The opinion of the court was delivered by: VAUGHN R. WALKER
Plaintiffs have filed a seventy-four page complaint with one-hundred-nineteen paragraphs, some with multiple subparts, purporting to allege a fraud-on-the-market securities class action against Clearly Canadian, Inc., and its officers and directors. Through the court's authority under FRCP 12(f), this order strikes the redundant and immaterial from these recitals to focus on any claims the facts at bar may present.
Plaintiffs claim that between August 3, 1992, and July 17, 1993, defendants artificially inflated the price of Clearly Canadian stock through a series of materially misleading statements, violating § 10(b) and Securities and Exchange Commission Rule 10b-5 and § 20(a) of the 1934 Securities and Exchange Act. Defendants move to dismiss plaintiffs' complain on the grounds that it fails to allege sufficient facts to support plaintiffs' claim of scienter. Defendants also claim their statements were not materially misleading and that plaintiffs have not sufficiently pled loss causation. In addition, defendants oppose plaintiffs' motion for class certification.
Not all of the company's plans came to fruition. Indeed, the 1992 summer was cooler than expected, decreasing consumers' demand for all types of softdrinks. In addition, Clearly Canadian began to face competition from industry heavyweights like Coca-Cola Co. and PepsiCo., which each introduced competitive "New Age" products. On top of that, flavored ice tea drinks gained newfound popularity and an increased market presence, giving consumers additional choices for softdrinks. As a result, Clearly Canadian in the fourth quarter of 1992 and in early 1993 failed to meet earnings expectations, and its stock began a downward drift from around $ 17 per share at the beginning of the purported class period to approximately $ 6 per share at the period's end.
Plaintiffs allege that defendants made a number of materially misleading statements about Clearly Canadian during the purported class period that violated § 10(b) and SEC Rule 10b-5 and § 20(a) of the Securities and Exchange Act of 1934. At the beginning of the period, for example, Clearly Canadian announced a planned European stock offering expected to generate $ 35 million to $ 45 million, a fact that the markets apparently viewed favorably, as demonstrated by a 9.6 percent increase in the price of the company's shares. Plaintiffs contend this statement was misleading in that Clearly Canadian had not secured interest or backing for its proposed offering, which never occurred. Plaintiffs also complain about other optimistic statements. On September 1, 1992, Clearly Canadian's CEO, defendant Mason, stated that he expected sales, which analysts had predicted were dipping in the third quarter of 1992, to rebound in the fourth quarter. In the same statement, Mason also said he expected sales to increase 30 to 35 percent in 1993. As it turned out, sales and net income for the first half of 1993 were one half that of the first half of 1992. Nevertheless, in mid-October 1992, Mason announced plans to expand Clearly Canadian's distribution systems and roll out new flavored beverages, and he expressed confidence the new flavor would be "the most popular of the Company's current product line." SAC P 69.
In conjunction with Clearly Canadian's November 4 announcement of its earnings for the third quarter of 1992, defendant Mason indicated that a portion of the company's sales increase for that quarter was attributable to an inventory build-up, which he believed would be depleted in the fourth quarter. Plaintiffs contend this statement was misleading in that Mason was aware that distributors were holding excess inventory and that Clearly Canadian's board had directed the company to reduce production through March 1993.
In a Barrons article published a month later, Clearly Canadian's COO, defendant Foreman, predicted fourth quarter revenues would be lower than expected because of an "inventory correction," but still in the $ 30-35 million range. Plaintiffs contend that internal sales reports available to Foreman indicated that sales through the end of November were less than $ 10 million and that his prediction of sales over $ 30 million lacked a reasonable basis based on past year's experience. When Clearly Canadian finally announced its sales for the full year 1992, fourth quarter sales turned out to be only around $ 15 million, and net income from operations dropped to $ .07 per share, compared to $ .19 per share for the same period in 1991. When adjusted for one-time charges related to the buyout of a distributorship agreement, Clearly Canadian actually posted a $ 9.9 million quarterly net loss of the last quarter of 1992. By the date of this announcement, in late February 1993, the price of Clearly Canadian stock had dropped to approximately $ 9 per share. Following the announcement of year end results for 1992, several analysts publicly commented they felt misled by Clearly Canadian's prior statements.
Finally, in late June 1993, Clearly Canadian's CFO, defendant Horton, allegedly assured analysts that sales for the quarter ending in June would be in line with expectations of five-and-a-half to six million cases, when in fact, as of the end of May, Horton allegedly knew quarterly sales had been just over 3 million cases. Plaintiffs argue Horton had no reasonable basis for assuming the company would meet his prediction. SAC P 96. When Clearly Canadian finally announced its earnings for the quarter ending in June, they turned out to be lower than some analysts had predicted. Following this announcement on July 19, the last day of the purported class period, Clearly Canadian's stock dropped to $ 6 per share.
Plaintiffs allege that in addition to making these misstatements, individual defendants engaged in illegal insider trading of the company's shares by trading while in possession of material nonpublic information. Plaintiffs also point out that the company repurchased its own shares during the purported class period, allegedly to boost the firm's stock price and allow individual defendants to sell their own shares at a profit. In addition, plaintiffs note that three times during the purported class period Clearly Canadian reduced the exercise price of options held by corporate insiders, allegedly to enable individual defendants to profit from their misstatements notwithstanding the overall erosion of the value of the company's shares.
