Gross v. Summa Four CV-94-364-B 11/08/95 UNITED STATES DISTRICT COURT
FOR THE DISTRICT OF NEW HAMPSHIRE
David Gross
v. Civil No. C-94-364-B
Summa Four, Inc., et al.
MEMORANDUM AND ORDER
This is a securities class action brought by David Gross as
representative of an uncertified class, against Summa Four, Inc.,
and certain of its officers and directors1 ("the Defendants"),
for claims arising under §§ 1 0 (b) and 2 0 (a) of the Securities
Exchange Act of 1934, 15 U.S.C.A. §§ 78j(b) and 78t(a) (West
1981), Securities Exchange Commission Rule 10b-5, 17 C.F.R. §
240.10b-5 (1994), and related common law. Gross alleges, on
behalf of all persons who purchased the common stock of Summa
Four from January 18, 1994 through July 5, 1994 ("the Class
Period"), that the Defendants perpetrated a fraud-on-the-market.
Specifically, he claims the Defendants falsely and recklessly
mislead the investing public through statements and omissions
made during the Class Period which artificially inflated the
market price of the company's common stock. The Defendants moved
to dismiss pursuant to Fed. R. Civ. P. 12(b)(6) and 9(b), after
1 The individual defendants are Barry Gorsun, current president, CEO and Chairman of the Board; James J. Fiedler, president and director from July 1993 through July 1994; John A. Shane, director since 1976; William M. Scranton, director since 1976; and Robert A. Degan, director since 1984. plaintiff filed his first amended complaint. For the following
reasons, I grant Defendants' Motion to Dismiss.
I. FACTUAL BACKGROUND
Because this case is before me on the Defendants' motion to
dismiss, I recite the extensive factual background in the light
most favorable to the plaintiff. Berniger v. Meadow Green-
Wildcat Corp., 945 F.2d 4, 6 (1st Cir. 1991) (court must accept
all facts in complaint as true, drawing all reasonable inferences
in plaintiff's favor).
A. Summa Four
Summa Four is a Delaware corporation with its principle
executive offices located in Manchester, New Hampshire. It
develops, distributes, and services, both domestically and
internationally, switching systems and advanced signaling
solutions for telephone companies. 55 12, 34, 35.2 Sales of its
products are directly to end-users of these systems as well as
through telecommunications systems integrators, including IBM and
Digital Eguipment Corporation. 5 35. The SDS series of
distributed switching systems and the Portico SS-7
2 All paragraph references are to the plaintiffs' First Amended Complaint. internetworking product are its leading products. 5 36.
On September 23, 1990, Summa Four completed its initial
public offering ("IPO") and provided a prospectus in which it
portrayed the company as expanding and "poised for rapid growth."
5 38. The individual defendants sold a portion of their common
shares into the IPO, but retained a substantial guantity of those
shares. 5 39. As provided in a "lock-up" agreement, these
retained shares could not be sold until 180 days after the date
of the IPO prospectus. 5 39.
In late 1993, the company, through its officers as well as
press releases, touted the progress and prospects of the company.
55 40 - 41. Summa Four had regular, extensive, and non-public
contact with various stock market professionals, analysts, and
money managers, including analysts from Montgomery Securities and
Cruttenden & C o . 5 42. At least with respect to the analysts
from Cruttenden & Co., Summa Four conveyed detailed information
regarding its business and operations not available to the
public. 5 42. As a result of these contacts, the analysts
released "extremely positive" reports. Newspapers, including the
Manchester Union Leader, guoted these statements in articles
printed during October 1993. 5 43.
3 On November 15, 1993, Summa Four issued a press release
indicating that it had entered into a world wide cooperative
agreement with IBM, with initial orders over $ 1 million. 5 44.
In December, the company issued another press release announcing
expansion of its European operations and also highlighting the
rapidly growing market share and opportunities of Summa Four.
55 45 - 46.
B. The Class Period
During the Class Period, the Defendants, as well as market
analysts, made numerous positive statements concerning the
company's financial position, market potential, and sales.
55 48 - 60. Contemporaneously, Summa Four was actually
experiencing downward trends evidenced by facts and events not
disclosed to the public. 55 61 - 98. During the Class Period,
on May 27, 1994, Gross purchased 200 shares of Summa Four Common
Stock at $ 27.5625 per share. 5 11.
1. Statements by the Defendants
On the first day of the Class Period, January 18, 1994,
Summa Four issued a press release containing several statements.
55 48 - 50. The press release announced the company's results
for the end of its third fiscal guarter, stating that its
revenues were $ 7,277,000 and its net income was $ 1,852,000. In
4 addition, the president of Summa Four stated: "We are also
seeing increased demand for our SDS distributed switch in a
number of international markets." (emphasis added). He
continued, "[t]he SDS distributed switch is becoming the platform
of choice." (emphasis added). Finally, the release noted that
Summa Four had received orders from Unisys, Sprint, IBM, DEC,
Pacific Bell, US West and AT&T.
