United States District Court, S.D. New York
July 27, 2004.
PAUL WHITE, on behalf of himself and all others similarly situated, Plaintiff,
H&R BLOCK, INC., et. al. Defendants.
The opinion of the court was delivered by: MICHAEL MUKASEY, Chief Judge, District
OPINION & ORDER
Plaintiffs represent a class of persons who purchased common
stock of defendant H&R Block ("Block") between November 8, 1997
and November 6, 2002 ("the Class Period"). Plaintiffs have sued
Block under Sections 10(b) and 20(a) of the Securities Exchange
Act of 1934 ("Exchange Act"), claiming that Block concealed from
investors 20 class action lawsuits relating to Block's Refund
Anticipation Loan ("RAL") program. Block has moved to dismiss
both claims. As explained below, because plaintiffs were on
notice of the facts underlying their claim more than two years
before they sued, their claims are time-barred and defendants'
motion to dismiss is granted.
The court appointed John L. Ross and Robert T. Ross as Lead
Plaintiffs on January 21, 2003. They purchased shares of Block
common stock during the Class Period. (Consolidated Amended Class
Action Complaint ("Compl.") ¶ 16) Plaintiffs Paul White, Richard
J. Rodney, Michael F. McCormack and Yuchong Smith also purchased
shares of Block common stock during the Class Period. (Id.)
Defendant Block is a Missouri corporation with its principal
offices in Missouri. (Id. at ¶ 17) Defendant Mark A. Ernst has
been Chief Executive Officer of Block since January 2001, President since September 1999, and a member of the board
of directors since 1999. (Id. at ¶ 18) Ernst was Chief
Operating Officer of Block from September 1998 through December
2000 and Executive Vice President from September 1998 until
September 1999. (Id. at ¶ 18) Defendant Frank J. Cotroneo
joined Block in 2000 and now serves as Block's Senior Vice
President and Chief Financial Officer. (Id. at ¶ 19) Defendant
Frank L. Salizzoni served as President of Block from June 1996
until September 1999, Chief Executive Officer from June 1996
through December 2000, and Chairman of the Board from September
2000 until September 2002. (Id. at ¶ 20) Defendant Matthew A.
Engel is Block's Assistant Vice President and Chief Accounting
Officer. (Id. at ¶ 21) Defendant Cheryl L. Givens is Block's
Vice President and Corporate Controller. (Id. at ¶ 22)
Defendant Ozzie Wenich served as Block's Senior Vice President
and Chief Financial Officer from at least the beginning of the
Class Period until 2000. (Id. at ¶ 23) Defendant Patrick D.
Petrie was Block's Vice President and Corporate Controller from
at least the beginning of the Class Period until 1998. (Id. at
Plaintiffs' claims arise under Sections 10(b) and 20(a) of the
Exchange Act, 15 U.S.C. § 78j(b) and 78t(a), and Rule 10b-5,
17 C.F.R. § 240.10b-5, promulgated by the Securities and Exchange
Commission ("SEC"). (Id. at ¶ 12) Federal question jurisdiction therefore is present pursuant to 15 U.S.C. § 78aa
and 28 U.S.C. § 1331, and venue in this court is proper under
28 U.S.C. § 1391(b) because a substantial part of the events giving
rise to the action occurred in this district. (Id. at ¶ 13)
The following facts are drawn from plaintiffs' Consolidated
Amended Class Action Complaint and related documents. All of the
documents reviewed for the purposes of deciding defendants'
motion to dismiss are well within the scope of this court's
review on a dismissal motion as they were (i) incorporated into
the complaint either by reference or through plaintiffs' reliance
in making the allegations in the complaint, see Rothman v.
