Carter v. Furniture Brands International, Inc. et al

Filing 62

OPINION, MEMORANDUM AND ORDER: HEREBY ORDERED that Defendants' Motion to Dismiss Plaintiffs' Consolidated Amended Complaint [Doc. No. 45 ] is GRANTED. FURTHER ORDERED that this matter is DISMISSED. Signed by District Judge Henry Edward Autrey on 01/27/2015. (CLK)

UNITED STATES DISTRICT COURT
EASTERN DISTRICT OF MISSOURI
EASTERN DIVISION
KEITH CARTER, Individually and on
Behalf of All Others Similarly Situated,
Plaintiffs,
v.
FURNITURE BRANDS
INTERNATIONAL, INC., RALPH P.
SCOZZAFAVA and VANCE C.
JOHNSTON,
Defendants.

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No. 4:13CV1600 HEA

OPINION, MEMORANDUM AND ORDER
This matter is before the Court on Defendants’ Motion to Dismiss Plaintiffs’
Consolidated Amended Complaint. [Doc. No. 45]. Plaintiffs have filed a response in opposition
to the motion. [Doc. No. 50]. Defendants have filed a Reply. [Doc. No. 55]. For the reasons set
forth below, the Motion to Dismiss will be granted.
Factual Background1
Plaintiffs, who purchased shares of the common stock of Furniture Brands, Inc. during
the alleged class period,2 filed this Consolidated Amended Complaint (“Complaint”)3 against
Ralph Scozzafava (“Scozzafava”), the former Chief Executive Officer and Chairman of the
Board of Directors of Furniture Brands, and Vance Johnston (“Johnston”), the former Chief

1

The factual circumstances are taken from the pleadings and other attachments to the pleadings. The facts and
inferences from these documents are taken solely for the purpose of the resolution of the motion and for no other
purposes in this piece of litigation. This recitation in no way relieves any party of the necessary proof of any fact in
later proceedings.
2

3

Between February 13, 2013 and August 5, 2013.

By Order entered on March 4, 2014, the Court consolidated this action with Case Number 4:13CV1703 HEA, and
appointed lead plaintiff and lead counsel. [Doc. No. 36]. The Consolidated Amended Complaint was filed on May
5, 2014. [Doc. No. 40].

Financial Officer of Furniture Brands, (collectively “Defendants”),4 for violations of sections
10(b) and 20(a) of the Exchange Act, and U.S. Securities and Exchange Commission (“SEC”)
Rule 10b-5.
A.

Furniture Brands’ Poor Sales Performance
Furniture Brands was in the business of designing, manufacturing, and marketing home

furnishings, such as furniture and home accessories. The company reported declining year-overyear net sales in 22 of the 24 quarters between the fourth quarter of 2006 and the third quarter of
2012. As a result of the company’s poor performance, Furniture Brands’ executive officers
neither received salary raises, nor short-term incentive bonuses, from 2008 onward.
Sometime in 2012, the Furniture Brands Human Resources Committee (“HR
Committee”) lowered the threshold metrics necessary for executive officers to receive bonuses.
Previously, the bonuses had been structured as “all or nothing” payouts, through which an
executive would not receive any bonus unless certain target metrics were reached. The new plan
allowed for executives to receive reduced bonuses if lower thresholds were met. Plaintiffs assert
that Defendant Scozzafava, in his role as Chairman of the Board of Directors, heavily
influenced the decision to decrease the standards for executive bonuses.
B.

Fourth Quarter of 2012
On February 13, 2013, Furniture Brands issued a press release announcing the

company’s financial results for the fourth quarter and full year of 2012. Despite one analyst’s
prediction that Furniture Brands’ year-over-year net sales would decline by 2% in the fourth
quarter of 2012, sales for that quarter increased by 3.3%. The company’s sales for the year were
$1.072 billion, which beat the incentive threshold of $1.066 billion by $6 million, or one-half of
4

Although Furniture Brands is listed as a defendant in the caption of the Complaint, Plaintiffs make clear that
Furniture Brands is a “non-party” and “is not named as a defendant in this action,” because, subsequent to the
initiation of this action, Furniture Brands filed a voluntary petition for reorganization under Chapter 11 of the
United States Bankruptcy Code. [Doc. No. 40 at ¶ 22].

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one percent of Furniture Brands’ sales for the year. As a result of meeting the sales threshold,
and keeping the net adjusted losses for the year ($30.4 million) under the $35 million threshold,
Defendants Scozzafava and Johnston received bonuses of $308,775 and $60,344, respectively.
One analyst asserted that that management likely employed a “heroic effort” to reach the sales
threshold by a “paltry” $6 million.
Additionally, in the fourth quarter of 2012, Furniture Brands reported a trade-name
impairment charge of $1.4 million, which was a significant improvement from the $9 million
trade-name impairment charge it reported in the fourth quarter of 2011.5
C.

First and Second Quarters of 2013 and Bankruptcy
Following the fourth quarter of 2012, Furniture Brands reported declining year-over-

year net sales in the first and second quarters of 2013—down 11.3% and 4%, respectively.
Further, in the second quarter of 2013, the company reported a $10.8 million trade-name
impairment charge, up from the $1.4 million trade-name impairment charge reported in the
fourth quarter of 2012.6 Plaintiffs assert that it was “extremely rare for the Company to take a
trade-name impairment charge outside of the fourth quarter,” and note that “this was only the
second time during defendant Scozzafava’s five years as CEO that the Company had taken a

5

Furniture Brands explained in its 2012 Form 10-K:
Our trade names are tested for impairment annually or whenever events or changes in business
circumstances indicate the carrying value of the assets may not be recoverable. Trade names are
tested by comparing the carrying value and fair value of each trade name to determine the amount,
if any, of impairment. The fair value of our trade names is estimated using a “relief from royalty
payments” methodology, which is highly contingent upon assumed sales trends and projections,
royalty rates, and a discount rate. Lower sales trends, decreases in projected net sales, decreases in
royalty rates, or increases in the discount rate would cause impairment charges and a
corresponding reduction in our earnings and net worth, as it has in past periods.
[Doc. No. 47-4 at 12].
6

Furniture Brands reported total impairment charges in the second quarter of 2013 of $26.9 million, up from $7.5
million in the fourth quarter of 2012. The company explained that $15.7 million of the $26.9 million impairment
charges “were recorded to reflect the abandonment of certain capitalized costs related to a company-wide software
implementation. . . . [T]he Company made the decision to abandon its plan to implement certain software programs
across the entire organization.” [Doc. No. 40 at ¶¶ 112, 116]. Plaintiffs do not assert any impropriety with respect
to these other impairment charges.

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trade-name impairment charge outside of the fourth quarter; the only other time had been in the
third quarter of 2011, after which no additional trade-name impairment charge had followed in
the subsequent fourth quarter.” [Doc. No. 40 at ¶ 62]. On September 9, 2013, Furniture Brands
filed a voluntary petition for reorganization under Chapter 11 of the United States Bankruptcy
Code.
Allegations
Plaintiffs allege that Furniture Brands’ reported year-over-year net sales and trade-name
impairment charge for the fourth quarter of 2012 were misrepresentations of facts, knowingly
made by Defendants, which induced Plaintiffs to buy stock in Furniture Brands at inflated
prices, before the truth emerged in the first and second quarters of 2013, causing the stock price
to fall. Plaintiffs further allege that Defendants Scozzafava and Johnston manipulated this
financial data so that they could receive bonuses before Furniture Brands filed its bankruptcy
petition. According to Plaintiffs, Defendants manipulated the data by (1) prematurely
recognizing revenue on purported sales before the Company’s products had actually been
shipped; and (2) selling furniture at steep discounts, as opposed to regularly priced sales.
Pleading Standard
Section 10(b) of the Exchange Act and SEC Rule 10b-5 “prohibit[] fraudulent conduct
in connection with the sale or purchase of securities.” Kushner v. Beverly Enters., 317 F.3d 820,
826 (8th Cir. 2003). To state a claim, a plaintiff must allege that a defendant made a misleading
statement or omission of material fact, with scienter, on which plaintiff relied, and which caused
plaintiff’s losses. See In re K-Tel Int’l, Inc. Sec. Litig., 300 F.3d 881, 888 (8th Cir. 2002). The
pleading requirements necessary to state a claim for private securities fraud are set forth under
the Private Securities Litigation Reform Act of 1995 (the “Reform Act”), 15 U.S.C. § 78u4(b)(1) and (2). The appropriate pleaded elements are: (1) a material misrepresentation of fact;

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(2) scienter; (3) a connection with the purchase or sale of a security; (4) reliance; (5) economic
loss; and (6) loss causation. See Minneapolis Firefighters’ Relief Ass’n v. MEMC Elec.
Materials, Inc., 641 F. 3d. 1023, 1028 (8th Cir. 2011). Here, Defendants argue that Plaintiffs
have failed to adequately plead the falsity of Defendants’ statements, Defendants’ scienter, and
loss causation.
Although the Court must view the factual allegations in the light most favorable to
plaintiffs, Ritchie v. St. Louis Jewish Light, 630 F.3d 713, 715–16 (8th Cir. 2011), the Reform
Act requires courts to “disregard catch-all or blanket assertions that do not live up to the
particularity requirements of the statute,” In re Amdocs Ltd. Sec. Litig., 390 F.3d 542, 547 (8th
Cir. 2004) (citing Florida State Bd. of Admin. v. Green Tree Fin. Corp., 270 F.3d 645, 660 (8th
Cir. 2001)). In passing the Reform Act, “Congress enacted two heightened pleading
requirements for securities fraud cases.” In re Navarre Corp. Secs. Litig., 299 F.3d 735, 741–42
(8th Cir. 2002). Congress imposed these more stringent pleading requirements as to the falsity
of the defendants’ statements, and the defendants’ scienter. In re St. Jude Med. Inc. Secs. Litig.,
836 F. Supp. 2d 878, 895 (D. Minn. 2011) (citing Gebhardt v. Conagra Foods, Inc., 335 F.3d
824, 830 n.3 (8th Cir. 2003)). “These pleading standards are unique to securities and were
adopted in an attempt to curb abuses of securities fraud litigation.” Navarre Corp., 299 F.3d at
741.
The Eighth Circuit explains:
First, [with regard to falsity,] the Reform Act requires the complaint to specify
each misleading statement or omission and specify why the statement or omission
was misleading. 15 U.S.C. § 78u-4(b)(1) (Supp. IV 1998). If the allegation “is
made on information and belief, the complaint shall state with particularity all
facts on which that belief is formed.” Id. Similarly, Rule 9(b) of the Federal Rules
of Civil Procedure had long required that “in all averments of fraud or mistake,
the circumstances constituting fraud or mistake shall be stated with particularity.
The text of the Reform Act was designed “to embody in the Act itself at least the
standards of Rule 9(b).” Greebel v. FTP Software, Inc., 194 F.3d 185, 193 (1st
Cir. 1999).
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Second, [with regard to scienter], Congress stated in the Reform Act that a
plaintiff’s complaint must “state with particularity facts giving rise to a strong
inference that the defendant acted with the required state of mind.” 15 U.S.C. §
78u-4(b)(2); Green Tree, 270 F.3d at 654. The Reform Act requires the court to
dismiss the complaint if these requirements are not met. 15 U.S.C. § 78u-4(b)(3).
“[U]nder the Reform Act, a securities fraud case cannot survive unless its
allegations collectively add up to a strong inference of the required state of mind.”
Green Tree, 270 F.3d at 660.
Kushner, 317 F.3d at 826.
The heightened pleading requirements for falsity and scienter under the Reform Act are
“more rigorous than those under Rule 9(b) of the Federal Rules of Civil Procedure.” Lustgraaf
v. Behrens, 619 F.3d 867, 874 n.2 (8th Cir. 2010); cf. Navarre Corp., 299 F.3d at 742 (“[T]he
investors technically do not need to meet the requirements of both Federal Rule of Civil
Procedure 9(b) and the [Reform Act], as the [Reform Act] supersedes reliance on 9(b) in
securities fraud cases and embodies the standards of 9(b).”).
Discussion
The Court finds that Plaintiffs have failed to meet the Reform Act’s heightened pleading
standard with regard to their falsity and scienter allegations. Plaintiffs’ falsity allegations
amount to fraud by hindsight. Further, Defendants disclosed the information which Plaintiffs
claim they omitted; the confidential witness upon whom Plaintiffs rely is unreliable; and
Plaintiffs’ channel stuffing allegations are factually unsupported. Finally, Plaintiffs’ scienter
allegations fail to meet the motive and opportunity standard.
A.

Falsity
Plaintiffs contend that the financial results for the fourth quarter and year of 2012, which

Furniture Brands reported in its February 13, 2013 press release, were misrepresentations of
material facts, born out of Defendants’ two-pronged scheme to prematurely recognize revenue
and to sell furniture for “pennies on the dollar.” Specifically, Plaintiffs allege that, through

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prematurely recognizing revenue and selling furniture at deep discounts, Defendants
manipulated sales data to reflect a 3.3% increase in year-over-year net sales for the fourth
quarter of 2012, which in turn “artificially stemmed the downward trend in the Company’s
sales.” [Doc. No. 50 at 14]. Thus, Defendants were able to “project higher sales, resulting in an
understated impairment charge in 4Q12 [of $1.4 million] and lower losses for that period.”
[Id.]. Finally, “Furniture Brands’ disclosure of the $10.8 million trade-name impairment charge
just two quarters later demonstrates the magnitude by which the $1.4 million charge taken in
4Q12 was understated.” [Id.].
“It is not enough, under the [Reform Act’s] falsity requirement, to allege that fraud has
occurred.” Lustgraaf, 619 F.3d at 874 (citing In re Cerner Corp. Sec. Litig., 425 F.3d 1079,
1083 (8th Cir. 2005)). The Reform Act’s heightened pleading standards require Plaintiffs to
“plead the ‘who, what, when, where, and how’ of the misleading statements or omissions.”
Cornelia I. Crowell GST Trust v. Possis Med., Inc., 519 F.3d 778, 782 (8th Cir. 2008) (quoting
K-Tel, 300 F.3d at 890). Further, the complaint “must indicate why the alleged misstatements
were false when made.” Lustgraaf, 619 F.3d at 874. The Eighth Circuit has “found allegations
insufficient where they point to a statement that a defendant made ‘and then show [] in
hindsight that the statement is false.’” Id. (quoting Elam v. Neidorff, 544 F.3d 921, 927 (8th Cir.
2008) (quoting Navarre Corp., 299 F.3d at 743)). Indeed, “[t]he purpose of [the Reform Act’s]
heightened pleading requirement was generally to eliminate abusive securities litigation and
particularly to put an end to the practice of pleading fraud by hindsight.” Navarre Corp., 299
F.3d at 742 (citations and internal quotations marks omitted).
1.