The Defendants made several statements in the Spring of
1994. 55 52 - 55. On April 25, 1994, they introduced a new
product, stating that it was a revolutionary product and would
put "carriers in a position to win back [lost] customers by
providing flexible cost-effective access to overlay network
services." Shortly thereafter, the Defendants reported their
fourth guarter, year-end operating results for fiscal 1994,
reporting revenues of $8,344,000 and net income of $1,675,000 for
the guarter, and revenues of $27,257,000 and net income of
$5,287,000 for the year.
In a press release issued the same day, the Defendants
stated: "We see the current market continuing to expand over the
next several years. ... We continue to be enthusiastic about our
opportunities to grow over the next several years." 5 54.
Furthermore, the Defendants stated they had received "significant
5 orders" for "new and existing applications, domestically and
internationally," from AT&T, McCaw, Sprint, GTE, Unisys and IBM.
5 55.
Finally, the Defendants made statements in the 10-k form
submitted to the Securities and Exchange Commission ("SEC") and
in a letter to shareholders accompanying the 1994 Annual Report
issued June 29, 1994. 55 59 - 60. In the 10K form, filed two
weeks before the end of the guarter, the Defendants described the
company in an optimistic light, stating more than once that it
"anticipated growth." Likewise, in its letter to shareholders
the tone was optimistic: "We have a . . . strong financial
position"; "We continue to be enthusiastic about our opportunity
to grow over the next several years"; "Our major goal in Fiscal
Year 1995 is to continue to further leverage our market
leadership position as the telecommunications industry continues
to expand worldwide."
2. Statements by analysts
Montgomery Securities issued three favorable analyst reports
regarding Summa Four, dated January 19, 1994, May 4, 1994, and
May 31, 1994, based in large part on the Defendants' public
statements and private communications between the individual
defendants and analysts at Montgomery. 55 51, 56, 57. The
6 January report included the following statements: "SUMA [sic]
business is very strong"; "We have increased our revenue and EPS
estimates"; "For FY:1995 we have increased our revenue and EPS
forecasts"; "The company is performing well with outstanding
prospects. We are, furthermore, aware of several situations
which could add some upside to our FY:95 forecast."
The May 4th report expressed similar optimism, stating:
"SUMA [sic] business remains strong"; "We have increased our
revenue estimates... and we have also increased our fiscal 1995
revenue estimate"; "The company is performing well, with
outstanding prospects. We are, furthermore, aware of several
situations which could add some upside to our FY:1995 forecast."
Finally, Montgomery issued a report on May 31st stating:
"The Company's intermediate to long-term prospects have never
looked brighter"; "The VCO [product] is an important product and
should result in a greater than doubling of SUMA's [sic]
addressable market to more than $300 million." In addition, the
report cited a deal with AT&T which Montgomery believed had
potential to Summa Four of "perhaps greater than $10 million over
an 18-24 month period."
3. Undisclosed, adverse facts
Plaintiff delineates several facts, relying primarily on
7 internal budgetary reports, which allegedly indicate that the
true state of affairs experienced by Summa Four during the Class
Period belied the positive statements and optimistic predictions
disseminated by the Defendants and analysts. 55 61 - 98.
Specifically, the company was unable to meet internally budgeted
results of operations, the Defendants employed, or authorized,
the use of undisclosed or unauthorized accounting procedures
which created a false and misleading impression of its growth and
prosperity and the company's international operations were "in a
state of disarray and ... had a materially negative effect upon
the Company's results during the Class Period." 5 61.
(a) Summa Four was consistently off-budget during the Class Period
In December 1993, the company made an adjustment for income
tax which "enabled the Company to meet or exceed analysts'
predictions with regard to the Company's operating results."
According to the company's internal reports, dated January 20,
1994, December 1993 revenues were $68,000 below projections,
general and administrative expenses were $11,000 over budget, and
research and development expenses were $37,000 over budget.
Similar results were reported for the guarter ending December 31,
1993. In addition, the report indicated that for the previous nine months the company had experienced "significant cost
overruns," totalling $746,000 over budget.
Both Summa Four's Monthly Operating Report and its Revised
Flash Report for January 1994, indicated that revenue, gross
margin, and net income fell below the forecasted budget. A
similar assessment was made of the company's situation in
February 1994. The company's president acknowledged to the Board
that several major orders were delayed and that he would have to
adjust downward the guarterly bookings forecast. I 70. By March
1, 1994, Summa Four was $2,019,000, or 43.66%, behind budgeted
revenues for the fourth fiscal guarter. Gross margin as well as
research and development expenses were below budget by similar
percentages. The February Flash Report stated that projected
operating profit for the fiscal year ending March 31, 1994, was
$532,000, or 13.51%, under budget. Net income reflected similar
shortfalls. These trends continued through March and April of
1994 .
(b) Improper recognition of revenue during the Class Period
According to GAAP and FASB, a company must wait in most
cases until goods are shipped in order to recognize revenue for
accounting purposes. $[$[ 110 - 111. In conformance with these principles, Summa Four's 10K form for fiscal 1994 states that
"[r]evenue from product sales is recognized generally on
shipment." Nevertheless, plaintiff contends that Summa Four
improperly recognized revenue as soon as orders were received.
As a result, plaintiff contends that Summa Four materially
overstated its revenues during the class period. It supports
this assertion with allegations that minutes for Summa Four's
June 20, 1994, board meeting state that a draft revenue
recognition policy had been prepared for review which "is a more
formalized and somewhat more restrictive policy than was
previously in place." Plaintiff also cites to a statement
allegedly made by defendant Fiedler at a June 19, 1995 board
meeting in which Fiedler claimed that Summa Four might be able to
generate up to $4.7 million in revenues in two weeks from
"orders" which had not yet been received. Since the complaint
alleges that Summa Four does not ship goods until long after
orders are received, plaintiff contends that this statement is
evidence of Summa Four's overstatement of revenues.
(c) International operations in disarray
In its Monthly Operating Report dated January 20, 1994, the
company commented that "overall international sales and marketing
efforts are currently under review and will be revised." In the
10 February 25, 1994 Operating Report, the company stated that it
planned "a major reorganization of sales responsibilities..." in
March. The refocusing of sales and marketing efforts in their
international subsidiary was confirmed in the company's March
Operating Report. In addition, Summa Four fired its Managing
Director of European Operations that month as well as two other
management team members. The company appointed a new managing
director that same month.
In addition, there were indications of slowdowns with
respect to certain international customers as of January 1994.
In June 1994, the Board dispatched one individual "to check one
more time to see if all international opportunities are abandoned
at this time."
4. The July 5, 1994 Announcement
As of the June 6, 1994 "Watch Meeting," Summa Four had only
shipped $4,298,720 in products, although the guarter was two
thirds complete and the predicted revenues were $8.7 million by
analysts and $9,025 million by the company for that guarter. The
company revised its expectations for the guarter setting an
additional $3.6 million in shipments as its goal for the
remainder of the guarter.
11 On June 14, 1994, the Board convened by phone to address the
issue again. It was determined at this point in the quarter that
revenues would reach only $7.7 to 7.8 million which fell 11.49%
and 14.68% behind analysts and company estimates respectively.
The below budget prospects were attributed to internal
disruptions experienced by regular customers as well as
international orders being received at a slower rate than
expected.
The Board determined that any insider trading at this point
would be inappropriate and further discussed this issue at a
meeting on June 20, 1994. At that meeting the Board also
discussed the prospect of making an announcement concerning
financial performance and guidelines for such announcements. No
decision was reached at that meeting, but further review was
undertaken in the subsequent weeks.
In its July 5th announcement the Defendants stated that they
anticipated net revenues for the first fiscal quarter 1995 of
between $7,400,000 to $7,600,000, and net earnings of $875,000 to
$1,000,000. These projected results contrasted with analysts'
projections which placed revenue estimates at $8.7 million for
that quarter.
12 Following the announcement, the company's stock experienced
a rapid sell-off resulting in a single-day decline of 46.6% in
Summa Four's market price.
C. The Aftermath
The company reported its earning for the first guarter 1995
on July 19, 1994, which confirmed its announcement made earlier
that month. Summa Four replaced its president that month and
attributed its failure to attain projections for that guarter on
"longer than anticipated negotiation and procurement processes"
of certain major customers. This assessment was echoed by
analysts' reports later that month which also contained revised
estimates of the company's future prospects. These revisions,
even taking into account the delays, showed a 23.91% decrease in
estimated projected earnings per share from previous estimates.
Estimates of revenue generating EPS were also adjusted downward
representing an 8.97% and a 13.79% decrease in revenues and
earnings per share respectively.
According to Montgomery Securities, two of the six contracts
needed to be closed in order for Summa Four to meet the original
projections for that guarter. In contrast, Summa Four closed
only one of the six contracts.
13 Summa Four also attributed its poor first quarter of 1995 to
decreased unit shipments of its SDS-1000 product in its Form 10-Q
filed with the SEC on August 11, 1994. This statement is in
contrast to its statements in December 1993 and March 1994
attributing increased revenues to the sale of its SDS products.