Gregor, 220 F.3d 81, 88 (2d Cir. 2000) (the review of documents
on a dismissal motion may encompass "any written instrument
attached to [the complaint] as an exhibit or any statements or
documents incorporated in it by reference . . . and documents
that the plaintiffs either possessed or knew about and upon which
they relied in bringing the suit") (citations omitted); I. Meyer
Pincus & Associates, P.C. v. Oppenheimer & Co., 936 F.2d 759,
762 (2d Cir. 1991) (the review may include a pertinent document
where "the complaint contains only `limited quotation' from that
document"), or (ii) constitute "matters of which judicial notice
may be taken under Fed.R.Evid. 201," Kramer v. Time Warner, Inc., 937 F.2d 767, 773 (2d Cir. 1991).
Plaintiffs' well-pleaded allegations have been accepted as true
for the purpose of this motion, see Leatherman v. Tarrant
County Narcotics Intelligence and Coordination Unit,
507 U.S. 163, 164 (1993), and all reasonable inferences have been drawn in
plaintiffs' favor, see Thomas v. City of New York,
143 F.3d 31, 37 (2d Cir. 1998) (internal quotation marks and citation
Block's RAL program enabled customers who were owed a refund on
their income taxes to take loans in the amount of their expected
refunds. (Compl. ¶ 3) RAL customers could then use their
anticipated refund sooner than if they had to wait for the refund
from the government. (Id.) Some RAL customers began to sue
Block beginning around 1992 for failing to disclose that Block
had a 50% participation in the interest on these loans and that
the bank which made the loans paid Block a fee for each loan.
(Id. at ¶¶ 3, 5) These customers claimed that Block misled them
into believing that they were receiving their actual refund
rather than an interest-bearing loan and that Block's actions
constituted Truth-in-Lending Act violations, usury, breach of
contract, fraud, unfair and deceptive trade practices, negligent
or intentional misrepresentation, R.I.C.O. violations, and breach
of fiduciary duty. (Id.) During the Class Period, Block made numerous filings with the
SEC, each of which was signed by one or more of defendants, and
issued several press releases. (Id. at ¶¶ 35-67) Plaintiffs
allege that defendants mentioned the RAL litigation specifically
in three of Block's SEC filings and press releases. (Id. at ¶¶
50, 54) Block discussed the RAL litigation in a press release
issued May 2, 2000, stating that it had reserved $5 million for a
pending settlement of class action lawsuits involving refund
anticipation loans and that Block had not lost any of the
lawsuits filed in the RAL litigation. (Id. at ¶ 50) Block again
referred to the RAL litigation in its Form 10-K405 filed with the
SEC July 28, 2000. (Id. at ¶¶ 51-54) Block reported its
year-end financial results as of April 30, 2000 in the
Form 10-K405 and incorporated by reference its Annual Report to
Shareholders. (Id.) In Block's Annual Report, Block reported
that it had "provided for the pending settlement of class action
lawsuits involving refund anticipation loans," that there had not
been "any final judgments rendered against it" in the RAL
litigation, and that it admitted no wrongdoing in the settlement
agreement. (Id. at ¶ 54) Finally, Block addressed the RAL
litigation in a press release issued September 26, 2000, in which
Block announced a nationwide settlement of the RAL litigation.
(Id. at ¶ 56) Plaintiffs allege that beginning July 30, 2001, Block added a
new section to its Form 10-K405 filing entitled "Legal
Proceedings." (Id. at ¶ 60) Although Block did not refer
expressly to the RAL litigation, the new section reported that
Block was "involved in various litigation and claims as both
defendant and plaintiff relating to matters which arise in the
normal course of business which management believes will not have
a material adverse effect on the Company's consolidated results
of operations or financial position." (Id.) This new section
appeared again in Block's Form 10-K405 filed July 29, 2002, and
again did not expressly reference the RAL litigation. (Id. at
¶¶ 64-66) The language of the "Legal Proceedings" section in the
2002 Form 10-K405 was substantially the same as that in the 2001
Form 10-K405, but the 2002 Form 10-K405 also reported that the
amounts claimed in the pending legal proceedings were
"substantial in some instances" and that "the ultimate liability"
was "difficult to predict." (Id. at ¶ 66)
On November 1, 2002, Avalon Research Group, Inc. ("Avalon")
released a report discussing two class action lawsuits filed
against Block in Texas seeking damages of up to $2 billion.
