Horowitz v. Green Mountain Coffee Roasters Inc. et al
Filing
57
OPINION AND ORDER granting without prejudice 34 MOTION to Dismiss filed by Robert P. Stiller, 35 MOTION to Dismiss Consolidated Class Action Complaint filed by Green Mountain Coffee Roasters Inc., 33 MOTION to Dismiss filed by Frances G. Rathke, Lawrence J. Blanford. Plaintiffs may move to amend their complaint within 30 days. Signed by Judge William K. Sessions III on 1/27/2012. (law)
UNITED STATES DISTRICT COURT
FOR THE
DISTRICT OF VERMONT
JERZY WARCHOL et al,
Individually and on Behalf
of all Others Similarly
Situated,
Plaintiffs,
v.
GREEN MOUNTAIN COFFEE
ROASTERS, INC., et al.,
Defendants.
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Case No. 2:10-cv-227
(Consolidated)
Opinion and Order:
Defendants’ Motions to Dismiss
This suit is a securities fraud class action brought
against Green Mountain Coffee Roasters, Inc. (“GMCR” or the
“Company”), its CEO, Lawrence Blanford, its CFO, Frances Rathke,
and its founder and current Chairman of the Board of Directors,
Robert Stiller (collectively, the “Defendants”).1
Before the
Court are motions to dismiss filed by each of the Defendants,
ECF Nos. 33-35, which came before the Court on a January 5, 2012
hearing, see Mots. to Dismiss Hr’g Tr. (“Tr.”), ECF No. 56.
After considering the parties’ extensive written and oral
argument, the Court concludes Plaintiffs do not allege material
misstatements attributable to Stiller.
Nor do they allege facts
1
Blanford, Rathke, and Stiller will be referred to
collectively as the “Individual Defendants.”
1
that collectively give rise to a “strong inference” of scienter
on the part of any of the other Defendants, a pleading
requirement imposed by The Private Securities Litigation Reform
Act of 1995 (“PSLRA”), 15 U.S.C. § 78u-4(b)(2)(A).
As a
consequence, the Court grants each of the motions to dismiss
without prejudice to Plaintiffs to move to amend their complaint
within 30 days of this order.
Background
In setting out the facts below, the Court generally assumes
the truth of the factual allegations in the complaint, Tellabs,
Inc. v. Makor Issues & Rights, Ltd., 551 U.S. 308, 322 (2007),
but not if they conflict with “the plain language of the
publicly filed disclosure documents.”
In re Optionable Sec.
Litig., 577 F. Supp. 2d 681, 692 (S.D.N.Y. 2008) (internal
citation and quotation omitted).
The Court may also consider,
“documents incorporated into the complaint by reference, and
matters of which a court may take judicial notice.”
551 U.S. at 322.
Tellabs,
This includes public disclosure documents
filed with the SEC as required by law, as well as documents
“possessed by or known to the plaintiff and upon which it relied
in bringing the suit.”
ATSI Commc’ns, Inc. v. Shaar Fund, Ltd.,
493 F.3d 87, 98 (2d Cir. 2007).
The Court is also permitted to
take judicial notice of stock prices.
Ganino v. Citizens Utils.
Co., 228 F.3d 154, 167 n.8 (2d Cir. 2000).
2
I.
The Parties and Legal Claims
Plaintiffs are a putative class of purchasers of GMCR stock
between July 28, 2010 and September 28, 2010 (the “Class
Period”) who principally allege violations of § 10(b) of the
Exchange Act of 1934, 15 U.S.C. § 78j(b).2
They also allege the
Individual Defendants were “controlling persons,” under § 20(a)
of the Exchange Act of 1934, 15 U.S.C. § 78t(a).
That provision
holds jointly and severally liable those defendants who
“directly or indirectly, control[ ]” persons who have violated
the securities laws, except “if the controlling person acted in
good faith and did not directly or indirectly induce the act or
acts constituting the violation or cause of action.”
Id.
2
§ 10(b) is implemented by SEC regulation at 17
C.F.R. § 240.10b-5, which provides:
It shall be unlawful for any person, directly or
indirectly . . .
(a) To employ any device, scheme, or artifice to
defraud,
(b) To 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, or
(c) To engage in any act, practice, or course of
business which operates or would operate as a fraud or
deceit upon any person, in connection with the
purchase or sale of any security.
For ease of reference, § 10(b) and 17 C.F.R. § 240.10b-5
are collectively labeled throughout the opinion as Ҥ
10(b).”
3
Plaintiffs charge Defendants with making misrepresentations that
led them to purchase GMCR shares at inflated prices during the
Class Period.
Consol. Class Action Compl. (“Compl.”) ¶ 116,
Feb. 23, 2011, ECF No. 26.
GMCR is a Delaware corporation headquartered in Vermont
that sells specialty coffee, coffee makers, and related beverage
products.
It roughly divides its operations into two
departments, Keurig, which it acquired in 2006, and the
Specialty Coffee Business Unit (“SCBU”).
Keurig concentrates in
selling a patented brewing device of the same name that produces
ready-to-drink beverages from K-Cups—single serving portions of
dried coffee, tea, or other products.
Cups as well as in other packaging.
SCBU sells coffee in K-
In recent years, the
Company has experienced rapid growth, with its stock price
rising from a low of $5.41 per share in Fiscal Year (“FY”) 2008
to a high of more than $37 in FY 2010, just prior to the end of
the Class Period.
GMCR 2010 10-K, GMCR Mem. in Supp. Mot. to
Dismiss Ex. 1 (“2010 10-K”), at 29, ECF No. 35-3.
it made $1.36 B in net sales.
2010 10-K at 31.
In FY 2010,
In August 2010,
Fortune magazine recognized GMCR as number two on its list of
the nation’s hundred fastest growing companies.
II.
Compl. ¶86.
Class Period Events
The start of the Class Period, July 28, 2010, coincides
with Defendants’ release of the Company’s third quarter 2010
4
earnings figures.
The market reacted positively to the reports:
the following day, the Company’s share price rose nine percent,
from $28.67 to $31.36.
Compl. ¶ 79.
On August 5, GMCR filed
its 10-Q quarterly financial statement with the SEC (the “Q3 10Q”), signed by CEO Blanford and CFO Rathke.
The Q3 10-Q
represented that the Company’s management, including the CEO and
CFO, had reviewed GMCR’s “disclosure controls and procedures”
and that the CEO and CFO found them “effective.”
83.
Compl. ¶¶ 80,
It reported that so far that fiscal year, GMCR’s pre-tax
income was nearly $99 MM, up from about $67 MM the year prior.
On August 10, 2010, GMCR announced a stock purchase
agreement with Italian coffeemaker Luigi Lavazza S.p.A
(“Lavazza”), in which Lavazza would buy $250 MM worth of GMCR
shares, valued based on the sixty-day weighted average closing
price of the stock.
The deal closed on the final day of the
Class Period, September 28, 2010.
On September 14, GMCR
announced another transaction, in which it would purchase all
outstanding shares of a Canadian competitor, Van Houtte, for
C$915 million, financed in part by a $1.35 B credit facility.
The deal closed December 17, 2010.
On August 13, Michelle Stacy, President of Keurig, made the
first of several Class Period stock trades, selling 30,000
shares for $30.95 each.
Stacy also sold 10,000 total shares on
September 13 and 21, yielding a Class Period total of $1.3 MM.
