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NOVAK v. KASAKS

March 10, 1998

CAROL NOVAK and ROBERT NIEMAN, on behalf of themselves and all others similarly situated, Plaintiffs, against SALLY FRAME KASAKS, PAUL E. FRANCIS, JOSEPH R. GROMEK, GERALD S. ARMSTRONG, JAMES J. BURKE, JR., MERRILL LYNCH & CO., MERRILL LYNCH, PIERCE, FENNER & SMITH INCORPORATED, MERRILL LYNCH CAPITAL PARTNERS, INC., ML IBK POSITIONS, INC., MERCHANT BANKING L.P. NO. III, KECALP, INC., ANNTAYLOR STORES CORPORATION and ANNTAYLOR, INC., Defendants.


The opinion of the court was delivered by: SCHWARTZ

 ALLEN G. SCHWARTZ, DISTRICT JUDGE:

 In this action, based upon alleged securities fraud, defendants move to dismiss the complaint pursuant to Rule 12(b)(6) of the Federal Rules of Civil Procedure (failure to state a claim) and Section 21D(b)(3) of the Securities Exchange Act of 1934 (failure to plead fraud with particularity and an inability to do so). For the reasons set forth below, defendants' motions to dismiss are granted.

 BACKGROUND1

 1. The Parties

 Plaintiff Carol Novak purchased twenty-five shares of AnnTaylor stock on November 30, 1994, and plaintiff Robert Nieman purchased three hundred shares of AnnTaylor stock on April 16, 1995. (Compl. P 31.) The named plaintiffs purport to represent a class of persons who bought AnnTaylor stock during the asserted class period of February 3, 1994 through May 4, 1995 (the "Class Period"). (Compl. P 1.)

 Defendant AnnTaylor Stores Corporation, through its wholly-owned subsidiary AnnTaylor, Inc. (collectively, "AnnTaylor"), is a specialty retailer of women's apparel, shoes, and accessories. (Compl. P 32(a).) Defendant Sally Frame Kasaks is the Chief Executive Officer and Chairman of the Board of AnnTaylor. (Compl. P 33(a).) Defendant Paul E. Francis is Executive Vice President for Finance and Administration, Chief Financial Officer, and a director of AnnTaylor. (Compl. P 33(b).) Defendant Joseph R. Gromek was a Senior Vice President and General Merchandise Manager of AnnTaylor from April 1993 through April 1995. *fn2" (Compl. P 33(c).) We shall refer to these defendants collectively as the "AnnTaylor defendants."

 Defendant Merrill Lynch & Co. is a holding company which operates, in part, through its subsidiaries defendant Merrill Lynch, Pierce, Fenner & Smith Incorporated and defendant Merrill Lynch Capital Partners, Inc. (Compl. P 34(a).) The latter entity, in turn, is the general partner in three limited partnerships (not defendants in this action) which sold 3.8 million shares during the Class Period. (Compl. P 34(c).) "Merrill Lynch" *fn3" controls and held AnnTaylor stock through defendants ML IBK Positions, Inc., Merchant Banking L.P. No. III, and KECALP, Inc. (Compl. P 34(b).) Defendants Gerald S. Armstrong and James J. Burke, Jr. are directors of AnnTaylor, partners in Merrill Lynch Capital Partners, and former managing directors of the Investment Banking Division of Merrill Lynch & Co. (Compl. PP 33(d)(i) and 33(e)(i).) We shall refer to the parties enumerated in this paragraph collectively as the "Merrill Lynch defendants." *fn4"

 2. The Allegations

 Simply put, plaintiffs allege that the AnnTaylor defendants artificially inflated the price of AnnTaylor stock by hiding excess inventory and failing to take write-downs at the proper times. Plaintiffs maintain that all defendants had actual or constructive knowledge that the company had serious inventory problems which were inconsistent with optimistic representations contained in public statements issued on AnnTaylor's behalf during the Class Period. Plaintiffs further contend that defendants refrained from disclosing this adverse information to the public until May 1995, and that these misrepresentations and omissions render defendants liable for securities fraud.

 More specifically, plaintiffs make the following allegations:

 . On February 3, February 14, and February 28, 1994, defendants Kasaks and Francis told securities analysts that inventories were in good shape and under control. (Compl. PP 47 - 49.)