(Id. at ¶ 68) Trading on Block's stock was temporarily halted
that day, and Block issued a press release in response to "market
rumors regarding litigation" in which Block echoed the language
of its 2001 and 2002 Forms 10-K405, stating that while the amounts claimed in the litigation were substantial and that
ultimate liability was difficult to predict, management did not
believe that any amounts that might be paid by Block would be
material. (Id. at ¶ 69) Block also reported in that press
release that it had not "lost any of the more than 20 class
action lawsuits filed against it involving the refund
anticipation loan program" and that it had "agreed to a
settlement on a nationwide basis." (Id.) Block explained that
the settlement involved a $25 million fund, of which Block would
pay half, and that the settlement would be reviewed in a fairness
hearing two weeks later. (Id.) Block further reported that the
settlement was not material. (Id.) After trading in Block's
stock resumed, the price of Block's shares dropped 8% by the
close of trading on November 1, 2002. (Id. at ¶ 71) Block's
stock then dropped 14% on November 7, 2002, the day after a Texas
court informed Block that it intended to order Block to repay
about $75 million in tax service fees to clients involved in the
RAL litigation. (Id. at ¶ 72).
Plaintiffs claim that Block's press releases and SEC filings
during the Class Period were false and misleading because they
"concealed the very existence of the RAL litigation." (Id. at ¶
76) Plaintiffs concede that defendants did make some references
to the RAL litigation, but they argue that defendants disclosed
only "good news" about those actions. (Id.) Plaintiffs allege several specific facts that defendants failed
to disclose during the Class Period: (1) that Block faced over 20
class action lawsuits; (2) the nature of the claims in these
lawsuits; (3) Block's purported liability; (4) charges of
excessive interest rates on the RAL loans that Block helped
arrange; (5) that damages could reach $2 billion; (6) that some
of these lawsuits were "successful" in a "number" of state and
federal courts; and (7) that the settlement Block announced in
its November 1, 2002 press release was "collusive," "that Block
was not even a party to that settlement," and that the settlement
had been rejected by the Court. (Id. at ¶¶ 76-77).
Additionally, plaintiffs contend that Block's statements that
it had not lost any of the RAL lawsuits and that there had been
no final judgments against Block in any of the RAL lawsuits were
misleading because Block failed to disclose that "most of those
actions were ongoing, or that the plaintiffs in some of those
actions had overcome motions to dismiss or that some had obtained
class certification." (Id. at ¶ 77) Plaintiffs claim also that
Block's financial statements filed during the Class Period failed
to comply with Generally Accepted Accounting Principles ("GAAP"),
and are therefore "presumptively misleading and inaccurate."
(Id. at ¶¶ 78-79) Finally, plaintiffs claim that defendants
understated Block's liabilities, thereby misrepresenting its
financial stability, during the Class Period, by reserving only $5 million when Block should have
reserved at least $1 billion for potential liability from the RAL
litigation. (Id. at ¶ 84) According to plaintiffs, each
individual defendant, by virtue of his position at Block, knew of
all the facts alleged above and exercised power and influence to
cause Block to make false and misleading statements during the
Class Period. (Id. at ¶¶ 85, 98-100).
Plaintiffs have brought two claims against defendants, the
first under Section 10(b) of the Exchange Act and Rule 10b-5,
and the second under Section 20(a) of the Exchange Act. (Id. at
¶¶ 1, 96, 98, 101) Defendants argue that both claims are
time-barred under the limitations provision of the Sarbanes-Oxley
Act, 28 U.S.C. § 1658, which states:
[A] private right of action that involves a claim of
fraud, deceit, manipulation, or contrivance in
contravention of a regulatory requirement concerning
the securities laws . . . may be brought not later
than the earlier of (1) 2 years after the discovery
of the facts constituting the violation; or (2) 5
years after such violation.
