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GERSHON v. WAL-MART STORES

UNITED STATES DISTRICT COURT FOR THE SOUTHERN DISTRICT OF NEW YORK


September 29, 1995

PETER GERSHON, et al., Plaintiffs, against WAL-MART STORES, INC. et al., Defendants.

The opinion of the court was delivered by: SOTOMAYOR

OPINION AND ORDER

 SONIA SOTOMAYOR, U.S.D.J.

 Defendant Wal-Mart Stores, Inc. ("Wal-Mart") moves for an order pursuant to Fed. R. Civ. P. 12(b)(6) and 9(b) dismissing, as against it, plaintiffs' Consolidated and Amended Class Action Complaint (the "Amended Complaint"). *fn1" For the reasons discussed below, the motion is GRANTED.

 BACKGROUND

 This litigation arose out of the March, 1994 bankruptcy of The Gitano Group, Inc. ("Gitano"), a New York-based apparel manufacturer and wholesaler. Plaintiffs in this action are a class of Gitano shareholders, comprising all persons who owned Gitano common stock between April 5, 1993 and January 24, 1994 (the "Class Period").

 Defendant Wal-Mart Stores, Inc. is an Arkansas-based retailer that was Gitano's largest customer, accounting for approximately one-third of Gitano's net sales during 1992, up from 18% in 1989. Am. Compl. at P 66. *fn2"

 For a year prior to filing for bankruptcy protection, Gitano experienced operating difficulties, reporting a $ 140 million loss in its annual report for 1992. The same annual report disclosed that Gitano was under investigation for criminal violations of U.S. Customs laws. At the time the 1992 annual report was published on May 19, 1993, Gitano also knew, but did not disclose, that Wal-Mart had a policy of discontinuing all purchases from any vendor found guilty of such customs violations. Am. Compl. P 78(iii). *fn3"

 On December 16, 1993 federal prosecutors announced that Gitano and three of its former top executives had pled guilty to felony charges arising from a scheme to evade customs laws. The triggering event to the Gitano bankruptcy was the announcement by Gitano on January 24, 1994 that, due to Wal-Mart's policy regarding customs violators, Wal-Mart would no longer purchase Gitano merchandise.

 Plaintiffs' claim against Wal-Mart advances the novel argument that Wal-Mart is liable for securities fraud because of its failure to warn Gitano stockholders that Gitano would likely suffer serious adverse consequences as a result of Wal-Mart's "no business with felons" policy (hereinafter, the "Customs Policy").

 The Amended Complaint makes a single claim against Wal-Mart: it violated Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated by the Securities and Exchange Commission thereunder. *fn4" Am. Compl. P 123-131. Importantly, the Amended Complaint makes no claim under Section 20(a) of the Exchange Act, which enlarges the boundary of liability to "every person who, directly or indirectly, controls" the issuer. *fn5"

 The claim is supported by an allegation that Wal-Mart owed a duty of disclosure to Gitano shareholders, because of its "close and longstanding business relationship with Gitano," Gitano's dependency on Wal-Mart for a third of its business, and Wal-Mart's resulting profit from that business. Am. Compl. P 25-28. The plaintiffs also claim that Wal-Mart deliberately concealed the Customs Policy in order to protect the continuity of supply of Gitano products through the Christmas shopping season, which it alleges explains Wal-Mart's six-week delay between the time Gitano pleaded guilty and the date on which Wal-Mart invoked its Customs Policy by cutting off purchases. Am. Compl. P 27, 79.