II. STANDARDS OF REVIEW AND ELEMENTS OF THE CLAIM
Defendants argue that the complaint should be dismissed
pursuant to Rule 12(b)(6) because it fails to state a claim and
pursuant to Rule 9 because it fails to plead fraud with
particularity.
A motion to dismiss pursuant to Federal Rule of Civil
Procedure 12(b)(6) requires the court to review the allegations
of the complaint in the light most favorable to the plaintiff,
accepting all material allegations as true, with dismissal
granted only if no set of facts entitles plaintiff to relief.
E.g., Berniger, 945 F.2d at 6; Dartmouth Review v. Dartmouth
College, 889 F.2d 13, 16 (1st Cir. 1989) .
In the context of a motion to dismiss a claim of fraud or
misrepresentation, however, the claim must also meet the special
pleading requirements of Fed. R. Civ. P. 9(b). Romani v.
14 Shearson Lehman Hutton, 929 F.2d 875, 878 (1st Cir. 1991); Havduk
v. Lanna, 775 F.2d 441, 443 (1st Cir. 1985) . Rule 9(b) provides:
"In all averments of fraud or mistake, the circumstances
constituting fraud or mistake shall be stated with particularity.
Malice, intent, knowledge, and other conditions of mind of a
person may be averred generally." Fed. R. Civ. P. 9(b). While
the term "fraud" need not appear in the complaint. Rule 9
reguires that the circumstances indicating fraud be stated with
particularity. Simcox v. San Juan Shipyard, Inc., 754 F.2d 430,
439 (1st Cir. 1985) (although plaintiffs did not use word fraud,
complaint stated with sufficient particularity circumstances
entitling them to relief on a theory of fraud).
The purpose of Rule 9(b)'s particularity reguirement is "to
apprise the defendant of fraudulent claims and of the acts that
form the basis for the claim [sic]." Havduk, 775 F.2d at 443
(emphasis added). Specifically in the context of securities
fraud cases, "Rule 9 operates to diminish the possibility that a
plaintiff with a largely groundless claim [will be able] to
simply take up the time of a number of other people [by extensive
discovery], ... [without] a reasonably founded hope that the
process will reveal relevant evidence." Wavne Inv., Inc. v. Gulf
Oil Corp., 739 F.2d 11, 13 (1st Cir. 1984) (internal guotations
15 and citations omitted). In order for this purpose to be
adequately fulfilled, the rule requires "specification of the
time, place, and content of an alleqed false representation."
McGintv v. Beranqer Volkswagen, Inc., 633 F.2d 226, 228 (1st Cir.
1980); accord Serabian v. Amoskeaq Bank Shares, Inc., 24 F.3d
357, 361 (1st Cir. 1994) (qeneral averments of defendant's
knowledqe of material falsity insufficient); Havduk, 775 F.2d at
444 (conclusory alleqations of fraud insufficient even if
repeated several times). Further, the complaint must "set forth
specific facts that make it reasonable to believe that defendants
knew that a statement was materially false or misleadinq" when
made. Lucia v. Prospect St. High Income Portfolio, Inc., 3 6 F.3d
170, 174 (1st Cir. 1994) (quotinq Serabian, 24 F.3d at 361);
accord Romani, 929 F.2d at 878 (time, place, and content
specificity insufficient where no factual support for inference
of fraud). This requirement is not relaxed even thouqh the bases
and specific supportinq facts relate "'to matters peculiarly
within the knowledqe of the opposinq party.1" Havduk, 775 F.2d
at 444 (quotinq Wavne, 739 F.2d at 14); see also Romani, 929 F.2d
at 878. Alleqations of fraud by hindsiqht are insufficient to
meet these requirements. Serabian, 24 F.3d at 367 (claim cannot
assume defendants knew severity of problems earlier because
16 conditions became bad later); accord Berliner v. Lotus Dev.
Corp., 783 F. Supp. 708, 710, 711 (D. Mass. 1992).
B. Elements of Claim under 10(b)
Section 1 0 (b) of the Securities Exchange Act, and Rule 10b-5
promulgated thereunder, prohibit any person from, directly or
indirectly, committing fraud in connection with the purchase or
sale of securities. 15 U.S.C.A. § 78j(b);3 17 C.F.R. § 240.10b.5
(1994);4 Rand v. Cullinet Software, Inc., 847 F. Supp. 200, 204
(D. Mass. 1994). "In order to prevail on a rule 10b-5 claim, a
plaintiff must show: (1) a material misstatement or omission by
3 Section 10(b) of the Act states in pertinent part: "It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce or of the mails, or of any facility of any national securities exchange ... (b) To use or employ, in connection with the purchase or sale of any security registered on a national securities exchange ..., any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the Commission may prescribe...." 15 U.S.C.A. § 78kj(b).
