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In re Petco Animal Supplies Inc.

November 13, 2006


The opinion of the court was delivered by: Marilyn L. Huff, District Judge United States District Court


On August 1, 2006, the Court denied in part and granted in part motions to dismiss this class action securities case. [Docket No. 60] The Court sustained the Consolidated Complaint as to Defendant Petco (and several officers) on one theory of fraud; however, the Court dismissed the Partnership Defendants*fn1 for failure to plead sufficient facts to show their involvement in the alleged fraud. The Court dismissed without prejudice and permitted Lead Plaintiff until September 1, 2006 to file a First Amended Consolidated Complaint. The Partnership Defendants have now filed a motion to clarify that in the event Lead Plaintiff choose not to amend the complaint within the time specified by the August 2006 Order, the dismissal will be with prejudice pursuant to the discovery stay of the Private Securities Litigation Reform Act ("PSLRA").

Initially, the Court ordered the motion submitted on the briefs. Civil Local Rule 7.1(d)(1). After further consideration, however, the Court convened a telephonic conference on November 8, 2006 to discuss the legal issue. Dan Drosman, Esq. appeared for Lead Plaintiff; Eric Waxman, Esq. appeared for the LGP Defendants; Tim Pestotnik, Esq. appeared for the LGP Defendants; and Peter Benzian, Esq. appeared for the Petco Defendants. Having carefully considered the arguments of both sides and for the reasons stated below, the Court DENIES the motion for clarification.

I. Procedural History

Initially, several plaintiffs filed securities class actions against Petco Animal Supplies, Inc. after its April 15, 2005 announcement that it had discovered an accounting error relative to certain under-accrued expenses in its distribution operations. The parties then stipulated to have the several actions consolidated and to select a Lead Plaintiff and Lead Counsel.

In October 2005, Lead Plaintiff filed a Consolidated Complaint against two categories of defendants: first, the Petco corporation and certain executives and officers, and second, the Partnership Defendants, who had once owned Petco. The Consolidated Complaint alleged that the defendants had violated the federal securities laws by issuing false and misleading statements and by engaging in insider trading at artificially-inflated prices. The Class Period began on August 18, 2004.

In January and February 2006, all defendants filed motions to dismiss for failure to state a claim for relief. Fed. R. Civ. P. 12(b)(6). Pursuant to the Private Securities Litigation Reform Act, the filing of those motions to dismiss automatically stayed all discovery pending resolution of the motion. 15 U.S.C. § 78u-4(b)(3)(B); Medhekar v. United States Dist. Ct., 99 F.3d 325, 327 (9th Cir. 1996) (per curiam).*fn2

The motions to dismiss were briefed and argued, and on August 1, 2006, the Court issued its decision. The Court denied the motion by Petco and some of its executives as to the allegations concerning an accounting impropriety, specifically, an alleged practice to defer the recording of incurred distribution expenses in order to make quarterly earnings goals.*fn3 The Court held that Lead Plaintiff had stated a claim, with factual allegations sufficient to demonstrate a strong inference of scienter by some of the Petco Defendants. Those Petco Defendants have answered the Consolidated Complaint and the Magistrate Judge has scheduled an Early Neutral Evaluation Conference for November 11, 2006.

The Court, however, agreed with the Partnership Defendants that the Consolidated Complaint failed to state a claim against them on either a theory of primary liability or as control persons. The Partnership Defendants had owned and managed Petco from 2000 to 2002, at which time they became majority shareholders. By the time the Class Period began in August 2004; however, the Partnership Defendants had sold most of their shares. After October 2004, the Partnership Defendants did not own any Petco common stock, though two individuals connected to the Partnerships continued to serve as outside directors. The Court found no basis for holding a former majority shareholder liable for corporate fraud.

The Court granted Lead Plaintiff leave to amend to attempt to cure the deficiencies, and permitted it until September 1, 2006 to file such an amended complaint. That date has now passed, and Lead Plaintiff has stated that it does not intend, at this time, to amend.

Lead Plaintiff has served subpoenas on the Partnership Defendants to produce various documents. Lead Plaintiff is seeking the discovery against these former parties under the rules that apply to non-parties.

The Partnership Defendants ask the Court to clarify its August 2006 Order to dismiss them with prejudice now that Lead Plaintiff has chosen not to amend the complaint within the time set by the Court.

II. Discussion

The Partnership Defendants contend that Lead Plaintiff is circumventing the discovery stay by leaving them "in a state of limbo without the finality they deserve after prevailing on their Motions to Dismiss." LGP's Br. at 3 ("If the Court were to permit Plaintiffs to discover their way into a viable securities claim against the dismissed defendants, the PSLRA discovery stay would become meaningless and the Congressional intent of the statute vitiated[.]" (quoting In re American Online Time Warner, Inc. Sec. and ERISA Litig., 2004 U.S. Dist. LEXIS 16017, at * 2 (S.D.N.Y. Aug. 11, 2004). They cite a statement from a Ninth Circuit decision that the discovery stay in the PSLRA shows that "Congress clearly intended that complaints in these securities actions should stand or fall based on the actual knowledge of the plaintiffs rather than information produced by the defendants after the action has been filed." Medhekar, 99 F.3d at 326. The Partnership Defendants argue that plaintiffs "should not be able to begin discovery while maintaining that they have a right to later amend their complaint against the dismissed ...

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