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August 17, 1999


The opinion of the court was delivered by: Scheindlin, District Judge.


Plaintiff Lawrence Milman, on behalf of himself and all others similarly situated, brings this securities fraud class-action lawsuit against Box Hill Systems Corp., a corporation in which Plaintiffs purchased stock through a public offering ("Box Hill" or "the Company"); Salomon Smith Barney Inc. and Nationsbanc Montgomery Securities Inc., investment banks serving as underwriters for that offering ("Underwriters" or "Underwriter Defendants"); and four officers of Box Hill whom Plaintiffs allege received substantial financial benefit as a result of the public offering ("the Individual Defendants").

Plaintiffs allege that Defendants violated sections 11, 12 and 15 of the Securities Act of 1933 by making false and misleading representations and by failing to disclose certain information in connection with and following a July 1997 public offering of Box Hill stock.*fn1 Defendants now move, pursuant to Federal Rule of Civil Procedure 12(b)(6), to dismiss Plaintiffs' Complaint in its entirety for failure to state a claim upon which relief may be granted. For the reasons that follow, Defendants' motions are denied in part and granted in part.*fn2

I. Standard of Review

Dismissal of a complaint pursuant to Rule 12(b)(6) is proper "only where it appears beyond doubt that the plaintiff can prove no set of facts in support of the claim that would entitle him to relief." Scotto v. Almenas, 143 F.3d 105, 109-10 (2d Cir. 1998) (internal quotations omitted). "The task of the court in ruling on a Rule 12(b)(6) motion is merely to assess the legal feasibility of the complaint, not to assay the weight of the evidence which might be offered in support thereof." Cooper v. Parsky, 140 F.3d 433, 440 (2d Cir. 1998) (internal quotations omitted). Thus, in deciding such a motion, the court must accept as true all material facts alleged in the complaint and draw all reasonable inferences in the nonmovant's favor. See Thomas v. City of New York, 143 F.3d 31, 36 (2d Cir. 1998). Nevertheless, "[a] complaint which consists of conclusory allegations unsupported by factual assertions fails even the liberal standard of Rule 12(b)(6)." De Jesus v. Sears, Roebuck & Co., 87 F.3d 65, 70 (2d Cir. 1996) (internal quotations omitted).

In considering a Rule 12(b)(6) motion, the district court must limit itself to "facts stated in the complaint or in documents attached to the complaint as exhibits or incorporated in the complaint by reference." Newman & Schwartz v. Asplundh Tree Expert Co., 102 F.3d 660, 661 (2d Cir. 1996). In addition, in securities fraud actions, the court "may review and consider public disclosure documents required by law to be and which actually have been filed with the SEC." Cortec Indus. Inc. v. Sum Holding L.P., 949 F.2d 42, 47 (2d Cir. 1991). See also Kramer v. Time Warner Inc., 937 F.2d 767, 774 (2d Cir. 1991); Salinger v. Projectavision, Inc., 934 F. Supp. 1402, 1405 (S.D.N.Y. 1996).*fn3

II. Background

The following allegations, taken from the Consolidated Amended Class Action Complaint ("Complaint"), are presumed true for the purposes of this motion to dismiss.

Box Hill is a small high-technology company registered and based in New York. Complaint ¶ 5. Box Hill manufactures and sells computer storage hardware devices which are marketed primarily to high-end customers in data intensive industries such as financial, corporate and academic institutions. Id. ¶ 19. Box Hill also provides consulting and support services in connection with its products. Id.

From 1992 through 1996, the demand for Box Hill's products and services grew rapidly, and the Company experienced an increase of more than 233% in its annual sales revenue for the period December 1992 to June 1997. Id. ¶¶ 21, 24. Box Hill's products were particularly popular among New York-based financial institutions, because those customers tended to rely heavily on the types of product support services Box Hill offered. Id. ¶ 21. In addition, Box Hill was one of the few computer data storage companies based in New York (rather than California) during the early to mid-1990s. Id.

By the beginning of 1997, however, the market for computer data storage products began to experience significant change which negatively impacted Box Hill's sales. Id. ¶ 22. First, Box Hill's customers had become more sophisticated with respect to traditional data storage products such as SCSI and RAID.*fn4 Id. ¶ 35. As a result, they no longer required — and were no longer willing to pay for — the support services offered by Box Hill. Id. Instead, many of Box Hill's customers began to purchase lower-priced data storage products from mail-order catalogs or other manufacturers. Id. ¶ 35. Moreover, in early 1997, Box Hill's largest competitor, California-based Andataco, opened a New Jersey office in order to directly compete with Box Hill in the New York/New Jersey markets. Id. ¶ 41. In response to these changes in the market for data storage products, Box Hill was forced to lower its prices in order to remain competitive. Id. ¶ 38.

Second, in January 1997, Box Hill began to market and sell its newly developed next generation storage technology: "fibre channel products". Id. ¶ 34. Box Hill hoped these products would provide the Company with a new source of high-margin sales earnings to offset the decline in sales of the older SCSI and RAID products. Id. ¶ 36. However, the introduction of these new products was unsuccessful. Id. ¶ 37. Box Hill's customers were reluctant to invest in an expensive upgrade to the unproven fibre channel technology. Id.