4 Rule 10b-5 states in pertinent part: "It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce, or of the mails or of any facility of any national securities exchange ... (b) To make any untrue statement of a material fact or to omitto state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading ... in connection with the purchase or sale of any security." 17 C.F.R. § 240.10b.5.
17 the defendant; (2) scienter;5 (3) reliance;6 and (4) due care by
the plaintiff." Rand, 847 F. Supp. at 204 - 05 (citing Blue Chip
Stamps v. Manor Drug Stores, 421 U.S. 723, 730 (1975)).
" [M]ateriality depends on the significance the reasonable
investor would place on the withheld or misrepresented
information." Basic, 485 U.S. at 240; accord Rand, 847 F. Supp.
at 205; Colby, 817 F. Supp. at 209. If a reasonable investor
would view the misrepresented or omitted fact as "having
significantly altered the total mix of information made
available," then the materiality reguirement is satisfied.
Basic, 485 U.S. at 232 (internal guotations and citations
omitted). Therefore, in pleading a claim under Rule 10b-5 in
conformity with the reguirements of Rule 9 (b), the complaint must
5 The scienter element is "...satisfied if plaintiffs 'prove an intent to deceive, manipulate, or defraud.'" Rand, 847 F. Supp. at 205. In this circuit, "recklessness amounting to indifference is an acceptable substitute." Id. (citing Hoffman v. Easterbrook & Co., 587 F.2d 509, 516 (1st Cir. 1978)). Under Rule 9(b), a plaintiff's complaint must support an inference that the defendant's knew, or should have known, that the statements were false or misleading. Romani, 929 F.2d at 878.
6 Reliance is presumed in a fraud on the market case. Colby v. Holoqic, Inc., 817 F. Supp. 204, 209 n.7 (D. Mass. 1993) (citing Basic Inc. v. Levinson, 485 U.S. 224, 246 - 47 (1988)); accord In re Apple Computer Sec. Litiq., 886 F.2d 1109, 1113 - 14 (9th Cir. 1989), cert. denied, 496 U.S. 943 (1990).
18 "(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." Shields v. Citvtrust Bancorp., Inc., 25 F.3d 1124,
1128 (2d Cir. 1994) (emphasis added) (internal quotations and
citations omitted); accord Suna v. Bally Corp., No. 94-273-M,
slip op. at 8 (D.N.H. Nov. 10, 1994) . With these principles in
mind, I address the sufficiency of the plaintiff's complaint.
III. THE COMPLAINT
The challenged statements at issue fall into three
categories: (1) allegedly false statements of current facts; (2)
allegedly false forward-looking statements; and (3) current or
forward-looking statements that were literally true, but
misleading because the speaker withheld other material
information on the same subject.7 I address each category in
7 Plaintiffs allege that not only were many statements misleading when made because of the omission of material facts necessary to make the statement complete, but that the Defendants had a duty to correct statements that became misleading only after the statements were made. 5 122. The First Circuit has definitively held that no duty to correct exists if the statements were true and not misleading when made. Backman, 910 F.2d at 17. Because I conclude plaintiff failed to adequately show that the statements at issue were false or misleading when
19 turn.
A. Statements of Current Fact
"[D]efendants may not be held liable under the securities
laws for accurate reports of past successes, even if present
circumstances are less rosy." Serabian, 24 F.3d at 361. "[I]f
defendants reported correctly, without more, 'This is our eighth
consecutive quarter in which our gross has increased,' there [is]
no duty to add, for the benefit of market buyers, 'We are
concerned about the next one.'" Capri Optics Profit Sharing v.
Digital Equip. Corp., 950 F.2d 5, 8 (1st Cir. 1991). If the
plaintiff alleges the statements were false when made, then the
complaint must contain facts which would support a reasonable
inference that the defendants deliberately or recklessly
disregarded known adverse facts at the time they made the
statements. Steiner v. Unitrode Corp., 834 F. Supp. 40, 43 (D.
they were made, I dismiss this portion of the complaint. See Fed. R. Civ. P. 12 (b) (6) . The complaint is also based in part on statements by analysts. There is no duty to correct statements by third parties unless the defendant has significantly entangled itself with the third party's production of the statement. Elkind v. Liggett & Myers, Inc., 635 F.2d 156, 163 - 64 (2d Cir. 1980). As discussed below, the plaintiff failed to plead with sufficient specificity any entanglement between the defendants and Montgomery Securities. Thus, this portion of the complaint is also dismissed. See Fed. R. Civ. P. 9(b).