Premature Revenue Recognition

Plaintiffs allege that both Generally Accepted Accounting Principles, and Furniture
Brands’ stated revenue recognition policy, prohibit recognizing revenue from the sale of goods

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until the goods have been delivered to the purchaser. [Doc. No. 40 at ¶¶ 126–27; Doc. No. 47-4
at 26]. Plaintiffs further allege that Defendants orchestrated a system of prematurely recognizing
revenue in the fourth quarter of 2012 by loading inventory onto tractor-trailers, which were not
attached to trucks, so that Furniture Brands could count the inventory as shipped and thus
prematurely recognize the revenue from the orders.
Plaintiffs’ source for this allegation is one of Furniture Brands’ former Retail Logistics
Managers (the “RLM”), whose identity has not been disclosed. Plaintiffs’ allegations regarding
premature revenue recognition are as follows:
According to the Former Retail Logistics Manager, at the end of the fiscal fourth
quarter in 2012, Furniture Brands employees “would load the trailers and we
would sit them in the parking lot and then, after a while, if they didn’t move, we
would bring the merchandise back in. . . . [I]t was all set to go to customers. It had
shipping labels on it, that’s the only way it would have gotten loaded on the
truck—if we had orders and there was [a] manifest.”
According to the Former Retail Logistics Manager, at the end of the quarter,
Furniture Brands personnel would load up trailers (that were not yet attached to
trucks), and the trailers would sit in the parking lot so Furniture Brands “could
count the revenue as being shipped.”
As the Former Retail Logistics Manager explained, “the main thing at the end of
the quarter and end of the month was to get out every piece of furniture we could
so that revenue could be put on the bill. . . . If we had orders that were going into
the next month, but could actually be shipped, that last Friday or whatever of the
physical month, then those trailers would be loaded, put out in the parking lot and
then they would be shipped the next week but we could count the revenue for that
month or that quarter.” According to the Former Retail Logistics Manager, the
customers were not actually expecting delivery until the following week (if at all),
but Furniture Brands personnel nonetheless put the goods on the trailers and
removed the trailers from the warehouse (by parking them in the lot) so that the
Company could then immediately recognize the revenue for that quarter. After the
end of the quarter, the Company would then actually ship the goods to the
customer or, according to the Former Retail Logistics Manager, in certain
circumstances, the orders would be cancelled and the furniture returned to
inventory. In those cases, product loaded on trailers and recorded as revenue were
never even delivered to customers.
The Former Retail Logistics Manager stated that each 53-foot trailer contained
approximately $50,000 worth of goods. The $50,000 figure was the wholesale
price; at retail, according to the Former Retail Logistics Manager, the price would
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be double that. The Former Retail Logistics Manager stated that there were four
or five trailers at quarter-end with $50,000 worth of wholesale goods located at
each of three Furniture Brands warehouses in North Carolina—totaling
approximately $600,000 to $750,000—that would be shipped a week after the end
of the quarter. However, the revenue for these goods was recognized during that
quarter, despite that the goods were not actually shipped until after the quarter (if
at all). The warehouses where this happened were the Causby Road Warehouse,
the Central Warehouse in Thomasville, and the Lenoir Warehouse, all located in
North Carolina.
The Former Retail Logistics Manager said that the customers who would receive
these shipments were Furniture Brands’ franchise dealers.
With respect to the inventory that sat in the trailers, the Former Retail Logistics
Manager explained that Furniture Brands personnel knew when to put it on the
trailers because the operating system “would do that. It would put the orders that
were in the system that were complete or if they were set to complete, those types
of things.” “The system would show that the order was ready to be shipped, that
every component was in the warehouse and it was ready to go. So it would be an
order complete and basically, when you are talking in the logistical system, you
get it on the trailer at the end of that month, and then it would make it to the
dealership pretty much on time.”
The Former Retail Logistics Manager explained how Furniture Brands’ personnel
knew to load the trailers with goods before the end of the quarter—so that the
Company could recognize revenue on those goods during that quarter—even
though the goods were not being shipped to the customer until the beginning of
the next quarter. According to the Former Retail Logistics Manager, “the system
would show us all available orders that were ready to ship, if they were ready to
ship, no matter what the ship dates were. Normally, the guys in the warehouse and
those types of folks would not see the requested ship dates. They would see that
that order is, there’s three sofas for that order, all three sofas are in the warehouse,
it’s ready to go and, if there’s no customer holds, like you know the customer was
on credit hold or anything like that, then it would be available to ship and, you
know, the warehouse folks, they had folks working overtime trying to find orders
that were ready to go.”
The Former Retail Logistics Manager said: “We would put out all stock at the end
of the quarter. You know we had a term for it, we called it ‘bang week.’ . . . Like
bang bang shoot ‘em up.” “We would work you know like an extra Saturday or
we would work you know Friday night until everything closes something like
that. We would work a couple of hours at the end of each day. . . . [W]e just knew
that everything had to get out and if it sits you know 15 extra hours at the end of
the month, it took 15 extra hours. And what would happen would be the next
week, start of the next physical month, we would have like a couple of days there
where we would work only partial shifts, or we wouldn’t work at all” because
there would be nothing to do since he and his colleagues had taken care of it
before the quarter ended the previous week. “We would suck the system dry.”
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That notwithstanding, the Former Retail Logistics Manager correctly understood
that Furniture Brands’ policy was to record revenue on shipment.
Prematurely recognizing revenue in this manner had the effect of inflating
Furniture Brands’ net sales in the quarter prior to the quarter in which the sales
should have been recorded. As a result, Defendants were able to achieve the
targeted net sales necessary to trigger their bonus payments.
[Doc. No. 40 at ¶¶ 68–77] [alterations and emphasis in original].
In response to these allegations, Defendants argue that “the timing of when a
handful of trailers were allegedly loaded—the only thing the CW actually purports to
know—does not indicate when the Company recognized revenue for any of the products
on those trailers (i.e., the Company could have legitimately reversed its revenue on goods
that were not actually shipped and the end of the quarter).” [Doc. No. 50 at 4] [emphasis
in original].
The Court agrees with Defendants. Nothing in Plaintiffs’ description of the RLM’s
duties and responsibilities is even tangentially related to accounting, or suggests that the RLM
would have any insight whatsoever into Furniture Brands’ accounting practices:
The Former Retail Logistics Manager was employed at Furniture Brands for 18
years. From 2005 to 2013, the Former Retail Logistics Manager was responsible
for all areas of logistics including home delivery, Retail Service Centers and
Customer Service. The Former Retail Logistics Manager oversaw home deliveries
from the retail stores; worked with personnel in Furniture Brands’ service centers;
worked with Furniture Brands designers on logistic problems and home delivery;
and located third parties to perform the deliveries. The Former Retail Logistics
Manager was a go-between with the different warehouses in North Carolina,
protection planning, retail, and home delivery. Most recently, the Former Retail
Logistics Manager worked at the warehouse on Causby Road in Morganton,
North Carolina. The Former Retail Logistics Manager sometimes reported to
senior executives based in Furniture Brands’ corporate headquarters in St. Louis.
Specifically, the Former Retail Logistics Manager reported to Edward D. Teplitz
(“Teplitz”), who was President of the Thomasville division, and Kevin Kramer,
who was Senior Vice President of the Thomasville division.
[Doc. No. 40 at ¶ 67].