5
As further outlined below, the September 21 sale came one day
after GMCR reported learning it was under investigation by the
SEC.
Although Stacy disclosed in an October correction to her
previous Form 4 stock sale filing that at least some of the
transactions had been pursuant to a Rule 10b5-1 trading plan,3
she did not note the plan when making the trades initially.
On
August 18, Scott McCreary, President of SCBU, sold 200,000
shares at a price of $33.08 each, realizing more than $6.6 MM.
The complaint alleges these were the first significant insider
trades made by Company officers since June 2009.
As GMCR points
out and Plaintiffs do not contest, both sets of sales involved
the exercise and sale of options, amounting to approximately 20
percent of the two presidents’ total holdings.
GMCR Mem. 21-22.
Bookending the Class Period, on September 28, 2010, GMCR
issued a Form 8-K announcing that “management [had] discovered
3
SEC Rule 10b5-1 provides affirmative defenses to
securities fraud allegations of trading “‘on the basis of’
material nonpublic information.” 17 C.F.R. § 240.10b5-1. The
insider may defend her trades by asserting they were pursuant to
a “written plan for trading securities,” drafted prior to the
insider learning of the material non-public information at issue
in the suit. Id. at (c)(1)(i)(A). The plan must list the
amount and price of the securities to be sold or purchased,
provide the date of the transaction, and prevent the insider
from exercising “any subsequent influence over how, when, or
whether to effect purchases or sales.” Id. at (c)(1)(i)(B). In
addition, the trade must have been executed according to the
plan’s terms. Id. at (c)(1)(i)(C). Finally, the plan must have
been composed “in good faith and not as part of a plan or scheme
to evade the prohibitions of this section.” Id. at (c)(1)(ii).
6
an immaterial accounting error” while preparing GMCR’s fourth
quarter financial statements.
Compl. ¶ 90.
The 8-K also
revealed that on September 20, 2010 the SEC had requested
evidence from the Company in connection with an investigation
GMCR believed to relate to “certain revenue recognition
practices and the Company’s relationship with one of its
fulfillment vendors.”
Compl. ¶ 90.4
GMCR’s stock price dropped
from $37.55 on September 27, its highest level during the Class
Period, to $31.06 one day after the announcement.
106-08.
Compl. ¶¶
It reached a post-announcement nadir of $26.87 on
October 11, 2010 before returning to its steady growth.
GMCR
Historic Stock Prices: July 28, 2010 – Apr. 21, 2011, GMCR Mem.
Ex. 3, at 4, ECF No. 35-5.5
On November 19, GMCR issued a press release warning
investors that, based on the recommendation of an internal
4
A confidential source told Plaintiffs that Company
employees had known of an SEC investigation months earlier, in
May 2010 at the latest. Compl. ¶¶ 68-69.
5
In spite of the negative disclosures, the Company’s
stock price rose above its Class Period high less than two
months after the September 28 8-K, attaining $37.63 on November
26. Id. The price dipped again to a low of $31.57 in December,
in the immediate wake of the Company’s 2010 10-K and earnings
restatement discussed below, but then returned to growth. Id.
On March 28, 2011, six months after the 8-K, the price was
$62.70 per share. GMCR Historical Share Prices, Yahoo! Finance,
available at http://finance.yahoo.com/q?s=gmcr&ql=1 (last
visited Jan. 23, 2012). On the one-year anniversary of the 8-K
the price stood at $103.88. Id. As of January 20, 2012, the
stock was worth $50.90. Id.
7
audit, the Company would restate its earnings for FYs 2007-09
and the first three quarters of FY 2010.
For that reason, it
told investors they should no longer rely upon the Company’s
previous reports for those periods.
It noted that GMCR “expects
to report a material weakness in the Company’s internal controls
over financial reporting.”
Compl. ¶ 92.
It advised, however,
that none of the irregularities implicated management or
employee misconduct or related to GMCR’s relationship with
MBlock & Sons, Inc. (“MBlock”), an Illinois third party
fulfillment entity for Keurig that presumably was the vendor
under review by the SEC.
On December 9, 2010, GMCR filed its FY 2010 10-K, signed by
Rathke, CEO Blanford, Chairman Stiller, and the Board of
Directors.
The report revealed the Company’s conclusions as to
the extent of the accounting errors and the revisions required
in response.
It announced GMCR had restated its financial
statements from FYs 2006-10.
GMCR repeated its assertion that
no errors were due to misconduct by management or employees or
related to MBlock.
It noted that GMCR was continuing to
cooperate with the SEC.
As relevant to this litigation, it
corrected the following errors revealed by the internal audit: a
$7.4 million pre-tax income overstatement due to the method for
calculating K-Cup inventory; a $0.7 million pre-tax income
overstatement related to inter-company brewer inventory; and
8
$1.0 million overstatement of pre-tax income because Keurig had
recognized royalty payments as income when it purchased K-Cups
from licensed third party brewers for re-sale.
5.
2010 10-K at 4-
It revealed the Company’s Q3 10-Q had overstated 39-week
earnings by approximately 6.2 percent.
Compl. ¶ 94.
Since the
restatement also uncovered some understatements in past
financials, it yielded a net overstatement of cumulative income
from FY 2006 – FY 2010 of $6.06 MM.
2010 10-K at 5.
As it predicted in November, GMCR announced it had
“identified certain material weaknesses in its internal control
over financial reporting,” and that its CEO and CFO had
determined “the Company’s disclosure controls and procedures
were not effective as of September 25, 2010.”
Compl. ¶ 95.6
It
elaborated that those shortcomings included failures to account
for transactions between the Company’s business segments.
Compl. ¶ 95; 2010 10-K at 56.
PricewaterhouseCoopers LLP
(“PWC”), as independent accountant, provided an audit opinion
affirming the restatement.
2010 10-K at 65-66.
6
As defined in the 10-K, a “material weakness is a
control deficiency, or combination of control deficiencies, such
that there is a reasonable possibility that a material
misstatement to the annual or interim financial statements will
not be prevented or detected on a timely basis.” 2010 10-K at
56.
9
Discussion
To state a § 10(b) claim, Plaintiffs must sufficiently
allege Defendants: (1) “made misstatements or omissions of
material fact,” with (2) requisite scienter.
105.7
ATSI, 493 F.3d at
Under Federal Rule of Civil Procedure 8(a)(2), Plaintiffs’
complaint must contain factual allegations sufficient to “raise
a right to relief above the speculative level.”
Bell Atl. Corp.
v. Twombly, 550 U.S. 544, 555 (2007); Ashcroft v. Iqbal, 129 S.
Ct. 1937, 1953 (2009).
Further, it is subject to Fed. R. Civ.
P. 9(b) (“In alleging fraud or mistake, a party must state with
particularity the circumstances constituting fraud or
mistake.”).
ATSI, 493 F.3d at 105.
Rule 9(b) requires the
complaint “(1) specify the statements that the plaintiff
contends were fraudulent, (2) identify the speaker, (3) state
where and when the statements were made, and (4) explain why the
statements were fraudulent.”
Rombach v. Chang, 355 F.3d 164,
170 (2d Cir. 2004).
Congress supplemented the Federal Rules provisions with the
7
Plaintiffs also must show: that the misrepresentations
were (3) “in connection with the purchase or sale of
securities”; (4) that Plaintiffs relied on the
misrepresentations; and (5) that such reliance proximately
caused Plaintiffs’ injury. Id. Defendants do not challenge
Plantiffs’ pleadings on those three additional fronts, nor need
the Court evaluate them here.
