Compl. P 49. As a result of this announcement, trading in Leslie Fay stock was suspended, and at the end of the trading day the stock had fallen to $ 7.375 per share from its close of $ 12 per share on the previous day. Compl. P 48. On February 2, 1993, it was reported that Kenia had admitted that he and 15 other employees of the Company's Wilkes-Barre, Pennsylvania offices had been falsifying invoices for over one year, and the Company announced that the false entries began in the last quarter of 1991 and continued through all of 1992. Compl. PP 55,50. Upon announcing his fraud, Kenia stated that he was coming forward because the discrepancies caused by the falsifications had become too large to hide. Compl. P 55. On February 16, 1993, Leslie Fay announced that it had commenced an investigation into possible false SEC filings made by the Company, and on March 26, 1993, it was announced that Leslie Fay was the subject of a Commission investigation as well. Compl. P 58,62.
On February 26, 1993, Leslie Fay announced the preliminary financial results of the Audit Committee investigation. The $ 29.4 million, or $ 1.55 per share, originally reported as earnings for 1991 was revised to $ 17 million, or $ 0.91 per share. In addition, a loss of $ 13.7 million, or $ 0.72 per share was estimated for 1992. The Company also announced that BDO Seidman had withdrawn its opinion of the Company's 1991 financial statement. Compl. P 60. On March 22, 1993, Polishan, CFO of the Company, took a leave of absence pending the final outcome of the Audit Committee report. Compl. P 61. Finally, on April 5, 1993, Leslie Fay filed a voluntary bankruptcy petition under Chapter 11 of the Federal Bankruptcy Code and, in response, its common stock price fell to $ 2.75 per share. Compl. PP 64,63.
Although J.J. Pomerantz insisted that Leslie Fay's executives were not aware of the wrongdoing, compl. P 45, he acknowledged that he was in close contact with the Wilkes-Barre office which contained the Company's finance and accounting offices. Indeed J.J. Pomerantz admitted in a Wall Street Journal article that he was in daily contact with Chief Financial Officer Polishan, who was stationed in the Wilkes-Barre facility, and that on a number of occasions during the class period, Polishan traveled to New York to discuss the Company's internal financial information with the other individual defendants. Compl. P 52.
On a motion to dismiss we accept all allegations in the complaint as true, and dismiss only if, after drawing all inferences in plaintiffs' favor, it is clear that they are not entitled to relief. Cosmas v. Hassett, 886 F.2d 8, 11 (2d Cir. 1989); see Conley v. Gibson, 355 U.S. 41, 45-46, 2 L. Ed. 2d 80, 78 S. Ct. 99 (1957). This motion is brought under Rule 9(b), Fed. R. Civ. P., which requires that averments of fraud state the circumstances constituting fraud with particularity. However, Rule 9(b) must be read in the context of Rule 8(a) which calls only for a "short and plain" statement of the claim for relief. DiVittorio v. Equidyne Extractive Indus., Inc., 822 F.2d 1242, 1247 (2d Cir. 1987). Further, Rule 9(b) does not require that mental conditions such as intent or knowledge be averred with particularity although plaintiffs must allege a factual foundation which creates an inference of scienter. Stern v. Leucadia Nat'l Corp., 844 F.2d 997, 1004 (2d Cir.), cert. denied, 488 U.S. 852, 102 L. Ed. 2d 109, 109 S. Ct. 137 (1988); Connecticut Nat'l Bank v. Fluor Corp., 808 F.2d 957, 962 (2d Cir. 1987). We find that plaintiffs' claims against the moving defendants meet the particularity requirement and defendants' motion is accordingly denied.
I. The Rule 10b-5 Claim Is Adequately Alleged
For the purposes of this motion, it is important to note that each moving defendant signed either the Company's 1991 Form 10-K or 1992 Form 10-Q filings. Moreover, the discussion above indicates specific public statements made by defendants J.J. Pomerantz, Gordon, and Golub regarding Leslie Fay's performance and position in the industry. It is virtually undisputed that these statements were false and misleading when they were made and therefore the moving defendants cannot contend that the complaint fails to particularize their connection to the fraud. See Zimmerman v. Prime Medical Serv., Inc., 729 F. Supp. 23, 25 (S.D.N.Y. 1990). The only issue at bar is whether the complaint sufficiently alleges that moving defendants made these statements with scienter, and we find that it does.