The Federal Rules of Civil Procedure require that a complaint contain "a short and plain statement of the claim showing that the pleader is entitled to relief." FRCP 8(a)(2). In addition, allegations of fraud must be pled with particularity. Id Rule 9(b). Courts are generally familiar with what to expect in fraud complaints involving direct or face-to-face transactions. Courts find less guidance about what to look for in a complaint such as the one at bar which claims a fraud on a securities market; this cause of action originated only recently and the opportunity for courts to develop pleading standards has been limited.
In assessing the adequacy of a complaint for securities market fraud under the Federal Rules, it is helpful to consider the information available to, and practical difficulties facing, a lawyer seeking to plead a claim of that type. As Professors Wright and Miller explain, "what constitutes a short and plain statement must be determined in each case on the basis of the nature of the action, the relief sought, and the respective positions of the parties in terms of the availability of information." 5 Charles Alan Wright & Arthur R. Miller, Federal Practice and Procedure § 1217 (2d ed 1990).
Drafting a complaint for securities market fraud is at once both easier and more difficult than drafting a complaint for direct fraud. Securities market fraud is simpler to plead than direct fraud in that the former requires fewer elements than the latter. To state a claim for direct securities fraud under Rule 10b-5, a pleader must allege: (A) a misstatement or an omission which renders misleading a statement actually made, (B) materiality of the misstatement or omission, (C) scienter on the part of those making the statement or omitting the information, (D) reliance by the plaintiff if a misstatement is alleged, (E) damages suffered by the plaintiff and (F) a causal link between the damages suffered and the misstatement or omission. See Thomas Lee Hazen, The Law Securities Regulation § 13.2 (2d ed 1990).
If the plaintiff sues under the fraud-on-the-market theory, however, reliance (element D) need no longer be pled. A securities market fraud case proceeds on the assumption that investors rely on the integrity of the market to establish a fair and correct price for openly traded securities. Hence, there is no need to prove that individual investors relied on any particular information about the prospects of the security's issuer. Basic, Inc v Levinson, 485 US 224, 244-47, 99 L. Ed. 2d 194, 108 S. Ct. 978 (1988); In re Seagate Technology II Sec Litig, 843 F Supp 1341, 1355 (ND Cal 1994). Moreover, an allegation that the defendants' misstatement distorted the market price of the security itself satisfies three of the elements required to state a claim of direct fraud (i.e., elements B, E and F). See Jonathan R. Macey, Geoffrey P. Miller, Mark L. Mitchell & Jeffry M. Netter, Lessons from Financial Economics: Materiality, Reliance, and Extending the Reach of Basic v. Levinson, 77 Va L Rev 1017 (1991). Given the presumption of reliance, when an alleged misstatement or omission occurs (element A) and effects the trading price of the security on the open market, this price effect denotes the materiality of the misinformation put into the market, satisfying element (B). The price effect, it is theorized, also furnishes elements (E) and (F). Because defendants misled the market, the market, according to the theory, was unable correctly to value the security, whose price diverged from its true value, leading plaintiffs to overpay for (or in the rare case undersell
) the security, causing plaintiffs' damages. The amount of those damages is simply the amount of the divergence.
See Green v Occidental Petroleum Corp, 541 F.2d 1335, 1341-42 (9th Cir 1976) (Sneed, J, concurring).
A complaint for market fraud therefore requires only two distinct elements, (A) and (C) above, along with an allegation that the price of the security responded significantly to defendants' alleged misstatements. This simplification greatly reduces the burden on the pleader drafting his complaint, especially since the price effect on the security of the alleged misrepresentation is usually known at the time the complaint is drafted.
The basic facts pertaining to elements (A) and (C) may also be known when the complaint is drafted. Indeed, these facts are frequently disseminated by the numerous media which cover and compile business and economic news and information and thus can be alleged with the particularity required by FRCP 9(b) without much difficulty. Damages, which need not be pled with specificity, can nevertheless also be precisely calculated because the effect of the allegedly misstated or omitted information can be observed in the price reaction of the security when the true facts about the issuer become known to the market. Although the price distortion will not necessarily equate with the price shock which triggered the lawsuit, see Baruch Lev & Meiring de Villiers, Stock Price Crashes and 10b-5 Damages: A Legal, Economic, and Policy Analysis, 47 Stan L Rev 7 (1994), econometric analysis of publicly available price and volume data will enable the price distortion to be calculated early in the litigation, perhaps even before the complaint is filed.
Another constraint is that the alleged misstatements or omissions must match temporally with the pattern of the security's price behavior. For a misstatement to be actionable, it must have an effect on the price of the security in the market. Similarly, an omission is actionable only if it causes the value line of the security to diverge from the price line. See Green, 541 F.2d at 1341; Seagate II, 843 F Supp 1341, 1347 (ND Cal 1994). No matter how untrue a statement and no matter the malignancy with which it is uttered or with which information is concealed, no market fraud is committed unless the statement omission moves the price of the security to depart from its true value. Often a pleader will be unable to match the misstatements or ...