 The offensive conduct Wal-Mart is charged with in this action is that of having remained silent in the face of misleading information made public by Gitano management. Am. Compl. P 79. There is no claim that Wal-Mart was trading in Gitano securities during the Class Period, or that it made any statements itself. *fn6"

 DISCUSSION

 A district court's function on a motion to dismiss under Fed. R. Civ. P. Rule 12(b)(6) is to assess the legal feasibility of the complaint. Kopec v. Coughlin, 922 F.2d 152, 155 (2d Cir. 1991). The issue "is not whether a plaintiff will evidence to support the claims." Scheuer v. Rhodes, 416 U.S. 232, 236, 40 L. Ed. 2d 90, 94 S. Ct. 1683 (1974). Allegations contained in the complaint must be construed favorably to the plaintiff. Walker v. New York, 974 F.2d 293, 298 (2d Cir. 1992), cert. denied, 507 U.S. 961, 122 L. Ed. 2d 762, 113 S. Ct. 1387 (1993). Dismissal is warranted only where "it appears beyond doubt that the plaintiff can prove no set of facts in support of his claim which would entitle him to relief." Ricciuti v. NYC Transit Authority, 941 F.2d 119, 123 (2d Cir. 1991) (quoting Conley v. Gibson, 355 U.S. 41, 45-46, 2 L. Ed. 2d 80, 78 S. Ct. 99 (1957) (footnote omitted)).

 In considering a Rule 12(b)(6) motion, a court must look to: (1) the facts stated on the face of the complaint; (2) documents appended to the complaint; (3) documents incorporated in the complaint by reference; and (4) matters of which judicial notice may be taken. Hertz Corp. v. City of New York, 1 F.3d 121, 125 (2d Cir. 1993), cert. denied, 127 L. Ed. 2d 375, 114 S. Ct. 1054, 114 S. Ct. 1055 (1994) (citing Allen v. WestPoint-Pepperell, Inc., 945 F.2d 40, 44 (2d Cir. 1991)). See also Samuels v. Air Transport Local 504, 992 F.2d 12, 15 (2d Cir. 1993) (same).

 The threshold legal issue before me on this motion to dismiss is whether the Amended Complaint alleges any set of facts from which it can be concluded that Wal-Mart owed any duty of disclosure at all to Gitano shareholders or that its actions had any connection to the purchase and sale of securities under Rule 10b-5. I hold it does not. *fn7"

 As the briefs have provided me with no cases on point, I have searched for cases, and consulted the leading treatises, seeking precedent or informed commentary asserting that shareholders of an issuer may hold a company whose only relationship to the issuer is through an arms-length supply contract culpable for the issuer's securities fraud. In the very ample list of categories of business entities having been found liable, either primarily or secondarily, for an issuer's fraud (see. e.g., 5C Arnold S. Jacobs, Litigation and Practice Under Rule 10b-5 § 66.02[a][ii] (rev. 1995) (listing 35 such categories)), I have found none analogous to Wal-Mart's role in this case. Those few reported cases involving defendants contracting with the issuer are confined to contracts for the purchase by the defendant of the issuer's securities, drawing the nexus of the alleged fraud and the issuer's stockholders much more tightly than is the case here. See, e.g., Crane Co. v. Westinghouse Air Brake Co., 419 F.2d 787 (2d Cir. 1969), cert. denied, 400 U.S. 822, 27 L. Ed. 2d 50, 91 S. Ct. 41 (1970); Gibson v. Cannon, 325 F. Supp. 706 (E.D. Pa. 1971).

 I inspect this claim then to determine whether generally applicable principles of disclosure duty recognized within the Rule 10b-5 context could confer upon plaintiffs a cognizable claim. The leading Supreme Court cases which speak to the issue answer in the negative. The dispositive case is Chiarella v. United States, 445 U.S. 222, 63 L. Ed. 2d 348, 100 S. Ct. 1108 (1980) which states: "We hold that a duty to disclose under § 10(b) does not arise from mere possession of nonpublic market information". Id. at 235. Chiarella established the parameters of the disclosure duty by asserting:

 

First, not every instance of financial unfairness constitutes fraudulent activity under § 10(b). Second, the element required to make silence fraudulent -- a duty to disclose -- is absent in this case. No duty could arise from petitioner's relationship with seller of the target company's securities, for petitioner had no prior dealings with them. He was not their agent, he was not a fiduciary, he was not a person in whom the sellers had placed their trust and confidence. He was, in fact, a complete stranger who dealt with the seller only through impersonal market transactions.