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The Eighth Circuit has clearly noted that confidential witness allegations will be
disregarded as unreliable under the heightened pleading standards of the Reform Act where a
plaintiff “fail[s] to provide any information regarding how employees at this level of the
company would have access to the [ ] information” alleged (Cornelia, 519 F.3d at 783); relies
on witnesses whose information comes only second or third-hand (Horizon Asset Mgmt. v. H&R
Block, Inc., 580 F.3d 755, 763 (8th Cir. 2009)); or fails to establish that the witnesses “would
have a basis to know what [defendants] knew.” Id.
The RLM states repeatedly, and in conclusory fashion, that trailers were loaded at the
end of the fourth quarter of 2012 for the express purpose of prematurely recognizing revenue.
Plaintiffs utterly fail to explain how the RLM, whose duties revolve around logistics and
delivery, would have access to information regarding when and how the company recognized
revenue for the fourth quarter of 2012, or any quarter. For purposes of evaluating the instant
Motion, the Court accepts as true Plaintiffs’ allegations that the trailers were loaded—at a
frantic pace—at the end of the fourth quarter of 2012. Green Tree, 270 F.3d at 666. However,
without factual allegations building a foundation for how the RLM had knowledge as to when,
how, and if revenue was recognized for the inventory loaded on the trailers, Plaintiffs’
allegations to that effect fail to meet the Reform Act’s heightened pleading standard. Indeed,
there could be any number of benign explanations for loading the trailers at the end of the
quarter, that may not have trickled into the unsubstantiated “water cooler chatter” that takes
place between employees of any company. See, e.g., City of Pontiac Gen. Emps. Ret. Sys. v
Schweitzer-Mauduit Int’l, Inc., 806 F Supp. 2d 1267, 1296–97 (N.D. Ga. 2011) (“[R]eliance on
confidential witnesses [in a securities case] is permissible only so long as the complaint
unambiguously provides in a cognizable and detailed way the basis of the whistleblower’s
knowledge. In other words, the Court must be able to determine whether the [confidential

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witness] has reliable first-hand knowledge or whether his statements are based on unreliable
hearsay or gossip.”) (citations and internal quotation marks omitted); Limantour v. Cray Inc.,
432 F. Supp. 2d 1129, 1141 (W.D. Wash. 2006) (“The Court must be able to tell whether a
confidential witness [in a securities case] is speaking from personal knowledge, or merely
regurgitating gossip and innuendo.”) (citation and internal quotation marks omitted).
For these reasons, Plaintiffs have failed to adequately plead falsity through the
premature recognition of revenue in the fourth quarter of 2012.
2.

Selling Furniture for Pennies on the Dollar

Plaintiffs further allege that the company was able to reach the sales threshold necessary
for Defendants Scozzafava and Johnston to receive their respective bonuses because, “towards
the end of 2012,” the company “was selling furniture for pennies on the dollar to discount stores
Big Lots, Tuesday Morning, and TJ Maxx.” [Doc. No. 40 at ¶ 78] [internal quotation marks
omitted]. Again relying on the RLM as a confidential witness, Plaintiffs assert that
approximately 5-10 “trailer loads” of discounted furniture were sent from each of at least four
different Furniture Brands warehouses to discounting stores in the fourth quarter of 2012.
Plaintiffs allege:
According to the Former Retail Logistics Manager, there were “trailer loads” of
discounted furniture on at least four different Furniture Brands warehouses in
North Carolina: Thomasville Central Warehouse (in Thomasville); Thomasville
warehouse (in Lenoir); Drexel Heritage and Henredon warehouses (in
Morganton); and the Broyhill warehouse (in Lenoir). The Former Retail Logistics
Manager stated that there were approximately 5-10 trailers in the fourth quarter in
each of the four warehouses. Based on his review of the appointment schedules
for the trailers, as well as conversations he had with workers loading the trailers
destined for discounting stores, the Former Retail Logistics Manager confirmed
that these trailers were, in fact, destined for discounting stores.
As the Former Retail Logistics Manager explained, “what they would do is offer
the product at well below cost profits to get the dealers to take it . . . .” Furniture
Brands “would take excess inventory and cut the wholesale price down so far that
the dealers would be jumping at it because they wouldn’t mess with the MSRP . .

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. [the dealers] would get a dresser or an entertainment center for – normally costs
$800 wholesale, they would get it for like $300.”
Discussing how he knew the price of this furniture, the Former Retail Logistics
Manager explained that it was “communicated through the channels from the
higher ups . . . that it was clearance goods, we had to get rid of the inventory . . .”
According to the Former Retail Logistics Manager, “Ralph mentioned it at one
of his meetings with all of us that, you know, they had to take such a beating on
that.” The Former Retail Logistics Manager was referring to defendant Ralph
Scozzafava. During a factory visit on or about October 2012, Scozzafava spoke to
the Former Retail Logistics Manager and his colleagues about how the Company
was reducing inventory by selling to discounters as a way of increasing its cash
flow.
According to the Former Retail Logistics Manager, Furniture Brands did not
normally sell its furniture to discounters. The Former Retail Logistics Manager
stated that, based on his extensive experience, discounters would be unable to sell
Furniture Brands’ merchandise for anything less than $0.10-$0.25 on the dollar.
Defendant Scozzafava periodically met with the Former Retail Logistics Manager
and other employees in North Carolina. The Former Retail Logistics Manager
explained that “[e]very once in a while [Scozzafava] would come in and tell us
how great things were and how we were well positioned to be the leaders and that
the Company’s finances weren’t as bad as what people were saying, that kind of
thing.”
According to the Former Retail Logistics Manager, decisions concerning pricing
of furniture “comes from St. Louis, from the corporate office.”
[Doc. No. 40 at ¶¶ 79–84] [alterations and emphasis in original].
Plaintiffs employ their allegations regarding Defendants’ use of “heavily discounted
sales,” to two ends. First, they argue that Defendants misled investors through the omission of
material facts. Second, they argue that Defendants engaged in impermissible “channel stuffing.”
i.