20 Mass. 1993); Berliner, 783 F. Supp. at 710, 711 (plaintiff's
claim amounted to fraud by hindsight because disclosure seven
months after alleged misrepresentation not sufficient to show
defendant's knew it was false when made). Absent a showing that
the statements were false or misleading at the time they were
made, such statements are not actionable under Rule 10b-5.
For the following reasons I find that the plaintiff's
allegations that defendants fraudulently misstated current fact
cannot meet the particularity reguirement of Rule 9. Therefore,
I dismiss this portion of the complaint.
1. Statements of current fact other than revenue statements
Plaintiff claims that certain statements in the January 18th
press release ("we are also seeing increased demand for our SDS
distributed switch . . . . [T]he SDS distributed switch is
becoming the platform of choice . . .. "), the May 3rd press
release (Summa Four had received "significant orders" from AT&T,
Sprint, GTE, Unysis, and IBM), and a letter accompanying the 1994
Annual Report (Summa Four is in a "strong financial position")
misstated current facts. 55 49-50, 55, 60. Defendants argue
that plaintiff has failed to satisfy his Rule 9 (b) burden of
pleading with particularity the facts which form the basis of his
21 claim that these statements were false when they were made.
The only pleaded facts that even arguably support
plaintiff's contention that the cited statements were false when
made are allegations in the complaint that Summa Four's own
documents establish that (1) the company's revenues, gross
margin, and net income during the Class Period were below
internal budget projections; (2) March bookings were lower than
expected; and (3) the company's internal operations were in a
state of disarray. 55 69-72, 74, 92-98, 121(b). However, these
allegations are insufficient to satisfy plaintiff's burden under
Rule 9 (b) to identify specific facts that make it reasonable to
believe that the statements were false. A reasonable person
could not infer from the pleaded facts that demand for the SDS
switch was no longer growing, that significant orders had not
been received from major corporations, or that the company was
not in a "strong financial position" simply because it did not
meet its short-term budget projections, its orders for one month
were lower than expected, and its international operations were
in a state of disarray. Accordingly, this portion of the
complaint must be dismissed.
22 2. Current Revenue Statements
Plaintiff alleges that defendants materially overstated
Summa Four's revenues. Specifically, he contends that Summa Four
stated in its public filings that it complied with GAAP and FASB
but nevertheless violated these standards by recognizing revenue
as soon as an order was placed rather than when goods were
shipped. As a result, plaintiff claims that Summa Four's revenue
statements were false and misleading.
The First Circuit recognizes that "a general allegation
that the practices at issue resulted in a false report of company
earning is not a sufficiently particular claim of
misrepresentation to satisfy the reguirements of Rule 9 (b).
Serabian, 24 F.3d at 362 n.5. Plaintiff seeks to satisfy this
reguirement by pointing to the minutes of the June 20, 1994 board
meeting (noting that the board's review of a draft revenue
recognition policy which was more conservative than the policy
then in effect) and the June 14, 1994 board meeting (noting
Fiedler's statement that Summa Four might be able to generate up
to $4.7 million in revenue in two weeks from "orders" which had
not yet been received). However, these records, simply will not
support a reasonable inference that Summa Four was materially
overstating its revenues during the period in guestion. Thus,
23 this portion of the complaint must be dismissed as well.
B. Forward-looking Statements
1. Analyst statements
Plaintiff seeks to attribute to the defendants three
statements by Montgomery Securities during the Class Period,
claiming that these statements regarding anticipated growth and
increasing revenues, were false and misleading, and lacking in a
reasonable basis. 5 121(a). Further, he alleges that the
defendants failed to correct these statements during the Class
Period when the statements were or became materially false and
misleading. 5 122. This part of the complaint is attacked by
the Defendants on grounds that it lacks the reguisite specificity
necessary to justify the inference that the Defendants so
entangled themselves that the statements may be treated as their
own.
In order to base a claim of fraud on statements by third
parties, the plaintiff must demonstrate that those statements may
be fairly attributed to the defendants. Raab v. General Physics
Corp., 4 F.3d 286, 288 - 89 (4th Cir. 1993). Where defendants
have so entangled themselves "with the analysts' forecasts such
that they assumed a duty to disclose the analysts' errors," the
statements by analysts may be attributed to the defendant.
24 Colbv, 817 F. Supp. at 210. "[S]ince the allegation of
entanglement is central to the overall allegation of securities
fraud, plaintiffs seeking to hold a corporate insider liable for
an analyst's forecasts should plead entanglement with the degree
of specificity reguired under [Rule 9]." In re Caere Corporate
Sec. Litiq., 837 F. Supp. 1054, 1059 (N.D. Cal. 1993) (limning
three reguirements to meet this hurdle). Rule 9 (b) imposes the
burden on the plaintiffs in this context to allege facts from
which it can be inferred that company exercised sufficient
control over an analyst such that company may be held liable for
the analyst's statements. Raab, 4 F.3d at 288 - 89; Elkind, 635
F.2d at 163 (where company so involves itself in preparation or
reports and projections of analysts it may have duty to correct
material errors); In re Caere, 837 F. Supp. at 1059 (advocating
strict construction of entanglement reguirement because analysts
make forecasts about publicly traded companies freguently).