On July 23, 1997, Box Hill filed a Form S-1 Registration Statement with the SEC for an initial public offering of Box Hill common stock ("Box Hill Offering" or "Offering"). Id. ¶ 15. Box Hill hired the Underwriter Defendants to act as co-lead underwriters for the Offering. Id. ¶ 7.

Prior to the Offering, Defendants went on a "Road Show" to promote Box Hill to the investment community. Id. ¶ 44. The Road Show included presentations by the Individual and Underwriter Defendants during which they spoke in positive terms about Box Hill's short and long term profits and made optimistic earnings projections for the remaining quarters of 1997 and into 1998. Id. Shortly after the Road Show, the Underwriters issued "booster shot" reports (favorable analyst reports) which again discussed Box Hill in highly positive terms. Id. ¶ 45.

On or about September 16, 1997, the prospectus for the Box Hill Offering ("Prospectus") became effective. Id. ¶ 16. Commencing on that date, Box Hill sold, through the Underwriter Defendants in a firm commitment underwriting, 6,325,000 shares of common stock at an offering price of $15 per share.*fn5 Id. ¶ 17. of those shares, 3,150,000 were issued and sold to the Underwriters by Box Hill. Three of the four Individual Defendants (Mark A. Mays, Benjamin Monderer and Carol Turchin) who were executives and sole shareholders in the Company at all relevant times prior to the Offering, sold an additional 2,350,000 shares to the Underwriters. Id. ¶ 18.*fn6 Finally, the Underwriters purchased the remaining 825,000 common shares from Box Hill pursuant to an overallotment option.*fn7 Id.

The total gross proceeds of the Offering were approximately $94.9 million of which Mays, Monderer and Turchin received $32.7 million. The Company received the remaining $56.6 million, after underwriters' fees and offering expenses of approximately $5.6 million. Id.

In early January 1998, unusual trading activity in Box Hill's stock prompted the New York Stock Exchange to request that Box Hill issue a public statement regarding its financial expectations. Id. ¶ 46. On January 8, 1998, Box Hill publicly announced that although it was "comfortable with consensus mean estimates for the 1997 fourth quarter" revenue, the Company considered consensus mean revenue estimates for its 1998 earnings to be "at the high end of the range." Id. The day after the announcement, Box Hill's stock declined 28% to $10.875 per share. Id. ¶ 47.

Plaintiffs allege that following the January 1998 announcement, the Company failed to make any disclosures from which investors could determine that Box Hill had persistent and long-range difficulties limiting the Company's ability to achieve the growth it projected at the time of the Offering. Id. ¶ 49. On February 17, 1998, Box Hill's CEO, Philip Black, appeared on the financial news television channel CNBC and stated that the Company was not experiencing margin pressures and that it expected solid growth in sales of its fibre channel products. Id. Three weeks later, on the business news television channel CNNfn, Black asserted that Box Hill expected to sustain its earlier growth rate of 35-45%. Id.

On April 14, 1998, Box Hill announced that its first quarter 1998 revenues and earnings per share would fall short of consensus estimates by 25% and 49% respectively. Id. ¶ 50. The following day, Box Hill shares fell 23% to approximately $10 per share. Id. ¶ 51. At the time Plaintiffs filed their original complaint in November 1998, Box Hill shares were trading at approximately $5 per share. Id.

On March 19, 1999, Plaintiffs filed the instant Complaint alleging violations under §§ 11, 12 and 15 of the Securities Act for omissions and material misrepresentations made by Defendants (i) during the pre-Offering Road Show; (ii) in the Prospectus; and (iii) after the time of the Offering. Plaintiffs allege that they purchased Box Hill stock pursuant to and in reliance upon Box Hill's Prospectus and the Defendants' oral representations, and that they were damaged when the value of the Box Hill stock subsequently declined. They seek money damages and recission of their stock purchases.

III. Discussion

Plaintiffs' Complaint sets forth the following eight omissions or misrepresentations that they allege violate §§ 11 and 12 of the Securities Act:*fn8

  (a) Defendants failed to disclose that fibre channel
      products had not achieved market acceptance;
  (b) Defendants failed to disclose that increased
      competition in Box Hill's core markets was causing
      sales growth to fall below expectations;
  (c) Defendants failed to disclose that Box Hill was
      materially reducing prices at the time of the
  (d) Defendants failed to disclose that Box Hill was
      experiencing a lengthening of its sales cycle;
  (e) Defendants failed to disclose that Box Hill's
      sales force was understaffed and ineffective;
  (f) Defendants failed to disclose that Box Hill's
      Washington, D.C. office was in disarray;
  (g) Box Hill materially overstated the potential
      market for Windows NT fibre channel products;
  (h) Box Hill's CEO made materially misleading
      statements in February and March 1998 regarding
      the ...

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