Omission of Material Facts

The Court finds no omission of material fact relating to furniture discounting. Furniture
Brands’ February 13, 2012 press release, which announced the sales and trade-name impairment
charges for the fourth quarter and year of 2012, stated:
Gross profit was $54.6 million and included $1.0 million in charges related to cost
reduction activities, resulting in a gross margin of 20.7%. Gross profit for the
fourth quarter of 2011 was $58.8 million and gross margin was 23.0%. Excluding
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these charges, the decrease in fourth quarter 2012 gross margin when compared to
the year ago period was primarily due to increased discounts, including the
additional clearance of older inventory and product that is being replaced.
[Doc. No. 47-2 at 3] [emphasis added].
The same day, Furniture Brands held a conference call with analysts and investors,
during which Defendant Johnston explained that the decrease in the company’s gross margin in
the fourth quarter of 2012 as opposed to the fourth quarter of 2011 “was primarily due to
increased discounts, including the additional clearance of older inventory and product that is
being replaced.” [Doc. No. 47-3 at 3] [emphasis added]. Defendant Scozzafava echoed the same
point: “Gross margin was down from the prior year quarter even after consideration of the
charges [Defendant Johnston] described, primarily driven by increased discounts including
those for older inventory and product that we are working on replacing.” [Id. at 4] [emphasis
added].
Similarly, the company’s 2012 Form 10-K discussed the decrease in net sales, gross
profit, and gross margin for 2012 as compared to 2011 and explained the significant role of
higher discounts and clearance of inventory in these respective declines:
Net sales for 2012 were $1,072.3 million compared to $1,107.7 million in 2011, a
decrease of $35.3 million or 3.2%. The decrease in net sales was primarily the
result of continued weak retail conditions resulting in decreased sales and higher
discounts, including the additional clearance of older inventory and product that
is being replaced. Supply chain disruptions early in 2012 also contributed to
lower sales when compared to the prior year.
Gross profit for 2012 was $244.3 million compared to $267.3 million in 2011.
The decrease in gross profit was primarily due to a decrease in net sales driven
by higher discounts, including the additional clearance of older inventory and
product that is being replaced, in addition to supply chain disruptions early in
2012 ($27.1 million), charges from inventory write-downs related to product
rationalization ($1.9 million) and increased freight expense ($4.1 million),
partially offset by lower employee compensation and benefits and other effects
from prior cost reduction activities ($9.6 million), and lower severance expense
($2.0 million). Gross margin for 2012 as a percentage of sales decreased to 22.8%
compared to 24.1% in 2011, primarily due to discounts, including the additional
clearance of older inventory and product that is being replaced and increased
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product writedowns, partially offset by lower employee compensation and
benefits and other effects from prior cost reduction activities, and lower severance
expense.
[Doc. No. 47-4 at 20] [emphasis added]. Thus, Defendants explicitly made known to investors,
repeatedly, that they had utilized discounts, including the clearance of older inventory and
product writedowns.
Plaintiffs argue that these were “insufficient disclosure[s] under securities law” and that
“Defendants’ failure to disclose the unprecedented extent of their discounting scheme deprived
investors of the ability to recognize the damaging impact Defendants knew it would have on:
(1) future sales, which were cannibalized by the steeply discounted goods; and (2) the
Company’s trade-name, which resulted in the oversized impairment charges at the end of the
Class Period.” [Doc. No. 50 at 6–7]. By “unprecedented extent of [Defendants’] discounting
scheme,” Plaintiffs refer to their repeated invocations of the RLM’s statement that the company
was “selling furniture for pennies on the dollar” to discount stores. Plaintiffs further argue that
“[h]aving chosen to discuss Furniture Brands’ use of discounts, Defendants were ‘obligated to
make a full disclosure of any material facts.’” [Id. at 16] [quoting Pub. Pension Fund Grp. v.
KV Pharm., 679 F.3d 972, 983 n.8 (8th Cir. 2012)].
However, while the RLM’s “pennies on the dollar” statement is vague and nonspecific,
as are most of Plaintiffs’ allegations regarding the alleged discounting scheme,7 Plaintiffs do
cite the RLM for one particularized and specific factual statement on this subject:
7

As Defendants correctly note:
[The RLM] never identifies a particular transaction with a particular discount store, much less
whether the amount of products offered to any particular store was unusual in 4Q12 as compared
to other reporting periods, or even what amount of product was subject to discounts in 4Q12.
This lack of particularity is unsurprising given the [confidential witness’] alleged former position
in the Company as Retail Logistics Manager who simply “oversaw home deliveries from the retail
stores.” While he may have been able to determine that certain trailers were “destined for
discounting stores” based on “his review of the appointment schedules,” the [RLM] is not alleged
to have been in any position to know the extent of these discounted sales, much less how they
were reported on the Company’s books or whether they were not properly disclosed in [Furniture
Brands’] financial statements.

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As the Former Retail Logistics Manager explained, “what they would do is offer
the product at well below cost profits to get the dealers to take it . . . .” Furniture
Brands “would take excess inventory and cut the wholesale price down so far that
the dealers would be jumping at it because they wouldn’t mess with the MSRP . .
. [the dealers] would get a dresser or an entertainment center for—normally costs
$800 wholesale, they would get it for like $300.”
[Doc. No. 40 at ¶ 80] [emphasis added]. Selling a product that costs $800 for $300 is the
equivalent of selling it for $0.37 on the dollar. This does not strike the Court as selling the
product for “pennies on the dollar,” or even at an “unprecedented” discount. Defendants’
labeling of such a discount in their public statements as a systematic “clearance” of older,
backlogged inventory that was being replaced does not appear to the Court to constitute an
omission of material facts.8 Further, Plaintiffs allege no facts in the way of comparative
information from Furniture Brands’ historical clearance discount pricing, or industry norms.
Plaintiffs rely on inapposite cases for support in asserting “[c]ourts have sustained
claims based on similar allegations that deep discounts were used to mislead investors.” [Doc.
No. 50 at 16] [citing Institutional Investors Grp. v. Avaya, Inc., 564 F.3d 242, 264 (3d Cir.
2009), and Lefkoe v. Jos. A. Bank Clothiers, 2007 U.S. Dist. LEXIS 98777, at *21 (D. Md. Sept.
10, 2007)].
Plaintiffs quote Avaya for its holding that the plaintiffs in that case “pled unusual price
discounting with the particularity required by the PSLRA.” 564 F.3d at 264. However, in Avaya
the allegations of price discounting came from several confidential witnesses with more relevant
roles in the company,9 as well as a report by Lehman Brothers which explained that its

[Doc. No. 55 at 10–11] [citations omitted].
8

The Court notes that Plaintiffs also quote the RLM as stating that “discounters would be unable to sell Furniture
Brands’ merchandise for anything less than $0.10-$0.25 on the dollar.” [Doc. No. 40 at ¶ 82]. The import and
relevance of this assertion is unclear to the Court.
9
The confidential witnesses included a former Global Contracts Manager who participated in negotiating contracts
with many of Avaya’s biggest clients; a former employee who was responsible for evaluating the profitability of
special bids that constituted half of Avaya’s revenue; a former Senior Client Executive; a former Director of