Where company officers are directly guoted, other courts
have sustained such allegations against Rule 9 challenges.
Colbv, 817 F. Supp. at 215 n.10 (collecting cases). The analysts
cited by the plaintiff here, however, do not directly guote the
defendants or make reference to information provided by the
defendants. See id. at 213 (analysts' statements not
25 attributable to company where no direct quoting and no reference
to misleading information provided by company). All three
reports "were presented as independent opinions and [none]
referred to any role of [Summa Four] or its officers in the
preparation, approval, or editing of the" reports. Id. at 213 -
14; accord Raab, 4 F.3d at 288 (failed to meet Rule 9 specificity
requirement where no allegations of who supplied information, how
it was supplied or how company controlled contents, especially
where report did not directly quote company). The amended
complaint only states that some defendants had private
communications with representatives from Montgomery Securities
and Cruttenden & Company. It does not allege facts which would
support a reasonable inference that the statements in question
were based on false or misleading information obtained directly
from the defendants. While it is unclear whether this circuit
would require that the reports quote the defendants in order to
impute the former to the latter, because there is no other basis
alleged which would establish any, let alone a significant,
connection between the defendants and the analysts, I find that
the analyst's statements fail to meet the Rule 9(b) requirement.
Therefore, claims based on these statements should also be
dismissed.
26 2. Defendants' Statements
Plaintiff cites several statements which he characterizes as
forward-looking statements that are actionable under Rule 10b-5
because they lacked a reasonable basis when made. These
statements are found in the May 3rd press release ("We see the
current market continuing to expand over the next several
years. ... We continue to be enthusiastic about our
opportunity to grow over the next several years"), Summa Four's
10K Form filed with the SEC ("anticipated growth"), and its
letter to shareholders accompanying its Annual Report ("We
continue to be enthusiastic about our opportunity to grow"; "Our
major goal in Fiscal Year 1995 is to continue to further leverage
our market leadership position"). 5 54, 59 and 60.
"Although 'predictions are inherently uncertain, they are
not exempt from the anti-fraud provisions of the federal
securities laws . . . materially misleading predictions made with
the scienter are actionable.'" Rand, 847 F. Supp. at 207
(citations omitted); accord In re Apple Computer, 886 F.2d at
1113. Because predictions imply a factual basis, they come
within the purview of Rule 10b-5's prohibitions. See Virginia
Bankshares v. Sandberg, 111 S. C t . 2749, 2758 (1991) (statements
of belief or opinion are factual statements actionable under
27 securities laws); In re Apple Computer, 886 F.2d at 1113 (listing
three factual assertions implied in predictions). Therefore, if
a reasonable investor would rely on the predictive statement in
making a decision to buy or sell securities, then the prediction,
if false or misleading, is actionable. See Basic, 485 U.S. at
248. Statements, however, that are general, vague, or lack
specificity, or are not guarantees, even if made without a
reasonable basis, are not actionable because a reasonable
investor would not rely on them. Capri Optics, 950 F.2d at 10;
Rand, 847 F. Supp. at 208; Colby, 817 F. Supp. at 210 - 11
("prospects for long term growth" not actionable because no
projection of earnings or sales statistics and no temporal
reference point); Elkind, 635 F.2d at 164 ("we expect another
good year in 1972," not actionable). Furthermore, absent a
showing of intentional deception, "optimistic predictions about
the future that prove to be off the mark likewise are
immunized...." Serabian, 24 F.3d at 361; accord Greenstone v.
Cambex Corp., 975 F.2d 22, 25 (1st Cir. 1992); Shapiro v. UJB
Fin. Corp., 964 F.2d 272, 282 (3d Cir.), cert. denied, 113 S. C t .
365 (1992); Dileo v. Ernst & Young, 901 F.2d 624, 627 (7th Cir.),
cert. denied, 498 U.S. 941 (1990).
28 The statements cited by the plaintiff although predictive,
lack any specificity as to projected earnings, lack any time
frame, and lack any guarantees. Compare Colby, 817 F. Supp. at
210, 211 (statement that "prospects for long term growth are
bright" not actionable because vague and no specific projections)
with Cosmas v. Hassett, 886 F.2d 8, 12 (2d Cir. 1989) (statement
predicting EPS of $.90 to 1.15 for next fiscal year actionable).
No reasonable investor would rely on such vague expressions of
optimism in deciding whether to purchase Summa Four's securities.
