On October 8, 1997, Quintel shares fell 1 7/16 to 8 15/16. See Compl.
On October 15, 1997, Quintel announced in a press release and its Form
10-Q the third quarter results for fiscal year 1997. Net income was $0.01
per share, as compared to $0.20 per share for the comparable period in
1996. Net revenues were $44,688,568, compared to $17,493, 179 in the
third quarter of fiscal year 1996. Schwartz commented that: "During and
subsequent to the third quarter we received information from our
providers indicating a substantial increase in the rate of chargebacks,
resulting in an under-reserve for prior periods and causing an increased
chargeback rate for the current period." Compl. ¶ 76.
The October 15, 1997 press release also indicated that AT & T modified
its contract with Quintel during the quarter ended August 31, 1997. AT &
T's limitation of Quintel's marketing efforts led to reductions in
revenue for the quarter.
Quintel filed its Form 10-Q for the third quarter of fiscal year 1997
with the Securities and Exchange Commission ("SEC") on October 16, 1997.
The provision for chargebacks increased from 35% in the third fiscal
quarter of 1996 to 44% in the comparable period of 1997. The third
quarter Form 10-Q attributed the increase of the provision for
chargebacks to information Quintel received during the quarter ending
August 31, 1997 about a significant increase in the rate of "900" service
chargebacks. See Compl. ¶ 79.
The third quarter Form 10-Q also commented upon AT & T's modification
of its contract with Quintel, stating that the adjustment was "commenced
in late July 1997."
On October 15, 1997, Quintel common stock was trading at $7.75 per
share, or less than half of its Class Period high of $15.625 per share.
According to its Form 10-K for fiscal year ended November 30, 1997,
Quintel used several companies to provide billing and collection services
in connection with its telephone entertainment services and "900"
numbers. One of these companies, West TeleServices Corporation ("West"),
provided Quintel with reports that included the amount of money received
for "900" calls in each month and the chargeback initially charged for
each month. Quintel would then use this information to project eventual
chargebacks within a given financial period. As of July 15, 1997, Quintel
would have received from West reports of the chargebacks for December
1996 through May 1997. See Compl. ¶¶ 102-03.
On a motion to dismiss under Rule 12(b)(6), the issue is "whether the
claimant is entitled to offer evidence to support the claims." Scheuer
v. Rhodes, 416 U.S. 232, 236, 94 S.Ct. 1683, 40 L.Ed.2d 90 (1974),
overruled on other grounds, Davis v. Scherer, 468 U.S. 183, 104 S.Ct.
3012, 82 L.Ed.2d 139 (1984). The Court must accept all of the
well-pleaded facts as true and consider those facts in the light most
favorable to the plaintiffs. See id.
Defendants move to dismiss on the grounds that (1) plaintiffs have
failed to state a claim under Section 10(b) of the Securities Exchange
Act of 1934 and Rule 10b-5 promulgated thereunder; (2) plaintiffs have
failed to meet the particularity required by Rule 9(b) of the Federal
Rules of Civil Procedure and the PSLRA; and (3) plaintiffs failed to
state a claim for control person liability under § 20(a).
I. Failure to State a Claim under § 10(b) and the PSLRA
To state a prima facie case under § 10(b) and Rule 10b-5
promulgated thereunder,*fn2 plaintiffs must allege: a
material misrepresentation or omission; made "with" scienter; upon which
plaintiffs relied; and which proximately caused plaintiffs injuries. See
Acito v. IMCERA Group, Inc., 47 F.3d 47, 52 (2d Cir. 1995). Because the
Complaint alleges fraud, Rule 9(b) heightens the pleading requirements
and requires that "the circumstances constituting fraud or mistake shall
be stated with particularity." Fed.R.Civ.P. 9(b). Also, the PSLRA
requires that plaintiffs specify each alleged misleading statement and
explain why it is misleading. The Second Circuit has interpreted Rule 9
(b) and the PSLRA as requiring the complaint to "(1) specify the
statements that the plaintiff contends were fraudulent, (2) identify the
speaker, (3) state where and when the statements were made, and (4)
explain why the statements were fraudulent." Id. at 51 (quoting Mills v.
Polar Molecular Corp., 12 F.3d 1170, 1175 (2d Cir. 1993)). Therefore,
when considering whether plaintiffs have stated a prima facie case, we do
so in light of the particularity requirements of Rule 9(b).
A. Material Misrepresentation or Omission
Plaintiffs allege the following misrepresentations or omissions in the
(1) The July 15, 1997 press release concerning
Quintel's financial reports for the second quarter
of fiscal year 1997 and the Form 10-Q filed on
that same day ("the July 1997 reports") were false
and misleading when made.
(2) Even if the July 1997 reports were not false,
defendants should have made a corrective
disclosure when they learned that the reports were
(3) Defendants' financial reports during the Class
Period were false and misleading because
defendants failed to disclose the existence of
known trends, events or uncertainties that they
reasonably expected would have a material
unfavorable impact on net revenues or income and
the reports were not in conformity with Generally
Accepted Accounting Practices (GAAP).
In response, defendants, in their Motion to Dismiss, first argue that
plaintiffs are relying on statements made before the Class Period to
establish a prima facie § 10(b) violation. Although defendants are
correct in that they are "liable only for those statements made during
the class period," In re Intern. Business Machines Corporate Sec.