condition in its Form 10-K for the 1995 fiscal year.
The alleged fraudulent scheme, according to the complaint, continued through the first two quarters of Fiscal 1996, during which time the net income was overstated by more than 116%. The investment community reacted positively to these optimistic financial results. However, the alleged fraudulent scheme began to unravel on February 23, 1996 when Health Management announced that it had "discovered certain accounting irregularities" and that a restatement was possible. By March 1996, BDO withdrew its opinion of Health Management's financial results for Fiscal 1995. Consequently, Health Management restated its results for each quarter of Fiscal 1995 and the first two quarters of Fiscal 1996.
A. Fed. R. Civ. P. 12(b)(6) standard
On a motion to dismiss for failure to state a claim, "the court should not dismiss the complaint pursuant to Rule 12(b)(6) unless it appears 'beyond doubt that the plaintiff can prove no set of facts in support of his claim which would entitle him to relief'". Goldman v. Belden, 754 F.2d 1059, 1065 (2d Cir. 1985)(quoting Conley v. Gibson, 355 U.S. 41, 45-46, 2 L. Ed. 2d 80, 78 S. Ct. 99 (1957)); see also IUE AFL-CIO Pension Fund v. Herrmann, 9 F.3d 1049, 1052-53 (2d Cir. 1993), cert. denied, 513 U.S. 822, 115 S. Ct. 86, 130 L. Ed. 2d 38 (1994). The Second Circuit stated that in deciding a Rule 12(b)(6) motion, a court may consider "only the facts alleged in the pleadings, documents attached as exhibits or incorporated by reference in the pleadings and matters of which judicial notice may be taken." Samuels v. Air Transport Local 504, 992 F.2d 12, 15 (2d Cir. 1993); see also Paulemon v. Tobin, 30 F.3d 307, 308-09 (2d Cir. 1994); Rent Stabilization Ass'n of the City of New York v. Dinkins, 5 F.3d 591, 593-94 (2d Cir. 1993) (citing Samuels, 992 F.2d at 15).
It is not the Court's function to weigh the evidence that might be presented at a trial; the Court must merely determine whether the complaint itself is legally sufficient, see Goldman, 754 F.2d at 1067, and in doing so, it is well settled that the Court must accept the allegations of the complaint as true, see Leeds v. Meltz, 85 F.3d 51 (2d Cir. 1996); LaBounty v. Adler, 933 F.2d 121, 123 (2d Cir. 1991); Procter & Gamble Co. v. Big Apple Indus. Bldgs, Inc., 879 F.2d 10, 14 (2d Cir. 1989), cert. denied, 493 U.S. 1022, 110 S. Ct. 723, 107 L. Ed. 2d 743 (1990), and construe all reasonable inferences in favor of the plaintiff. See Scheuer v. Rhodes, 416 U.S. 232, 236, 94 S. Ct. 1683, 40 L. Ed. 2d 90 (1974); Leeds, supra, 85 F.3d at 51; Bankers Trust Co. v. Rhoades, 859 F.2d 1096, 1099 (2d Cir. 1988), cert. denied, 490 U.S. 1007, 109 S. Ct. 1642, 104 L. Ed. 2d 158 (1989).
The Court is mindful that under the modern rules of pleading, a plaintiff need only provide "a short and plain statement of the claim showing that the pleader is entitled to relief", Fed. R. Civ. P. 8(a)(2), and that "all pleadings shall be so construed as to do substantial justice," Fed. R. Civ. P. 8(f).
The issue before the Court on a Rule 12(b)(6) motion "is not whether a plaintiff will ultimately prevail, but whether the claimant is entitled to offer evidence to support the claim." Villager Pond, Inc. v. Town of Darien, 56 F.3d 375, 378 (2d Cir. 1995) (citing Scheuer, supra, 416 U.S. at 235-36). Recovery may appear remote and unlikely on the face of the pleading, but that is not the test for dismissal under Rule 12(b)(6). Gant v. Wallingford Bd. of Educ., 69 F.3d 669, 673 (2d Cir. 1995) (citing Scheuer, supra, 416 U.S. at 236).
It is within this framework that the Court addresses the present motions to dismiss.
B. Pleading scienter pursuant to the Private Securities Litigation Reform Act
BDO, Hotte and Belloise maintain that the plaintiffs have failed to satisfy the heightened pleading requirement for securities fraud actions prescribed by the Private Securities Litigation Reform Act of 1995, Pub. L. No. 104-67, 15 U.S.C. § 78u-4 (the "PSLRA"), which amended the Securities Exchange Acts of 1933 and 1934. Specifically, BDO maintains that the "motive and opportunity" test adopted by the Second Circuit for pleading scienter, the mental state required for securities fraud liability, has been abrogated by the PSLRA. In addition, BDO and Hotte argue that recklessness no longer suffices to plead scienter. For the reasons that follow, the Court finds these arguments unpersuasive.
Prior to the passage of the PSLRA, the courts of appeals have interpreted the pleading standards under Fed. R. Civ. P. 9(b) in conflicting ways. For example, prior to the enactment of the PSLRA, the Second Circuit established the following test for pleading scienter in Rule 10(b) cases:
The requisite "strong inference" of fraud may be established either (a) by alleging facts to show that defendants had both motive and opportunity to commit fraud, or (b) by alleging facts that constitute strong circumstantial evidence of conscious misbehavior or recklessness.
San Leandro Emergency Med. Plan v. Philip Morris Companies, Inc., 75 F.3d 801, 813 (2d Cir. 1996); Acito v. IMCERA Group, Inc., 47 F.3d 47, 53 (2d Cir. 1995); Shields v. Citytrust Bancorp, Inc., 25 F.3d 1124, 1128 (2d Cir. 1994). However, the Ninth Circuit rejected the Second Circuit's "strong inference" test and concluded that scienter may be averred generally, without requiring identification of facts giving rise to an inference of scienter. See In re Glenfed, Inc. Sec. Litig., 42 F.3d 1541, 1546-47 (9th Cir. 1994).
Congress saw a need to "establish uniform and more stringent pleading requirements to curtail the filing of meritless lawsuits." H.R. Conf. Rep. No. 104-369, at 41 (1995), reprinted in 1995 U.S.C.C.A.N. 730, 740. Hence, with the enactment of the PSLRA, the requisite state of mind in securities fraud actions is as follows:
In any private action arising under this chapter in which the plaintiff may recover money damages only on proof that the defendant acted with a particular state of mind, the complaint shall, with respect to each act or omission alleged to violate this chapter, state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind.