On January 3, 1995, defendants Kasaks and Francis told securities analysts that no major or unusual markdowns were anticipated. (Compl. P 91.)
. 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 that Merrill Lynch could unload even more shares, which it did during late November and early December 1994, selling 781,000 additional shares. (Compl. PP 9, 13.)
As we have noted, plaintiffs purchased shares of AnnTaylor common stock in the period between February 3, 1994 and May 4, 1995, during which time the AnnTaylor defendants allegedly hid the fact that unsalable inventory was accumulating and that earnings were therefore overstated. Plaintiffs advance a "fraud on the market" theory of reliance and causation, alleging that they purchased AnnTaylor stock at artificially inflated prices and suffered damage as a result of the AnnTaylor defendants' material misrepresentations and omissions. Plaintiffs assert claims for relief against all defendants under Section 10(b) of the Securities Exchange Act of 1934 ("the 1934 Act"), 15 U.S.C. § 78j(b), and Rule 10b-5 promulgated thereunder, 17 C.F.R. 240.10b-5, and against defendants Kasaks, Burke, Armstrong, AnnTaylor and "Merrill Lynch" under Section 20 of the 1934 Act, 15 U.S.C. § 78t.
It is by now well recognized that securities class actions such as this one present an "inevitable tension between two powerful interests." In re Time Warner Inc. Sec. Litig., 9 F.3d 259, 263 (2d Cir. 1993). On the one hand, there is the interest in deterring fraud in the securities market and remedying it when it occurs. As Chief Judge Newman noted in Time Warner :
That interest [in deterring fraud] is served by recognizing that the victims of fraud often are unable to detail their allegations until they have some opportunity to conduct discovery of those reasonably suspected of having perpetrated a fraud. Consistent with that interest, modern pleading rules usually permit a complaint to survive dismissal 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." See Conley v. Gibson, 355 U.S. 41, 45-46, 78 S. Ct. 99, 101-102, 2 L. Ed. 2d 80 (1957).