Nor could such statements be considered so significant as to
alter the total mix of information available to the reasonable
investor. Colby, 817 F. Supp. at 211. Thus, these statements
fail to meet the materiality reguirement necessary to state a
claim under Rule 10b-5. Therefore, this portion of the complaint
is dismissed. See Fed. R. Civ. P. 12 (b) (6) .
C. Omissions
Finally, plaintiff asserts that many of the statements
cited, while technically true, were in fact misleading because of
defendants' failure to disclose the whole truth. The challenged
statements include portions of the January 18th press release
(I 50), the May 3d press release (I 55), and the April 25th
announcement of their new product (I 52). Plaintiff points to
29 several omitted facts that he claims should have been disclosed
in order to cure the misleading nature of the public statements,
including: numerous reports during the Class Period indicating
that Summa Four was not meeting budget targets; a June 6, 1994
report indicating that two-thirds through the first guarter of
1994 Summa Four had only shipped 50% of what analysts had
predicted and even less than its own predictions 5 84; a June
14th report indicating that revenue would only be $7.7 million,
approximately 30% below projections (I 87); and an acknowledgment
on June 14th that lower revenues were due to delays in the
approval of contracts (I 88).
Where the plaintiff alleges that a defendant's silence
precipitated the fraud, the complaint must allege that the
omitted facts were not only material, but also that the defendant
had a duty to disclose those facts. Basic, 485 U.S. at 239 n. 16;
Dirks v. SEC, 463 U.S. 646, 657-58 (1983); Backman, 910 F.2d at
12. Nondisclosure in the context of fraud on the market deals
with reliance by investors on misleading statements, i.e.,
misleading because prior disclosures were inaccurate or
incomplete. Backman, 910 F.2d at 13; Boeder v. Alpha Indus.,
Inc., 814 F.2d 22, 26 (1st Cir. 1987) . Thus, where "a
corporation does make a disclosure - whether it be voluntary or
30 required - there is a duty to make it complete and accurate."
Lucia, 36 F.3d at 175. (internal quotations and citations
omitted).
There is no duty, however, that companies make full
disclosure of all material information. Backman, 910 F.2d at 12,
16 (duty to disclose does not arise from mere possession of
nonpublic information nor from disclosure of one fact about a
product) (quotinq Chiarella v. United States, 445 U.S. 222, 235
(1980)). "Manaqement cannot be expected to disclose information
that some may find distasteful but that does not alter the total
mix of information made available to the investor." Boeder, 814
F.2d at 26 (internal quotations and citations omitted); accord
Colbv, 817 F. Supp. at 213 (duty to disclose does not arise
merely because investors may be interested in the information).
Althouqh the "adverse" facts cited by the plaintiff present
a picture of a company concerned about its ability to meet its
own projections, nothinq in these facts indicates that the
challenqed statements were misleadinq for failure to include
these facts. See Backman, 910 F.2d at 16 (disclosed facts cannot
be so incomplete as to mislead). Althouqh the omitted facts
miqht have been important to the reasonable investor, absent a
sufficient showinq that the disclosed information was so
31 incomplete as to be misleading, defendants were under no duty to
disclose this information. Absent something more, this portion
of the complaint amounts to nothing more than "fraud by
hindsight," not actionable under the securities laws. Thus, this
portion of the complaint is dismissed. See Fed. R. Civ. P. 9(b).
IV. LEAVE TO AMEND
At oral argument. Plaintiff reguested that in the event that
I dismissed his complaint, or portions of it, he be granted leave
to amend. Ordinarily leave to amend should be grated liberally.
In this case, however. Plaintiff has had the benefit of
Defendants' first motion to dismiss as well as limited discovery
to prepare the present complaint. Thus, he had "ample
opportunity to allege any facts . . . from which liability may
flow." Tapogna v. Egan, 141 F.R.D. 370, 373 (D. Mass. 1992). In
light of these circumstances, I deny Plaintiff's reguest for
leave to amend.
V. OTHER ISSUES
Because Count I of the complaint is dismissed with
prejudice, the Plaintiff cannot assert a claim under 15 U.S.C.A.
§ 78t(a) (West 1981). Therefore, that claim is also dismissed
32 with prejudice. Finally, I decline to exercise supplemental
jurisdiction over the pendent state law claims. See 28 U.S.C.A.
§ 1367(c)(3) (West 1993) Therefore, these claims are dismissed
without prejudice.
VI. CONCLUSION
For the foregoing reasons I grant Defendants' Motion to
Dismiss (document no. 17) .
SO ORDERED.
Paul Barbadoro United States District Judge
November 8, 1995
cc: Peter J. MacDonald Edward L. Hahn Jules Brody Lee Shalov Joseph H. Weiss