Appeal from a judgment of the United States District Court for the Western District of New York, Michael A. Telesca, Judge, see 580 F. Supp. 1373 (1984), dismissing, pursuant to Fed. R. Civ. P. 12(b) (6) and 9(b), plaintiff's amended complaint alleging violations of § 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b), and Rule 10b-5, 17 C.F.R. § 240.10b-5, and awarding costs and attorney's fees of $2,500.00 to defendant John R. Sykes pursuant to Fed. R. Civ. P. 11. Vacated and remanded.
Before: FEINBERG, Chief Judge, and MANSFIELD and KEARSE, Circuit Judges.
Plaintiff Steven Goldman appeals from a judgment of the United States District Court for the Western District of New York, Michael A. Telesca, Judge, dismissing his amended complaint charging defendants Sykes Datatronics, Inc. ("Sykes" or the "Company"), and three of its officials with having made material misrepresentations and omissions, in violation of § 10(b) of the Securities Exchange Act of 1934 ("1934 Act"), 15 U.S.C. § 78j(b) (1982), and Rule 10b-5, 17 C.F.R. § 240.10b-5 (1984), promulgated thereunder. In an opinion reported at 580 F. Supp. 1373 (1984), the court dismissed the amended complaint pursuant to Fed. R. Civ. P. 12(b)(6) and 9(b) on the grounds that it failed to state a claim under the 1934 Act or Rule 10b-5 and failed to state a claim under the 1934 Act or Rule 10b-5 and failed to plead scienter adequately. Pursuant to Fed. R. Civ. P. 11, the court awarded costs and attorney's fees of $2,500.00 to defendant John R. Sykes on the ground that plaintiff's allegations against John Sykes lacked a sufficient factual and legal foundation. For the reasons below we conclude that the amended complaint adequately stated a claim against all defendants-appellees under § 10(b) and Rule 10b-5. We therefore vacate both the dismissal and the imposition of sanctions, and we remand the case for further proceedings.
The amended complaint (hereafter referred to as the "Complaint"),*fn1 filed as a class action on behalf of Goldman and all others who purchased common stock of Sykes during the period May 7, 1982, through August 30, 1982 ("class period"), asserted, in essence, that Sykes and certain of its officials had, during the class period, disseminated very positive forecasts about its operations which were materially misleading to the investing public. In addition to Sykes, the Complaint named as defendants Robert F. Sykes, Sykes's Chairman and Chief Executive Officer; G.C. Belden, Jr., its President and Chief Operating Officer and a director; and John Sykes, a vice president and director. The Complaint included the following allegations.
Sykes, a company that designed, manufactured, and marketed microcomputer systems used in information processing and telecommunications, purveyed two principal lines of products. The "Comm-Stor" line, which enabled businesses to record information relating to out-going telephone calls, was introduced successfully in 1978, following which Sykes's sales and earnings per share effectively doubled in each of its fiscal years until 1982. The other product line, called "InnVoice," was introduced in 1982. InnVoice was designed to aid hotels in recording their guests' long-distance calls. Sykes expected to market this product through AT&T, as it had marketed its previous products. The Complaint asserted that a number of material misstatements and omissions were made by defendants in a series of documents disseminated by the Company during the class period.
The Complaint alleged, inter alia, that a May 7, 1982 letter to shareholders within the Sykes 1982 Annual Report for the fiscal year ending February 28, 1982 ("Shareholder Letter") attributed a disappointing first quarter of fiscal 1983 to regulatory delays relating to tariffs filed by AT&T; stated that the Company expected to begin shipping InnVoice in volume during the second quarter of fiscal 1983 (Complaint P32(b)); and stated that Sykes expected 1983 to be a year of strong growth in sales and earnings (id. P32(a)). At the 1982 annual meeting, held on June 16, 1982, Robert Sykes stated, inter alia, that although Sykes had some competition with respect to InnVoice, the Company expected to be the dominant supplier in the market. (Id. P34(c).) He stated that the Company was "geared up to do a lot more business than [it did] last year. And we are going to be doing it." (Id. P34(d).) In estimating the amount of growth expected for the Company, he stated that the Company wanted "orderly growth," avoiding ups and downs, and was aiming for "40 or 50% [growth], or better," which industry analysts and observers considered a good rate of growth. (Id.) The Complaint alleged that at the annual meeting Belden stated that the breakup of AT&T would "create increasing opportunities" for Sykes and be favorable to Sykes, and that however AT&T was split, the resulting Bell companies would continue to be major customers of Sykes. (Id. PP34 (a), 44(a).) The remarks of Robert Sykes and Belden at the annual meeting were transcribed by Sykes ("Meeting Transcript") and distributed to its shareholders and to the investing public. (Id. P.34.)
Sykes's report for the first quarter of fiscal 1983, signed by Belden and Robert Sykes and disseminated on or about June 28, 1982, did nothing to make less positive the predictions made in the Shareholder Letter and the Meeting Transcript. It reiterated that the outlook was for good growth in the remainder of fiscal 1983. (Id. P35.)
