaint is not sufficient to invoke it. The complaint fails to allege either that the pre-April 17, 1990 statements were themselves misleading or materially incomplete, or that they were in fact true, but contributed to an overall misleading impression. The Court therefore dismisses with leave to amend plaintiff's 10b-5 claim to the extent it is based on statements other than the April 17, 1990 press release.
This brings the Court to the question of whether the April 17, 1990 release was not misleading as a matter of law, as defendants contend. According to plaintiff, the release contained three representations of fact: (1) that Vitalink had developed the "ability to manage a balanced distribution strategy"; (2) that Vitalink had experienced "continued growth of direct sales"; and (3) that Vitalink was maintaining "solid sales in the current quarter." Plaintiff asserts that each of these representations was false. Defendants counter that a "plain reading" of the press release reveals that these representations concerned only the previous quarter, which ended on March 31, 1990, not the third quarter, during which the representations were made. Accordingly, defendants could not have been making any forecasts with respect to the third quarter -- the quarter which saw the stock dramatically plunge in value and defendant Archuleta "resign."
In his Memorandum in Opposition, plaintiff argues that defendants' optimistic language in the release did in fact refer to the third, rather than the second, quarter. Unfortunately, a "plain reading" of the press release does not resolve the parties' dispute. On the one hand, the statements in question immediately follow a discussion of the second quarter's performance, but on the other, defendant Archuleta referred to the "solid performance this quarter " and the company's "solid sales in the current quarter." Given this factual dispute, it is improper for the Court to decide as a matter of law whether the representations were misleading. See Marx v. Computer Sciences Corp., 507 F.2d 485, 492 (9th Cir. 1974) (whether the failure to disclose was an omission to state a material fact necessary to make the statements not misleading is a factual determination for the jury); In re Seagate Technology II Sec. Litig., Fed. Sec. L. Rep. (CCH) P 94,502, at 93,201 (N.D. Cal. 1989) (court will dismiss misrepresentation claims only if a review of the alleged omissions does not raise factual questions or require information beyond the reports cited in the complaint).
Moreover, even if defendants' statements in the press release did refer to the previous, rather than the then-current quarter, plaintiff nonetheless makes out a bare-bones claim. At a minimum, these statements can be construed as a general expression of optimism regarding Vitalink's condition. The Ninth Circuit has held that "projections and general expressions of optimism may be actionable under the federal securities laws." In re Apple Computer Sec. Litig., 886 F.2d 1109, 1113 (9th Cir. 1989), cert. denied, 496 U.S. 942, 110 L. Ed. 2d 676, 110 S. Ct. 3229 (1990). At this early stage of the litigation, it cannot be determined as a matter of law that the April 17, 1990 press release was not misleading and materially incomplete. See Usher v. City of Los Angeles, 828 F.2d 556, 561 (9th Cir. 1987) (on a motion to dismiss, courts must presume all factual allegations of the complaint to be true and draw all reasonable inferences in favor of the nonmoving party).
(2) Loss Causation
"In an action brought under Rule 10b-5 for material omissions or misstatements, the plaintiff must prove both transaction causation, that the violations in question caused the plaintiff to engage in the transaction, and loss causation, that the misrepresentations or omissions caused the harm." Securities Investor Protection Corp. v. Vigman, 908 F.2d 1461, 1467 (9th Cir. 1990) (citation omitted) (emphasis added). Loss causation, the Ninth Circuit further noted, is just another term for proximate cause. Id. A plaintiff must plead that his loss is the result of the defendant's wrongdoing. In re Fortune Sys. Sec. Litig., 680 F. Supp. 1360, 1365 (N.D. Cal. 1987). Defendants contend that Vitalink's stock dropped in value as a result of the announcement of defendant Archuleta's resignation. Archuleta's resignation, they argue, was an independent intervening event breaking the causal chain between defendants' alleged omissions and the loss suffered by plaintiff as a result of Vitalink's stock's precipitous decline.
Defendants' contention is unfounded. Accepting plaintiff's factual allegations as true, as this Court must, defendant Archuleta resigned as a result of Vitalink's poor financial performance -- information that plaintiff contends should have been disclosed. Thus Archuleta's resignation was a dependent, rather than independent, cause of the stock's plunge. The cases cited by defendants for the proposition that intervening causes disrupt the causal chain involved truly independent causes of the plaintiffs' losses, such as a market fluctuation or a change in SEC regulations.
Furthermore, plaintiff alleges that the stock drop was also caused by the new CEO's warning that there was a "reasonable probability" that Vitalink's third-quarter earnings would be below analysts' estimates. In response to these adverse disclosures, which allegedly should have been made long ago, Vitalink's stock lost its artificially inflated value. Plaintiff therefore has sufficiently pleaded that the class's loss resulted from defendants' purportedly misleading statements.
To state a Rule 10b-5 claim, a plaintiff must allege that the defendant acted with scienter, "a mental state embracing intent to deceive, manipulate, or defraud." Ernst & Ernst v. Hochfelder, 425 U.S. 185, 194 n.12, 47 L. Ed. 2d 668, 96 S. Ct. 1375 (1976). Defendants contend that plaintiff has failed to plead defendants' fraudulent intent with the specificity required by Federal Rule of Civil Procedure 9(b).