 

We cannot affirm petitioner's conviction without recognizing a general duty between all participants in market transactions to forego actions based on material, nonpublic information. Formulation of such a broad duty which departs radically from the established doctrine that duty arises from a specific relationship between two parties. . . should not be undertaken absent some explicit evidence of congressional intent.

 Id. at 232-33 (citations omitted) (emphasis added).

 Even presuming that Wal-Mart was in possession of material non-public information in the form of (i) its Customs Policy and (ii) its intention to discontinue Gitano purchases after the guilty plea, and even if Wal-Mart was a "participant in market transactions" in Gitano stock merely by virtue of its wholesaler-retailer contractual relationship with Gitano (which, for the reasons I set forth in the next paragraph, I do not believe to be the case), it still had no disclosure duty under the Chiarella standard because it lacked the requisite fiduciary relationship to Gitano shareholders.

 Fresh reiteration of Chiarella's validity, and the principle of strictly construing the parameters of § 10(b), comes from Central Bank of Denver, N.A. v. First Interstate Bank of Denver, 128 L. Ed. 2d 119, 114 S. Ct. 1439, 1447 (1994) (quoting and expressly reaffirming Chiarella) and In re Time Warner Inc. Sec. Litig., 9 F.3d 259, 267 (2d Cir. 1993), cert. denied, 114 S. Ct. 1397, 128 L. Ed. 2d 70 (1994) ("[A] corporation is not required to disclose a fact merely because a reasonable investor would very must like to know that fact. Rather, an omission is actionable under the securities laws only when the corporation is subject to a duty to disclose the omitted facts.") See also Basic Incorporated v. Levinson, 485 U.S. 224, 239 n.17, 99 L. Ed. 2d 194, 108 S. Ct. 978 (1988) ("Silence, absent a duty to disclose, in not misleading under Rule 10-b5"). *fn8"

 Plaintiffs' fraud claim also founders because Wal-Mart's conduct did not result in Wal-Mart's reaping profits from trading in Gitano securities. Section 10(b) and Rule 10b-6 require that the proscribed conduct must be "in connection with the purchase or sale of any security" for it to be cognizable. The Amended Complaint conflates Wal-Mart's profits gained in perpetuating a source of supply with ill-gotten gains from securities fraud. The reach of Rule 10b-5 is not so extensive as to grasp all actors whose behavior has a negative impact on the market price of an issuer's securities. "An insider will be liable under Rule 10b-5 for inside trading only where he fails to disclose material nonpublic information before trading in it and thus makes 'secret profits.'" Dirks v. S.E.C., 463 U.S. 646, 654, 77 L. Ed. 2d 911, 103 S. Ct. 3255 (1983) (citation omitted) (emphasis added). The Supreme Court has long read the "in connection with" language narrowly. See. e.g., Blue Chip Stamps v. Manor Drug Stores, 421 U.S. 723, 44 L. Ed. 2d 539, 95 S. Ct. 1917 (1975). *fn9"

 In summary, plaintiffs have failed to demonstrate that Wal-Mart had any fiduciary relationship to Gitano stockholders which would give rise to a duty to disclose. As an alternate ground for dismissal, plaintiffs have failed to show that Wal-Mart's action (or inaction) implicated Section 10(b) or Rule 10-b5, as there was no nexus between Wal-Mart and the market for Gitano securities in which the plaintiffs suffered their loss.

 CONCLUSION

 For the reasons set forth herein, Wal-Mart's motion to dismiss is granted and the Consolidated and Amended Class Action Complaint is dismissed, with prejudice. The Clerk of the Court is directed to enter judgment in accordance with this Opinion.

 SO ORDERED.

 Date: New York

 September 29, 1995

 SONIA SOTOMAYOR

 U.S.D.J.


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