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knowledge of the level of the defendants’ discounts came from interviewing the company’s
resellers. Id. at 248–50. Further, the defendants in Avaya made repeated public statements, in
response to direct questions during an earnings conference call, which denied employing
unusual pricing discounts and instead reassured investors that the pricing of goods remained
“fairly steady.” Id. The same defendants later admitted to offering 30–40% discounts during the
same period. Id. Finally, the Avaya court accepted the plaintiffs’ falsity allegations based on the
defendants’ denials—in response to direct questions—of their use of discounting, but rejected
the plaintiffs’ falsity allegations based on the defendants issuing financial projections which
they allegedly knew to be false because of their use of discounts. Id. at 267.
Here, in contrast to Avaya, where the defendants denied using discounts, Defendants
disclosed that they had employed discounting and clearance of their inventory. Further,
Plaintiffs’ falsity allegations here are predicated upon reported financials—particularly the trade
name impairment charge—which Plaintiffs claim misled investors about future performance. In
Avaya, the court outright rejected the plaintiffs’ falsity claim based on financial projections.
Similarly, in Lefkoe, the plaintiffs alleged that “on approximately 12 separate occasions,
Defendants affirmatively misrepresented inventory issues and omitted from public statements
their knowledge of the Company’s excessive levels of inventory over the class period, its need
to steeply discount inventory, and the resulting harm to sales of core merchandise and the
Spring 2006 line.” The plaintiffs in Leftkoe alleged that, although “[t]he[] discounts resulted in
increased sales of the surplus merchandise, . . . the aggressive pricing strategy . . . eroded the
Company’s overall profit margin.” Again, in contrast, Defendants here not only disclosed the
utilization of discounting the company’s backlogged inventory, they identified these practices as
the primary cause of Furniture Brands’ decrease in net sales, gross profit, and gross margin for
Operations for Global Solutions Sales and Support; and an independent Avaya Sales Manager who sold Avaya’s
products but was not employed by the company.

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2012 as compared to 2011. [Doc. No. 47-4 and 20]. Thus, neither Avaya, nor Lefkoe, supports
Plaintiffs’ position.
For the reasons stated, the Court finds that Plaintiffs have failed to meet the Reform
Act’s pleading standard in alleging that Defendants misled investors through the omission of
material facts.
ii.

Channel Stuffing

Plaintiffs’ channel stuffing allegations fail as well. The Seventh Circuit has explained:
The term [“channel stuffing”] refers to shipping to one’s distributors more of
one’s product than one thinks one can sell. A certain amount of channel stuffing
could be innocent and might not even mislead—a seller might have a realistic
hope that stuffing the channel of distribution would incite his distributors to more
vigorous efforts to sell the stuff lest it pile up in inventory. Channel stuffing
becomes a form of fraud only when it is used, as the complaint alleges, to book
revenues on the basis of goods shipped but not really sold because the buyer can
return them. They are in effect sales on consignment, and such sales “cannot be
booked as revenue. Neither condition of revenue recognition has been fulfilled—
ownership and its attendant risks have not been transferred, and since the goods
might not even be sold, there can be no certainty of getting paid. But those
strictures haven’t stopped some managers from using consigned goods to fatten
the top line—that is, the revenue line—of the corporate income statement.”
Makor Issues & Rights, Ltd. v. Tellabs Inc., 513 F.3d 702, 709 (7th Cir. 2008) (emphasis added)
(quoting H. David Sherman et al., Profits You Can Trust, Spotting & Surviving Accounting
Landmines 30 (Financial Times Prentice Hall 2003), and citing SEC v. McAfee, Inc., Civ.
Action No. 06-009 (PJH), 2006 SEC LEXIS 2 (N.D. Cal. Jan. 4, 2006)); see also Phillips v.
Scientific-Atlanta, Inc., 489 F. App’x 339, 340 n.1 (11th Cir. 2012) (“While ‘channel stuffing’
is not per se illegal or fraudulent, it ‘may amount to fraudulent conduct when it is done to
mislead investors.’ One particular way ‘channel stuffing’ can mislead investors is by creating
the impression that sales for a product are strong, and will continue to be strong, when—in
fact—‘stuffed’ product is stacking up at customers; and the product backlog will likely cause a
slowing of future orders.”) (citation omitted); Ok. Firefighters Pension & Ret. Sys. v. Smith &

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Wesson Holding Corp., 669 F.3d 68, 76 (1st Cir. 2012) (affirming grant of summary judgment
for defendant on channel stuffing allegations, noting that “offering discounts to stimulate sales
is not automatically manipulation and may well stimulate demand,” and finding that “the
plaintiffs’ case . . . rests on only three pull-in deals plus rhetoric; nothing shows that the pull-ins
were unusual, represented a significant percentage of the reported sales for the quarter, or were
otherwise suspect. . . In sum, such practices are neither inherently fraudulent nor always
innocent; size, design, purpose, transparency, and history are all relevant.”).
Not only do Plaintiffs make clear that the discounting stores were not Furniture Brands’
normal distributors,10 Plaintiffs fail to allege that any of the discounted merchandise was ever
returned.11 Thus, Plaintiffs fail to allege that any of the discounted sales were consignment
sales, impermissibly recognized as revenue. Cf. Dutton v. D&K Healthcare Res., 2006 U.S.
Dist. LEXIS 42553, at *88–89 (E.D. Mo. June 23, 2006) (denying defendants’ motion to
dismiss in a securities case where plaintiff “set out with particularity the material misstatements
in the public statements which omitted, among other things, the alleged channel-stuffing
transactions and the alleged nature of the ‘sales’ as actually being consigned inventory. . . .
[Plaintiff] further allege[d] that defendants delayed recognition of the true nature of these
channel-stuffing transactions, and delayed accounting for the true nature of these transactions as
consigned inventory while publicly touting strong future profits and continued excellent
business prospects with current customers.”) (emphasis added).
10

“According to the Former Retail Logistics Manager, Furniture Brands did not normally sell its furniture to
discounters.” [Doc. No. 40 at ¶ 82].
11

With regard to the furniture which Plaintiffs allege was loaded onto trailers at the end of the fourth quarter of
2012 for the purpose of prematurely recognizing revenue, Plaintiffs allege that “in certain circumstances, the orders
would be cancelled and the furniture returned to inventory. In those cases, product loaded on trailers and recorded
as revenue were never even delivered to customers.” [Doc. No. 40 at ¶ 70]. However, Plaintiffs specify that “the
customers who would receive these shipments were Furniture Brands’ franchise dealers.” [Id. at ¶ 72]. In other
words, Plaintiffs delineate clearly between the furniture that was allegedly loaded onto trailers to recognize revenue
prematurely, which was meant for the company’s franchise dealers, and the 5-10 trailers per warehouse of furniture
sent to the discount stores.

