Oklahoma Firefighters Pension & Retirement System v. Smith & Wesson Holding Corp.

United States Court of Appeals
For the First Circuit
No. 11-1436
IN RE: SMITH & WESSON HOLDING CORP. SEC. LITIG.
__________
OKLAHOMA FIREFIGHTERS PENSION & RETIREMENT SYSTEM,
Plaintiff, Appellant,
v.
SMITH & WESSON HOLDING CORP.;
MICHAEL GOLDEN; JOHN A. KELLY,
Defendants, Appellees.
APPEAL FROM THE UNITED STATES DISTRICT COURT
FOR THE DISTRICT OF MASSACHUSETTS
[Hon. Michael A. Ponsor, U.S. District Judge]
Before
Boudin and Lipez, Circuit Judges,
and Smith,* District Judge.
Bryan A. Wood with whom Glen DeValerio, Norman Berman, John H.
Sutter and Berman DeValerio were on brief for appellant.
John A. Sten with whom Jason C. Moreau and Greenberg Traurig,
LLP were on brief for appellees.
February 17, 2012
*
Of the District of Rhode Island, sitting by designation.
BOUDIN, Circuit Judge. A class of plaintiffs
representing purchasers of Smith & Wesson Holding Corporation
securities sued the company ("Smith & Wesson") and two of its high-
ranking officers, Michael Golden and John A. Kelly, alleging that
the company issued false or misleading public statements about the
demand for its products in violation of the Securities Exchange Act
of 1934 and related regulations.1 The district court granted
summary judgment to Smith & Wesson, and the plaintiffs now appeal.
Smith & Wesson is the parent company of the well-known
gun manufacturer; Golden was the President and Chief Executive
Officer of Smith & Wesson during the period in question, and Kelly
was the Chief Financial Officer. The lead plaintiff, Oklahoma
Firefighters Pension and Retirement System, represents a class of
all persons purportedly suffering damages as a result of the
purchase of Smith & Wesson common stock on the open market between
June 14, 2007, and December 6, 2007. It is common ground that the
stock suffered precipitous declines starting with the company's
release in late October 2007 of unfavorable preliminary second-
quarter earnings data and downwardly revised earnings projections.
1
Count I charged the corporation and individual defendants
with violations of Section 10(b) of the Act, 15 U.S.C. § 78j(b)
(2006), and Rule 10b-5, 17 C.F.R. § 240.10b-5 (2011), while Count
II alleged violations by the individual defendants of Section 20(a)
of the Act, 15 U.S.C. § 78t(a). The latter claim is derivative,
ACA Fin. Guar. Corp. v. Advest, Inc., 512 F.3d 46, 67-68 (1st Cir.
2008), and needs no separate discussion.
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By contrast, for the two quarters prior to the decline,
the company had provided investors with impressive sales numbers
and optimistic future earnings projections. In plaintiffs' view,
ballooning inventory and various internal reports indicated
flagging business by the summer of 2007 and prompted the company to
inflate artificially the sales numbers through unusual promotions
and discounting that stripped revenues from future quarters. The
chronology of press releases and public statements is as follows.
The first relevant announcement, issued on June 14, 2007,
and titled "Smith & Wesson Holding Corporation Posts Record Annual
Revenues and Earnings," reported strong performance in the final
quarter of the company's fiscal year 2007 and the fiscal year
overall--periods not coinciding with ordinary calendar quarters.2
In addition to providing historical performance data, the company
made several statements about its expectations for fiscal year
2008; in particular, it announced that it was "raising [its] sales
expectations for fiscal 2008 from $320 million to $330 million,
which would represent a 40.5% increase over fiscal 2007 sales"; it
also upwardly revised earnings guidance from $0.60 per share to
$0.62 per share, which the company pointed out was double the
earnings guidance from the previous fiscal year.
2
Smith & Wesson's fiscal year runs from May 1 through April
30, so fiscal year 2007 covered the period May 1, 2006, through
April 30, 2007. Accordingly, the final quarter of fiscal 2007
encompassed February-April 2007; the first quarter fiscal 2008,
May-July 2007; and the second, August-October 2007.
