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KLEIN v. GOETZMANN

August 27, 1990

ALBERT M. KLEIN, BLANCHE TAVE AND DANIEL SLANE, PLAINTIFFS,
v.
HARRY E. GOETZMANN, JR., JOHN L. BARTOLO, LYNN H. SMITH, HENRY A. PANASCI, JR., CHRIS J. WITTING, ALVIN O. BEILING, ROBERT C. HAYMAN, THOMAS J. PRINZING AND JAMES J. MOSHER, DEFENDANTS.



The opinion of the court was delivered by: McCURN, Chief Judge.

MEMORANDUM-DECISION AND ORDER

Introduction

Plaintiffs, shareholders in Continental Information Systems, Inc., have brought suit against certain of the corporation's officers and directors alleging that the defendants made material misrepresentations and omissions in information provided to the investing public, in violation of Sections 10(b) and 20(a) of the Securities and Exchange Act of 1934, 15 U.S.C. § 78j(b) and § 78t(a), and Rule 10b-5, 17 C.F.R. § 240.10b-5, promulgated thereunder. The plaintiffs also assert causes of action based in common law fraud and negligent misrepresentation. The defendants move to dismiss the consolidated amended complaint ("complaint") on the grounds that it fails to state a claim for relief under the federal securities laws and New York common law, and for failure to plead fraud with particularity as required by Fed.R.Civ.P. 9(b).

Background

The plaintiffs, Albert Klein, Blanche Tave, and Daniel Slane, are representatives of a putative class of purchasers of stock of Continental Information Services, Inc. ("CIS"), during the period from April 29, 1987 through November 18, 1988. The defendants are nine individuals who were officers and/or directors of CIS during that period. The individual defendants were signatories to CIS's Securities and Exchange Form 10-K and the Annual Report to Shareholders for the fiscal year 1988, issued on or about May 12, 1988.

The factual background pertinent to this motion, as alleged in the complaint, is as follows:*fn1

CIS's primary business was the leasing of computer equipment. Prior to the Tax Reform Act of 1986, the bulk of CIS's business deals involved arrangements with businesses to lease computer equipment, in which CIS would then sell 90 percent of that lease agreement to a bank. CIS would sell the remaining 10 percent of the lease agreement to a third party seeking a tax shelter. Instead of receiving lease payments, the 10 percent investor would receive the computer equipment's depreciation tax writeoffs, and half of the equipment's resale value when the lease expired. CIS would then buy the equipment and deliver it to the business, earning a commission on the deal. At the end of the lease, CIS would sell the equipment and split the residual value with the tax shelter investor.

The Tax Reform Act of 1986, however, eliminated the type of tax shelters CIS was providing, forcing the company to devise new strategies to earn its profits. These strategies included the acquisition of three companies in an attempt to diversify CIS's business. In August 1987, CIS acquired CMI Corp., a previous competitor. Also in FY 1988, CIS acquired Aviron Computer Technologies, Inc., a company which refurbished, reconfigured and modified computer equipment, and COM-PRO, another company in the computer field.

The 1988 Annual Report indicated a period of strong growth for CIS. According to the report, between the years 1986 and 1988, total revenues increased from $221,073,000 to $547,497,000; earnings before income tax increased from $18,028,000 to $27,718,000; and net earnings increased from $10,993,000 to $16,070,000. However, according to the plaintiffs, CIS improperly recorded the sale of an aircraft on its books in order to misrepresent its earnings in either FY 1987 or 1988.*fn2

Plaintiffs also include in the complaint several examples of representations made by the defendants which they allege indicate defendants' misrepresentations about the true condition of CIS's business. The representations cited by the plaintiffs are numerous, but some examples include:

— In the 1987 Annual Report, with respect to CIS's profits and revenues:

  CIS anticipates EVEN more accelerated growth in
  the foreseeable future. This optimism is founded
  on the Company's remarketing strength in
  maximizing the residual value of all assets it
  manages.

— In the 1987 Annual Report, regarding the effects of the Tax Reform Act of 1986:

  We have said that tax reform would be beneficial
  to our industry and continue to believe so . . .
  our higher revenues and pre-tax earnings evidence
  that our outlook in this respect is correct.
  Prospects for the coming year are excellent. We
  look forward to continued ...

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