10
PSLRA’s more exacting standards.
ATSI, 493 F.3d at 99.
The
PSLRA mandates securities fraud complaints:
specify each statement alleged to have been
misleading, the reason or reasons why the statement is
misleading, and, if an allegation regarding the
statement or omission is made on information and
belief, the complaint shall state with particularity
all facts on which that belief is formed.
15 U.S.C. § 78u-4(b)(1).
Concerning scienter, the PSLRA
requires the complaint “state with particularity facts giving
rise to a strong inference that the defendant acted with the
required state of mind.”
Id. § 78u-4(b)(2)(A).
Failure to meet
the PSLRA’s specifications requires granting a motion to
dismiss.
Id. § 78u-4(b)(3)(A); ATSI, 493 F.3d at 99.
I.
Misstatements or Omissions of Material Fact
The complaint details false statements connected to the
release of GMCR’s 2010 third quarter earnings for the 39-week
period then-ended: the press release, the earnings call, the Q3
10-Q, and the related certifications and representations about
the Company’s financial figures and disclosure controls
contained within them (collectively, the “Q3 Statements”).
The
complaint further describes that the statements were made by
Blanford and Rathke, as CEO and CFO, on behalf of the Company.
Plaintiffs then allege the Q3 Statements were later proven
falsely inflated both by the Company’s 2010 10-K, which restated
earnings and admitted to faulty disclosure controls, and the
11
improper inventory and accounting practices involving MBlock to
which the Company did not admit, but which Plaintiffs’ allege
occurred based on confidential witness (“CW”) reports.
Finally,
Plaintiffs describe that they relied to their detriment on those
misstatements, purchasing GMCR shares at an overly high price.
The parties spar vigorously over MBlock, which this opinion
takes up in detail in relation to scienter.
However, there is
little debate that the Q3 Statements, regardless of the MBlock
practices, were false—GMCR admitted as much in restating them.
In re Atlas Air Worldwide Holdings, Inc. Sec. Litig., 324 F.
Supp. 2d 474, 486 (S.D.N.Y. 2004) (“the mere fact that financial
results were restated is sufficient basis for pleading that
those statements were false when made.”).
Nor must the Court
resolve the MBlock debate to decide whether the misstatements
were “material.”
That question requires the Court to assess
whether “‘there is a substantial likelihood that a reasonable
shareholder would consider [the information] important in
deciding how to [act].’”
ECA & Local 134 IBEW Joint Pension
Trust of Chi. v. JP Morgan Chase Co., 553 F.3d 187, 197 (2d Cir.
2009) (quoting Basic, Inc. v. Levinson, 485 U.S. 224, 231-32
(1988)) (internal quotations omitted).
Put differently, the
misstatement must “significantly alter[ ] the ‘total’ mix of
information available” to the reasonable investor.
12
Id.
Useful in the materiality analysis is an SEC internal
guidance document, Staff Accounting Bulletin No. 99 (“SAB 99”),
64 Fed. Reg. 45,150, which provides that both quantitative and
qualitative factors are significant.
ECA, 553 F.3d at 197.
Materiality is a mixed question of fact and law, so courts will
only remove the issue from the finder of fact if the statements
in question are “‘so obviously unimportant to a reasonable
investor that reasonable minds could not differ on the question
of their importance.’”
ECA, 553 F.3d at 197 (quoting Ganino,
228 F.3d at 162) (internal quotation omitted).
Plaintiffs’ allegations, at the least, meet that low
threshold.
For one, the misstatements led to a restatement,
which, according to GAAP, is only appropriate when an error is
“material.”
In re Atlas Air, 324 F. Supp. 2d at 486.
Further,
the value of the restatement for the 39-week period covered by
the Q3 Statements was approximately 6.2 percent.
Compl. ¶ 94.
As a five percent threshold is a “good starting place for
assessing the materiality of the alleged misstatement,” ECA, 553
F.3d at 204, the magnitude of the changes also argue for
materiality.
Although changes in stock price are alone “too blunt an
instrument to be depended on” to gauge materiality, SAB 99, 64
Fed. Reg. at 45152 (internal quotation omitted), GMCR’s shares
rose nine percent the day after the third quarter earnings
13
announcements, and dropped more than sixteen percent the day
after GMCR disclosed the accounting errors.
08.
Compl. ¶¶ 79, 106-
Finally, the nature of the errors—particularly the
admission that the Company’s internal disclosure controls,
rather than being “effective,” Compl. ¶¶ 80, 83, suffered from
“certain material weaknesses,” Compl. ¶ 95 (emphasis added)—
indicates systemic flaws that a reasonable investor would
consider important in evaluating a company.
See Varghese v.
China Shenghuo Pharm. Holdings, Inc., 672 F. Supp. 2d 596, 60607 (S.D.N.Y. 2009) (finding statements by the defendant company
were actionable that referred to improving deficient internal
controls when plaintiffs alleged facts indicating the controls
were far weaker than portrayed publicly).
Plaintiffs’ claims begin to fray, however, at the point of
connecting a material misstatement to Stiller.8
In general, Rule
9(b) requires “inform[ing] each defendant of the nature of his
alleged participation in the fraud.”
DiVittorio v. Equidyne
Extractive Indus., 822 F.2d 1242, 1247 (2d Cir. 1987).
did not sign the Q3 10Q.
Stiller
Plaintiffs do not allege he made
public claims related to the Company’s earnings or helped
compile or certify the Q3 Statements.
8
GMCR, Blanford, and Rathke do not dispute the Q3
Statements are attributable to them.
14
Rather than tie Stiller to the Q3 Statements directly,
Plaintiffs argue that he was responsible on the basis of the
Group Pleading Doctrine.
(2d Cir. 1986).
See Luce v. Edelstein, 802 F.2d 49, 55
The doctrine pre-dates the PSLRA and developed
as an exception to Rule 9(b).
In re BISYS Sec. Litig., 397 F.
Supp. 2d 430, 438 (S.D.N.Y. 2005).
scope.”
It is “extremely limited in
SEC v. Espuelas, 699 F. Supp. 2d 655, 660 (S.D.N.Y.
2010) (internal citation and quotation omitted).
It “‘allows
plaintiffs to rely on a presumption that statements in
prospectuses, registration statements, annual reports, press
releases, or other group-published information, are the
collective work of those individuals with direct involvement in
the everyday business of the company.’”
In re Van der Moolen
Holding N.V., 405 F. Supp. 2d 388, 399 (S.D.N.Y. 2005) (quoting
Polar Int'l Brokerage Corp. v. Reeve, 108 F. Supp. 2d 225, 237
(S.D.N.Y. 2000)) (internal quotation omitted).9
9
Some circuits have rejected the doctrine as
conflicting with the commands of the PSLRA. Winer Family Trust
v. Queen, 503 F.3d 319, 337 (3d Cir. 2007); Southland Sec. Corp.
v. INSpire Ins. Solutions, Inc., 365 F.3d 353, 365 (5th Cir.
2004); Pugh v. Tribune Co., 521 F.3d 686, 693 (7th Cir. 2008).
The Second Circuit has not addressed whether the doctrine
survived the PSLRA, but it has at least suggested that district
courts must still consider it. Ill. State Bd. of Inv. v.