Plaintiff asserts that in making the allegedly misleading statements in the April 17, 1990 press release, defendants "knew," "recklessly disregarded," and "but for their recklessness failed to know," that Vitalink had not cured its over-dependence on Digital and that it was not experiencing a "continued growth of direct sales," or "solid sales in the current quarter." Complaint, para. 16. Plaintiff does not provide any factual source for its conclusion that defendants possessed this fraudulent mental state.
The Court notes that there is a disagreement within this District regarding the detail with which a 10b-5 plaintiff is required to plead scienter.
The Ninth Circuit, however, has held that a pleading satisfies Rule 9(b)'s particularity requirement "if it identifies 'the circumstances constituting fraud so that the defendant can prepare an adequate answer from the allegations.'" Deutsch v. Flannery, 823 F.2d 1361, 1365 (9th Cir. 1987), cert. denied, 498 U.S. 818, 112 L. Ed. 2d 37, 59 U.S.L.W. 3244, 111 S. Ct. 62 (1990). "Rule 9(b) does not . . . require plaintiffs in a securities fraud case to set forth facts which, because no discovery has yet occurred, are in the exclusive possession of the defendants." Id. (citation omitted). Plaintiff has supplied defendants with a sufficiently complete description of the circumstances constituting fraud. Defendants should be able to devise an adequate answer to the allegations. Indeed, they do not contend that they are unable to do so.
For these reasons, the Court denies defendants' motion to dismiss with respect to the April 17, 1990 press release, and grants the motion to dismiss, but with leave to amend, with respect to defendants' pre-April 17 reports.
II. Negligent Misrepresentation
Defendants contend that plaintiff cannot state a claim for negligent misrepresentation under California law because such claims cannot be based on "aftermarket" statements. Aftermarket statements are those made after a public stock offering rather than in the offering prospectus. In re Wyse Technology Sec. Litig., 744 F. Supp. 207, Fed. Sec. L. Rep. (CCH) P 94,972, at 95,432 (N.D. Cal. 1990). This contention is well-taken.
Under California law, liability for negligent misrepresentation attaches only when the plaintiff establishes that the defendant breached a duty of care owed to him. Goodman v. Kennedy, 18 Cal. 3d 335, 342, 556 P.2d 737, 134 Cal. Rptr. 375, 380 (1976). Applying the six factors set forth by the California Supreme Court in Goodman as to when a defendant will be held liable to a third person not in privity,
seven judges in this District have found that negligent misrepresentation claims cannot be based upon aftermarket statements.
These judges reasoned that unlike statements made in connection with a public offering, those made in routine SEC filings, press releases, and shareholder reports are not intended to affect future shareholders. See, e.g., Alfus, 745 F. Supp. 1511, Fed. Sec. L. Rep. (CCH) P95,207, at 95,851; Wyse, 744 F. Supp. 207, Fed. Sec. L. Rep. (CCH) P94,972, at 95,432. Hence the statements are not "intended to affect the plaintiff." Moreover, a broader liability rule would render the liability of corporations and their officers and directors "vast and limitless." See, e.g., Genentech, Fed. Sec. L. Rep. (CCH) P 94,544, at 93,482; Weinberger, slip op. at 8-9. Such expansive liability is unwarranted in light of the broad protections afforded plaintiffs under federal and state securities laws. Id.
Claiming that defendants should reasonably have foreseen that prospective buyers would be harmed by defendants' misleading statements, plaintiff argues that this Court should apply the "reasonable foreseeability" test of International Mortgage Co. v. John P. Butler Accountancy Corp., 177 Cal. App. 3d 806, 819, 223 Cal. Rptr. 218, 227 (1986). In that case the court applied the foreseeability test to extend a negligent public auditor's liability to adversely affected third parties. All seven judges in this District who have dismissed aftermarket negligent misrepresentations claims have considered the applicability of Butler to the securities fraud context and concluded that Butler was based on the independent auditor's "unique public function," which is not parallel to corporations' obligations toward prospective shareholders. See, e.g., Alfus, 745 F. Supp. 1511, Fed. Sec. L. Rep. (CCH) P95,207, at 95,851. In fact, the reasonable foreseeability test of Butler has not been extended beyond the public accountant context. The recent case Bily v. Arthur Young & Co., 222 Cal. App. 3d 289, 271 Cal. Rptr. 470 (1990), cited by plaintiff, does nothing to negate this fact. Bily reaffirmed the Butler's foreseeability test in a case which again involved public auditors.
The Court agrees with the seven decisions of judges of this Court and dismisses with prejudice plaintiff's negligent misrepresentation claim.
IT IS HEREBY ORDERED that:
(1) Defendants' motion to dismiss plaintiff's Rule 10b-5 claim is GRANTED with leave to amend with respect to statements other than the April 17, 1990 press release;
(2) Defendants' motion to dismiss plaintiff's Rule 10b-5 claim is DENIED with respect to the April 17, 1990 press release; and
(3) Defendants' motion to dismiss plaintiff's negligent misrepresentation claim is GRANTED with prejudice.