In Re: Burlington

Opinions of the United
1997 Decisions States Court of Appeals
for the Third Circuit
6-10-1997
In Re: Burlington
Precedential or Non-Precedential:
Docket 96-5187
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Recommended Citation
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Filed June 10, 1997
UNITED STATES COURT OF APPEALS
FOR THE THIRD CIRCUIT
No. 96-5187
IN RE BURLINGTON COAT FACTORY
SECURITIES LITIGATION
P. GREGORY BUCHANAN, JACOB TURNER AND
RONALD ABRAMOFF,
Appellants
ON APPEAL FROM THE
UNITED STATES DISTRICT COURT
FOR THE DISTRICT OF NEW JERSEY
(D.C. Civil Nos. 94-04663, 94-04737, 94-04751)
Argued: December 12, 1996
Before: GREENBERG, ALITO, and ROTH, Circuit Judges.
(Opinion Filed: June 10, 1997)
Jeffrey W. Golan (argued)
Leonard Barrack
Gerald J. Rodos
Robert A. Hoffman
BARRACK, RODOS & BACINE
3300 Two Commerce Street
2001 Market Street
Philadelphia, PA 19103
David J. Bershad
Sharon Levine Mirsky
Edith M. Kallas
MILBERG WEISS BERSHAD HYNES
& LERACH, LLP
One Pennsylvania Plaza
49th Floor
New York, NY 10119
Howard D. Finkelstein
FINKELSTEIN & ASSOCIATES
600 B Street
Suite 1400
San Diego, CA 92101
Alfred G. Yates, Jr.
ALFRED G. YATES, JR. &
ASSOCIATES
429 Forbes Avenue, Room 519
Allegheny Building
Pittsburgh, PA 15219
Attorneys for Appellants
2
Robert A. Alessi (argued)
CAHILL GORDON & REINDEL
Eighty Pine Street
New York, NY 10005
John L. Thurman
MASON, GRIFFIN & PIERSON, P.C.
101 Poor Farm Road
Princeton, New Jersey 08540
Attorneys for Appellees
OPINION OF THE COURT
ALITO, Circuit Judge:
Burlington Coat Factory Warehouse Corporation ("BCF "),
a Delaware corporation based in New Jersey, announced its
fourth quarter and full fiscal year results for 1994 on
September 20, 1994. The results were below the investment
community's expectations, and BCF's common stock fell
sharply, losing approximately 30% in one day. Within a day
of the initial announcement, the first investor suit was filed.
In the next few days, the company made additional
explanatory disclosures, and the stock price fell even
further. More investor suits were filed. The action at hand
is the product of the consolidation of these suits.
BCF and certain of its principal officers and directors
were sued under Sections 10(b) and 20(a) of the Securities
Exchange Act of 1934 (the "Exchange Act"). 15 U.S.C.
§§ 78j(b), 78(t)(a). Section 10(b) provides a broad prohibition
on the use of "manipulative or deceptive devices" in
connection with the purchase or sale of a security. 15
U.S.C. § 78j(b). Section 20, in turn, provides liability for
"controlling persons." 15 U.S.C. § 78(t)(a). Plaintiffs assert
that they represent the class of investors who purchased
BCF common stock between October 4, 1993, and
September 23, 1994. Plaintiffs claim that, as a result of
BCF's misleading statements and omissions during the
class period, the company's stock price was artificially
inflated.
3
The district court dismissed the case both for failure to
state claims on which relief could be granted and for failure
to plead those claims with adequate particularity. The court
also denied plaintiffs' request that they be allowed to
amend and replead their claims in the event of a dismissal.
On appeal, plaintiffs challenge the dismissal of four of
their six original claims. Since the fourth claim has two
distinct parts, we describe the four claims as five.
According to plaintiffs, the district court erred in ruling: (1)
that the alleged earnings overstatements during fiscal year
1994 were not materially misleading because no violation of
GAAP had been shown and that, in any event, the claim
stated was, at most, a claim for negligence; (2) that the
failure to disclose that the company had not received its
usual discounts in its inventory build-up in January and
February of 1994 was "largely irrelevant"; (3) that
overstatements regarding the sales attributable to an extra,
53rd week in 1993 were not actionable; (4) that
management's expression of "comfort" with certain specific
earnings forecasts by analysts was not actionable because
BCF did not "adopt" the analysts' estimates; and (5) that a
statement that the company's earnings would continue to
grow faster than revenues was not actionable because it
was no more than "puffery." Plaintiffs argue that these were
proper, viable claims under Section 10(b) and that they
pled facts in support of their claims that met the
particularity requirements for fraud claims. As afinal
matter, plaintiffs contend that even if the district court's
dismissal of their claims on particularity grounds was
justified, they should have been given leave to amend and
replead their claims.
We affirm the district court's dismissals on claims (2), (3),
and (5). Claims (1) and (4) were properly dismissed on
particularity grounds, but we disagree with the district
court's holding that these claims could not be viable. Since
leave to amend appears to have been denied on the grounds
of futility alone, we hold that plaintiffs may amend their
complaint and replead claims (1) and (4).
I.
BCF is one of the leading retailers of coats in the United
States. Its specialty is selling brand name clothes at
4
discount prices. By mid-1993, BCF was operating a total of
185 stores in 39 states. The stores ranged in size from
16,000 to 133,000 square feet and featured outerwear
(coats, jackets, and raincoats) and complete lines of
clothing for men, women, and children.
BCF opened in 1924, under the management of Abe
Milstein, and specialized in wholesale outerwear. In the
1950's, Abe's son, Monroe, joined the business. In 1972,
BCF acquired a coat factory and outlet store in Burlington,
New Jersey, and began operation as a retailer.
BCF is a public company traded on the New York Stock
Exchange. During the class period for this case, the average
daily trading volume for BCF common stock was 100,000
shares. Plaintiffs assert that BCF's securities are actively
followed by numerous analysts and that the market in BCF
stock was "efficient" at all periods relevant to this case.1
BCF's fortunes have been on the rise over the past
decade. BCF's 1992 Annual Report stated that "[t]he
Company's revenues have increased each year for the past
13 years, from $24 million in 1978 to over $1 billion in
1992." Further, BCF's earnings per share rose from $0.60
in 1990 to $1.06 in 1993.
BCF's top corporate officers, some of whom are
defendants in this case, hold large portions of BCF's
outstanding common stock. This seems especially true of
those officers who are members of the Milstein family,
which as a whole owned approximately 55% of BCF's
common stock.2
_________________________________________________________________
1. Asserting that the market in BCF's stock was "efficient" is relevant to
plaintiffs, such as those here, who are attempting to use the "fraud on
the market" theory to satisfy the reliance requirement in a Section 10(b)
claim. See, e.g., Daniel R. Fischel, Efficient Capital Markets, The Crash,
and the Fraud on the Market Theory, 74 Cornell L. Rev. 907, 908-12
(1989) (describing both the "fraud on the market" theory and its link to
the efficient market hypothesis); Jonathan Macey, et al., Lessons From
Financial Economics: Materiality, Reliance, and Extending the Reach of
Basic v. Levinson, 77 Va. L. Rev. 1017 (1991); see also n.8, infra.
2. As of May 11, 1994, there were 41,119,463 shares of BCF's common
stock outstanding. The stock ownership figures and percentages are
those alleged in the Complaint.
5
The defendant-officers are: (1) Monroe G. Milstein, BCF's
chief executive officer and chairman of the board, who
owned approximately 30.7% of the stock; (2) Stephen E.
Milstein, a vice-president, director, and general
merchandise manager, who owned approximately 4.9% of
the stock; (3) Andrew R. Milstein, a vice-president, director,
and executive merchandise manager, who owned
approximately 5.4% of the stock; (4) Robert R. LaPenta,
controller, and chief accounting officer; and (5) Mark A.
Nesci, vice-president for store operations, director, and
chief operating officer.
This case was brought as a class action on behalf of all
purchasers of BCF common stock during the period from
October 4, 1993, through and including September 23,
1994.3 Plaintiffs claim that during this period defendants
(the company and the individual officer-defendants),
through a number of misstatements in and omissions from
disclosures made to the public, defrauded plaintiffs into
purchasing BCF stock at artificially high prices.
Plaintiffs explain that the individual defendants, as a
result of their positions of control in the company, were
able to manipulate BCF's press releases and other
disclosures so as to deceive the market into overpricing the
company's stock. Allegedly, the individual defendants
behaved in this manner so as to:
(i) artificially inflate and maintain the market price of
BCF's common stock during the Class Period and
thereby cause plaintiffs and the other members of the
Class to purchase such common stock at artificially
inflated prices and, in the case of certain of the
defendants, to personally gain from the sale of inflated
stock; and
(ii) protect, perpetuate and enhance their executive
positions and the substantial compensation, prestige
and other perquisites of executive compensation
obtained thereby.
_________________________________________________________________
3. Excluded from the class are defendants, their immediate families, the
officers, directors, and affiliates of BCF, members of their immediate
families, and any trusts or entities which they control.
6
Complaint, ¶ 15.
Defendants who are alleged to have personally gained
from selling their stock during the class period are Andrew
R. Milstein (who sold 10,000 shares on March 17 and
March 21, 1994, at $27.75 per share), Mark A. Nesci (who
sold 10,000 shares on March 18 and March 25, 1994, at
$27.50), and Robert R. LaPenta (who sold 1,500 shares on
March 4, 1994 at $28.00 per share and 2,500 shares on
April 6, 1994, at $26.25 per share). The price drop between
September 20 and September 23, 1994 -- the days of the
announcements that allegedly caused a correction in the
stock price to reflect the true state of BCF's fortunes --
was from a high of $23.25 to a low of $13.63. Assuming
that the price drop of approximately $10 was due entirely
to the correction of false information, Andrew Milstein's and
Mark Nesci's trading gains would each amount to
approximately $100,000, and Robert LaPenta's gains would
be approximately $40,000.
II.
On September 20, 1994, BCF reported its year-end
revenues and earnings for fiscal 1994. These results were
below the market's expectations, with the earnings per
share for fiscal 1994 being $1.12 as compared to the $1.37
that analysts had been predicting. On September 20 itself,
the price of BCF stock fell almost 30%, from $23.25 to
$15.75 per share. Between September 20 and September
23 both BCF and outside analysts attempted to explain the
reasons for the worse-than-expected results. By the close of
the market on September 23, 1994, the price of BCF stock
had fallen to $13.63.
The first of plaintiffs' three suits was filed within a day of
the first price drop on September 20, alleging that BCF had
violated Sections 10(b) and 20(a) of the Exchange Act. Two
other similar actions were filed two days later, on
September 23, 1994. The three actions were consolidated,
and the consolidation resulted in the filing, in January
1995, of the "Consolidated Amended and Supplemental
Class Action Complaint" (the "Complaint").
7
Defendants moved to dismiss the Complaint under
Federal Rule of Civil Procedure 12(b)(6) for failure to state
a claim upon which relief could be granted and under
Federal Rule of Civil Procedure 9(b) for failure to plead
fraud with particularity.