Authentidate Holding Corp., 369 F. App’x 260, 266 (2d Cir. 2010)
(unpublished decision). District courts have continued to apply
it. In re Van der Moolen, 405 F. Supp. 2d at 399 (“The majority
rule in this district is that the group pleading doctrine has
survived the PSLRA.”).
15
Nowhere does the complaint allege with particularity
Stiller’s participation in the daily business of the Company.
In re BISYS, 397 F. Supp. 2d at 440-41.
In fact, the only
allegation the complaint makes specifically as to Stiller is
that he is the Company’s founder and Board Chairman and an
“Individual Defendant” in this action.
Compl. ¶¶ 17, 20.
Otherwise, it makes broad assertions as to the roles of the
“Individual Defendants” or the “Defendants.”
¶¶ 21-25, 97-98, 114, 119.
See, e.g., Compl.
That is not enough.
Dresner v.
Utility.com, Inc., 371 F. Supp. 2d 476, 493 (S.D.N.Y. 2005) (“A
number of courts have recognized that such indiscriminate
defendant ‘clumping’ does not adhere to the particularity
standards of Fed. R. Civ. P. 9(b) and the PSLRA.”).
Plaintiffs’ response brief, drawing from GMCR SEC filings,
adds detail to the complaint’s description.
Still, only some of
those facts at all advance the proposition that Stiller was
involved in the Company’s routine affairs, like his 12 percent
ownership stake in GMCR, his occasional role as an advisor to
management, or that, when CEO and as Chairman, he signed other
financial statements that were covered by the restatement.
Pls’. Omnibus Opp’n to Mots. to Dismiss 18-19 & n.22.
Otherwise, the additional information favors the view Stiller no
longer was participate in daily business decisions.
As
Plaintiffs describe, he chaired GMCR’s Corporate Social
16
Responsibility Committee and relinquished many of the
traditional duties of a Board Chairman to another director.
Opp’n 18-19 & n.24.
That description is insufficient to allege
Stiller had an active role in the Company’s everyday work.
As a result, the complaint does not adequately plead
Stiller’s role in the alleged securities fraud, failing to
attribute a material misstatement or omission to him.
In
accordance with the PSLRA, the Court grants his motion to
dismiss.
As to GMCR, Blanford, and Rathke, however, the
complaint meets the pleading requirements: it specifies
material, false statements, describes the time and place at
which they were made, names their authors, and explains why they
were false.
As to those Defendants, the Court advances to the
second prong, scienter.
II.
Scienter
The PSLRA requires each complaint “state with particularity
facts giving rise to a strong inference that the defendant acted
with the required state of mind.”
(emphasis added).
15 U.S.C. § 78u-4(b)(2)(A)
Plaintiffs may demonstrate scienter on a
showing of either: (1) “both motive and opportunity to commit
the fraud” or (2) “strong circumstantial evidence of conscious
misbehavior or recklessness.”
ATSI, 493 F.3d at 99.
An
inference is strong “only if a reasonable person would deem [it]
cogent and at least as compelling as any opposing inference one
17
could draw from the facts alleged.”
Tellabs, 551 U.S. at 324.
As such, the Court’s inquiry is holistic, based on the totality
of the facts alleged, and comparative, judged relative to nonfraudulent inferences.
Id. at 322-23.
Plaintiffs must allege scienter adequately as to each
individual defendant, and the Group Pleading Doctrine does not
apply to the mental state prong.
Teamsters Allied Benefit Funds
v. McGraw, No. 09-cv-140 (PGG), 2010 WL 882883, at *11 n.6
(S.D.N.Y. Mar. 11, 2010).
To establish scienter on the part of
the Company, Plaintiffs must allege facts creating a “strong
inference that someone whose intent could be imputed to the
corporation acted with the requisite scienter,” even if that
person is not an Individual Defendant.
Teamsters Local 445
Freight Div. Pension Fund v. Dynex Capital Inc. (“Dynex”), 531
F.3d 190, 195-96 (2d Cir. 2008).
The Court begins by reviewing
Plaintiffs’ allegations of Defendants’ scienter individually and
then turns to whether their sum total is at least as compelling
as opposing inferences drawn from the events.
A. Motive and Opportunity to Commit the Fraud
A motive is a “concrete benefit[ ] that could be realized
by one or more of the false statements and wrongful
nondisclosures alleged.”
Novak v. Kasaks, 216 F.3d 300, 307 (2d
Cir. 2000) (quoting Shields v. Citytrust Bancorp, Inc., 25 F.3d
18
1124, 1130 (2d Cir. 1994)).10
Plaintiffs posit two fraudulent
motives: permitting lucrative insider stock sales and gaining
leverage for the Company in Class Period transactions.
Neither
proposed motive contributes to an inference of scienter.
1.
Insider Stock Sales
A plaintiff successfully alleges motive in demonstrating
“corporate insiders . . . ma[de] a misrepresentation in order to
sell their own shares at a profit.”
ECA, 553 F.3d at 198.
Plaintiffs argue Keurig President Michelle Stacy’s and SCBU
President Scott McCreary’s stock sales were such trades.
¶¶ 102-05.
Compl.
Evidence of fraudulent trading lies in “unusual
insider trading activity during the class period.”
Acito v.
IMCERA Group, Inc., 47 F.3d 47, 54 (2d Cir. 1995).
A trade is
“unusual,” if “‘in amounts dramatically out of line with prior
trading practices and at times calculated to maximize personal
benefit from undisclosed inside information.’”
In re Gildan
Activewear, Inc. Sec. Litig., 636 F. Supp. 2d 261, 270 (S.D.N.Y.
2009) (quoting In re Glenayre Techs., Inc. Sec. Litig., No. 96cv-8252 (HB), 1998 WL 915907, at *4 (S.D.N.Y. Dec. 30, 1998)).
The inquiry is highly context-specific.
Russo v. Bruce, 777 F.
10
Defendants do not object to the complaint’s
allegations of “opportunity” to commit fraud, see Compl. ¶ 23,
which is defined as “the means and likely prospect of achieving
concrete benefits by the means alleged.” Novak, 216 F.3d at
307.
19
Supp. 2d 505, 517 (S.D.N.Y. 2011); In re Oxford Health Plans,
Inc., 187 F.R.D. 133, 140 (S.D.N.Y. 1999) (“There is no guide
for determining whether certain insider trades are unusual or
suspicious in amount.”).
Here, the complaint alleges some grounds for suspicion.
Stacy’s and McCreary’s were the first significant trades by
Company officers since June 2009.
The timing might also raise
eyebrows, given that Stacy sold 5000 shares on September 21, a
week before GMCR announced the SEC investigation and
restatement, and one day after the Company claimed it was first
contacted by the SEC.
See In re Oxford Health Plans, 187 F.R.D.
at 139 (“[t]rades made a short time before a negative public
announcement are suspiciously timed.”).
In fact, relying on a
CW report discussed in the section on Plaintiffs’ allegations of
conscious recklessness that follows, Plaintiffs argue Stacy and
McCreary should have been aware of the SEC inquiry well before
making any of their trades, in May 2010 at the latest.
¶¶ 68-69.
Compl.
Moreover, the trades were sizable, amounting to about
twenty percent of both presidents’ stock and options11 and
yielding $1.3 MM and $6.6 MM during the Class Period.