Plaintiffs do not dispute that the limitations period set by the
Sarbanes-Oxley Act applies to this action. However, they do
dispute that their claims are time-barred, arguing that five
years is the applicable period and that the Class Period extends
five years prior to the date plaintiffs filed the first complaint in this case. Defendants, on the other hand, argue that the
two-year limitations applies because plaintiffs should have
discovered the facts surrounding the RAL litigation more than two
years before filing this action.
The two-year limitations period begins to run after a plaintiff
has "notice of the facts, which in the exercise of reasonable
diligence, would have led to actual knowledge." See LC Capital
Partners, LP v. Frontier Insurance Group, Inc., 318 F.3d 148,
154 (2d Cir. 2003) (internal quotation marks omitted). This is
often called "constructive notice" or "inquiry notice." Id.
"Such circumstances are often analogized to `storm warnings.'"
Id. (internal quotation marks omitted). The Court of Appeals
The duty of inquiry results in the imputation of
knowledge of a fraud in two different ways, depending
on whether the investor undertakes some inquiry. If
the investor makes no inquiry once the duty arises,
knowledge will be imputed as of the date the duty
arose. However, if the investor makes some inquiry
once the duty arises, we will impute knowledge of
what an investor `in the exercise of reasonable
diligence, should have discovered' concerning the
fraud, and in such cases the limitations period
begins to run from the date such inquiry should have
revealed the fraud.
Id. (internal citations omitted). Because plaintiffs filed the
first complaint in November 2002 and have not alleged that they
undertook any inquiry at any time, whether their claims are
time-barred depends on whether a duty of inquiry arose prior to November 2000, two years before the first complaint was filed.
"Dismissal is appropriate when the facts from which knowledge
may be imputed are clear from the pleadings and the public
disclosures themselves." In re Ultrafem Inc. Sec. Litig.,
91 F. Supp.2d 678, 692 (S.D.N.Y. 2000). Defendants argue that the
pleadings and public disclosures here show that plaintiffs, and
the market as a whole, were on "inquiry notice" concerning the
RAL litigation as early as 1994 and as late as July 2000.
Defendants claim that a string of published court decisions in
the RAL litigation dates back to 1994 and that these decisions
were all publicly available. Defendants emphasize the allegations
in the complaint that in July 2000 Block issued a press release
concerning a settlement agreement in the RAL litigation, that it
released to its shareholders its annual report discussing the
settlement agreement, and that it publicly disseminated its
annual report by incorporating the report into its Form 10K filed
with the SEC. Defendants also emphasize the press reports
published before November 2000 concerning the RAL litigation.
According to defendants, all of this public information put
plaintiffs on "inquiry notice" before November 2000.
Plaintiffs argue that the public filings and news coverage did
not provide "notice of the number, type and location of the pending RAL class actions sufficient to trigger the
statute of limitations." (Plaintiffs' Memorandum of Law in
Opposition to Defendants' Motion to Dismiss the Consolidated
Amended Class Action Complaint ("Pl. Mem.") 23) However,
"[p]laintiffs need not be able to learn the precise details of
the fraud. . . ." Ultrafem, 91 F. Supp.2d at 692 (internal
quotation marks omitted). They need only "be capable of
perceiving the general fraudulent scheme based on the information
available to them." Id. One opinion in this District has held:
The information that triggers inquiry notice of the
probability of an alleged securities fraud is any
financial, legal, or other data, including public
disclosures in the media about the financial
condition of the corporation and other lawsuits
alleging fraud committed by the defendants, available
to the plaintiff providing him with sufficient storm
warnings to alert a reasonable person to the
probability that there were either misleading
statements or significant omissions involved in the
sale of the securities.