The district court determined that the Complaint
contained six distinct claims:
First, plaintiffs allege that BCF's 1993 annual report
misrepresented the impact of an additional week (the
"fifty-third week") on the fiscal year-end sales revenue.
...
Second, plaintiffs allege that defendants failed to
announce that the discounts BCF received on
merchandise purchased for January, 1994, and
February, 1994, were substantially less than the
discounts received in previous years. . . .
Third, plaintiffs claim that "during each quarter during
the Class Period, defendants overstated BCF's profits
from operations by 2-3 cents EPS (earnings per share)
per quarter by failing to properly match their operating
expenses with sales." . . .
Fourth, plaintiffs allege that defendants, in a press
release of March 1, 1994, stated that BCF's store
expansion program would be internally funded, when,
in truth, BCF was borrowing heavily to fund that
expansion. . . .
Fifth, plaintiffs claim that defendants, in promoting the
store expansion program, asserted in various reports
. . . that 95% of all new stores were profitable within
six months, and that the new stores were opened
efficiently and without great expense. . . .
Finally, plaintiffs allege that throughout the putative
class period, defendants championed their growth in
revenue, profit margins and earnings, but did not
disclose shortcomings in their accounting and cost
control systems.
(Dist. Ct. Op. at 3).
8
On February 20, 1996, the district court dismissed
plaintiffs' claims pursuant to Rules 12(b)(6) and 9(b).
Plaintiffs had requested leave to amend should the
Complaint be dismissed, but the district court dismissed
the action in its "entirety."
Plaintiffs then took this appeal. Plaintiffs contest the
district court's dismissal of four of the six claims.4 Plaintiffs
also challenge the court's denial of their request for leave to
amend.
III.
A. Section 10(b) Claims
Plaintiffs assert claims under Sections 10(b) and 20(a) of
the Exchange Act, 15 U.S.C. §§ 78j(b), 78t(a), and Rule 10b-
5 promulgated thereunder, 17 C.F.R. § 240.10b-5. The
private right of action under Section 10(b) and Rule 10b-55
reaches beyond statements and omissions made in a
registration statement or prospectus or in connection with
an initial distribution of securities and creates liability for
false or misleading statements or omissions of material fact
that affect trading on the secondary market. See Central
Bank of Denver, N.A. v. First Interstate Bank of Denver,
N.A., 511 U.S. 164, 171 (1994); Shaw v. Digital Equip.
_________________________________________________________________
4. The claims abandoned on appeal are (1) that BCF, by stating that the
company " ``[c]ontinue[s] to anticipate funding most of [its] growth
through internal profits[,]' " misrepresented "that BCF's store expansion
program would be internally funded, when in truth BCF was borrowing
heavily to fund that expansion" and (2) that "defendants, in promoting
the store expansion program, [misrepresented] . . . that 95% of all new
stores were profitable within six months, and that the new stores were
opened efficiently and without great expense."
5. Section 10(b) prohibits the "use or employ[ment], in connection with
the purchase or sale of any security, . . . [of] any manipulative or
deceptive device or contrivance in contravention of such rules and
regulations as the Commission may prescribe." 15 U.S.C. § 78j(b). Rule
10b-5, in turn, makes it illegal "[t]o make any untrue statement of a
material fact or to omit to state a material fact necessary in order to
make the statements made in the light of the circumstances under
which they were made, not misleading . . . in connection with the
purchase or sale of any security." 17 C.F.R. § 240.10b-5(b).
9
Corp., 82 F.3d 1194, 1216-17 (1st Cir. 1996); Eckstein v.
Balcor Film Investors, 8 F.3d 1121, 1123-24 (7th Cir. 1993).
The first step for a Rule 10b-5 plaintiff is to establish
that defendant made a materially false or misleading
statement or omitted to state a material fact necessary to
make a statement not misleading. See In re Phillips
Petroleum Sec. Litig., 881 F.2d 1236, 1243 (3d Cir. 1989);
Lovelace v. Software Spectrum, Inc., 78 F.3d 1015, 1018
(5th Cir. 1996). Next, plaintiff must establish that
defendant acted with scienter and that plaintiff's reliance
on defendant's misstatement caused him or her injury. See
Phillips, 881 F.2d at 1244; San Leandro Emergency Medical
Group Profit Sharing Plan v. Philip Morris Cos., Inc., 75 F.3d
801, 808 (2d Cir. 1996). Finally, since the claim being
asserted is a "fraud" claim, plaintiff must satisfy the
heightened pleading requirements of Federal Rule of Civil
Procedure 9(b). See Suna v. Bailey Corp., 107 F.3d 64, 68
(1st Cir. 1997).
Rule 9(b) requires that "[i]n all averments of fraud or
mistake, the circumstances constituting fraud or mistake
shall be stated with particularity." This particularity
requirement has been rigorously applied in securities fraud
cases. See Suna, 107 F.3d at 73; Gross v. Summa Four,
Inc., 93 F.3d 987, 991 (1st Cir. 1996). For example, where
plaintiffs allege that defendants distorted certain data
disclosed to the public by using unreasonable accounting
practices, we have required plaintiffs to state what the
unreasonable practices were and how they distorted the
disclosed data. See Shapiro v. UJB Fin. Corp., 964 F.2d 272,
284-85 (3d Cir. 1992). Rule 9(b)'s heightened pleading
standard gives defendants notice of the claims against
them, provides an increased measure of protection for their
reputations, and reduces the number of frivolous suits
brought solely to extract settlements. See Tuchman v. DSC
Communications Corp., 14 F.3d 1061, 1067 (5th Cir. 1994);
Cosmas v. Hassett, 886 F.2d 8, 11 (2d Cir. 1989). Despite
Rule 9(b)'s stringent requirements, however, we have stated
that "courts should be ``sensitive' to the fact that application
of the Rule prior to discovery ``may permit sophisticated
defrauders to successfully conceal the details of their
fraud.' " Shapiro, 964 F.2d at 284 (citing Christidis v. First
10
Pa. Mortgage Trust, 717 F.2d 96, 99 (3d Cir. 1983)).
Accordingly, the normally rigorous particularity rule has
been relaxed somewhat where the factual information is
peculiarly within the defendant's knowledge or control. See
Shapiro, 964 F.2d at 285. But even under a relaxed
application of Rule 9(b), boilerplate and conclusory
allegations will not suffice. Id. Plaintiffs must accompany
their legal theory with factual allegations that make their
theoretically viable claim plausible. Id.Rule 9(b) also says that "[m]alice, intent, knowledge, and
other condition of mind of a person may be averred
generally." The meaning of this sentence has been the
source of considerable debate. The Second Circuit, among
others, has emphasized that although state of mind may be
"averred generally," a plaintiff alleging securities fraud must
still allege specific facts that give rise to a "strong inference"
that the defendant possessed the requisite intent. See, e.g.,
Acito v. IMCERA Group, Inc., 47 F.3d 47, 53 (2d Cir. 1995);
see also Suna, 107 F.3d at 68; Tuchman, 14 F.3d at 1068.
"The requisite ``strong inference' of fraud may be established
either (a) by alleging facts to show that defendants had both
motive and opportunity to commit fraud, or (b) by alleging
facts that constitute strong circumstantial evidence of
conscious misbehavior or recklessness." Acito, 47 F.3d at
52; see also Dileo v. Ernst & Young, 901 F.2d 624, 629 (7th
Cir. 1990) ("People sometimes act irrationally, but indulging
ready inferences of irrationality would too easily allow the
inference that ordinary business reverses are fraud").
By contrast, the Ninth Circuit has rejected such a
requirement that plaintiff allege facts from which intent to
commit fraud may be inferred. See In re GlenFed, Inc. Sec.
Litig., 42 F.3d 1541 (9th Cir. 1994) (in banc). In GlenFed,
the court argued that since the second sentence of Rule
9(b) states that "malice, intent, knowledge, and other
condition of mind may be averred generally," the Rule
leaves no room for requiring specific facts to be pled. Id. at
1545-47.
We agree with the Second Circuit's approach. Cf. In re
ValueVision Int'l, Inc., Sec. Litig., 896 F. Supp. 434, 446
(E.D. Pa. 1995) (noting the Third Circuit's silence on the
issue). While state of mind may be averred generally,
11
plaintiffs must still allege facts that show the court their
basis for inferring that the defendants acted with "scienter."
Otherwise, strike suits based on no more than plaintiffs'
detection of a few negligently made errors in company
documents or statements (errors detected in the aftermath
of a stock price drop) could survive the pleading threshold
and subject public companies to unneeded litigation
expenditures. Public companies make large quantities of
information available to the public, as a result of both
mandatory disclosure requirements and self-initiated
voluntary disclosure. Cf. Roberta Romano, The Genius of
American Corporate Law 93-95 (1993). Large volumes of
disclosure make for a high likelihood of at least a few
negligent errors. To allow plaintiffs and their attorneys to
subject companies to wasteful litigation based on the
detection of a few negligently made errors found
subsequent to a drop in stock price would be contrary to
the goals of Rule 9(b), which include the deterrence of
frivolous litigation based on accusations that could hurt the
reputations of those being attacked.6 See Tuchman, 14 F.3d
at 1067; In re Discovery Zone Sec. Litig., 943 F. Supp. 924,
934 (N.D. Ill. 1996).
Plaintiffs' Complaint advances numerous claims of
nondisclosure and misstatement. On appeal, the myriad
allegations have been whittled down to five: (1) that BCF
overstated certain quarterly earnings reports; (2) that BCF
wrongfully failed to disclose the receipt of certain reduced
discounts on purchases; (3) that BCF misrepresented the
sales attributable to the 53rd week of 1993; and (4) & (5)
that BCF made certain forward-looking statements without
_________________________________________________________________
6. The parties do not contend that the recently enacted Private Securities
Litigation Reform Act of 1995 (the "Reform Act") applies to this case. Cf.
Hockey v. Medhekar, 1997 WL 203704, *3-4 (N.D. Cal.) (holding that the
Reform Act applies only to class actions filed after December 22, 1995).
We note, however, that Section 21(D)(b)(2) of the Reform Act requires
that complaints brought under Rule 10b-5 "state with particularity facts
giving rise to a strong inference that the defendant acted with the
requisite state of mind." 15 U.S.C. § 78u-4(b)(2); see also Friedberg v.
Discreet Logic, Inc., 1997 WL 109228, *5 (D. Mass.); John C. Coffee, Jr.,
The Future of the Private Securities Litigation Reform Act: Or, Why the Fat
Lady Has Not Yet Sung, 51 Bus. Law. 975, 978-79 (1996).