Finally,
use of a Rule 10b5-1 trading plan ordinarily weighs heavily
11
Although it is an issue of controversy, “the weight of
authority” favors taking account of both options and stock in
the denominator when calculating the relative magnitude of an
insider’s sales. In re Gildan Activewear, 636 F. Supp. 2d at
271 n.5.
20
against finding motive, see, e.g., In re Gildan Activewear, 636
F. Supp. 2d at 272, but here the timing and coverage of Stacy’s
plan is unclear.
Nonetheless, the balance of the factors does not support
viewing the trades as evidence of fraudulent motive on the part
of the Company.
Chiefly, the complaint does not allege any
Individual Defendant or other insider sold stock during the
Class Period.
See Acito, 47 F.3d at 54; San Leandro Emergency
Med. Grp. Profit Sharing Plan v. Philip Morris Cos., 75 F.3d
801, 814 (2d Cir. 1996).
Nor do Plaintiffs specifically contend
Stacy or McCreary were parties to the fraud.
Russo, 777 F.
Supp. 2d at 517-18 (finding it “[f]urther problematic for
plaintiffs' theory” that Oppenheimer, an outside director and
the sole defendant alleged to have engaged in insider trading,
was not alleged to have “participated in the fraud.”).
Instead
of selling, a number of GMCR directors actually made modest
stock purchases during the Class Period.
GMCR Mem. Exs. 19-22,
ECF Nos. 21-24.
The basis offered in the complaint to assume that Stacy
and McCreary were aware of an SEC investigation related to
MBlock in May 2010 is weak, as described infra.
Even if it were
taken as true, however, other than Stacy’s September 21 sale,
none of the transactions took place near the dates on which the
officers were likely to maximize profits on the basis of that
21
knowledge.
See City of Brockton Ret. Sys. v. Shaw Grp. Inc.,
540 F. Supp. 2d 464, 476 (S.D.N.Y. 2008) (“Bernhard did not sell
his stock at the end of the putative class period, when insiders
would have ‘rushed to cash out’ before the financial statements
were restated,” when Bernhard sold his stock more than ten weeks
before the company announced a restatement.).
More importantly, Blanford actually added to his GMCR stock
after the alleged earlier SEC disclosure, exercising options to
purchase and retain 15,000 shares on July 22.
Lawrence Blanford
Form 4, dated July 23, 2010, Blanford & Rathke Mem. in Supp. of
Mot. to Dismiss Ex. 1, ECF No. 33-2.
It is difficult to read
Plaintiffs’ argument as consistent with Blanford’s investment.
Doing so would require the Court to infer that Blanford was
either unaware of the ongoing fraud, unwilling to reap its
rewards, or assisting Stacy and McCreary by making their suspect
sales appear less suspicious.
All of those theories run counter
to the thrust of the complaint, which charges Blanford and
Rathke with fraudulently manipulating the Company’s stock price.
See Russo, 777 F. Supp. 2d at 519 (“the Complaint gives no
indication as to why the Individual Defendants would have been
motivated to defraud investors in order to enrich others, not
themselves.”); In re Keyspan Corp. Sec. Litig., 383 F. Supp. 2d
358, 383-84 (E.D.N.Y. 2003) (finding it a factor weighing
against scienter that the defendant company’s CEO did not sell
22
shares at the same time other insiders did, when the CEO made
most of the alleged misstatements and was thus best placed to
profit from them).
While the Court cannot ignore their timing,
especially Stacy’s September sale, the factors surrounding the
insider trades point against ascribing to the Company a
fraudulent motive on that basis.
2.
Consummating the Class Period Transactions
The second motive the complaint attributes to Defendants is
gaining favorable terms in the deals GMCR signed during the
Class Period with Lavazza and Van Houtte.
As the complaint
describes, an inflated stock price would reduce the equity stake
Lavazza could obtain in GMCR, since Lavazza had pledged to
purchase $250 MM worth of GMCR stock, without regard to the
corresponding quantity of shares.
Compl. ¶ 101.
Relatedly,
Plaintiffs allege bolstering the Company’s earnings would result
in more favorable debt financing in the deal to acquire Van
Houtte.
Compl. ¶ 100.
Typically, cultivating the appearance of profitability and
entering into deals on the best terms are generalized motives
that do not support scienter.
ECA, 553 F.3d at 201 (“Such
generalized desires fail to establish the requisite scienter
because ‘the desire to achieve the most lucrative acquisition
proposal can be attributed to virtually every company seeking to
be acquired,’ Kalnit, 264 F.3d at 141, or to acquire another.”);
23
Dynex, 531 F.3d at 196 (“we have consistently rejected” the
“desire to maintain the appearance of profitability” as
sufficient motive).
This principle makes intuitive sense
because such transactions often could be at least as consistent
with benefiting plaintiff shareholders as with defrauding them.
See Kalnit v. Eichler, 264 F.3d 131, 141 (2d Cir. 2001)
(“achieving a superior merger benefitted all shareholders,
including the defendants.”).
Inflating stock prices to cement deals can be a basis for
scienter “‘in some circumstances’” such as when there is “a
unique connection between the fraud and the acquisition,” ECA,
553 F.3d at 201 n.6 (quoting Rothman v. Gregor, 220 F.3d 81, 9294 (2d Cir. 2000)).
Courts have found that “[s]tock sales that
are unusual in scope or timing may support an inference of
scienter.”
In re ATI Tech., Inc. Sec. Litig., 216 F. Supp. 2d
418, 439 (E.D. Pa. 2002).
But that is not the case here.
The
Van Houtte deal closed December 17, well outside the Class
Period and more than a week after the 2010 10-K correcting the
Company’s earnings.
Plaintiffs fail to articulate motive when
the deal was sealed after GMCR admitted its earnings were
overvalued and restated them.
The Lavazza deal closed September 28—the last day of the
Class Period.
In In re ATI Technologies, Inc. Securities
Litigation, the Eastern District of Pennsylvania found motive
24
when the defendant company signed and closed a deal during the
class period to acquire another company for $453 MM worth of
common stock and options.
216 F. Supp. 2d at 439.
The
plaintiffs there alleged the stock was overvalued: the defendant
company would have had to issue over twice as many shares and
options for the transaction than if it had closed after the
defendant’s corrective disclosures concerning inventory values.
Id. at 439-40.
That case is unlike the Lavazza transaction, which closed
as GMCR announced it was under investigation by the SEC and that
it was reviewing its previous financial statements—poor timing,
to say the least, if Defendants had intended to exploit the
false Q3 Statements for profit.
In addition, the complaint does
not allege that the revelations prompted any change in the terms
of the Lavazza deal, or that either party had second thoughts.12
Finally, absent from the complaint are allegations that the
Individual Defendants would have benefitted personally from
completing the transactions at an artificially high stock price,
12
Of course, alleging Lavazza or Van Houtte got a poor
deal would not demonstrate that the class of GMCR shareholders
who are the plaintiffs in this action were defrauded. ECA, 553
F.3d at 200-01 (finding inapposite plaintiffs’ reliance on a
case “support[ing] the contention that excessive fees show
motive to defraud another company's shareholders”). While
Lavazza might theoretically be a member of the class in this
case, as it purchased GMCR shares during the Class Period, at
oral argument neither party believed that it was. Tr. 41-42,
103.
25
making it even more tenuous to attribute scienter to them than
as to the Company as a whole.
Rombach, 355 F.3d at 177.