-3-
The projections were accompanied by a clearly labeled
"Safe Harbor Statement" warning that the press release contained
"forward-looking statements," including statements regarding future
sales, income, income per share, earnings, penetration rates for
new and existing markets, strategies, and the demand for the
company's products, and that those statements were "qualified by
important factors [identified in the statements] that could cause
actual results to differ materially from those reflected by such
forward-looking statements."3
Golden and Kelly participated in an investor conference
call later that day, which began with a similar announcement that
all forward-looking statements made during the call were
necessarily subject to uncertainty. In response to a question
about why the company raised its guidance, Kelly stated:
So as we look in the business, we ended the
year with pretty good backlog. Demand has
been strong, and that's--the Thompson, our
capacity in Thompson, we've gotten our barrel
output up by 20% in the first whatever it's
been, five months, that we've had it. So
we're putting all those together, and that's
why we reacted confidently with our new
guidance.
Kelly also noted that "[p]lanned capital expenditures for fiscal
2008 of $17.7 million represents [sic] a $1.7 million increase from
3
The "safe harbor" provisions of the Private Securities
Litigation Reform Act ("PSLRA"), 15 U.S.C. § 78u-5, sharply limit
liability of companies and their management for certain "forward-
looking statements," defined in the statute, when such statements
are accompanied by appropriate cautionary language.
-4-
our previous estimate and allows for an expansion of our polymer
pistol manufacturing capacity due to increased demand." The
company's stock price rose 8 percent the next trading day.
On September 6, 2007, following the close of the first
quarter of fiscal 2008 (May-July 2007), Smith & Wesson issued a
press release reporting record earnings for the quarter: "Smith &
Wesson Holding Corporation Posts Record First Quarter Revenues and
Profits." It quoted Golden as offering the following explanation:
Our results for the first quarter of fiscal
2008 demonstrate progress across many
initiatives and reflect growth in our core
handgun business as well as our newly
established long gun business. Our sales
growth was particularly strong given that the
comparable quarter of the prior year included
$5.2 million in U.S. government orders for
Afghanistan that were not duplicated in the
current quarter. Handgun sales into the
retail channel increased by 41.0% for the
quarter, driven by our direct sales force and
a number of ongoing retail initiatives.
The company once again increased its fiscal 2008 earnings
expectations, this time from the $0.62 per share amount announced
in June to $0.63 per share. The release also stated that "[w]e
expect second quarter revenue to increase by approximately 60% over
revenue in second quarter of fiscal 2007, driven by continued
expansion in our existing markets and the addition of revenue from
Thompson/Center [acquired in January 2007]." The September press
release, and the conference call that followed, contained "safe
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harbor" statements similar to those contained in the June 2007
communications.
In the conference call held later on the day of the
release, Golden and Kelly made several statements characterizing
the first-quarter results and offering some explanation for the
upward revision to earnings guidance:
Th[e] increase in our annual earnings
projection from our previously announced
guidance reflects the stronger than
anticipated first quarter performance.
[W]e continue to deliver double digit growth
in year-over-year quarterly revenue, supported
by strong sales into the retail channel and
our ongoing penetration in law enforcement.
The results we delivered this quarter in the
retail channel reflect growth in our core
handgun business as well as the addition of
and growth in our newly established long gun
business.
I want to point out that our sales growth was
particularly strong during the first quarter
given that it compares to some major events
that occurred in the comparable quarter in the
prior year.
The company's stock price rose about 5 percent the next trading
day.
However, on October 29, 2007, the company revealed
disappointing preliminary financial results for the second quarter
(August-October 2007), which it attributed to
a combination of factors that emerged late in
the quarter. Among these factors were
softness in the market for hunting rifles and
shotguns, driven by lower than expected
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consumer demand, a buildup of pre-season
retail inventories, and unseasonably warm
autumn weather, which decreased retail traffic
and compressed the fall hunting season.
The company also revised down its earnings guidance from $0.63 per
share to $0.53 per share. Smith & Wesson's stock price dropped 40
percent the next trading day.
On December, 6, 2007, the company released its final
second-quarter results, and further revised down its earnings
guidance from $0.53 per share to $0.40 per share, citing the same
factors listed in its October 29 press release as well as an
"industry-wide inventory buildup, accentuated by lower retail
traffic, caus[ing] order activity to slow beginning in October."