12
a reasonable basis.7 Plaintiffs have further alleged that the
nondisclosures and misstatements were made with
fraudulent intent, that defendants' conduct artificially
inflated the market price of BCF stock, and that this fraud
on the market caused plaintiffs to suffer damages.8
_________________________________________________________________
7. Under existing law, where purchasers or sellers of stock have been
able to identify a specific false representation of material fact or omission
that makes a disclosed statement materially misleading, a private right
of action lies under Section 10(b) and Rule 10b-5. See Hayes v. Gross,
982 F.2d 104, 106 (3d Cir. 1992). Plaintiffs, however, did not merely
assert that defendants made affirmative misstatements in and omissions
from disclosed statements. They also alleged that defendants had failed
to comply with affirmative disclosure requirements under "Item 303 of
Regulation S-K." Complaint, ¶ 12. Plaintiffs tell us that under Item 303
defendants had a duty to "report all trends, demands or uncertainties
that were reasonably likely to (i) impact BCF's liquidity; (ii) impact
BCF's net sales, revenue and/or income; and/or (iii) cause previously
reported financial information not to be indicative of future operating
results." Complaint, ¶ 12; see also 17 C.F.R. § 229.303.
It is an open issue whether violations of Item 303 create an
independent cause of action for private plaintiffs. See Shaw, 82 F.3d at
1222 (declining to reach the issue); In re Wells Fargo Sec. Litig., 12 F.3d
922, 930 n.6 (9th Cir. 1993) (same); In re Canandaigua Sec. Litig., 944
F. Supp. 1202, 1209 n.4 (S.D.N.Y. 1996) ("far from certain that the
requirement that there be a duty to disclose under Rule 10b-5 may be
satisfied by importing the disclosure duties from S-K 303").
We do not need to reach this issue, however, because it has not been
raised on appeal.
8. The "fraud on the market" theory accords plaintiffs in Rule 10b-5
class actions a rebuttable presumption of reliance if plaintiffs bought or
sold their securities in an "efficient" market. See Donald C. Langevoort,
Theories, Assumptions and Securities Regulation: Market Efficiency
Revisited, 140 U. Pa. L. Rev. 851, 889-91 (1992); see also Shaw, 82 F.3d
at 1218. Plaintiffs using this theory need not show that they actually
knew of the communication that contained the misrepresentation or
omission. Instead, plaintiffs are accorded the presumption of reliance
based on the theory that in an efficient market the misinformation
directly affects the stock prices at which the investor trades and thus,
through the inflated or deflated price, causes injury even in the absence
of direct reliance. See Basic, Inc. v. Levinson, 485 U.S. 224, 241-42
(1988) (theory presumes that the plaintiffs relied on market integrity to
accurately and adequately incorporate the company's value into the price
13
Defendants counter that none of the statements or
omissions identified by plaintiffs was materially false,
misleading, or otherwise actionable. Defendants protest
that:
This lawsuit constitutes a frivolous attempt by
appellants to extort money from a healthy, successful
company that saw its revenues and earnings per share
increase steadily from fiscal 1990 through fiscal 1994.
The Company's only alleged sin is to have reported
accurately on September 20, 1994 its year-end
revenues and earnings for fiscal 1994, which, while
surpassing the performance of any prior year in its
history, failed to meet the earnings-per-share
projections of a handful of bullish securities analysts.
(Appellees' Br. at 18) (internal citations omitted). We
address each of plaintiffs' claims in turn.
(1) Earnings Overstatements
Plaintiffs allege that "during each quarter during the
Class Period, defendants overstated BCF's profits from
operations by 2-3 cents [earnings per share] per quarter by
failing to properly match their operating expenses with
sales." Complaint, ¶ 73(c). The Complaint explains:
In order to achieve their goal of inflating the Company's
stock price, defendants manipulated BCF's financial
statements through improper and misleading
accounting practices in violation of GAAP. Statement of
Financial Accounting Concepts 6 (SFAC [No.] 6), set
forth by the Financial Accounting Standards Board
(FASB), provides that expenses -- which are defined as
decreases in assets or increases in liabilities during a
period resulting from delivery of goods, rendering of
_________________________________________________________________
of the security); see also Langevoort, Market Efficiency at 890-91.
Therefore, in order to avail themselves of the fraud on the market theory
and the benefit of not having to plead specific reliance on the alleged
misstatement or omission, plaintiffs have to allege that the stock in
question traded on an open and efficient market. See Hayes v. Gross,
982 F.2d 104, 107 (3d Cir. 1992); Peil v. Speiser, 806 F.2d 1154, 1161
(3d Cir. 1986). It is undisputed that plaintiffs have met this burden.
14
services, or other activities constituting the enterprise's
central operations -- must be matched with revenues
resulting from those expenses. See SFAC[No.] 6 [ ]. The
matching principle requires that all expenses incurred
in the generating of revenue should be recognized in
the same accounting period as the revenues are
recognized. Defendants violated SFAC [No.] 6 by failing
to properly account for the expenses associated with
BCF's purchases of inventory during the Class Period,
and thereby artificially inflated the reported net income
and earnings per share during the first, second and
third quarters of fiscal year 1994. Because of the
Company's inadequate financial and accounting
controls, defendants were able to and did, in fact, . . .
materially understate BCF's expenses, on a quarter-
by-quarter basis during fiscal year 1994, and thereby
overstate very significantly during the Class Period
BCF's profitability, earnings and prospects for fiscal
year 1994.
Complaint, ¶ 67 (emphasis added).
The court dismissed the earnings overstatement claim
because it "fail[ed] to allege how defendants intentionally or
recklessly deviated from generally accepted accounting
principles." (Dist. Ct. Op. at 19). Although defendants
argued that plaintiffs had failed to state a legally cognizable
claim because they did not point to a violation of GAAP, the
district court's decision to dismiss this claim is most easily
read as being on Rule 9(b) grounds alone, i.e., a failure to
plead with particularity. However, to read the district
court's opinion as dismissing the claim under Rule 9(b)
alone would be inconsistent with the court's simultaneous
failure to grant leave to amend on the ground of futility. See
Section B, infra. Hence, we review the district court's
dismissal as if it were based on both Rule 12(b)(6) and Rule
9(b). In evaluating the Rule 12(b)(6) dismissal we assume
that the district court accepted defendants' arguments on
the issue.
(i) Rule 12(b)(6)
Defendants argue here, as they did before the district
court, that the earnings overstatement claim fails under
15
Rule 12(b)(6). A motion to dismiss pursuant to Rule 12(b)(6)
may be granted only if, accepting all well pleaded
allegations in the complaint as true, and viewing them in
the light most favorable to plaintiff, plaintiff is not entitled
to relief. Bartholomew v. Fischl, 782 F.2d 1148, 1152 (3d
Cir. 1986). "The issue is not whether a plaintiff will
ultimately prevail but whether the claimant is entitled to
offer evidence to support the claims." Scheuer v. Rhodes,
416 U.S. 232, 236 (1974).
Defendants argue that their earnings statements could
not have been materially misleading because BCF's
accounting practices were consistent with GAAP.9
Defendants assert that violations of mere accounting
"concepts" such as SFAC No. 6, which is what plaintiffs
have alleged, are not violations of GAAP, and therefore are
not enough to give rise to disclosure violations under the
securities laws.10 Defendants suggest that the earnings
_________________________________________________________________
9. Defendants do not attempt to suggest that the alleged earnings per
share overstatements of 2-3 cents themselves should be ruled
immaterial. Indeed, earnings reports are among the pieces of data that
investors find most relevant to their investment decisions. In deciding
whether to buy or sell a security, reasonable investors often rely on
estimates or projections of the underlying firm's future earnings. See
Wielgos v. Commonwealth Edison Co., 892 F.2d 509, 514 (7th Cir. 1989).
Information concerning the firm's current and past earnings is likely to
be relevant in predicting what future earnings might be. See Glassman
v. Computervision Corp., 90 F.3d 617, 626 (1st Cir. 1996). Thus,
information about a company's past and current earnings is likely to be
highly "material." Cf. Louis Lowenstein, Financial Transparency and
Corporate Governance: You Manage What You Measure, 96 Colum. L.
Rev. 1335, 1355 (market places an "enormous emphasis" on earnings
reports); Victor Brudney and William W. Bratton, Corporate Finance A-1
(1993) ("The issuance of an income statement is often preceded or
followed by increased market activity in the company's shares.").
10. GAAP is not a set of rigid rules ensuring identical treatment of
identical transactions, but rather characterizes the range of reasonable
alternatives that management can use. See Thor Power Tool Co. v.
Commissioner, 439 U.S. 522, 544 (1979); Lovelace v. Software Spectrum,
Inc., 78 F.3d 1015, 1021 (5th Cir. 1996). "GAAP [is] an amalgam of
statements issued by the [American Institute of Certified Public
Accountants] through the successive groups it has established to
promulgate accounting principles: the Committee on Accounting
16
overstatement claim is based on no more than the fact that
BCF uses one accounting method to value merchandise on
a quarterly basis (the "gross profit" method) and a different
method to value its merchandise on an annual basis (the
"retail inventory" method). In addition, defendants inform
us that the market knew about this practice because the
use of the different methods was disclosed to investors in
BCF's quarterly 10-Q filings with the SEC.
If BCF is correct (a) that the alleged overstatements of
quarterly earnings are merely the result of the use of valid,
accepted, and understood accounting methods, and (b) that
this concurrent use of different accounting methods was
fully and adequately disclosed to the market (alleged here
to be efficient), plaintiffs' claims would likely fail. However,
at this stage, we cannot say, as a matter of law, that the
alleged earnings overstatements can be fully explained by
BCF's use of different accounting methods for analyzing
quarterly versus annual data (even assuming that these
were fully disclosed to the market). Moreover, assuming
that consistency with GAAP is enough to preclude liability,
it is a factual question whether BCF's accounting practices
were consistent with GAAP. Cf. Discovery, 943 F. Supp. at935 n.9 ("This Court finds that whether FASB[SFAC] No. 6
constitutes GAAP is best resolved by expert testimony, and
thus should not be addressed on a motion to dismiss"); cf.
also In re Westinghouse Sec. Litig., 90 F.3d 696, 709 n.9 (3d
Cir. 1996). And, of course, since the claim at issue was
dismissed at the pleading stage, we are required to credit
_________________________________________________________________
Procedure, the Accounting Principles Board, and the Financial
Accounting Standards Board [(FASB)]. . . . GAAP include[s] broad
statements of accounting principles amounting to aspirational norms as
well as more specific guidelines and illustrations. The lack of an official
compilation allows for some debate over whether particular
announcements are encompassed within GAAP." Bily v. Arthur Young &
Co., 834 P.2d 745, 750-51 (Cal. 1992); see also Providence Hosp. of
Toppenish v. Shalala, 52 F.3d 213, 218 n.7 (9th Cir. 1995). At issue here
is SFAC No. 6, which although issued by FASB, is allegedly not GAAP --
at least according to defendants. But cf. Anthony Phillips et al., Basic
Accounting for Lawyers 39 (4th ed. 1988) (including FASB's Statements
of Financial Concepts within its table of "Sources of Generally Accepted
Accounting Principles").
17
plaintiffs' allegations rather than defendants' responses.
See, e.g., Westinghouse, 90 F.3d at 706 ("we must accept as
true plaintiffs' factual allegations, and we may affirm the
district court's dismissals only if it appears certain that
plaintiffs can prove no set of facts entitling them to relief")
(citation omitted). Consequently, we cannot sustain the
district court's dismissal of this claim under Rule 12(b)(6).
