Plaintiff Food and Allied Service Trades Department, AFL-CIO ("FAST"), brought this securities class action on behalf of itself and a class of similarly situated shareholders of defendant Millfeld Trading Co., Inc. ("Millfeld"). Millfeld is a Delaware corporation in the primary business of importing and marketing shoes; it went public in January 1990. In early 1992, the price of Millfeld stock collapsed after Millfeld disclosed that it was being investigated by federal prosecutors for systematic underpayment of its Customs duties over the preceding five years (the "Announcement").
This collapse of Millfeld stock, not surprisingly, produced more than one lawsuit against the company and its directors. Two such cases against Millfeld and its officers are before this Court -- the instant suit brought by FAST in July 1992, and another one filed a month earlier by plaintiffs Pentland USA, Inc. and Pentland Group PLC (collectively, "Pentland"). Both suits arise out of the same underlying transactions by Millfeld, and both allege securities fraud in violation of Section 10(b) of the Securities Exchange Act of 1934 (the "Exchange Act"), Rule 10b-5, and state common law.
In both cases, defendants moved to dismiss plaintiffs' complaint on the grounds that it failed to allege fraud with the particularity required by Federal Rule of Civil Procedure 9(b). In a hearing on December 10, 1992, this Court granted defendants' motions in both cases and gave plaintiffs leave to file amended complaints in both actions.
Plaintiffs in both actions filed their amended complaints on February 1, 1993, both of them adding allegations intended to support what had been lacking in the original complaints -- the inference that Millfeld's underpayment of its Customs duties was made with scienter, that is, with defendants' knowledge or with reckless disregard for the truth. Defendants in both actions moved to dismiss the amended complaints, alleging that, as before, they failed to plead fraud with the particularity required by Rule 9(b). By Opinion dated December 15, 1993 (the "Pentland Opinion"), we denied the motions to dismiss in the Pentland action.
For the reasons set forth below, we now deny defendants' motions to dismiss this action, with the exception of the motion to dismiss made by defendant Terren Peizer, which is granted. Familiarity with the Pentland Opinion is assumed.
This action resembles the Pentland action in most material respects. In particular, both actions arise from the same set of underlying transactions, and the complaints in both actions allege essentially the same set of material facts. The fundamental differences between the two actions are twofold:
1) FAST brings this action as representative of a class. The named class comprises all shareholders who purchased shares of Millfeld common stock between January 19, 1990, the date on which Millfeld went public, and April 27, 1992, the date on which it claims the market fully assimilated Millfeld's February 1992 disclosure of its Customs underpayments; and
2) While Pentland named as defendants only Millfeld and Barry Feldstein, Millfeld's former CEO, president and chairman, FAST names four additional individual defendants who were officers and/or directors of Millfeld during the relevant time period.
The first distinction -- the class nature of this action -- has no bearing on the motions to dismiss. As to the second distinction, we will treat the motions to dismiss in two groups -- those brought by defendants who were also defendants in the Pentland action (the "Pentland defendants"), and those brought by defendants not named in Pentland (the "non-Pentland defendants").
I. The Pentland Defendants
Millfeld and Barry Feldstein are the defendants named in both Pentland and this action. As noted above, by Opinion dated December 15, 1993 we denied these two defendants' motions to dismiss in the Pentland action. Finding no material differences between the two matters with respect to these common defendants, we now adopt the reasoning of the Pentland Opinion with regard to these two defendants, and we deny the motions to dismiss made by Millfeld and Barry Feldstein in this action.
II. The Non-Pentland Defendants
Having concluded that FAST has adequately alleged a "primary" violation of Section 10(b) with regard to Millfeld and Barry Feldstein, we now address issues of "secondary" liability with regard to the remaining defendants. FAST offers two theories of secondary liability under the Exchange Act for the remaining defendants: first, that they incurred liability as "controlling persons" under Section 20(a) of the Exchange Act; second, that they "aided and abetted" the primary violators.
A. The Defendants
The remaining defendants are described as follows in the Amended Complaint:
1) Glenn Feldstein, a son of Barry Feldstein, was Vice President of Sales, Secretary, and a director of Millfeld from 1989 to about February 1992, when he was terminated from these positions in the wake of the Announcement. The Amended Complaint alleges that he was the subject of an ongoing criminal investigation by the United States Attorney in connection with Millfeld's Customs underpayments since February 1992 or before.
2) Dale Whitney became Vice President of Operations and Treasurer of Millfeld in 1981, and became a director in August 1989. He was terminated as Vice president and Treasurer and resigned from the Board in February 1992. The Amended Complaint alleges that he was also the subject of a criminal investigation by the United States Attorney.
3) Michael Callahan became Vice President of Finance, Chief Financial Officer, and a director of Millfeld in 1989. He became President and Chief Executive Officer in or about April 1992, after Barry Feldstein was terminated from both of those positions in the wake of the Millfeld stock collapse.
For each of these three defendants, the Amended Complaint alleges that by virtue of the positions they held throughout the relevant period the defendants "exercised control over Millfeld -- including over the Company's Customs practices and financial disclosure obligations relating thereto -- and initiated, participated in, knew about, and permitted the wrongs alleged herein." Am. Compl. PP 13, 14, 16.
4) Terren Peizer is the one individual defendant who was not an officer of Millfeld during the relevant period; in addition, he was also not a director for much of the relevant time. Peizer became a director in June 1991 when he purchased $ 3.5 million worth of convertible debentures from Millfeld. He had by that time already purchased 135,000 shares of Millfeld common stock in the open market, and when he became a director he received warrants to purchase 1,118,436 shares of Millfeld common stock at $ 10.00 per share. Peizer resigned as a director on or about February 20, 1992, following the Announcement.
Peizer divested himself of over 90 percent of his Millfeld stock on September 23, 1991, one day before Millfeld first publicly acknowledged that it had materially underpaid its Customs obligations since 1986 and faced a $ 1.6 million liability. The Amended Complaint alleges:
Peizer's timely divestment of his Millfeld stock, along with the fact of his positions as Millfeld director and major stockholder after June of 1991, support the inference that Terren Peizer exercised control over Millfeld . . . and initiated, participated in, knew about, and permitted the wrongs alleged herein.
Am. Compl. P 15.
The Amended Complaint alleges fraud by each of the defendants as follows:
The individual defendants, by virtue of their offices, directorships, stockholdings, and/or specific acts were, at the time of the wrongs alleged herein, controlling persons of Millfeld within the meaning of Section 20(a) of the Exchange Act. Each such defendant had and exercised the power and influence to cause Millfeld to engage in the illegal practices complained of herein. Each of the individual defendants is sued as a direct participant in the wrongdoing alleged herein and in his capacity as a controlling person of Millfeld.