The stock price fell another 29 percent the next day.
Three different lawsuits, later consolidated, were filed
against Smith & Wesson, Golden, Kelly and a third officer who was
later dismissed. In a thorough and thoughtful decision, the
district court denied Smith & Wesson's motion to dismiss, In re
Smith & Wesson Holding Corp. Sec. Litig., 604 F. Supp. 2d 332(D. Mass. 2009), which relied primarily on the "safe harbor"
provisions of the PSLRA; but the district court made clear that
those provisions narrowed the plaintiffs' case and that they had
gotten only a ticket to discovery.
The district court agreed that the plaintiffs' complaint
"contain[ed] allegations based mainly on forward-looking
statements" that qualified for protection under the PSLRA; but
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"distinguish[ing] carefully between non-actionable forward looking
statements and potentially actionable statements of present or
historical fact," In re Smith & Wesson Holding Corp. Sec. Litig.,
604 F. Supp. 2d at 334, the court found "sufficient, albeit thin,
allegations of Defendants' intentionally false statements of
present or historical fact." Id. at 335.
The court granted class certification and the case
proceeded to discovery, after which Smith & Wesson sought summary
judgment and the plaintiffs sought partial summary judgment on one
issue. Thereafter the court granted summary judgment for Smith &
Wesson, finding a lack of misrepresentation and of scienter,
without reaching two other issues raised by Smith & Wesson (loss
causation and "controlling person" liability). In re Smith &
Wesson Holding Corp. Sec. Litig., No. 07-30238-MAP, 2011 WL 6089727(D. Mass. Mar. 25, 2011). The plaintiffs have now appealed to this
court.
Summary judgment is proper where "the movant shows that
there is no genuine dispute as to any material fact and the movant
is entitled to judgment as a matter of law," Fed. R. Civ. P. 56(a);
we review grants of summary judgment de novo, considering the facts
in the light most favorable to the nonmoving party. Bos. & Me.
Corp. v. Mass. Bay Transp. Auth., 587 F.3d 89, 98 (1st Cir. 2009).
In this case, the factual disagreements are largely about the
inferences to be drawn from the record.
-8-
Claims under Section 10(b) and Rule 10b-5 have six
elements: (1) a material misrepresentation or omission; (2)
scienter, or a wrongful state of mind; (3) a connection with the
purchase or sale of a security; (4) reliance; (5) economic loss;
and (6) loss causation. Miss. Pub. Emps.' Ret. Sys. v. Bos.
Scientific Corp., 649 F.3d 5, 20 (1st Cir. 2011). Only the first
two elements are at issue in this appeal and, as to both,
plaintiffs rely heavily on three kinds of evidence to show that
Smith & Wesson knew demand was weakening when it reported strong
sales numbers in June and September.
First, Smith & Wesson generated monthly inventory reports
that were distributed, along with other financial reports, in a
"red book" reviewed by senior management during monthly executive
meetings. Although inventory generally built up in the first
quarter to satisfy increased demand later in the fiscal year,
plaintiffs say that the excess inventory was usually sold off by
August, yet in August 2007 inventory "exploded" to $12.8 million in
goods (compared to $3.9 million the previous year) and continued to
trend upward.
Second, plaintiffs point to a host of internal tracking
data indicating that demand was flagging:
"Orderometer" reports containing up-to-
date information about the company's progress
toward meeting revenue goals, reviewed each
day by senior management, showed the company
consistently falling short of sales targets,
including (by plaintiffs' calculations) a 54
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percent total shortfall in August and even
higher misses in subcategories described as
strong in the company's press releases, such
as M&P (69 percent miss) and Sigma (80 percent
miss) model pistols.
"Call Reports," in which sales managers
described interactions with customers at both
the distributor and dealer levels, showed
during the first quarter of fiscal 2008
evidence of demand decreases due to bloated
customer inventories with statements like:
"[distributors are] Extremely Stuffed with
product" (July 6, 2007), and "[distributors
are] reporting inventory buildup at levels
never seen by them at this time" (July 11,
2007). Indeed, the plaintiffs note (and Smith
& Wesson does not dispute) that four out of
Smith & Wesson's six largest distributors
declined or substantially reduced orders in
July, all citing bulging inventories.