Dietrich v. Bauer, 76 F. Supp.2d 312, 343-44 (S.D.N.Y. 1999)
(internal quotation marks omitted).
Here, the public information concerning the RAL litigation was
more than sufficient to reveal the "general fraudulent scheme"
alleged by plaintiffs. The fraud alleged by plaintiffs is,
succinctly stated, the "conceal[ment] from investors [of] the
existence of 20 class action lawsuits in connection with Block's
Refund Anticipation Loan (`RAL') Program." (Compl. ¶ 2) This is
not a case involving private information held internally by the company, hidden away from the
public and available only to the officers or directors. To the
contrary, the information that plaintiffs allege Block concealed
involved public filings in public proceedings in publicly
accessible courts all across the country.*fn1 There is no
allegation that the numerous pleadings and motions in any of
these proceedings, much less all of them, were filed under seal.
In short, the "concealed" information was inherently public
Even assuming arguendo that Block could have concealed enough
of the RAL litigation that plaintiffs and market professionals
would not have had actual knowledge of the litigation before
November 2000, there was nevertheless more than enough publicly disseminated information to put plaintiffs on
"inquiry notice" concerning the RAL litigation before November
2000. Additionally, Block itself publicly discussed the RAL
litigation before November 2000. On May 2, 2000, Block disclosed
that it had reserved $5 million for a pending settlement in the
RAL litigation. (Compl. at ¶ 50) Then, on July 28, 2000, Block
discussed the RAL litigation in its Annual Report to
Shareholders, which was incorporated into a public SEC filing and
which reported that Block had "provided for the pending
settlement of class action lawsuits involving refund anticipation
loans." (Id. at ¶¶ 51-54) Finally, Block discussed the RAL
litigation in a press release issued September 26, 2000, in which
Block announced a nationwide settlement of the RAL litigation.
(Id. at ¶ 56).
If the public filings and press releases were not enough to put
plaintiffs on "inquiry notice," there were also numerous articles
about the RAL litigation published before November 2000 in
newspapers all over the country.*fn2 Many of these articles discussed the "number, type and location of the pending
RAL class actions" in detail. See, supra, note 2. In
particular, plaintiffs certainly could not or should not have
overlooked the torrent of articles published around the country
on July 25, 2000, reporting that a court had rejected a $25
million settlement in a lawsuit over Block's RAL
program.*fn3 These articles were clear "storm warnings" which would have led a
reasonable investor or market professional to inquire into the
RAL litigation. See In re Merrill Lynch & Co., Inc.,
273 F. Supp.2d 351, 389 (S.D.N.Y. 2003) (Pollack, J.) ("The plethora of
public information would have required even a blind, deaf, or
indifferent investor to take notice of the purported alleged
`fraud.' Every investor of reasonable intelligence would have
been absolutely on inquiry notice.") (emphasis in
original).*fn4 From the press articles and other public information concerning
the RAL litigation, plaintiffs were on "inquiry notice"
concerning the RAL litigation well before November 2000. See
LC Capital, 318 F.3d at 154 (holding that a single press
article "contribut[ed] to a duty of inquiry" and that the
complaint was therefore time-barred); Berry Petroleum Co. v.