 . In early 1994, "Merrill Lynch and AnnTaylor" did a national "roadshow" during which "AnnTaylor executives" said that inventories were under control and within expected levels. (Compl. P 56.)

 . On June 1, 1994, defendants Kasaks and Francis told securities analysts that inventories were at very reasonable levels. (Compl. P 62.)

 . On June 13, 1994, AnnTaylor filed its Form 10-Q for the quarter ending April 30, 1994, signed by defendant Francis, with the Securities and Exchange Commission ("SEC"). This form attributed higher inventory levels to expansion. (Compl. P 63.)

 . On July 7, 1994, "AnnTaylor insiders" told securities analysts that inventory levels were in good shape. (Compl. P 64.)

 . On August 4, 1994, defendants Kasaks and Francis told securities analysts that inventories were in great shape. (Compl. P 65.)

 . On September 1, 1994, defendants Kasaks and Francis told securities analysts that inventories were light. (Compl. P 68.)

 . On September 12, 1994, AnnTaylor filed its Form 10-Q for the quarter ending July 30, 1994, signed by defendant Francis, with the SEC. This form attributed higher inventory levels to expansion. (Compl. P 71.)

 . In mid-September 1994, defendants Kasaks and Francis told securities analysts that inventories were under control. (Compl. P 74.)

 . On November 8, 1994, defendants Kasaks and Francis told securities analysts that inventories were up 64%, but that this was due to accelerating growth. (Compl. P 81.)

 . On December 9, 1994, AnnTaylor filed its Form 10-Q for the quarter ending October 29, 1994, signed by defendant Francis, with the SEC. This form attributed higher inventory levels to expansion. (Compl. P 87.)

 . On February 21, 1995, defendants Kasaks and Francis told securities analysts that inventories were up 22%, but that this was in line with planned sales. (Compl. P 94.)

 . On April 19, 1995, "AnnTaylor" told securities analysts that inventories would be in good shape at the end of April. (Compl. P 103.)

 . In early May 1995, AnnTaylor announced that same store sales were down, that new stores were performing well below expectations, that its inventories were too high, and that inventory liquidation would result in fiscal 1995 earnings much lower than previously forecast. (Compl. P 107.)

 Plaintiffs allege that this series of unwaveringly favorable statements followed by an unexpected announcement of financial difficulties caused the price of AnnTaylor stock to rise to an artificially high level and then plummet. Specifically, the stock climbed from $ 20-1/2 per share in January 1994 to a high of $ 44-7/8 in November 1994. (Compl. P 1.) Shares traded in the $ 37 range until April 1995, but had lost 50% of their value by early May, dropping to $ 18-3/8. This included a one-day plunge of 25% on May 3-4, coinciding with one of the negative announcements. (Compl. P 107.) By October 1995, the share price had declined to $ 15, and thereafter fell to a low of $ 9. (Compl. P 18.)

 Plaintiffs further allege that throughout the Class Period, the AnnTaylor defendants were participating in a "box-and-hold" scheme in which excess inventory was hidden in warehouses and not written down according to Generally Accepted Accounting Principles ("GAAP"). (Compl. P 117-18.) Had AnnTaylor timely taken these write-downs, plaintiffs contend, the company would have shown a net loss for the fiscal year ending January 29, 1994 (rather than the $ 3.2 million net income reported), and net income of approximately $ 10 million less than the $ 31.7 million reported for the year ending January 28, 1995. (Compl. PP 119, 123.) By hiding inventory and delaying in taking write-downs, the AnnTaylor defendants presumably first caused stock prices to rise to inflated levels by misleading the public as to the company's financial health, and then caused prices to plummet by revealing the true state of affairs.

 Plaintiffs allege that among the factors motivating the AnnTaylor defendants to forestall disclosure of the company's true inventory situation was a desire to inflate the share price in advance of a May 1994 secondary stock offering. (Compl. P 6.) In this offering, "Merrill Lynch" sold off 4 million shares of AnnTaylor stock which it had been holding since the initial public offering in May 1991. (Compl. PP 2, 6.) The secondary offering also permitted AnnTaylor to sell one million new shares, allowing it to reduce its debt levels. (Compl. P 6.) Plaintiffs further allege that AnnTaylor was motivated to keep the share price high after the offering so ...


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