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Further, as discussed above, Defendants were transparent with investors regarding their
use of discounting for the purpose of clearing out backlogged inventory that was being replaced
and did not make public statements about future sales. See Ok. Firefighters, 669 F.3d at 76
(noting that the “size, design, purpose, transparency, and history” of offering discounts are
important in channel stuffing allegations). This stands in stark contrast to cases in which the
corporate defendants allegedly engaged in channel stuffing activities, failed to apprise investors
of their use of discounts or the fact that the “sales” were contingent, and made public statements
about sustaining sales numbers without disclosing that the sales were impermissibly recognized
on the strength of unsustainable discounts or consignment sales. See, e.g., St. Jude, 836 F. Supp.
2d at 891 (“Plaintiffs allege that STJ mislead investors by stating that its earnings and growth
rate would be maintained even though STJ was engaging in an unsustainable pattern of channel
stuffing and not properly accounting for its sales.”); Dutton, 2006 U.S. Dist. LEXIS 42553, at
*88–89 (E.D. Mo. June 23, 2006) (“[Plaintiff] further alleges that defendants delayed
recognition of the true nature of these channel-stuffing transactions, and delayed accounting for
the true nature of these transactions as consigned inventory while publicly touting strong future
profits and continued excellent business prospects with current customers.”).
Plaintiffs cite a letter a financial analyst familiar with Furniture Brands filed with the
Bankruptcy Court in which he stated that, based on his analysis, “management almost certainly
‘stuffed the channel’ with respect to sales in its fourth quarter [of 2012] to meet the sales
threshold needed to pay itself the short-term incentive.” [Doc. No. 40 at ¶ 59]. However,
Plaintiffs cite no basis the analyst gave for forming such a belief, thus rendering his statement
conclusory and inadequate under the Reform Act. See In re Synovis Life Techs., Inc. Sec. Litig.,
2005 U.S. Dist. LEXIS 18187 (D. Minn. Aug. 25, 2005) (“The bald assertion of one
broadcasting analyst is insufficient to plead with particularity that Defendants failed to adjust

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Synovis’ guidance when it possessed information indicating it was appropriate to do so.”); cf.
Avaya, 564 F.3d at 263 (considering analyst’s assertion that the defendant company offered
“aggressive” and “unusually attractive” discounts, where the complaint disclosed that the report
was based on information obtained from the company’s resellers).
Instead, Plaintiffs repeatedly cite the analyst’s statement that management likely
employed a “heroic effort” to reach the sales threshold:
Moreover, in response to an analyst’s question, CEO Scozzafava replied that
December sales were up 13%, January sales were down, February “relatively flat”
and down in March. By implication, this suggests that October/November sales
were down by about 10% and that January sales were down at a level equal to or
greater than the 11% reported decrease of the first quarter overall. As we read it,
management likely used some heroic effort to “make” the sales threshold target
by the paltry $6 million it reported. We leave it to the Court to decide whether to
investigate this issue further and to reach its own conclusion about management
behavior.
[Doc. No. 40 at ¶ 59] [emphasis in original]. These allegations, devoid of any particularity, do
not meet the heightened pleading standard required under the Reform Act.
In Cerner Corp., the Eighth Circuit affirmed the dismissal of a channel stuffing
allegation:
Although Crabtree is not required to describe in detail the circumstances of
Cerner’s pulling in activities, he is required to plead with particularity the ‘who,
what, when, where, and how’ of the pulling in. Here, Crabtree’s complaint alleges
that the pulling in took place and caused an overstatement in Cerner’s earnings
during each quarter in the class period and an impairment in Cerner’s ability to
meet future earnings guidance. The complaint fails, however, to allege the amount
of any overstatements, the extent of any pulling in that took place, or the amount
of any revenue that was pulled in from future quarters. Thus, the complaint’s
general description of the pulling in, without more, cannot satisfy the heightened
falsity pleading standard.
425 F.3d at 1084 (emphasis added) (citing Navarre, 299 F.3d at 744–75 (general description of
alleged wrongdoing by defendants, unaccompanied by more specific information, does not
reach the level of particularity required by the Reform Act).

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Here too, Plaintiffs fail to provide anything beyond a general description of an alleged
channel stuffing scheme to pull in revenue from future quarters. Plaintiffs’ channel stuffing
allegations thus fail to meet the Reform Act’s heightened pleading standard.
3.

Falsity Conclusion

In sum, Plaintiffs’ falsity allegations—when the unreliable statements of the RLM are
disregarded—constitute pleading fraud by hindsight. The Court “cannot countenance pleading
fraud by hindsight[.]” K-Tel, 300 F.3d at 891 (quoting Green Tree, 200 F.3d at 662). Plaintiffs’
stripped-down argument is that the $10.8 million trade name impairment charge which
Furniture Brands took in the second quarter of 2013 demonstrates the falsity of the sales the
company reported for the fourth quarter of 2012, and the corresponding $1.4 million trade name
impairment charge it took that quarter. These allegations cannot survive a motion to dismiss
under the Reform Act. See Id. (“Mere allegations that statements in one report should have been
made in earlier reports do not make out a claim of securities fraud. Corporate officials need not
be clairvoyant; they are only responsible for revealing those material facts reasonably available
to them.”) (citations and internal quotation marks omitted). Accordingly, Plaintiffs have failed
to adequately plead falsity.
B.

Scienter
Under the Reform Act, Plaintiffs are required to plead scienter by “stat[ing] with

particularity facts giving rise to a strong inference that the defendant acted with the required
state of mind.” Cerner Corp., 425 F.3d at 1083 (alteration in original) (quoting 15 U.S.C. § 78u4(b)(2)). Plaintiffs fail to plead a “strong inference” of scienter under the Reform Act’s
heightened pleading standard.
The Eighth Circuit has noted that “[s]cienter can be established in three ways: (1) from
facts demonstrating a mental state embracing an intent to deceive, manipulate, or defraud, (2)

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from conduct which rises to the level of severe recklessness; or (3) from allegations of motive
and opportunity.” Cornelia, 519 F.3d at 782 (citation omitted). Here, Plaintiffs attempt to
establish scienter by alleging that “Defendants possessed the requisite motive and opportunity to
artificially inflate Furniture Brands’ net sales and net earnings.” [Doc. No. 40 at ¶ 178].
Plaintiffs argue that “Defendants were motivated to manipulate the two specific financial
metrics that they needed to qualify for long-awaited bonuses, which they expected to be their
last bonuses before the Company went bankrupt.” [Doc. No. 50 at 20].
To determine whether Plaintiffs have adequately pled scienter, the Court must consider
“whether all of the facts alleged, taken collectively, give rise to a strong inference of scienter,
not whether any individual allegation, scrutinized in isolation, meets that standard.” Tellabs,
Inc. v. Makor Issues & Rights, Ltd., 551 U.S. 308, 322–23 (2007). The Supreme Court has
explained:
[I]n determining whether the pleaded facts give rise to a “strong” inference of
scienter, the court must take into account plausible opposing inferences. . . . The
strength of an inference cannot be decided in a vacuum. The inquiry is inherently
comparative: How likely is it that one conclusion, as compared to others, follows
from the underlying facts? To determine whether the plaintiff has alleged facts
that give rise to the requisite “strong inference” of scienter, a court must consider
plausible, nonculpable explanations for the defendant’s conduct, as well as
inferences favoring the plaintiff. The inference that the defendant acted with
scienter need not be irrefutable, i.e., of the “smoking-gun” genre, or even the
“most plausible of competing inferences.” Recall in this regard that § 21D(b)’s
pleading requirements are but one constraint among many the [Reform Act]
installed to screen out frivolous suits, while allowing meritorious actions to move
forward. Yet the inference of scienter must be more than merely “reasonable” or
“permissible”—it must be cogent and compelling, thus strong in light of other
explanations. A complaint will survive, we hold, only if a reasonable person
would deem the inference of scienter cogent and at least as compelling as any
opposing inference one could draw from the facts alleged.
Id. at 323–24 (citations and footnote omitted).
With regard to Plaintiffs’ allegation that Defendants Scozzafava and Johnston were
motivated to manipulate financial data in order to receive bonuses of $308,775 and $60,344,