That the Company would make such allegedly damning disclosures
in the midst of completing significant transactions undermines
Plaintiffs’ claim that the misstatements were aimed at boosting
GMCR’s dealmaking prospects.
B. Recklessness
Recklessness is “‘at the least, conduct which is highly
unreasonable and which represents an extreme departure from the
standards of ordinary care . . . to the extent that the danger
was either known to the defendant or so obvious that the
defendant must have been aware of it.’”
Novak, 216 F.3d at 308
(quoting Rolf v. Blyth, Eastman Dillon & Co., Inc., 570 F.2d 38,
47 (2d Cir. 1978)) (internal quotations omitted).
It is “‘a
state of mind approximating actual intent and not merely a
heightened form of negligence.’”
S. Cherry St., LLC v.
Hennessee Group, LLC, 573 F.3d 98, 109 (2d Cir. 2009) (quoting
Novak, 216 F.3d at 312).
A complaint will meet this standard if
it alleges “defendants knew facts or had access to non-public
information contradicting their public statements” and
“defendants . . . knew or should have known they were
misrepresenting material facts with respect to the corporate
business.”
In re Scholastic Corp. Sec. Litig., 252 F.3d 63,
76 (2d Cir. 2001).
“Under certain circumstances,” it can also
26
be met when “plaintiffs allege[] facts demonstrating that
defendants failed to review or check information that they had a
duty to monitor, or ignored obvious signs of fraud.”
F.3d at 308.
Novak, 216
However, if the complaint fails to plead a motive
to commit fraud, it must make a “‘correspondingly greater’”
showing of strong circumstantial evidence of recklessness.
ECA,
553 F.3d at 198-99 (quoting Kalnit, 264 F.3d at 142) (internal
quotation omitted).
Plaintiffs contend Defendants should have been aware of
facts belying the Q3 Statements—in particular, the Company’s
poor accounting practices and its improper shipments to MBlock—
and recklessly failed to act on them.
Compl. ¶¶ 24, 89, 114.
Corporate officers have a duty to disclose material information
relevant to accounting practices and publicly-filed financial
statements.
See Kalnit, 264 F.3d at 143.
But without further
evidence of fraudulent intent, a restatement or accounting
errors cannot demonstrate recklessness.
City of Brockton, 540
F. Supp. 2d at 473; Stevelman v. Alias Research Inc., 174 F.3d
79, 84 (2d Cir. 1999).
To show the failure to correct was
reckless, Plaintiffs must adequately plead that Defendants “‘had
access to contrary facts’” and “‘specifically identify the
reports or statements containing this information.’”
F.3d at 196 (quoting Novak, 216 F.3d at 309).
Dynex, 531
To make that
showing, Plaintiffs rely on the nature of the Individual
27
Defendants’ positions with the Company and the contention,
supported by CW statements, that they were on notice of poor
practices within the Company before or during the Class Period.
Plaintiffs advance a theory known as the “Core Operations
Doctrine.”
1989).
See Cosmas v. Hassett, 886 F.2d 8, 13 (2d Cir.
The doctrine provides that “if the subject-matter of the
alleged misstatements is sufficiently ‘significant’ to a
defendant company, it may be possible for knowledge of
contradictory information (and thus, scienter) to be imputed to
individual defendants even in the absence of specific
information contradicting their public statements.”
In re
eSpeed, Inc. Sec. Litig., 457 F. Supp. 2d 266, 293 (S.D.N.Y.
2006).
Plaintiffs allege that as CEO and CFO, Blanford and
Rathke reasonably can be expected to know of problems with
accounting systems and improper MBlock revenue recognition
practices.
Courts differ on whether the Core Operations Doctrine
survives the PSLRA.
See In re Atlas Air, 324 F. Supp. 2d at 490
(applying the doctrine pre-Tellabs); Bd. of Trs. of City of Ft.
Lauderdale Gen. Emps. Ret. Sys. v. Mechel OAO, No. 09-cv-3617
(RJS), 2011 WL 3502016, at *15 (S.D.N.Y. Aug. 9, 2011)
(surveying post-Tellabs cases, noting decisions that have
rejected the doctrine altogether, confined Atlas to its facts,
28
or applied it only when other information also supports
scienter).
A recent decision within the Circuit addressing the issue
determined that whether or not the doctrine survives, it cannot
form the sole basis on which to find a strong inference of
scienter, but only part of the “holistic assessment of the
scienter allegations” required by Tellabs.
Ft. Lauderdale, 2011
WL 3502016, at *16; see also New Orleans Emps. Ret. Sys. v.
Celestica, Inc., No. 10-cv-4702, 2011 WL 6823204, at *2 n.3 (2d
Cir. Dec. 29, 2011) (summary order) (noting in dictum that such
an approach accords with the decisions of the courts within the
Circuit).
Applying that view, the Court need not address the
difficult question of whether the Company’s accounting systems
and revenue recognition practices regarding MBlock were
themselves “core operations.”
It is possible that they are.
Cf. Celestica, 2011 WL 6823294, at *2 (“inventory, especially
when taken in relation to the company's overall sales, was key
to measuring Celestica's financial performance and was a subject
about which investors and analysts often inquired.”).
However,
even if the Court were to consider them core operations, the
additional grounds for scienter the complaint offers are
29
insufficient to demonstrate an inference of scienter under the
PSLRA.13
To show Blanford, Rathke, and the Company were on notice of
wrongful revenue recognition at MBlock and general accounting
difficulties, Plaintiffs offer the CW statements.
In Novak, the
Second Circuit approved the use of anonymous sources, so long as
plaintiffs describe the source in the complaint “with sufficient
particularity to support the probability that a person in the
position occupied by the source would possess the information
alleged.”
216 F.3d at 314.
Since Tellabs, skepticism of using
CW sources to prove scienter has grown.
See Campo v. Sears
Holdings Corp., 371 F. App’x 212, 216 n.4 (2d Cir. 2010)
(unpublished disposition in which the court, in dictum, found no
error in the district court’s decision ordering the plaintiffs’
CWs deposed to confirm their allegations in order to decide a
motion to dismiss, noting “[t]he anonymity of the sources . . .
frustrates the requirement, announced in Tellabs, that a court
weigh competing inferences to determine whether a complaint
13
Plaintiffs relatedly argue that Blanford and Rathke,
as CEO and CFO, signed and certified the Q3 10-Q, obligating
them to investigate the accuracy of GMCR’s financials and the
effectiveness of its disclosure controls. But that still does
not dispose of the general requirement that Plaintiffs allege
facts available to Defendants that would have illuminated the
falsities. Dynex, 531 F.3d at 196; In re Take-Two Interactive
Sec. Litig., 551 F. Supp. 2d 247, 304-05 (S.D.N.Y. 2008) (“[A]
Sarbanes–Oxley certification is probative of scienter only if
the complaint alleges specific contrary information.”).
30
gives rise to an inference of scienter . . . .”); Higginbotham
v. Baxter Int’l, Inc., 495 F.3d 753, 757 (7th Cir. 2007)
(“Perhaps these confidential sources have axes to grind. Perhaps
they are lying. Perhaps they don't even exist.”); In re MRU
Holdings Sec. Litig., 769 F. Supp. 2d 500, 516-17 (S.D.N.Y.
2011) (citing Campo and Higginbotham to discount plaintiffs’ CW
allegations, without considering the Novak framework).