"End of Month Backlog" reports--
"backlog" referring to orders expected to ship
in the following six months--similarly showed
declining year-over-year performance in each
month of the first quarter, culminating in a
July backlog that was down 29 percent from the
previous year.
Third, plaintiffs point to various promotions and
discounts that Smith & Wesson used allegedly to pull revenues from
future quarters to compensate for declining sales. Plaintiffs
point to two sets of promotions; the first consisted of three so-
called "pull forward" promotions in the fourth quarter of fiscal
2007; the second set of promotions occurred in July 2007, allegedly
pulling future revenues into the first quarter of fiscal 2008 (May-
July 2007).
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To show that senior management was aware of serious sales
problems before the company issued the September 2007 statements,
plaintiffs point to a pair of August 20, 2007, e-mails from Kelly:
"it seems like we are digging a deep hole to start the quarter,"
and "it looks like we will have net sales of about $16 million for
the month and miss the profit target by at least three to four
cents . . . We may not even be ahead of last year. Ouch." Also,
notes from an August 29, 2007, business review meeting attended by
Golden and Kelly recorded: "Market is booming. July is first month
in 32 months we were down year-over-year, August is second month in
33 months. Industry is growing by 15-17% and we're shrinking."4
Smith & Wesson's oft-repeated response to the plaintiffs'
evidence is that the June and September statements reported
accurate figures; but "the fact that a statement is literally
accurate does not preclude liability under federal securities
laws." Lucia v. Prospect St. High Income Portfolio, Inc., 36 F.3d
170, 175 (1st Cir. 1994). For Rule 10b-5 creates liability
(assuming scienter, causation and other elements of the offense)
not only where a material misstatement occurs, but also where a
material omission exists. 17 C.F.R. § 240.10b-5(b).
4
The company's former Operations Controller, Thomas Coghill,
said of the July and August sales that "[w]e were building [guns]
to plan, and the sales didn't materialize to reduce our inventory
levels"; Coghill also stated that Kelly and Vice President of
Finance John Dineen were aware of the troublesome inventory numbers
in July 2007.
-11-
"[M]ere possession of material, nonpublic information
does not create a duty to disclose it," Hill v. Gozani, 638 F.3d
40, 57 (1st Cir. 2011) (internal punctuation omitted), but "when a
company speaks, it cannot omit any facts 'necessary in order to
make the statements made, in the light of the circumstances under
which they were made, not misleading.'" Id. (quoting 17 C.F.R.
§ 240.10b-5). Materiality means a substantial likelihood exists
that a reasonable investor would have viewed the fact as
significantly altering the total mix of information made available.
City of Dearborn Heights Act 345 Police & Fire Ret. Sys. v. Waters
Corp., 632 F.3d 751, 756 (1st Cir. 2011).
The gist of the plaintiffs' case is this: (1) that the
company's June and September 2007 press releases and accompanying
statements indicated or implied that strong existing demand
supported the reported sales numbers; (2) that the strong sales
numbers resulted in part from discounts used to pull orders from
future quarters; and (3) that in any event at least by July signs
of declining demand were apparent and so should have been disclosed
in the early September statements.
In our view, the strong sales numbers, however accurate,
and the company's cheerleading commentary (described and quoted
above) did carry with them (or at least a jury could so find) an
implied message that they reflected strong demand, as of the time
the sales were made. Purely forward looking statements that
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accompanied the sales numbers do enjoy considerable protection, see
note 3 above; but the implication was that the sales numbers
represented market demand at the time of the sales, which concerned
past factual conditions--not predictions.
Further, as to the September statements, because the past
sales and upbeat commentary were reported a month or more after the
quarter reported on had ended, a culpable omission could exist if
management knew that conditions had deteriorated significantly
after the quarter had ended. To the extent that such an omission
was misleading, it would be made so by facts already known to have
occurred in July and August and not by errors in a mere forecast as
to expectations for the second quarter.
Admittedly, with a possible ambiguous exception in the
June statements,5 the statements did not purport to be describing
overall demand--and this may be of some comfort to defendants. But
the September statements, which alone turn out to matter, could
still be taken to imply that overall demand in the first quarter
was strong; for example: "[o]ur sales growth was particularly
strong" and "we continue to deliver double digit growth in year-
5
One of the June 2007 references could be read, as the
district court did, as referring only to one line of business, but
it is arguably ambiguous; the other explicit mention of demand in
the June statements referred only to a specific line of products.