Moving defendants contend that the fraud at Leslie Fay was perpetrated by Corporate Comptroller Kenia and a number of low ranking employees and did not extend to the upper echelon of the Company's management. However, it is a generally recognized exception to Rule 9(b) that plaintiffs need not plead facts if they are peculiarly within the opposing party's knowledge. DiVittorio, 822 F.2d at 1247. In cases where it is undisputed that fraud occurred within a corporation, we have held that the facts that show which corporate officials knew of the fraud cannot be ascertained by plaintiffs without discovery and need not be alleged in the complaint. In re AES Corp. Sec. Litig., 825 F. Supp. 578, 589 (S.D.N.Y. 1993). Therefore, even if the complaint contained only spare factual allegations to particularize moving defendants' scienter, we would be inclined to deny this motion. See Dannenberg v. Dorison, 603 F. Supp. 1238, 1241 (S.D.N.Y. 1985) (knowledge inferred from defendant's insider status); In re Coleco Sec. Litig., 591 F. Supp. 1488, 1490 (S.D.N.Y. 1984) (same); Bernstein v. Crazy Eddie, Inc., 702 F. Supp. 962, 977-78 (E.D.N.Y. 1988), vacated on other grounds, 714 F. Supp. 1285 (E.D.N.Y. 1989) (scienter need not be particularized as to each individual defendant if defendants are insiders or affiliates of offending corporation); see also Robbins v. Moore Medical Corp., 788 F. Supp. 179, 190-91 (S.D.N.Y. 1992) (Rule 9(b) motion denied because plaintiffs alleged, in general terms, facts supporting scienter that they could not be expected to know with specificity at the pleading stage); Maywalt v. Parker & Parsley Petroleum Co., 808 F. Supp. 1037, 1046-47 (S.D.N.Y. 1992).
However, as discussed below, the complaint contains facts which support a strong inference of scienter as to each of moving defendants, and therefore, these allegations are far from conclusory.
To allege scienter under 10b-5 plaintiffs may either (1) identify behavior which is either knowing and deliberate or so reckless that an inference of knowledge and intent is raised or (2) set out facts showing a motive for committing fraud and a clear opportunity to do so. See discussion in In re The Leslie Fay Co., Inc. Sec. Litig., 92 Civ. 8036 (October 22, 1993). Plaintiffs' complaint is sufficient under either pleading method.
Each of moving defendants was a high ranking officer of Leslie Fay, and all but Polishan were inside directors of the Company during the class period.
Haberkamp v. Steele, 1992 U.S. Dist. LEXIS 4917, 1992 WL 84544 (S.D.N.Y. 1992) (defendant's status and function are important factors in determining scienter). Polishan was the CFO of the Company and was stationed at the Wilkes-Barre facility where it is conceded that the inventory fraud took place. In addition Polishan was one of the two officials of the Company alleged to have been forced to take a leave of absence as a result of the accounting scandal; the other was Corporate Comptroller Kenia who confessed to fraudulent behavior. Moreover, plaintiffs point to Leslie Fay's uneven pattern of orders and erosion in gross profit margins and claim that this should have put moving defendants on notice that something was amiss with the corporate books. J.J. Pomerantz acknowledged that he was in close, indeed daily, contact with Polishan and the Company's Wilkes-Barre accounting office. Further, on a number of occasions during the class period, Polishan traveled to New York to discuss the Company's internal financial information with the other individual defendants. This coupled with the fact that these defendants, at a minimum, failed to discover inventory fraud to the extent of $ 12.4 million in the last quarter of 1991 and $ 43.1 million throughout 1992,
indicates a degree of recklessness from which intent might be inferred. See Goldman v. Belden, 754 F.2d 1059, 1070 (2d Cir. 1985) (scienter properly alleged because defendants' own public statements revealed that they "had or had access to" the undisclosed information); see also Breard v. Sachnoff & Weaver Ltd., 941 F.2d 142, 144 (2d Cir. 1991); Ouaknine v. MacFarlane, 897 F.2d 75, 81 (2d Cir. 1990).