More
recently, however, the Second Circuit applied the Novak standard
to find CW statements credible to support an inference of
scienter.
Celestica, 2011 WL 6823294, at *2-3.
Although the
decision is unpublished, it adds additional weight to the fact
that the Second Circuit has not overruled the test in Novak.
The Court uses the Novak rule to evaluate the CW statements
here.
The core of Plaintiffs’ case comes from CW 1, a former
“distribution planning manager” for GMCR who reported that
GMCR’s Vice President of Operations, Jonathan Wettstein, and
Director of Operations, Don Holly, purposefully caused the
Company to produce more products than customers demanded,
sending the excess to MBlock warehouses.
Compl. ¶ 65.
CW 2, an
ex-regional sales manager at GMCR also claimed product remained
in warehouses past its expiration date and said that “anyone at
the Company would acknowledge that MBlock, was, in essence, a
captive company and would do as GMCR instructed.”
31
Compl. ¶ 66.
Because of that practice, CW 1 further “believed that revenue
was improperly recorded [by GMCR] on ‘sales’ to MBlock.”
Compl.
¶ 65.
CW 1 also specifically “indicated” that “GMCR improperly
recognized revenue on 150 truck loads of product” sent to MBlock
sometime in the first quarter of FY 2010 (which ended December
2009).
Compl. ¶ 70.
The basis for this belief was that CW 1
and other employees were “unable to locate the requisite
paperwork . . . traditionally used by GMCR to validate the
sale,” leading to the inference that MBlock never paid for the
products.
Compl. ¶¶ 70-71.
CW 1 estimated the truck deliveries
carried $7.5-15 MM in product.
Compl. ¶ 71.
He also indicated
that Wettstein, among other officials, knew of the shipment,
and, as the complaint notes in parenthesis, that Wettstein
“regularly provided updates to CEO Blanford.”
Compl. ¶ 71.
CW
6, a VP of Operations at GMCR in 2010, told Plaintiffs that
GMCR’s accounting office asked him or her to record shipments to
MBlock as a sale, even though CW6 did not know whether MBlock
gained ownership of the products it received.
Compl. ¶ 76.
Finally, the complaint notes that in May 2010 CW 1 was
contacted by colleagues at GMCR asking whether he or she had
been a whistleblower in an SEC investigation.
Compl. ¶ 68.14
14
Read most naturally, the complaint actually suggests
it was CW 3, an MBlock employee from 2001-09 with undescribed
32
Plaintiffs contend this account belies GMCR’s September 28, 2010
8-K disclosure that the Company was first contacted by the SEC
on September 20, 2010.
Compl. ¶¶ 68-69.
CW 1’s account is lengthy and richly textured as to the
mechanics of the shipments, lending that portion credence.
As a
GMCR distribution planning manager during the time of the
alleged shipments, CW 1’s background provides some basis to
believe he or she could have witnessed deliveries sent to
MBlock.
Nonetheless, CW 1’s disclosed characteristics provide less
reason to believe that the 150 truckloads were wrongly marked as
revenues.
Plaintiffs did not allege that accounting was part of
CW 1’s job description or that he or she had a background in the
subject.
In re Accuray, Inc. Sec. Litig., 757 F. Supp. 2d 936,
948-49 (N.D. Cal. 2010) (“None of the CWs held financing or
accounting positions, so none was in a position to know when or
if revenue was recognized based on a particular deposit or how
often deposits were refunded.”).
CW 1’s conclusion of improper
revenue recognition rested solely on the fact that sales
paperwork was missing.
That CW 1 observed the deliveries and
responsibilities, not CW 1, who was contacted by the SEC in May.
See Compl. ¶¶ 67-68. However, Plaintiffs in their opposition
brief, Opp’n 5, 25, 40, and at oral argument referred to the
witness as CW 1. Given the Court’s obligation to read inferences
in Plaintiffs’ favor and some ambiguity in the complaint’s
language, the Court will attribute that statement to CW 1 for
purposes of deciding this motion.
33
could not locate the requisite paperwork does not provide
insight into how GMCR accountants recorded the shipments on the
Company’s balance sheet.
CW 6 supported the general theory that MBlock shipments
were treated as sales, but the complaint alleges only that CW 6
worked at GMCR in 2010, not in 2009 at the time of the 150
truckloads described by CW 1.
While CW 6 “did not know if
MBlock ever owned the products shipped to it” because of its
“arms-length relationship” with GMCR, the complaint does not
specify whether the witness believed MBlock or third party
customers never paid for the product, as CW 1 contends with the
150 truckloads.
Compl. ¶ 76.15
In addition, the alleged
15
Plaintiffs also point to changes in GMCR’s revenue
recognition policy as evidence of scienter. GMCR changed its
revenue recognition policy in its 2010 10-K. The 2010 policy
clarified that the Company marked revenue on Keurig goods only
“when the fulfillment entities ship the product based on the
contractual shipping terms.” Compl. ¶¶ 72-74; 2010 10-K at 49.
In 2009, the policy was ambiguous. It stated only that revenue
was “recognized upon product delivery,” but “in some cases”
booked “upon product shipment.” GMCR 2009 10-K, Opp’n Ex. J
(“2009 10-K”), at 3, ECF No. 43-11. However, unlike the 2010
10-K, which delineates separate policies for different types of
SCBU and Keurig sales, the 2009 10-K applies simply to
“wholesale and consumer direct sales.” 2009 10-K at 3. As
Defendants pointed out at oral argument, it is thus unclear
whether the 2009 policy relates to sales conducted through
fulfillment entities like MBlock. Tr. 117-19. Even if it did,
it is possible to read both statements harmoniously, assuming
that “shipment” in the 2009 statement refers to shipping from
MBlock to customers and not from GMCR to MBlock. In fact, the
2010 10-K notes that “[t]itle to the product passes to the
fulfillment entity immediately before shipment to the
retailers.” 2010 10-K at 49. Regardless, reading the change in
34
accounting improprieties run counter to the restatement’s
findings and PWC’s independent review of GMCR’s books, which
turned up no concerns with MBlock revenue recognition.
Plaintiffs have not quarreled with the adequacy of the
restatement or the independent audit.
The largest weakness in CW 1’s account, however, is at
precisely the most relevant point: Defendants’ awareness of the
falsity of the Q3 Statements.
Instructive by way of contrast to
this case is Celestica, which applied Novak to credit CW
accounts as to show recklessness.
2011 WL 6823204, at *3.
In
Celestica, the plaintiffs’ claim was based on incorrect
inventory accounting that ultimately required defendant
Celestica to write off $30 MM worth of unsold goods stored at
its Monterrey, Mexico plant, as well as $60–80 MM in additional
costs related to a recent restructuring.
Id.
The plaintiffs presented evidence from confidential sources
whose positions “afforded them direct knowledge of Celestica's
inventory buildup during the class period,” three of whom
“either provided information about rising inventory levels to
[the CEO and CFO] directly or participated in meetings where
they heard [the CEO and CFO] informed by others about the
the 2010 10-K as sinister still does not support a finding of
recklessness. The policy change does not demonstrate a
connection between the false statements and facts available to
the Defendants to warn them that the statements were false.
35
company's inventory management problems.”
Id. at *1.
One CW
provided the CEO and CFO a spreadsheet indicating excess
inventory at the Monterrey facility.
Id at *2.