Adams & Peck, 518 F.2d 402, (2d Cir. 1975), abrogated on other
grounds by Menowitz v. Brown, 991 F.2d 36, 41 (2d Cir. 1993)
(holding that plaintiffs were on inquiry notice concerning
possible fraud after financial newspapers published articles
reporting an SEC action against the company); In re Merrill
Lynch & Co., Inc. Research Reports Sec. Litig., 289 F. Supp.2d 416,
423 (S.D.N.Y. 2003) (Pollack, J.) (holding that "there was
clearly enough publicly available information to put the
plaintiffs on inquiry notice of their claims more than two years
before the commencement of any of these actions"); Ultrafem,
91 F. Supp.2d 678, 691-92 (S.D.N.Y. 2000) (holding that a single press article
"placed plaintiffs on inquiry notice" and that the complaint was
therefore time-barred). Because plaintiffs have not alleged that
they conducted any inquiry at any time, knowledge of the RAL
litigation is imputed to them as of the date the duty to inquire
arose. See LC Capital, 318 F.3d at 154. The latest date upon
which the duty to inquire could have arisen was July 25, 2000
given the flood of press articles published on that date and
other information publicly available then, and therefore
plaintiffs' complaint is time-barred because it was filed more
than two years after discovery of the facts constituting the
violation.*fn5 See 28 U.S.C. § 1658. Accordingly,
defendants' motion to dismiss both of plaintiffs' claims is
A. Plaintiffs' Section 10(b) and Rule 10b-5 Claim
Defendants have also moved to dismiss plaintiffs' Section 10(b)
and Rule 10b-5 claim on the merits. Section 10(b) makes it
unlawful "[t]o use or employ, in connection with the purchase or
sale of any security . . ., any manipulative or deceptive device
or contrivance in contravention of such rules and regulations as
the Commission may prescribe as necessary or appropriate in the public interest or for the protection of
investors." 15 U.S.C. § 78j(b). Rule 10b-5 lists the following
among the acts proscribed by Section 10(b): "To make any untrue
statement of a material fact or to omit to state a material fact
necessary in order to make the statements made, in the light of
the circumstances under which they were made, not misleading."
17 C.F.R. § 240.10b-5(b).
To state a claim under Section 10(b) and Rule 10b-5, a
plaintiff must allege that the defendant: "(1) made misstatements
or omissions of material fact; (2) with scienter; (3) in
connection with the purchase or sale of securities; (4) upon
which plaintiffs relied; and (5) that plaintiffs' reliance was
the proximate cause of their injury." In re IBM Corp. Sec.
Litig., 163 F.3d 102, 106 (2d Cir. 1998) (citations omitted).
Further, "it is well-established that a securities fraud
complaint must also plead certain facts with particularity in
order to state a claim. Fed.R.Civ.P. 9(b) requires that, whenever
a complaint contains allegations of fraud, `the circumstances
constituting fraud . . . shall be stated with particularity."
Novak v. Kasaks, 216 F.3d 300, 306 (2d Cir. 2000). "A
plaintiff cannot base securities fraud claims on speculation and
conclusory allegations." Kalnit v. Eichler, 264 F.3d 131, 142
(2d Cir. 2001). Defendants argue that plaintiffs have failed to
plead scienter and materiality. 1. Scienter
Section 10(b)'s scienter requirement "demands that plaintiffs
establish a strong inference of fraudulent intent 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." Suez Equity Investors, L.P. v.
Toronto-Dominion Bank, 250 F.3d 87, 99-100 (2d Cir. 2001). "To
show motive and opportunity, plaintiffs must allege a likelihood
that defendants could realize `concrete benefits' through the
deception." Id. at 100. Under the "conscious misbehavior"
theory, plaintiffs "must show that they alleged reckless conduct
by the [defendant], which is at the least, conduct which is
highly unreasonable and which represents an extreme departure
from the standards of ordinary care to the extent that the danger
was either known to the defendant or so obvious that the
defendant must have been aware of it." In re Carter-Wallace,
Inc., Securities Litigation, 220 F.3d 36, 39 (2d Cir. 2000)
(internal quotation marks omitted).