(ii) Rule 9(b)
The district court specifically ruled that the earnings
overstatement claim failed the particularity requirements of
Rule 9(b). Rule 9(b) requires a plaintiff to plead here (1) a
specific false representation of material fact, (2) knowledge
of its falsity by the person who made it, (3) ignorance of its
falsity by the person to whom it was made, (4) the maker's
intention that it should be acted upon, and (5) detrimental
reliance by the plaintiff. Westinghouse, 90 F.3d at 710. The
district court held that plaintiffs did not comply with Rule
9(b) because they failed to allege:
how defendants intentionally or recklessly deviated
from generally accepted accounting principles. The
Amended Consolidated Complaint is devoid of any
indication as to the particular error(s), [and/or] the
standard(s) from which defendants deviated and even
the allegation of scienter.
(Dist. Ct. Op. at 19) (emphasis added). The court concluded
that plaintiffs had offered no more than "rote allegations of
fraud predicated on the drop in price of BCF stock," and
that these allegations fell below the "who, what, when,
where and how" elements necessary to establish an
intentional or reckless misstatement or omission under
Rule 9(b). (Dist. Ct. Op. at 19). See Dileo, 901 F.2d at 627(equating the particularity required by Rule 9(b) with "the
first paragraph of any newspaper story"). In addition,
according to the court, plaintiffs' claim sounded in
"negligence." (Dist. Ct. Op. at 18).
We disagree that plaintiffs' claim, at this stage, boils
down to a blanket assertion of fraud premised on no more
than a drop in stock price.11 Plaintiffs have alleged that 2-3
_________________________________________________________________
11. The issue is not whether there was a deviation from any set of formal
accounting practices, but whether BCF's earnings statements were
18
cent overstatements of earnings occurred in the company's
public announcements of results for the first, second, and
third quarters of 1994 and that these overstatements
occurred because BCF failed to account properly for
expenses associated with purchases of inventory and
thereby violated a specific accounting concept: SFAC No. 6.
This is an adequate allegation of "how" BCF overstated its
earnings, so we cannot say that plaintiffs have failed to
state their claim with adequate particularity. Cf.
Westinghouse, 90 F.3d at 711 (where plaintiffs alleged that
defendant had arbitrarily moved loans from non-earning to
earning status just before mandated public reporting, when
nothing had changed regarding the likelihood of collection
on the loans, allegations were adequate under Rules
12(b)(6) and 9(b)).
The district court also ruled that plaintiffs inadequately
pled scienter. Here, we agree. To satisfy the scienter
requirement, plaintiffs "must allege facts that give rise to an
inference that [BCF] knew or was reckless in not knowing
that [BCF's] financial statements" were misleading. Id. at
712. It is not enough for plaintiffs to allege generally that
defendants "knew or recklessly disregarded each of the
false and misleading statements for which [they were]
sued," Complaint, ¶ 16; plaintiffs must allege facts that
could give rise to a "strong" inference of scienter. Suna, 107
F.3d at 68; San Leandro, 75 F.3d at 813-14. Plaintiffs must
either (1) identify circumstances indicating conscious or
reckless behavior by defendants or (2) allege facts showing
both a motive and a clear opportunity for committing the
fraud. San Leandro, 75 F.3d at 813.
In this case, plaintiffs have failed to allege facts that
would constitute circumstantial evidence of reckless or
conscious misbehavior on the part of defendants in making
the overstatements of earnings. Cf. id. at 812-13 (describing
_________________________________________________________________
materially misleading. Deviations from accounting standards are
important insofar as reasonable investors expect those standards to be
followed. Given that the market expects that a certain set of accounting
standards will be followed, we imagine that a demonstration of explicit
compliance with these standards will at least generally negate the
possibility that reasonable investors were misled.
19
the types of allegations of fact that would indicate
conscious or reckless behavior).
Plaintiffs have also endeavored to plead scienter by
alleging facts that point towards motive and opportunity to
commit fraud. Plaintiffs have alleged (and it is undisputed)
that the individual defendants were top officers of BCF and
hence had the opportunity to manipulate BCF's disclosures
to the public. Id. at 813. In addition, plaintiffs have alleged
that defendants artificially inflated the price of BCF's stock
so as to enable certain top BCF officials to sell portions of
their stock holdings at these prices.12 See Acito v. IMCERA
Group, Inc., 47 F.3d 47, 53 (2d Cir. 1995) ("Plaintiffs may
plead scienter by alleging ``facts establishing a motive to
commit fraud and an opportunity to do so,' or alleging ``facts
_________________________________________________________________
12. Plaintiffs also allege, generally, that the individual officer-defendants
sought to inflate the company's stock price so as to "protect, perpetuate
and enhance their executive positions and the substantial compensation,
prestige and other perquisites of executive employment obtained
thereby." Complaint, ¶ 15. This general allegation, however, does not
help plaintiffs in adequately alleging scienter because they fail to explain
to us how a temporary inflation of BCF's stock price would help
management increase its compensation or preserve its jobs. Cf. Acito v.
IMCERA Group, Inc., 47 F.3d 47, 54 (2d Cir. 1995) ("[T]he existence,
without more, of executive compensation dependent upon stock value
does not give rise to a strong inference of scienter."); cf. also In re
HealthCare Compare Corp. Sec. Litig., 75 F.3d 276, 284 (7th Cir. 1996);
but cf. In re Wells Fargo Sec. Litig., 12 F.3d 922, 925 & 931 (9th Cir.
1993). An example of a situation in which management might be able to
preserve its compensation and job security by causing a temporary stock
price increase could be where the incumbent management fears a
specific takeover bid and is seeking to deter the takeover (by causing the
target company's stock price to be artificially inflated for a short period).
See Stransky v. Cummins Engine Co., Inc., 51 F.3d 1329, 1331 (7th Cir.
1995) (where plaintiffs articulated such a theory); see also HealthCare,
75 F.3d at 284. As a general matter, though, causing temporary
inflations of price through the dissemination of false information hurts
the long-term stock price of the company and thereby presumably hurts
managerial compensation that may be tied to the long-term performance
of the company. This is so because these disseminations of false
information (that are eventually discovered by the market) increase the
volatility of the company's stock and in turn increase its risk and long-
term price. Cf. Marcel Kahan, Securities Laws and the Social Costs of
"Inaccurate" Stock Prices, 41 Duke L. J. 977, 1025-26 (1992).
20
constituting circumstantial evidence of either reckless or
conscious misbehavior.") (quoting In re Time Warner Sec.
Litig., 9 F.3d 259, 269 (2d Cir. 1993)); see also Shaw v.
Digital Equip. Corp., 82 F.3d 1194, 1224 (1st Cir. 1996). In
support of this theory, plaintiffs' Complaint provides us
with the names of the insiders who sold stock, the
quantities of stock sold and the prices at which the sales
occurred, and the dates of the sales. Complaint, ¶ 51.
What these allegations boil down to is that two of the five
officer-defendants made a profit of approximately $100,000
each and that a third officer-defendant made a profit of
approximately $40,000 as a result of the artificial inflation
of the price of BCF's stock. The two officer-defendants who
are not alleged to have traded are Monroe Milstein, the CEO
and chairman of the board, who owned 30.7% of BCF's
stock, and Stephen Milstein, a vice-president and general
merchandise manager, who owned 4.9% of the stock.
Of the three defendants who are alleged to have traded
on nonpublic information, plaintiffs have provided us with
the total stock holdings of only one defendant. This
defendant, Andrew Milstein, owned 5.4% of the stock. The
Complaint tells us that as of May 11, 1994, there were
41,119,463 shares of BCF's common stock outstanding. A
5.4% holding, therefore, translates to approximately
2,220,451 shares. Of these, Andrew Milstein is alleged to
have profited on the sale of 10,000 shares, i.e.,
approximately 0.5% of his holdings. With respect to the
other two officer-defendants who are alleged to have traded
on the nonpublic information, the Complaint provides us
with the number of shares they traded, but not what their
total stock holdings were.
These allegations are inadequate to produce a "strong"
inference of "fraudulent intent." See San Leandro, 75 F.3d
at 814. First, two officer-defendants are not alleged to have
traded at all, and these two defendants appear to be two of
the more powerful among the group of five. One of them
was the CEO, chairman of the board, and holder of over
30% of the stock. Second, the one defendant for whom we
have information as to his total stock holdings appears to
have sold no more than a minute fraction of his holdings,
0.5%. Further, we have no information as to whether such
21
trades were normal and routine for this defendant. Nor do
we have information as to whether the profits made were
substantial enough in relation to the compensation levels
for any of the individual defendants so as to produce a
suspicion that they might have had an incentive to commit
fraud. Finally, for two of the officer-defendants who are
alleged to have traded during the class period, we do not
even have information as to their total BCF stock holdings,
and we therefore have even less of a basis to infer that their
sales were unusual or suspicious. To the extent plaintiffs
choose to allege fraudulent behavior based on what they
perceive as "suspicious" trading, they have to allege facts
that support that suspicion.
A large number of today's corporate executives are
compensated in terms of stock and stock options. Cf. Elliott
J. Weiss, The New Securities Fraud Pleading Requirement:
Speed Bump or Road Block?, 38 Ariz. L. Rev. 675, 687
(1996). It follows then that these individuals will trade
those securities in the normal course of events. We will not
infer fraudulent intent from the mere fact that some officers
sold stock. See Shaw, 82 F.3d at 1224; cf. Tuchman, 14
F.3d at 1068 (noting that if "incentive compensation" could
be the basis for an allegation of fraud, "the executives of
virtually every corporation in the United States would be
subject to fraud allegations") (citation omitted). Instead,
plaintiffs must allege that the trades were made at times
and in quantities that were suspicious enough to support
the necessary strong inference of scienter. See Shaw, 82
F.3d at 1224; see also Searls v. Glasser, 64 F.3d 1061,
1068 (7th Cir. 1995); cf. Weiss, Securities Fraud Pleading at
686-87 (question courts should ask is whether the benefits
realized by executives as a result of the inflation in stock
price are "sufficiently large to constitute evidence of motive"
to commit fraud).
We conclude, therefore, that while dismissal on Rule
12(b)(6) alone would not have been proper, the dismissal on
Rule 9(b) grounds was. We do not discard the possibility,
however, that plaintiffs will be able to amend the Complaint
to allege trading by the defendant-officers that adequately
supports the requisite strong inference of scienter.
22
(2) The 53rd Week
Fiscal year 1993 for BCF contained an extra, 53rd week.
In its 1993 annual report, filed with the SEC on October 4,
1993, BCF represented that this 53rd week had accounted
for an increase of $12.2 million in sales. Specifically, the
1993 annual report stated:
Fiscal 1993 was a 53 week fiscal year compared with
52 week fiscal years in 1992 and 1991. Net sales for
the 53rd week in fiscal 1993 amounted to $12.2
million.