In addition,
the plaintiffs explained why, in light of the recent
restructuring and investor inquiries, inventory issues would be
important for the CEO and CFO to monitor.
Id.
The Second
Circuit found the complaint both explained how the defendants
were informed of the wrongfulness of their original statements
and why they should have been attentive to that information.
Id.
Here, the complaint suggests merely how Defendants might
have known of improper treatment of the 150 truckloads: one
sentence stating that CW 1 alleges that Wettstein knew of the
shipments and that Wettstein regularly updated Blanford.
¶ 71.
Compl.
Taken as true, the statement does not clearly allege that
Wettstein knew the shipments were improperly recorded or, if he
did, that he told Blanford.
There is also no reference
whatsoever to Rathke’s awareness of the shipments.
Those
missing links are fatal to establishing scienter by recklessness
as to MBlock, because the complaint does not show Defendants
were alerted to information contradicting the Q3 Statements.
See In re Accuray, 757 F. Supp. 2d at 948-49 (finding CW
accounts failed to prove recklessness in part because six of the
seven individual defendants had no contact with the CWs).
36
Similarly, the SEC investigation into GMCR’s fulfillment
entity revenue recognition policies near the end of the Class
Period does not bolster CW 1’s account.
De Oliveira v. Bessemer
Trust Co., No. 09-cv-0713 (PKC), 2010 WL 1253173, at
*6 (S.D.N.Y. Mar. 24, 2010).
Plaintiffs assert Defendants were
aware of the inquiry at the time of the Q3 Statements, relying
CW 1’s claim that GMCR employees had asked whether he or she had
been a whistleblower “in an SEC investigation of GMCR” in May
2010, Compl. ¶ 68.
However, that statement is not pled with
adequate particularity either.
First, CW 1 does not provide any
information about the alleged May SEC review, and there is no
particular reason to believe that CW 1 refers to the
investigation into fulfillment entities that the Company
disclosed on September 28.
Second, CW 1 does not allege that
senior officials at the Company, let alone the Individual
Defendants, were on notice of the inquiry prior to the Q3
Statements.
Further still, the fact of an ongoing SEC investigation
standing alone, even if it had been related to MBlock and known
to the Defendants, is not enough to support a finding of
recklessness.
See Glazer Capital Mgmt., LP v. Magistri, 549
F.3d 736, 740, 748-49 (9th Cir. 2008) (finding an SEC cease-anddesist order that described the defendant company’s violations
of the Foreign Corrupt Practices Act and criticized the company
37
for its lack of internal controls and proper training
insufficient to support scienter).
It is particularly
speculative to make that assumption here, where the SEC has
issued no findings and the Company conducted an independently
certified restatement of its financials that uncovered no errors
related to MBlock.
The same infirmities plague the CW allegations related to
accounting controls.
Plaintiffs offer statements from CWs 7-10
indicating that Keurig and SCBU used different accounting
systems.
Compl. ¶ 82.
Plaintiffs argue this fact should have
put the Company, Blanford, and Rathke on notice as to the
inadequacy of its internal controls.
But only CW 10 opined that
the multiple systems caused difficulties, saying “problems with
intercompany transfers could arise.”
Compl. ¶ 82.
CW 10 did
not work for Keurig or SCBU, but rather was an “accounting
manager” for “a roaster acquired by GMCR.”
Compl. ¶ 82.
The
complaint does not specify when CW 10’s employer was acquired by
GMCR or when he had access to GMCR’s accounting platforms.
Finally, there is no mention whether senior officials were
alerted to any problems.
Since the complaint does not plead with particularity any
CW statements demonstrating that Defendants knew of problems in
the Company’s accounting systems and revenue recognition
practices related to MBlock, it does not sufficiently allege
38
Defendants’ scienter on the basis of recklessness.
In sum, the
Court concludes Plaintiffs have not adequately pled individual
grounds for scienter as to Blanford, Rathke, or the Company.
Nevertheless, Tellabs commands a holistic, comparative weighing
of the factors giving rise to scienter against parallel, nonfraudulent explanations, and the Court now turns to that
analysis.
C. Tellabs Comparative Analysis
The combined facts amounting to an inference of scienter
must be “at least as compelling as any opposing inference of
nonfraudulent and nonreckless intent.”
at 111.
S. Cherry St., 573 F.3d
An innocent reading of the facts—suggested by the 2010
10-K—is that the lapses in disclosure controls and faulty
accounting were unintended consequences of the Company’s rapid
growth.
In August 2010, Fortune magazine ranked GMCR as the
nation’s second fastest growing company.
Compl. ¶86.
It had
acquired Timothy’s Coffee of the World Inc. in November 2009 and
Diedrich Coffee, Inc. in May 2010, and announced the Van Houtte
deal during the Class Period, 2010 10-K at 11-12, all while
continuing to integrate Keurig, which it had acquired in 2006.
After the Company was notified of the SEC investigation in
September 2010, it disclosed that fact to the market about a
week later and initiated an internal audit.
The audit, verified
by PWC, led to a restatement that was relatively small: the
39
ultimate value of the restatement’s deductions was 6.2 percent
of 2010 39-week revenues and $6.06 MM spread out between 2006
and 2010.
The fact that the restatement was a collection of
several small mistakes, rather than a single, large error, also
minimizes any fraudulent reading.
See 2010 10-K at 4-5.
Moreover, Plaintiffs do not allege the largest error listed in
the restatement, a $7.4 MM overstatement resulting from applying
K-Cup inventory cost standards, id., was itself the product of
fraud.
Finally, after the Company admitted to mistakes, its
stock rebounded and continued its rapid growth.
The benign explanation does not conclusively explain
Stacy’s and McCreary’s stock trades, particularly Stacy’s
September 21 sale.
It also does not account for the 150
truckloads of product deposited at MBlock in CW 1’s account.
On
the balance, though, the Court finds that the optimistic view of
the facts offers a more compelling reading of the events than
the fraudulent one presented by Plaintiffs.
at 324.
Tellabs, 551 U.S.
For that reason, it grants Defendants’ motions to
dismiss the § 10(b) count of the complaint.
Since the Court dismisses the § 10(b) claims, it must also
dismiss the § 20(a) count, as Plaintiffs do not show an
underlying violation of the securities laws.
See Boguslavsky v.
Kaplan, 159 F.3d 715, 720 (2d Cir. 1998) (“In order to establish
a prima facie case of liability under § 20(a), a plaintiff must
40
show: (1) a primary violation by a controlled person; (2)
control of the primary violator by the defendant; and (3) ‘that
the controlling person was in some meaningful sense a culpable
participant’ in the primary violation.” (quoting SEC v. First
Jersey Sec., Inc., 101 F.3d 1450, 1472 (2d Cir. 1996)).
In their brief and at the hearing, Plaintiffs requested any
dismissal be without prejudice so they might amend their
complaint.
Defendants did not object.
As such, the Court
grants Plaintiffs’ request for dismissal without prejudice and
with leave to move to amend the complaint.
Thirty days would be
sufficient time for Plaintiffs to evaluate their allegations in
light of this opinion and determine whether to amend.
Conclusion
For the foregoing reasons, the Court grants Defendants’
motions to dismiss, but does so without prejudice to Plaintiffs
to move to amend their complaint within 30 days.
Dated at Burlington, in the District of Vermont, this 27th
day of January, 2012.
/s/ William K. Sessions III
William K. Sessions III
U.S. District Court Judge
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