Plaintiffs also claim that nothing could reasonably be said about
demand based merely on sales figures--that inherently such
statements imply elaborate statistical studies--but this is not
evident to us.
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over-year quarterly revenue, supported by strong sales into the
retail channel and our ongoing penetration in law enforcement."
Turning then to the evidence, we start with the June
statements. While the plaintiffs suggest that some signs of a
looming problem emerged prior to the June statements, that evidence
is razor thin and often limited to a single product line--for
example, Orderometer reports showing missed internal handgun sales
targets in five of the seven months before June and a few
references to soft markets in other products.
But the Orderometer reports plaintiffs cite were, at
best, mixed, as were the Call Reports, and their significance was
therefore limited. Three of the five so-called failures to meet
handgun targets were misses of less than 5 percent, and the
plaintiffs also omit mention of some exceptionally strong results--
for example, April sales exceeding targets by 46 percent--during
the same period. Further, internal targets may be designed as
incentives as much as predictions. In re Smith & Wesson Holding
Corp. Sec. Litig., 2011 WL 6089727, at *8.
And, Smith & Wesson enjoyed substantial sales growth
leading up to the June statements: using the most conservative
growth figures cited to us, 39 percent growth in Q3 over the
comparable quarter the previous year, 22 percent growth in Q4, and
34 percent growth in the fiscal year overall. Minor failures to
meet aggressive internal sales growth targets do not show crumbling
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demand--especially when the sales themselves show growth. Cf. In
re Symbol Techs. Class Action Litig., 950 F. Supp. 1237, 1243-44
(E.D.N.Y. 1997).
Plaintiffs assert that the company's April promotions
accelerated revenues slated for Q1 2008 into Q4 2007 and amounted
to "channel stuffing," that is, "inducing purchasers to increase
substantially their purchases before they would, in the normal
course, otherwise purchase products from the company," thus
"shifting earnings into earlier quarters, quite likely to the
detriment of earnings in later quarters." Greebel v. FTP Software,
Inc., 194 F.3d 185, 202 (1st Cir. 1999).
But offering discounts to stimulate sales is not
automatically manipulation and may well stimulate demand. Makor
Issues & Rights, Ltd. v. Tellabs Inc., 513 F.3d 702, 709 (7th Cir.
2008). Anyway, here the plaintiffs' case as to June rests on only
three pull-in deals plus rhetoric; nothing shows that the pull-ins
were unusual, represented a significant percentage of the reported
sales for the quarter, or were otherwise suspect. In re Smith &
Wesson Holding Corp. Sec. Litig., 2011 WL 6089727, at *9.
That brings us to the company's September statements, and
we begin with the July discounts. Here, both manipulation and
causation are open to question. As Judge Posner explained in
Makor,
[a] certain amount of channel stuffing could
be innocent and might not even mislead--a
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seller might have a realistic hope that
stuffing the channel of distribution would
incite his distributors to more vigorous
efforts to sell the stuff lest it pile up in
inventory.
513 F.3d at 709. In sum, such practices are neither inherently
fraudulent nor always innocent; size, design, purpose,
transparency, and history are all relevant. See In re Cableton
Sys., Inc., 311 F.3d 11, 34-35 (1st Cir. 2002); Aldridge v. A.T.
Cross Corp., 284 F.3d 72, 81 (1st Cir. 2002); In re Stac Elecs.
Sec. Litig., 89 F.3d 1399, 1407 (9th Cir. 1996), cert. denied, 520
U.S. 1103 (1997).
Plaintiffs say that about $7 million of Smith & Wesson's
first-quarter 2008 revenues--one-third of its July sales and about
10 percent of the company's quarterly revenue--were the result of
discounting, but plaintiffs do not dispute that discounting is
common in the firearms industry nor do they offer comparable
figures from prior years. And the July quarter, as the company had
disclosed in a 10-K statement, was traditionally the weakest, so
greater efforts to stimulate July sales would not be surprising.