(Dist. Ct. Op. at 15). According to plaintiffs, however, this
statement was false when made. Claiming that the true
increase in sales attributable to the 53rd week was $23.2
million, not $12.2 million, plaintiffs rely on the following
statement made by BCF in a September 20, 1994, press
release:
[T]he fourth quarter of 1994 was a 13 week quarter
compared with a 14 week fiscal quarter in 1993. This
extra week, a year ago, added $23.2 million in sales,
and approximately $5 million in pre-tax profit, to
1993's fourth quarter.
(Dist. Ct. Op. at 15).
Plaintiffs claim that BCF's initial understatement of the
effect of the 53rd week caused investors materially to
overestimate BCF's future prospects. Complaint,¶ 35.
The two BCF statements on which plaintiffs rely appear
to be inconsistent with respect to the effect of the 53rd
week. The district court, however, found them consistent
and consequently rejected plaintiffs' claim. The court
explained:
The 1993 Annual Report and the September 20, 1994
press release compare two separate periods. The 1993
Annual Report focuses on the week of June 27, 1993 to
July 3, 1993 as the extra, non-comparable week
between fiscal 1992 and fiscal 1993. That week, which
was the fifty-third week in fiscal 1993, accounted for
$12.2 million in sales. The September 20, 1994 press
release, however, focuses on another week -- that of
23
March 28, 1993 to April 3, 1993 -- as the non-
comparable week between fifty-three-week fiscal 1993
and fiscal 1994, which had only fifty-two weeks.
(Dist. Ct. Op. at 16) (emphasis added; internal citations
omitted).
Unlike the district court, we see nothing in the 1993
Annual Report or the September 20, 1994, press release
that makes clear that the 53rd weeks discussed in the two
documents were two different calendar weeks fromfiscal
year 1993. As far as we can see, the only source of
information before the district court that could have
provided a basis for the conclusion it reached was
defendants' brief in support of their motion to dismiss.
Indeed, the district court's opinion specifically cites to an
affidavit proffered by defendants on this point. (Dist. Ct.
Op. at 16). However, since the district court was ruling on
a motion to dismiss, it was not permitted to go beyond the
facts alleged in the Complaint and the documents on which
the claims made therein were based. See Angelastro v.
Prudential-Bache Sec., Inc., 764 F.2d 939, 944 (3d Cir.
1985); see also In re Donald J. Trump Casino Sec. Litig., 7
F.3d 357, 368 n.9 (3d Cir. 1993). Thus, if we stopped our
analysis here, we would have to reverse the district court's
dismissal of this claim. There is an alternative basis,
however, that warrants affirmance of the district court's
decision.
The district court's opinion notes that, on July 29, 1994,
approximately two months prior to the September 20 press
release (where it was disclosed that the 53rd week of 1993
accounted for $23.2 million in sales), BCF had disclosed
the information as to the $23.2 million in sales. (Dist. Ct.
Op. at 16). Plaintiffs' Complaint tells us that this
information, when released to the public, had "no
appreciable effect on the market price of BCF common
stock or on analysts' projections [as to the company's
earnings for the year]." Complaint, ¶ 57. Plaintiffs'
Complaint also informs us that BCF's stock was actively
traded and carefully followed by market analysts and that
the market for BCF stock was "efficient." Complaint, ¶ 23.
Because the market for BCF stock was "efficient" and
because the July 29 disclosure had no effect on BCF's
24
price, it follows that the information disclosed on
September 20 was immaterial as a matter of law.
Ordinarily, the law defines "material" information as
information that would be important to a reasonable
investor in making his or her investment decision. See
Westinghouse, 90 F.3d at 714. In the context of an
"efficient" market, the concept of materiality translates into
information that alters the price of the firm's stock. Cf.
Shaw, 82 F.3d at 1218 (in cases involving the fraud on the
market theory of liability, statements identified as
actionably misleading are alleged to have caused injury,
"not through the plaintiffs' direct reliance upon them, but
by dint of the statements' inflating effect on the price of the
security purchased") (emphasis added); Raab v. General
Physics Corp., 4 F.3d 286, 289 (4th Cir. 1993) (" ``Soft',
``puffing' statements . . . generally lack materiality because
the market price of a share is not inflated by vague
statements predicting growth") (emphasis added). This is so
because efficient markets are those in which information
important to reasonable investors (in effect, the market, see
Shaw, 82 F.3d at 1218) is immediately incorporated into
stock prices. See Langevoort, Market Efficiency, at 851; see
also Roots Partnership v. Lands' End, Inc., 965 F.2d 1411,
1419 (7th Cir. 1992); Wielgos, 892 F.3d at 510 ("The
Securities and Exchange Commission believes that markets
correctly value the securities of well-followedfirms, so that
new sales may rely on information that has been digested
and expressed in the security's price."). Therefore, to the
extent that information is not important to reasonable
investors, it follows that its release will have a negligible
effect on the stock price. In this case, plaintiffs have
represented to us that the July 29 release of information
had no effect on BCF's stock price. This is, in effect, a
representation that the information was not material. See
Fischel, Efficient Capital Markets, at 909-910; cf. Roots
Partnership, 965 F.2d at 1419 (plaintiff asserting fraud on
the market theory claimed to have been misled into
purchasing company's securities on July 25, 1989 by
earnings projection for the first quarter that was made on
April 4, 1989; claim failed because company had disclosed
its actual first quarter earnings on May 18 , 1989 and under
plaintiffs' own efficient market theory this information
25
should have been incorporated into the price prior to
plaintiff's purchase on July 25). If the July 29 information
was immaterial, its nondisclosure in the 1993 Annual
Report is not actionable.
(3) Reduced Supplier Discounts
Plaintiffs assert that "BCF purchased the bulk of its
inventory of coats for 1994 in January and February 1994,
yet defendants failed to disclose in its statements and
reports from March 1, 1994 to September 23, 1994, that
the discounts received were substantially less than in prior
years." Complaint, ¶ 73(b). In order for an omission or
misstatement to be actionable under Section 10(b) it is not
enough that plaintiff identify the omission or misstatement.
The omission or misstatement must also be material, i.e.,
something that would alter the total mix of relevant
information for a reasonable investor making an investment
decision. See Westinghouse, 90 F.3d at 714. Although
questions of materiality have traditionally been viewed as
particularly appropriate for the trier of fact, complaints
alleging securities fraud often contain claims of omissions
or misstatements that are obviously so unimportant that
courts can rule them immaterial as a matter of law at the
pleading stage. See, e.g., Shaw, 82 F.3d at 1217-18;
Glassman, 90 F.3d at 635. Along these lines, the district
court rejected plaintiffs' claim predicated on the
undisclosed supplier discounts. The court made its ruling
on the ground that the allegedly omitted information was
too immaterial to form the basis for a legally viable claim.
There is a threshold procedural question that we must
address before reaching the merits of the district court's
decision on materiality. Plaintiffs claim that the district
court committed reversible error in using information
contained in BCF's 1994 Annual Report as a basis for its
materiality analysis because the 1994 Annual Report was
neither attached to, nor referred to, in the Complaint.
As a general matter, a district court ruling on a motion
to dismiss may not consider matters extraneous to the
pleadings. Angelastro, 764 F.2d at 944. However, an
exception to the general rule is that a "document integral to
or explicitly relied upon in the complaint" may be
26
considered "without converting the motion [to dismiss] into
one for summary judgment." Shaw, 82 F.3d at 1220(emphasis added); see also Trump, 7 F.3d at 368 n.9 ("a
court may consider an undisputedly authentic document
that a defendant attaches as an exhibit to a motion to
dismiss if the plaintiff's claims are based on the
document.") (quoting Pension Benefit Guar. Corp. v. White
Consol. Indus., 998 F.2d 1192, 1196 (3d Cir. 1993)).
The rationale underlying this exception is that the
primary problem raised by looking to documents outside
the complaint -- lack of notice to the plaintiff-- is
dissipated "[w]here plaintiff has actual notice . . . and has
relied upon these documents in framing the complaint."
Watterson v. Page, 987 F.2d 1, 3-4 (1st Cir. 1993) (quoting
Cortec Indus., Inc. v. Sum Holding L.P., 949 F.2d 42, 48 (2d
Cir. 1991)); see also San Leandro, 75 F.3d at 808-09. What
the rule seeks to prevent is the situation in which a plaintiff
is able to maintain a claim of fraud by extracting an
isolated statement from a document and placing it in the
complaint, even though if the statement were examined in
the full context of the document, it would be clear that the
statement was not fraudulent. See Shaw, 82 F.3d at 1220.
As best we can tell, plaintiffs are correct that the
Complaint does not explicitly refer to or cite BCF's 1994
Annual Report. But the language in both Trump and Shaw
makes clear that what is critical is whether the claims in
the complaint are "based" on an extrinsic document and
not merely whether the extrinsic document was explicitly
cited. See Trump, 7 F.3d at 368 n.9; Shaw, 82 F.3d at
1220. Plaintiffs cannot prevent a court from looking at the
texts of the documents on which its claim is based by
failing to attach or explicitly cite them.
In this case, every time in the Complaint that plaintiffs
refer to their claim that data as to lower discounts in
January-February 1994 was required to be disclosed, but
was not, plaintiffs support their claim by arguing that the
data as to the January-February period was crucial to
investors because this was the period during which BCF
purchased the bulk of its 1994 inventory. Complaint,¶¶ 50,
54(b), 62, 73(b). This is an unambiguous reference to full-
year cost data for 1994. The Complaint, however, does not
27
provide a citation for the source of full-year data for 1994.
In the absence of such a citation, we think it was
reasonable for the district court to have looked to the 1994
Annual Report that defendants provided.
Plaintiffs next argue that, even if consideration of the
1994 Annual Report were legitimate, the district court erred
in dismissing their claim. The district court reasoned that
to the extent the allegedly lower discounts in January-
February 1994 were relevant to investors, they would be
reflected in the 1994 "costs of goods sold." (Dist. Ct. Op. at
12). Plaintiffs assert that the court erred in looking at total
costs. We disagree.
As previously noted, reasonable investors often rely on
estimates of a firm's future earnings in deciding whether to
invest in a firm's securities. See Glassman, 90 F.3d at 626.
A reduction in discounts received on merchandise
purchases would be material if it affected total costs and
therefore earnings. In evaluating the materiality of the
allegedly undisclosed lower discounts, therefore, the district
court correctly looked to the effect of these allegedly lower
discounts on total costs. The impact was negligible; total
costs between 1993 and 1994 increased only 0.2%, and
many factors other than merchandise discounts go into
total costs. Where the data alleged to have been omitted
would have had no more than a negligible impact on a
reasonable investor's prediction of the firm's future
earnings, the data can be ruled immaterial as a matter of
law. Cf. Westinghouse, 90 F.3d at 714-15 (where plaintiffs
alleged misstatements regarding loan loss reserves, but the
claim was based on a failure to do a single write down that
would have produced no more than a 0.54% change in the
firm's net income, claim could be ruled immaterial as a
matter of law); Glassman, 90 F.3d at 633 (where allegedly
undisclosed information as to quarter-to-quarter changes in
backlog was no more than a few percent, the claim of
nondisclosure could be ruled immaterial as a matter of
law). Hence, we affirm the district court's dismissal of this
claim.