Plaintiffs also allege facts supporting moving defendants' motive to commit fraud. In Cosmas, the plaintiffs claimed to have been defrauded by the directors of a corporation. 886 F.2d at 13. To support scienter the plaintiff in Cosmas alleged that the directors owned stock in the corporation and that the false and misleading statements were designed to inflate or maintain at an artificially high level the price of that stock. These allegations alone were found sufficient to support a motive to defraud on the part of the directors. In the case at bar, plaintiffs allege that J.J. Pomerantz, Golub, L.H. Pomerantz, and Gordon owned 1,584,583, 516,415, 1,581,900, and 18,250 shares of Leslie Fay stock, respectively. Compl. P 12(a)(b)(d)(e). Further, during the class period J.J. Pomerantz sold 60,000 shares at over $ 20 per share and gave away another 123,000 shares, while his wife sold 60,000 shares for between $ 18.50 and $ 20.75 per share and disposed of 123,000 shares by gift. Similarly, Golub sold 25,000 shares for between $ 20 and $ 21 per share and transferred another 7,200 shares by gift during the class period. Moreover, pursuant to the Leslie Fay management and partnership agreement, senior corporate officials at the Company received bonuses based on an effective rate of 7.51% of Leslie Fay's net earnings over $ 16 million. This agreement resulted in J.J. Pomerantz receiving a bonus of $ 2,852,697 in addition to his $ 798,915 of ordinary salary and bonuses in 1991. Likewise, Golub received $ 1,893,887 in addition to his 1991 salary and bonuses of $ 525,000. Similarly, Polishan, in addition to his $ 254,000 salary, is alleged to have received an unreported bonus pursuant to the management agreement, and Gordon received a 1991 salary and bonus totaling $ 403,146.
In Cosmas the Second Circuit upheld a plaintiff's Rule 10b-5 allegations noting that "the implication of the Complaint is that the alleged [misrepresentations were] intended to permit individual defendants to profit from an inflated market price before the truth became known." Id. (quoting Goldman, 754 F.2d at 1070). An analogous scenario is presented here, although the factual support for the allegation at bar is far more detailed than that in Cosmas. Thus, moving defendants' motive to defraud is more than adequately pled. See Coleco, 591 F. Supp. at 1490 (scienter may be inferred from insider stock sales).
Since plaintiffs have alleged a factual basis which creates a strong inference of scienter on the part of moving defendants, the motion to dismiss the Rule 10b-5 claim is denied.
II. The Aiding And Abetting Claim Is Adequately Alleged
Moving defendants also move to dismiss the aiding and abetting claims made against them. To state a claim for aiding and abetting a securities violation, plaintiffs must allege: (1) a securities violation by a primary wrongdoer, (2) "knowledge" of the violation on the part of the aider and abettor, and (3) substantial assistance by the aider and abettor in perpetrating the fraud. Bloor v. Carro, Spanbock, Londin, Rodman & Fass, 754 F.2d 57, 62 (2d Cir. 1985); IIT, an Int'l Inv. Trust v. Cornfeld, 619 F.2d 909, 922 (2d Cir. 1980). Moving defendants argue that the complaint fails to allege that they committed affirmative acts with the intention of furthering the fraud. However, as discussed above, each moving defendant endorsed at least one publicly filed document which contained false and misleading statements, and plaintiffs have alleged a factual basis supporting the conclusion that moving defendants acted with scienter. Therefore, the motion to dismiss the aiding and abetting claims is denied.
Bernstein, 702 F. Supp. at 978 (facts supporting a primary 10b-5 violation also supported an aiding and abetting claim).
III. Moving Defendants' Control Status Is Adequately Alleged
To properly allege control person liability under section 20(a) of the Securities and Exchange Act of 1934, plaintiffs need only allege that defendants either directly or indirectly held the power to exercise control over the primary violator. Borden, Inc. v. Spoor Behrins Campbell & Young, Inc., 735 F. Supp. 587, 588-91 (S.D.N.Y. 1990) (J. Conner).
The SEC has defined control as "the possession, directly or indirectly, of the power to direct or cause the direction of the management and policies of a person, whether through the ownership of voting securities, by contract, or otherwise." 17 C.F.R. § 240.12(b)-2(f). As stated above, each of moving defendants is alleged to have been a high-ranking officer and, except for Polishan, an inside director of Leslie Fay during the class period. Further, each moving defendant signed at least one of the SEC filings in which false and misleading statements were made.
Thus, moving defendants' control person status has been adequately alleged. See Robbins, 778 F. Supp. at 188; Zimmerman, 729 F. Supp. at 25.
For the foregoing reasons moving defendants' motion to dismiss is denied.
Dated: New York, New York
October 27, 1993
William C. Conner
United States District Judge