Further, the fall-off in demand in the second half of
2007 turns out to have lasted long after the July discounts and in
some degree to have affected the industry and not just Smith &
Wesson, so--notwithstanding one anecdotal opinion6--it is uncertain
6
Plaintiffs' point to an August 5, 2007, Call Report from one
of the company's National Accounts Managers, David McDaniel, who
noted under the heading "Key distributor activity and issues" that
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how far the July promotions explain the August fall-off of sales
for the defendant. In all events, plaintiffs--who had access to
discovery--are surprisingly light in quantitative evidence that the
discounts exceeded what was traditional for the slack period. That
the July offers targeted individual customers who were proving
difficult to lure is hardly surprising or ominous.
The failure to disclose the documented fall in sales in
August is a different matter. That sales did fall substantially is
reasonably clear--August net sales decreased about one-third from
the previous year (from $12,184,000 to $8,595,000) and gross
profits fell by more than 50 percent (from $2,736,000 to
$1,240,000). These are troubling figures even though the August 29
meeting notes also contained positive assessments7 and the hard
numbers are only for the first month of a quarter when sporting and
hunting sales usually picked up considerably.
Still, even if we assume arguendo that bad present
numbers should trump optimism and ought to have been disclosed or
even that more should have been said about discounting, the present
"[w]e have pulled a tremendous number of sales from August and
September into July trying to make the numbers. We'll have to
watch this closely as it might be an issue to deal with for August
and September."
7
"Walther is over plan"; "Consumer is above plan"; "Revolvers
over [plan]"; "Order flow is strong now"; "Feedback [from
distributors] so far is spotty, some guys up, some guys flat";
"[W]e have inventory to support additional orders, and we have
programs to drive those sales."
-17-
suit fails for lack of proof of scienter. Section 10(b) is
primarily a fraud provision and "a showing of either conscious
intent to defraud or a high degree of recklessness" is required.
Miss. Pub. Emps.' Ret. Sys., 649 F.3d at 20 (internal quotation
marks omitted). Recklessness in this context is
a highly unreasonable omission, involving not
merely simple, or even inexcusable negligence,
but an extreme departure from the standards of
ordinary care, and which presents a danger of
misleading buyers or sellers that is either
known to the defendant or is so obvious the
actor must have been aware of it.
Miss. Pub. Emps.' Ret. Sys., 649 F.3d at 20.
Scienter is inherently a fact-intensive inquiry, Dolphin
& Bradbury, Inc. v. SEC, 512 F.3d 634, 639 (D.C. Cir. 2008), and
courts are normally cautious about granting summary judgment for
the defense on this issue.8 But this hesitancy assumes that there
is either some evidence of subjective bad intent, or,
alternatively, misstatements or omissions so blatantly improper
that bad intent or recklessness can be inferred, e.g., Malone v.
Microdyne Corp., 26 F.3d 471, 478-79 (4th Cir. 1994). There is no
evidence of the former in this case and, at best, a thin and
debatable case as to misstatements or omissions.
8
E.g., Miss. Pub. Emps.' Ret. Sys., 649 F.3d at 20; Provenz v.
Miller, 102 F.3d 1478, 1489-90 (9th Cir. 1996), cert. denied, 522
U.S. 808 (1997); P.H. Glatfelter Co. v. Voith, Inc., 784 F.2d 770,
774 (7th Cir. 1986); cf. In re Chavin, 150 F.3d 726, 727-28 (7th
Cir. 1998).
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As City of Dearborn said, "[i]f it is questionable
whether a fact is material or its materiality is marginal, that
tends to undercut the argument that defendants acted with the
requisite intent or extreme recklessness in not disclosing the
fact." 632 F.3d at 757. The July promotions have not been clearly
shown to be abnormal; and failure to disclose in early September
the decline evidenced from the August figures may have been a
negligent misjudgement; but, without more, an inference of culpable
recklessness is a bridge too far.
Once the downward trend became clear with the
second-quarter numbers, the company explicitly acknowledged that
its forecasts had been undermined; as described at the outset, it
offered preliminary negative figures in late October well before
the final numbers were in hand, attributing the decline to "a
combination of factors that emerged late in the quarter." Whether
or not it was negligent to have remained too sanguine in early
September, there is no evidence of anything close to fraud.
Affirmed.
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