(4) & (5) Forward-Looking Statements
Plaintiffs allege that BCF misrepresented its future
prospects to the public by making two forward-looking
28
statements that lacked a reasonable basis. The federal
securities laws do not obligate companies to disclose their
internal forecasts. See In re Lyondell Petrochemical Co. Sec.
Litig., 984 F.2d 1050, 1052 (9th Cir. 1993); see also
Glassman, 90 F.3d at 631; Shaw, 82 F.3d at 1209.
However, if a company voluntarily chooses to disclose a
forecast or projection, that disclosure is susceptible to
attack on the ground that it was issued without a
reasonable basis. See In re Craftmatic Sec. Litig., 890 F.2d
628, 645-46 (3d Cir. 1990); Herskovitz v. Nutri/System,
Inc., 857 F.2d 179, 184 (3d Cir. 1988); Searls v. Glasser, 64
F.3d 1061, 1067 (7th Cir. 1995) ("Before management
releases estimates to the public, it must ensure that the
information is reasonably certain. If it discloses the
information before it is convinced of its certainty,
management faces the prospect of liability.") (citations
omitted). The two forward-looking statements that plaintiffs
attack are (1) a representation that BCF "believe[d] [it could]
continue to grow net earnings at a faster rate than sales,"
and (2) a BCF officer's expression of "comfort" with analyst
projections of $1.20 to $1.30 as a mid-range for earnings
per share for fiscal year 1994. Complaint, ¶ 36. We examine
the statements in turn, concluding that while the claims as
to both were properly dismissed, plaintiffs should be given
leave to amend their claims as to one.
Statement of Belief
BCF's Chief Accounting Officer's statement on November
1, 1993, that the company "believe[d] [it could] continue to
grow net earnings at a faster rate than sales" can be broken
down into two component parts. First, that as of November
1, 1993, the company's earnings had grown at a faster rate
than sales, and second, that the company believed that this
trend would continue. As to the first part of the statement,
plaintiffs have not alleged that as of November 1, 1993,
earnings had not been growing faster than sales. Instead,
plaintiffs' claim focuses on the second portion of the
statement -- the forward-looking portion.
The forward-looking portion of the statement here is a
general, non-specific statement of optimism or hope that a
trend will continue. Claims that these kinds of vague
expressions of hope by corporate managers could dupe the
29
market have been almost uniformly rejected by the courts.
See San Leandro, 75 F.3d at 811 (subdued, generally
optimistic statements constituted nothing more than
puffery and were not actionable); see also Shapiro v. UJB
Fin. Corp., 964 F.2d 272, 283 n.12 (3d Cir. 1992);
Glassman, 90 F.3d at 636; Searls, 64 F.3d at 1066; Hillson
Partners Ltd. Partnership v. Adage, Inc., 42 F.3d 204, 212
(4th Cir. 1994) (deeming prediction of "significant sales
gains . . . as the year progresses" too vague to be material).
We agree, and thus hold that the statement at issue is too
vague to be actionable. Moreover, to the extent plaintiffs are
asserting that there was either a duty to correct or update
the forward-looking portion of the statement,13 those claims
fail on account of the original statement's vagueness and
resultant immateriality. See Gross v. Summa Four, Inc., 93
F.3d 987, 994-95 (1st Cir. 1996); Shaw, 82 F.3d at 1219
n.33 (cautiously optimistic statements, expressing at most
a hope for a positive future, do not trigger a duty to
update); In re Time Warner, Inc. Sec. Litig., 9 F.3d 259, 267
(2d Cir. 1993) (statements at issue lacked "definite positive
projections" of the sort that might require later correction),
cert. denied, 114 S. Ct. 1397 (1994).
Expression of Comfort
The second forward-looking statement at issue is BCF's
Chief Accounting Officer's statement during a securities
analysts' conference that he was "comfortable" with
analysts' estimates of $1.20 to $1.30 as a mid-range for
fiscal 1994 earnings per share. This statement was reported
by Reuters on November 1, 1993. Plaintiffs assert (1) that
this statement was actionable because it was not made
with a reasonable basis, and (2) that BCF failed to fulfill its
duty to correct this unreasonable forecast in the period
following November 1, 1993. The district court, however,
ruled that a corporate officer's expression of comfort with
an analyst's projection of earnings cannot be the basis for
a Section 10(b), Rule 10b-5 claim.
The Supreme Court has held that statements of opinion
by top corporate officials may be actionable if they are
_________________________________________________________________
13. As the district court noted, the Complaint is hardly a model of
clarity.
30
made without a reasonable basis. See Virginia Bankshares,
Inc. v. Sandberg, 501 U.S. 1083, 1098 (1991); see also
Trump, 7 F.3d at 372 n.14 (applying the rationale of
Virginia Bankshares, a Section 14(a) proxy solicitation case,
to the Section 10(b) context); Glassman, 90 F.3d at 627. In
particular, in Virginia Bankshares, the Court held
actionable a board of directors' expression of opinion
concerning a specific merger price. Id. at 2758-59 (board of
directors expressed the opinion that merger price was
"fair"); see also Glassman, 90 F.3d at 627 (holding
actionable representations by the company and its
underwriters that the prices for a public offering were fair
and estimated based on the most current information
available at the time of the offering). As explained by the
Court in Virginia Bankshares, statements of opinion by
corporate officials can be materially significant to investors
because investors know that these top officials have
knowledge and expertise far exceeding that of the ordinary
investor. 501 U.S. at 1090-91; see also Glassman, 90 F.3d
at 631. The rationale of Virginia Bankshares is applicable
here, where BCF's Chief Accounting Officer expressed his
agreement with certain projections by analysts.14
The district court rejected plaintiffs' claim on the ground
that a company is not liable for an analyst's projection
unless the company expressly "adopted or endorsed" the
analyst's report. (Dist. Ct. Op. at 10, citing Weisbergh v. St.
Jude Medical, Inc., 158 F.R.D. 638, 644 (D. Minn. 1994)
("This Court will not hold defendants responsible for the
projections of market analysts absent an indication that
defendants were responsible for the projections or in a
position to influence or control them"), aff'd, 62 F.3d 1422(8th Cir. 1985) and Raab v. General Physics Corp., 4 F.3d
286, 288 (4th Cir. 1993) ("The securities laws require
General Physics to speak truthfully to investors; they do
_________________________________________________________________
14. Certain vague and general statements of optimism have been held
not actionable as a matter of law because they constitute no more than
"puffery" and are understood by reasonable investors as such. See, e.g.,
San Leandro, 75 F.3d at 810. The puffery defense does not apply here
since the expression of comfort was not vague; it was an agreement with
a specific forecast range. Cf. Glassman, 90 F.3d at 636 (distinguishing
vague statements of optimism from specific projections).
31
not require the company to police statements made by third
parties for inaccuracies, even if the third party attributes
the statement to General Physics)). Although we have no
problem with the "adopt or endorse" test, we disagree with
its application here.
To say that one is "comfortable" with an analyst's
projection is to say that one adopts and endorses it as
reasonable. When a high-ranking corporate officer explicitly
expresses agreement with an outside forecast, that is close,
if not the same, to the officer's making the forecast.15 We
see no reason why adopting an analyst's forecast by
reference should insulate an officer from liability where
making the same forecast would not.
The cases the district court cites in support of its
conclusion concern attacks on statements by analysts and
claims that those statements should be attributed to the
defendant company because the company allegedly
provided the analysts with information. See Raab, 4 F.3d at
288; Weisbergh, 158 F.R.D. at 643. Plaintiffs' claim here,
however, is not an indirect attempt to attribute an analyst's
prediction to the company where the company itself has
made no explicit statement (for example, because the
company provided the analyst with all the relevant data or
somehow controlled what the analyst was doing). Instead,
plaintiffs directly attack BCF's CAO's own statement, as it
was reported by Reuters. The attribution issue does not
arise because at this stage we take as true the allegation
that BCF's CAO did express comfort with the analyst
projections at issue. Cf. Elkind v. Liggett & Myers, Inc., 635
F.2d 156, 163 (2d Cir. 1980) ("attribution" question is
answered by asking whether company officials have,
expressly or impliedly, made a representation that the
analyst projections are in accordance with their views); In re
Adobe Systems, Inc. Sec. Litig., 767 F. Supp. 1023, 1027-28
(N.D. Cal. 1991) (denying motion to dismiss where
_________________________________________________________________
15. This is not to discount the possibility of situations where the
expression of agreement is so unenthusiastic that no reasonable investor
would attach relevance to it. Here, however, as alleged by plaintiffs, the
CAO's expression of comfort was enthusiastic enough that we cannot
deem it immaterial as a matter of law.
32
corporate officer stated he "preferred" certain analyst
estimates to others). Put differently, it is a statement by a
BCF officer itself that is being attacked, not an analyst's
statement.16
The next question for us is whether there are sufficient
factual allegations supporting plaintiffs' theory for the claim
to survive the Rule 9(b) hurdle. To adequately state a claim
under the federal securities laws, it is not enough merely to
identify a forward-looking statement and assert as a general
matter that the statement was made without a reasonable
basis. Instead, plaintiffs bear the burden of "plead[ing]
factual allegations, not hypotheticals, sufficient to
reasonably allow the inference" that the forecast was made
with either (1) an inadequate consideration of the available
data or (2) the use of unsound forecasting methodology.
Glassman, 90 F.3d at 628-29 (rejecting plaintiffs' earnings
projection claim on Rule 12(b)(6) grounds alone, albeit in
the context of the plaintiffs having had the benefit of full
discovery); cf. Virginia Bankshares, 501 U.S. at 1092-94(describing the type of hard contemporaneous facts that
could show an opinion as to the fairness of a suggested
price to have been unreasonable when made); cf. also
Shapiro, 964 F.2d at 284-85 (in attacking afirm's
accounting practices with a claim that those practices
resulted in the disclosure of misleading data, plaintiffs
must (a) identify what those practices are and (b) specify
how they were departed from)). In deciding a motion to
dismiss, a court must take well-pleaded facts as true but
need not credit a complaint's "bald assertions" or "legal
_________________________________________________________________
16. The district court also noted that the earnings projections of $1.20-
$1.30 per share for fiscal 1994 were not materially off the mark in that
earnings turned out to be $1.12 per share. But this is an ex post
justification. Securities laws approach matters from an ex ante
perspective. See Pommer, 961 F.2d at 623. The fact that we see in
hindsight that earnings per share did in fact turn out to be roughly
within the range they were projected does not tell us conclusively that
the forecasts were reasonable at the time they were made. Cf. Glassman,
90 F.3d at 627 ("[W]hile forecasts are not actionable merely because they
do not come true, they may be actionable because they are not
reasonably based on, or are inconsistent with, the facts at the time the
forecast is made.").
33
conclusions." Glassman, 90 F.3d at 628. In this case,
plaintiffs identified the offending forecasts and then alleged:
The foregoing statements were materially false and
misleading when made since, at the time they were
made, defendants knew, or recklessly disregarded, that
their public statements and statements to analysts
promoting BCF and its stock would artificially maintain
and inflate the market price of BCF's common stock
due to the false and misleading positive assurances
contained therein. In particular, defendants had no
reasonable basis to state publicly on November 1,
1993, and not to correct the November 1, 1993
statement in subsequent forward-looking projections,
that Burlington Coat Factory would earn between
$1.20 to $1.30 per share in fiscal year 1994 . . ..