The Complaint alleged that the defendants' positive predictions for the Company's good fortunes in the marketing of InnVoice were made falsely or with reckless disregard for the truth because the defendants knew or should have known, inter alia, (1) that InnVoice was to be marketed at a competitive disadvantage because (a) AT&T could not sell the equipment but was required to lease it, (b) AT&T was required to lease it at published tariff rates rather than at negotiated rates, and (c) the cost of a two-year lease would be no less than the price to purchase a competing system, thereby leading most customers to choose a competing system rather than InnVoice (id. PP29(b) and (c)); (2) that many hotels already had in place front desk computer equipment for recording other charges and that InnVoice was not compatible with that equipment, although some competing products were (id. P29(e)); (3) that InnVoice, unlike other systems, could not calculate charges for international telephone calls, and this would limit InnVoice's acceptance in gateway cities such as New York, San Francisco, Los Angeles, and Miami (id. P29(f)); and (4) that any upgrading of InnVoice, even if there were no additional charge to customers, would be far slower than any upgrading by private competitors because of the requirement that AT&T obtain new tariff approvals for any new features (id. P29(d)). The Complaint also alleged that Sykes had no reasonable basis for its projects of InnVoice sales because (1) unlike other Sykes products, InnVoice was not to be sold to AT&T for its internal own use; hence past experience could not be an adequate guide; and (2) Sykes had made no independent survey of the needs of hotel and motel owners. (Id. P44(d)(ii).) The Complaint also repeatedly asserted that it was not realistically possible for defendants to have predicted success with InnVoice because the effect of the dismantling of AT&T was gravely uncertain. (Id. passim.)
Goldman alleged that he and others, relying on the representations of the defendants, purchased Sykes common stock at prices that were artificially inflated by those recklessly favorable statements. (Id. P48.) Goldman purchased 1,000 shares of the stock on August 26, 1982, at a price of $15.50 per share. (Id. P5.) The Complaint alleged that during the period that the class members were buying Sykes common stock, John Sykes and Robert Sykes, who were in possession of information revealing that the optimistic projects were unfounded, sold, respectively, 40,000 and 29,000 shares of Sykes common stock at those artificially high prices; in addition, Belden sold 400 shares during the class period and had sole 10,000 shares shortly prior to that period. (Id. PP 36, 47.)
On August 30, 1982, the Company issued a press release stating that the expected growth in sales of its recently introduced products had not materialized; that sales for the quarter ending August 31, 1982 would be even lower than those of the first quarter (which it had characterized as sluggish but improving); and that sales for the year 1983 would be approximately $50,000,000 some $13-18,000,000 lower than the volume of annual sales projected some two months earlier (an increase over 1982 of 10% rather than the targeted 40 or 50% or better). (See id. PP 33, 34(d), 37.) The August 30 announcement caused the market price of Sykes common stock to drop precipitously, from $13.00 per share to $7.50 per share in one day. (Id. P38.) Sykes's second-quarter report to shareholders attributed the low sales and earnings to the low rate of sales to the Bell Companies. (Id. P39.)
Defendants moved (1) pursuant to Rule 12(b)(6) for the dismissal of the Complaint for failure to state a claim on which relief may be granted, (2) pursuant to Rule 9(b) for failure to plead with particularity the circumstances constituting the claims of fraud, and (3) pursuant to Rule 11 for an award of costs, including attorney's fees, on the ground that plaintiff had no sound factual basis for the allegations of the Complaint. Defendants' motions relied on "all papers and memoranda theretofore submitted" in the action. The district court granted the motions to dismiss and granted the motion for sanctions with respect to John Sykes.
The court granted defendants' Rule 12(b)(6) motion in part on the basis of statements found in the Sykes annual report and other Sykes corporate documents, ruling that
because copies of all of these documents are presently before the Court, having been submitted on defendants' original motion, and because their authenticity and accuracy have not been questioned, they may properly be considered on this motion in determining whether the amended complaint fairly states a claim under Rule 10b-5. Cf. Decker v. Massey- Ferguson, Ltd., 681 F.2d 111, 113 (2nd Cir. 1982); Denton Construction Co. v. Missouri Portland Cement Co., 507 F. Supp. 53, 54 (E.D. Mo. 1981).
580 F. Supp. at 1378. After reviewing the substantive requirements of § 10(b) of the 1934 Act and Rule 10b-5,*fn2 the court concluded that the Complaint did not adequately plead fraud or scienter.
Taking the view that it was entitled to "assume that the amended complaint now before the Court is a model of clarity and precision and that plaintiff has now set forth all of the factual allegations he can muster in support of his claim," 580 F. Supp. at 1378, the court concluded that the Complaint did not meet the requirements of Rule 12(b)(6) because the omissions and misrepresentations attributed to the defendants amounted to no more than faulty prognostication. It found principally (1) that "to the extent that plaintiff alleges that some of these problems were inherent in marketing products with AT&T, it is far from clear whether they were in fact problems," 580 F. Supp. at 1378-80 (footnote omitted); (2) that even if the Complaint were read as asserting that the alleged "'problems' should have been disseminated to the public, the amended complaint does not state a claim that defendants failed to do so," id. at 1380 (footnote omitted); (3) that the Sykes annual report and first quarter report were "replete with references to the amount of business previously conducted with AT&T and the tariffs" AT&T was required to file in order to sell the Company's products, and thus Sykes's dependence on AT&T and the peculiarities involved in marketing through AT&T were disclosed, id. at 1379; (4) that if plaintiff sought to "indict defendants for failing to correctly forecast the outcome of the AT&T anti-trust settlement, the allegations are spurious," id.; (5) that the Complaint "attack[ed] the corporate directors for their failure to perceive problems with the AT&T breakup and with their INNVOICE product itself," id. 1380; and (6) that the estimate given of 40-50% growth for the for the fiscal year 1983 "must be viewed in the context of Sykes' past earnings history," and that in light of the Company's past annual doubling of its sales and earnings, the 40-50% estimate could actually be viewed as a pessimistic forecast, id. at 1379.
The court concluded that the Complaint thus did not state a claim under the securities laws and that "defendants' statements and alleged omissions, when viewed in this light, do not provide the requisite 'probable cause' necessary for the issuance of a 'judicial search warrant' into Sykes' corporate management." 580 F. Supp. at 1380 (quoting ...