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respectively, the Court notes that “general allegations of a desire to increase stock prices,
increase officer compensation or maintain continued employment are too generalized and are
insufficient” to plead scienter under the Reform Act. K-Tel, 300 F.3d at 895 (citation omitted).
The exception being “where an individual defendant will benefit to an unusual degree, based
upon the magnitude of a compensation package tied to earnings and the timing of an
overstatement of earnings.” Id. at 894 (citing Green Tree, 270 F.3d at 661).
In Green Tree, one of the defendant executives had a “remarkable contract awarding
him 2.5% of Green Tree’s pre-tax income,” which resulted in him allegedly being “the highest
paid business executive in the United States,” receiving $65 million and $102 million in 1995
and 1996, respectively, with a base salary of $430,000. 270 F.3d at 650, 661. The Green Tree
plaintiffs alleged that the executive’s “remarkable contract” would expire at the end of 1996
and, thus, he knew that “1996 would be the last year for which he would receive bonus
compensation valued in the tens of millions of dollars . . . [the executive]’s 1997 compensation
was valued at approximately $4.8 million, about $97 million less than the value of his original
1996 compensation.”12 Id. at 661. The Green Tree court “conclude[d] that the magnitude of [the
executive]’s compensation package, together with the timing coincidence of an overstatement of
earnings at just the right time to benefit [the executive], provide[d] an unusual, heightened
showing of motive to commit fraud.” Id.
Here, Defendants argue:
[T]he actual bonus amounts Scozzafava and Johnston received in 2012—
$308,775 and $60,344, respectively—are insufficient to create an inference of
scienter absent other suspicious circumstances, and Plaintiff does not offer any
“suspicious” circumstances. See Horizon Asset Mgmt. v. H&R Block, Inc., 580
F.3d 755, 766 (8th Cir. 2009) (defendant’s bonuses over two years totaling
approximately $258,000 held insufficient to create inference of sceienter);
Kushner, 317 F.3d at 830 ($630,000 bonus and options were not sufficient to give
12

After Green Tree restated its 1996 earnings, the executive had to repay a portion of his 1996 bonus. Green Tree,
270 F.3d at 661.

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rise to any inference of scienter); In re Synovis Life Technologies, 2005 WL
2063870, at *16 (stock gain bonus of $1.6 million insufficient to provide evidence
of scienter); In re Cerner Corp, 425 F.3d at 1085 (finding that neither largest
incentive bonus paid to any one individual defendant totaling approximately
$355,000, nor $1 million aggregate bonuses, created an inference of an improper
motive).
[Doc. No. 46 at 20]. Plaintiffs counter that, notwithstanding the relatively small size of
Defendants’ bonuses in this case,13 Plaintiffs have pled “suspicious circumstances.” [Doc. No.
50 at 21]. Specifically, Plaintiffs argue that the “heroic efforts” they allege that Defendants
undertook to meet their sales target, the fact that “the Company [was] teetering on the brink of
bankruptcy,” and “Defendants underst[anding] [of] 2012 as their last opportunity to earn a
bonus before the Company went bankrupt,” constitute “unusual circumstances” sufficient to
plead scienter. [Id.]. Plaintiffs further contend that “the cases cited by Defendants concerning
the bonus amounts they received are distinguishable because they did not involve companies on
the brink of bankruptcy.” [Id. at 21 n.19].
Given the facts of this case, and Plaintiffs’ failure to plead falsity, the Court finds that
Plaintiffs have not alleged the requisite “unusual circumstances” to demonstrate Defendants’
motive and opportunity as means of establishing a “strong inference” of scienter. Nor do
Plaintiffs allege other facts indicating a strong inference of Scienter. Cf. Navarre Corp., 299
F.3d at 741 (“Evidence we have found relevant to the scienter issue includes: insider trading in
conjunction with false or misleading statements; a divergence between internal reports and
public statements; disclosure of inconsistent information shortly after the making of a fraudulent
statement or omission; bribery by top company officials; evidence of an ancillary lawsuit,
charging fraud, which was quickly settled; disregard of current factual information acquired

13

As compared with the executive bonuses in the relevant case law cited above.

- 25 -

prior to the statement at issue; accounting shenanigans; and evidence of actions taken solely out
of self-interest.”) (Quoting Geffon v. Micrion Corp., 249 F.3d 29, 36 (1st Cir. 2001)).14
The Court finds that the “inference of scienter” Plaintiffs allege is not as compelling as
the opposing inference: that despite non fraudulent efforts, Defendants were unsuccessful in
preventing a company that had been performing poorly for six years from having to declare
bankruptcy.
C.

Section 20(a) Claim
In order to state a claim under Section 20(a) of the Act, a plaintiff must adequately plead

a primary violation of securities laws. See K-tel, 300 F.3d at 904 n.20. Because Plaintiffs’
Section 20(a) claim is derivative of their claims under Section 10(b), Plaintiffs cannot pursue a
Section 20(a) claim. Accordingly, the dismissal of Plaintiffs’ 10(b) claims are fatal to their
Section 20 claim. In re Hutchinson Tech., Inc. Secs. Litig., 536 F.3d 952, 961 (8th Cir. 2008).
Conclusion
Based upon the foregoing analysis, Plaintiffs have failed to sufficiently plead a cause of
action under the Exchange Act, in light of the heightened pleading requirements of the Reform
Act. Their claims are therefore dismissed.
Accordingly,
IT IS HEREBY ORDERED that Defendants’ Motion to Dismiss Plaintiffs’

14

Plaintiffs spend nearly ten pages of the Complaint alleging that Defendant Scozzafava was an overpaid executive
who put himself before the company during his tenure, and continued such practices during the bankruptcy
proceedings. These allegations are far too tangential and generalized to be relevant to the scienter determination in
the present case.

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Consolidated Amended Complaint [Doc. No. 45] is GRANTED.
IT IS FURTHER ORDERED that this matter is DISMISSED.
Dated this 27th day of January, 2015.

HENRY EDWARD AUTREY
UNITED STATES DISTRICT JUDGE

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