Complaint, ¶ 37.
Plaintiffs' allegations do not suffice. In asserting that
there was "no reasonable basis" for the November 1, 1993,
earnings projection, plaintiffs simply mouth the required
conclusion of law. See Glassman, 90 F.3d at 629-30.
Plaintiffs' Complaint contains a number of vague factual
assertions regarding the period prior to November 1, 1993,
but plaintiffs have failed to link any of these allegations to
their claim that the November 1 forecast was actionably
unsound when made. The earnings projection claim
therefore fails Rule 9(b)'s heightened pleading requirements.
The existence of these unlinked factual allegations,
however, precludes us from holding that the Complaint is
so bereft of facts, as the Glassman complaint was held to
be, see id., that granting plaintiffs the opportunity to
replead would be futile. On remand, therefore, plaintiffs
should be given the opportunity to attempt to recast this
claim in terms that satisfy Rule 9(b).
We turn next to the duties to correct and update an
earnings projection.
Duties to Update and Correct
Plaintiffs also assert that BCF had a duty to correct the
November 1, 1993, expression of comfort with the analysts'
projections. In particular, plaintiffs point to the refusal of
34
BCF's CEO, Monroe Milstein, in an interview given to
Reuters --reported on March 22, 1994 -- to comment on
analysts' earnings projections for both the third quarter of
1994 and the full year. Plaintiffs assert that on March 22,
1994, and at other unspecified points in time after
November 1, 1993, defendants had had a duty to correct
the November 1 earnings projection.17 Although plaintiffs
characterize their claim as a "duty to correct" claim, they
appear to be asserting both a duty to correct and a duty to
update.
The Seventh Circuit explained in Stransky v. Cummins
Engine Co., Inc., 51 F.3d 1329 (7th Cir. 1995), that the duty
to correct is analytically different from the duty to update,
although litigants, as appears to be the case here, often fail
to distinguish between the two. Id. at 1331. As the Stransky
court pointed out, a Section 10(b) plaintiff ordinarily is
required to identify a specific statement made by the
company and then explain either (1) how the statement was
materially misleading or (2) how it omitted a fact that made
the statement materially misleading. Id. The duties to
update and correct are two other avenues of finding a duty
to disclose that "have been kicked around by courts,
litigants and academics alike." Id.; cf. William B. Gwyn, Jr.
and W. Christopher Matton, The Duty to Update the
Forecasts, Predictions, and Projections of Public Companies,
24 Sec. Reg. L. J. 366 (1997); Robert H. Rosenblum, An
Issuer's Duty Under Rule 10b-5 to Correct and Update
Materially Misleading Statements, 40 Cath. U. L. Rev. 289(1991).
(a) Duty to Correct
The Stransky court articulated the duty to correct as
applying:
_________________________________________________________________
17. Plaintiffs suggest that by March 22, 1994, analysts' projections for
BCF's 1994 earnings per share had risen above the $1.20 to $1.30 mid-
range with which BCF's CAO had expressed comfort some months prior.
Complaint ¶ 49. The fact that analysts' projections independently
increased above the predicted range, however, has no relevance to the
claim at hand because plaintiffs have not identified any free-standing
duty on the part of a public company to "police" the forecasts being
made by analysts. See Raab, 4 F.3d at 288 (no duty to police statements
by third parties).
35
when a company makes a historical statement that, at
the time made, the company believed to be true, but as
revealed by subsequently discovered information
actually was not. The company then must correct the
prior statement within a reasonable time.
51 F.3d at 1331-32 (emphasis added); see also Backman v.
Polaroid Corp., 910 F.2d 10, 16-17 (1st Cir. 1990) (in banc)
("Obviously, if a disclosure is in fact misleading when
made, and the speaker thereafter learns of this, there is a
duty to correct it.") (emphasis added). We have no quarrel
with the Stransky articulation, except to note that we think
the duty to correct can also apply to a certain narrow set
of forward-looking statements. We will attempt to illustrate
the kinds of circumstances we have in mind with an
example.
Imagine the following situation. A public company in
Manhattan makes a forecast that appears to it to be
reasonable at the time made. Subsequently, the company
discovers that it misread a vital piece of data that went into
its forecast. Perhaps a fax sent by the company's factory
manager in some remote location was blurry and was
reasonably misread by management in Manhattan as
representing sales for the past quarter as 100,000 units as
opposed 10,000 units. Manhattan management then makes
an erroneous forecast based on the information it has at
the time. A few weeks later, management receives the
correct sales figures by mail. So long as the correction in
the sales figures was material to the forecast that was
disclosed earlier, we think there would likely be a duty on
the part of the company to disclose either the corrected
figures or a corrected forecast. In other words, there is an
implicit representation in any forecast (or statement of
historical fact) that errors of the type we have identified will
be corrected. This duty derives from the implicit factual
representation that a public company makes whenever it
makes a forecast, i.e., that the forecast was reasonable at
the time made. What is crucial to recognize is that the
error, albeit an honest one, was one that had to do with
information available at the time the forecast was made and
that the error in the information was subsequently
discovered. Cf. Rudolph v. Arthur Andersen & Co., 800 F.2d
361040, 1043-44 (11th Cir. 1986) (distinguishing between
information that is subsequently discovered that shows a
report to have been erroneous at the time made (where a
duty to correct might exist) and ordinary subsequently
developing information that might reflect on the report, but
does not show it to have been inaccurate at the time made
(where there is no duty to correct)).
Plaintiffs phrase their claim as based on a "duty to
correct." Earlier in the opinion, we explained that plaintiffs'
attack on the reasonableness of the earnings forecast failed
because plaintiffs had not met their duty of pleading an
adequate set of specific factual allegations from which one
could reasonably infer that the November 1, 1993, forecast
was made unreasonably. Similarly, as to the "duty to
correct" claim, plaintiffs have failed to allege how and what
the specific error or set of errors might have been that went
into the November 1, 1993, forecast. Nor have the plaintiffs
identified the specific times at which those errors were
discovered, so as to allow correction and trigger defendants'
alleged duty. Therefore, the "duty to correct" claim (to the
extent one is being made) fails Rule 9(b)'s pleading
standards. In any event, we think plaintiffs' claim is better
characterized as a "duty to update" claim.
(b) Duty to Update
The duty to update, in contrast to the duty to correct,
concerns statements that, although reasonable at the time
made, become misleading when viewed in the context of
subsequent events. See Greenfield v. Heublein, Inc., 742
F.2d 751, 758 (3d Cir. 1984); Backman, 910 F.2d at 17. In
Greenfield, we explained that updating might be required if
a prior disclosure "[had] become materially misleading in
light of subsequent events." 742 F.2d at 758; cf. Time
Warner, 9 F.3d at 267. However, although we have
generally recognized that a duty to update might exist
under certain circumstances, we have not clarified when
such circumstances might exist. Cf. Phillips, 881 F.2d at
1245; Greenfield, 742 F.2d at 758-60; Backman, 910 F.2d
at 17 (the duty arises only under "special circumstances").
Specifically, we have not addressed the question whether a
duty to update might exist for ordinary, run-of-the-mill
forecasts, such as the earnings projection in this case.
37
At issue here is the statement of BCF's CAO on
November 1, 1993, that he was comfortable with analyst
projections of $1.20 to $1.30 as a mid-range for earnings
per share in fiscal 1994. Plaintiffs' argument appears to be
that, as BCF obtained information in the period subsequent
to November 1, 1993, that would have produced a material
change in the earnings projection for fiscal 1994, there was
an ongoing duty to disclose this information. In essence
then, the claim is that the disclosure of a single specific
forecast produced a continuous duty to update the public
with either forecasts or hard information that would in any
way change a reasonable investor's perception of the
originally forecasted range. We decline to hold that the
disclosure of a single, ordinary earnings forecast can
produce such an expansive set of disclosure obligations.
For a plaintiff to allege that a duty to update a forward-
looking statement arose on account of an earlier-made
projection, the argument has to be that the projection
contained an implicit factual representation that remained
"alive" in the minds of investors as a continuing
representation. Cf. Stransky, 51 F.3d at 1333 (in
determining the scope of liability that a forward-looking
statement can produce, one looks to the implicit factual
representations therein); Kowal v. MCI Communications
Corp., 16 F.3d 1271, 1277 (D.C. Cir. 1994). Determining
whether such a representation is implicit in an ordinary
forecast is a function of what a reasonable investor expects
as a result of the background regulatory structure. In
particular, we note three features of the existing federal
securities disclosure apparatus:
1. Except for specific periodic reporting requirements
(primarily the requirements to file quarterly and annual
reports), there is no general duty on the part of a company
to provide the public with all material information. See Time
Warner, 9 F.3d at 267 ("a corporation is not required to
disclose a fact merely because a reasonable investor would
very much like to know that fact"). Thus, possession of
material nonpublic information alone does not create a
duty to disclose it. See Shaw, 82 F.3d at 1202; Roeder v.
Alpha Indus., Inc., 814 F.2d 22, 26 (1st Cir. 1987) (citing
Chiarella v. United States, 445 U.S. 222, 235 (1980)).
38
2. Equally well settled is the principle that an accurate
report of past successes does not contain an implicit
representation that the trend is going to continue, and
hence does not, in and of itself, obligate the company to
update the public as to the state of the quarter in progress.
See Shaw, 82 F.3d at 1202; Raab v. General Physics Corp.,
4 F.3d 286, 289 (4th Cir. 1993); In re Convergent
Technologies Sec. Litig., 948 F.2d 507, 513-14 (9th Cir.
1991) (rejecting plaintiffs' contention that accurate
reporting of past results "misled investors by implying that
[the company] expected the upward first quarter trend to
continue throughout the year"); Zucker v. Quasha, 891 F.
Supp. 1010, 1015 (D.N.J.), aff'd, 82 F.3d 408 (3d Cir.
1996).
3. Finally, the existing regulatory structure is aimed at
encouraging companies to make and disclose internal
forecasts by protecting them from liability for disclosing
internal forecasts that, although reasonable when made,
turn out to be wrong in hindsight. See Stransky, 51 F.3d at
1333. Companies are not obligated either to produce or
disclose internal forecasts, and if they do, they are
protected from liability, except to the extent that the
forecasts were unreasonable when made. See Glassman, 90
F.3d at 631. The regulatory structure seeks to encourage
companies to disclose forecasts by providing companies
with some protection from liability. However, where it
comes to affirmative disclosure requirements, the current
regulatory scheme focuses on backward-looking "hard"
information, not forecasts. See id. (citing Frank H.
Easterbrook and Daniel R. Fischel, The Economic Structure
of Corporate Law, 305-06 (1991)). Increasing the obligations
associated with disclosing reasonably made internal
forecasts is likely to deter companies from providing this
information -- a result contrary to the SEC's goal of
encouraging the voluntary disclosure of company forecasts.
Cf. Stransky, 51 F.3d at 1333; Raab, 4 F.3d at 290.
Based on features one and two, we do not think it can be
said that an ordinary earnings projection contains an
implicit representation on the part of the company that it
will update the investing public with all material
information that relates to that forecast. Under existing law,
39
the market knows that companies have neither a specific
obligation to disclose internal forecasts nor a general
obligation to disclose all material information. Shaw, 82
F.3d at 1202 & 1209. We conclude that ordinary, run-of-
the-mill forecasts contain no more than the implicit
representation that the forecasts were made reasonably and
in good faith. Cf. Stransky, 51 F.3d at 1333; Kowal, 16
F.3d at 1277. Just as the accurate disclosure of a line of
past successes has been ruled not to contain the
implication that the current period is going just as well, see
Gross, 93 F.3d at 994, disclosure of a specific earnings
forecast does not contain the implication that the forecast
will continue to hold good even as circumstances change.
Finally, the federal securities laws, as they stand today,
aim at encouraging companies to disclose their forecasts. A
judicially created rule that triggers a duty of continuous
disclosure of all material information every time a single
specific earnings forecast is disclosed would likely result in
a drastic reduction in the number of such projections made
by companies. It is these specific earnings projections that
are the most useful to investors in deciding whether to
invest in a firm's securities. Cf. Marx v. Computer Sciences
Corp., 507 F.2d 485, 489 (noting the importance of
earnings projections to investors who are assessing the
value of a stock); John S. Poole, Improving the Reliability of
Management Forecasts, 14 J. Corp. L. 547, 548 & 558
(1989) (noting both the importance to investors of
projections of future financial performance and the problem
of using these forecasts where companies make them
vague). The only types of projections that would be exempt
from the duty of continuous disclosure advocated by
plaintiffs, and hence the only types of projections that
would likely be disclosed under the rule proposed by
plaintiffs, would be vague expressions of hope and
optimism that are of little use to investors. See, e.g., Lewis
v. Chrysler Corp., 949 F.2d 644, 652-53 (3d Cir. 1991);
Raab, 4 F.3d at 289. Therefore, apart from the fact that
plaintiffs' disclosure theory has no support in the existing
regulatory structure, adopting it would severely undermine
the goal of encouraging the maximal disclosure of
information useful to investors. Cf. Hillson, 42 F.3d at 219(increasing the level of liability for projections would
40
produce a result contrary to the goals of full disclosure that
underlie the federal securities laws). In sum, under the
existing disclosure apparatus, the voluntary disclosure of
an ordinary earnings forecast does not trigger any duty to
update.18
We pause to reemphasize that the circumstances in
Greenfield and Phillips, two cases in which we recognized
that a duty to update might exist, were vastly different from
the situation at hand: the disclosure of an ordinary
earnings projection. In both Greenfield and Phillips, the
initial disclosures that were argued to have triggered the
duty to update involved information about events that
could fundamentally change the natures of the companies
involved. Specifically, both cases involved takeover
attempts, and the plaintiffs were claiming that they should
have been updated with information as to these attempts.
See Greenfield, 742 F.2d at 758-59; Phillips, 881 F.2d at1239 & 1245.19 Where the initial disclosure relates to the
announcement of a fundamental change in the course the
company is likely to take, there may be room to read in an
implicit representation by the company that it will update
_________________________________________________________________
18. We do not need to decide now whether our analysis would differ if
the context were one in which the company had a pattern or practice of
disclosing periodic updates any time it made a forecast. Plaintiffs have
not alleged that BCF had a practice of providing periodic updates on
earnings projections; nor have they alleged that such was the industry
or market practice.
19. The "duty to update" claims were eventually rejected in both cases.
In Greenfield, the court held that there had been no initial statement as
to the existence of a takeover attempt or merger negotiations that could
have triggered a subsequent duty. 742 F.2d at 759. In Phillips, although
there was an initial triggering statement, plaintiffs did not produce
evidence of any subsequently arising change of intent that might have
been required to be disclosed. 881 F.2d at 1246.
In addition, it is worth noting that the source of the "duty to update"
requirement in Phillips was a specific regulation, 17 C.F.R. § 240.13d-1,
that required that "where ``any material change occur[ed] in the facts set
forth' in a Schedule 13D," a company was required to " ``promptly' file ``an
amendment disclosing such change' with the Securities and Exchange
Commission, the issuer of the security, and with any exchange on which
the security is traded." 881 F.2d at 1245.
41
the public with news of any radical change in the
company's plans -- e.g., news that the merger is no longer
likely to take place.20 Cf. Phillips, 881 F.2d at 1246 (noting
that "[f]ew markets shift as quickly and dramatically as the
securities market, especially where a publicly traded
company has been ``put in play' by a hostile suitor. The . . .
statements were broad and unequivocal, providing no
contingency for changing circumstances . . . [and could]
fairly be read as a statement by the Partnership that, no
matter what happened, it would not change its
intentions."). But finding a duty to update a disclosure of a
takeover threat is a far cry from finding a duty to update a
simple earnings forecast which, if anything, contains a
clear implication that circumstances underlying it are likely
to change.
B. Leave to Amend
Plaintiffs' final contention is that the district court erred
in denying them leave to replead. The district court granted
defendants' motion to dismiss on both Rule 12(b)(6) and
Rule 9(b) grounds. Plaintiffs had requested that, in the
event their Complaint was dismissed, they be given leave to
replead. The court, however, dismissed the action in its
entirety.
As a general matter, we review the district court's denial
of leave to amend for abuse of discretion. See Lorenz v. CSX
Corp., 1 F.3d 1406, 1413 (3d Cir. 1993); De Jesus v. Sears
Roebuck & Co., 87 F.3d 65, 71 (2d Cir. 1996). Federal Rule
of Civil Procedure 15(a) provides that "leave[to amend]
shall be freely given when justice so requires." Glassman,
90 F.3d at 622. The Supreme Court has cautioned that
although "the grant or denial of an opportunity to amend is
_________________________________________________________________
20. We emphasize that we are not saying that once a fundamental
change is announced the company faces a duty continuously to update
the public with all material information relating to that change. Instead,
we think that the duty to update, to the extent it might exist, would be
a narrow one to update the public as to extreme changes in the
company's originally expressed expectation of an event such as a
takeover, merger, or liquidation. But cf. Eisenstadt v. Centel Corp., __
F.3d __, __ 1997 WL 242251, *8 (7th Cir.) (suggesting that even such a
narrow duty might not exist).
42
within the discretion of the District Court, . . . outright
refusal to grant the leave without any justifying reason
appearing for the denial is not an exercise of that
discretion; it is merely an abuse of that discretion and
inconsistent with the spirit of the Federal Rules." Forman v.
Davis, 371 U.S. 178, 182 (1962). Among the grounds that
could justify a denial of leave to amend are undue delay,
bad faith, dilatory motive, prejudice, and futility. Id.;
Lorenz, 1 F.3d at 1414; Glassman, 90 F.3d at 622.
The district court made no finding that plaintiffs acted in
bad faith or in an effort to prolong litigation; nor did the
court find that defendants would have been unduly
prejudiced by the amendment. Cf. Glassman, 90 F.3d at
622. We are left to conclude, therefore, that the denial of
leave to amend was based on the court's belief that
amendment would be futile. In fact, in discussing this
issue, defendants' brief starts out by urging us to affirm the
district court's denial of leave to amend because"any
attempted additional amendment of that pleading would be
futile." (Appellees' Br. at 43) (citation and internal quotation
omitted). "Futility" means that the complaint, as amended,
would fail to state a claim upon which relief could be
granted. Glassman, 90 F.3d at 623 (citing 3 Moore's Federal
Practice ¶ 15.08[4], at 15-80 (2d ed. 1993)). In assessing
"futility," the district court applies the same standard of
legal sufficiency as applies under Rule 12(b)(6). Id. (citing 3
Moore's at ¶ 15.08[4], at 15-81). The district court here
rejected plaintiffs' claims on both Rule 12(b)(6) and Rule
9(b) grounds.
Ordinarily where a complaint is dismissed on Rule 9(b)
"failure to plead with particularity" grounds alone, leave to
amend is granted. See Shapiro, 964 F.2d at 278; Luce v.
Edelstein, 802 F.2d 49, 56-57 (2d Cir. 1987); Yoder v.
Orthomolecular Nutrition Inst., Inc., 751 F.2d 555, 561-62 &
n.6 (2d Cir. 1985) (citation omitted). However, the
Complaint in this case was plaintiffs' second. Further,
plaintiffs not only had approximately four months between
the initially filed complaints and the revised, consolidated
complaint that is at issue here, but the Complaint appears
to have represented the efforts of not one, but four
different, law firms. Hence, it is conceivable that the district
43
court could have found undue delay or prejudice to the
defendants. But the court made no such determination,
and we cannot make that determination on the record
before us. Therefore, to the extent we can affirm the district
court's determinations on Rule 12(b)(b) grounds alone (i.e.,
for futility, see Glassman, 90 F.3d at 623), we shall affirm
the denial of leave to replead. These claims would not
survive a Rule 12(b)(6) motion even if pled with more
particularity. See Luce, 802 F.2d at 56-57. But, where the
district court's dismissals can be justified only on Rule 9(b)
particularity grounds we reverse the denial of leave to
replead. See id. On the latter set of claims, we borrow the
words of the Second Circuit that "because we are hesitant
to preclude the prosecution of a possibly meritorious claim
because of defects in the pleadings, we believe that the
plaintiffs should be afforded an additional, albeitfinal
opportunity, to conform the pleadings to Rule 9(b)." Ross v.
A.H. Robins Co., 607 F.2d 545, 547 (2d Cir. 1979).
IV.
We conclude that the Complaint survives scrutiny under
Rule 12(b)(6) to the extent that it alleges: (1) that the
defendants overstated BCF's quarterly income by 2-3 cents
per share in each quarter of fiscal year 1994; (2) that
management's expression of "comfort" with analysts'
projections of a mid-range of earnings of $1.20 to $1.30 per
share for fiscal 1994 was unreasonable when made. Neither
of these claims, however, survives Rule 9(b)'s particularity
requirements.21 Ordinarily, complaints dismissed under
Rule 9(b) are dismissed with leave to amend. See Luce, 802
F.2d at 56. As best we can tell from the district court's
opinion, the reason for the denial of leave to amend here
appears to be that the court thought plaintiffs had failed
the threshold burden of stating claims that could survive a
Rule 12(b)(6) motion. However, since we hold that the
above-mentioned claims did pass Rule 12(b)(6) we reverse
_________________________________________________________________
21. The duty to update portion of the attack on the earnings projection
fails altogether as we decline to recognize the existence of such a claim
for an ordinary earnings forecast.
44
the court's denial of leave to amend on these claims.22 In all
other respects, we affirm the district court.
A True Copy:
Teste:
Clerk of the United States Court of Appeals
for the Third Circuit
_________________________________________________________________
22. On remand, after plaintiffs tender their proposed amendments, the
district court shall consider whether the amendments would be futile.
44