a. Motive and Opportunity
According to plaintiffs, defendants' motive for committing the
purported fraud was "to produce the appearance of prospering
performance and financial results." (Compl. ¶ 88) However, the
Court of Appeals has expressly held such an allegation as insufficient to establish motive for committing
securities fraud. See, e.g., Kalnit, 264 F.3d at 139-40;
Novak, 216 F.3d at 307; Chill v. General Electric Co.,
101 F.3d 263, 268 (2d Cir. 1996); Shields v. Citytrust Bancorp,
Inc., 25 F.3d 1124, 1130 (2d Cir. 1994). In Novak, the Court
Plaintiffs could not proceed based on motives
possessed by virtually all corporate insiders,
including: (1) the desire to maintain a higher
corporate rating, or otherwise sustain the appearance
of corporate profitability or of the success of an
investment; and (2) the desire to maintain a high
stock price in order to increase executive
compensation or prolong the benefits of holding
corporate office. Rather, plaintiffs had to allege
that defendants benefitted in some concrete and
personal way from the purported fraud.
Id. at 307-08 (internal citations and quotation marks omitted).
Plaintiffs have not alleged any personal benefit much less a
"concrete benefit" to defendants arising from the purported
fraud. Indeed, plaintiffs have failed to plead anything more than
a general motive "possessed by virtually all corporate insiders,"
and thus they have failed to plead motive sufficient to sustain a
securities fraud claim. Id. at 307.
Plaintiffs have also failed to plead "opportunity."
"Opportunity would entail the means and likely prospect of
achieving concrete benefits by the means alleged." Id. The
means by which plaintiffs claim defendants sought to commit
securities fraud was silence or anodyne references to the RAL litigation in Block's public filings and press releases. First,
as already discussed, plaintiffs have not alleged any "concrete
benefits" that inured to defendants from the purported fraud.
Second, given that the RAL litigation was the subject of a trove
of public information, ranging from public court filings to
numerous press articles, see, supra, at 12-16, the "prospect
of achieving concrete benefits by the means alleged" was far from
"likely." Information on the RAL litigation was publicly
available from any court where the cases were pending as well as
in the innumerable press articles covering the litigation. See
Id. Information was also publicly available from Block itself
in its Annual Report to Shareholders and SEC filings. See Id.
In short, Block had no "opportunity" to conceal the RAL
litigation no matter how much it may have wanted to.
b. Conscious Misbehavior or Recklessness
Where a plaintiff has "failed to demonstrate that defendants
had a motive to defraud the shareholders, he must produce a
stronger inference of recklessness." Kalnit, 264 F.3d at 143
(emphasis added). "[S]ecurities fraud claims typically have
sufficed to state a claim based on recklessness when they have
specifically alleged defendants' knowledge of facts or access to
information contradicting their public statements. Under such
circumstances, defendants knew or, more importantly, should have
known that they were misrepresenting material facts related to the corporation." Novak, 216 F.3d at 308. Plaintiffs
allege that defendants "recklessly engaged in acts, transactions,
practices and a course of business which operated as a fraud upon
Plaintiffs and the other members of the Class." (Compl. ¶ 87)
However, plaintiffs' conclusory claim is unsupported by pleaded
facts. See Kalnit, 264 F.3d at 142.
Plaintiffs allege that defendants "acted with reckless
disregard for the truth by failing to ascertain and disclose the
true facts [sic] in the statements made by them or other Block
personnel to the SEC, Plaintiffs, and other members of the
Class." (Compl. ¶ 89) However, plaintiffs never allege what these
"true facts" were. "Where plaintiffs contend defendants had
access to contrary facts, they must specifically identify the
reports or statements containing this information." Novak, 216
F.3d at 308. Plaintiffs have not identified any particular,
non-public reports or statements in the possession of defendants
containing facts contrary to defendants' public statements about
the RAL litigation.
Plaintiffs also allege that defendants "recklessly disregarded
that such statements would be issued or disseminated to the
investing public." (Compl. ¶ 90) However, as already discussed
above, there was a wealth of public information on the RAL
litigation, ranging from court filings to numerous press
articles. See, supra, at 12-16. It was not unreasonable for defendants to believe that the investing public would give these
court filings and news articles the same attention as defendants'
public statements, in which case the investing public would be
well aware of the RAL litigation. As in Kalnit, this is not a
case involving "affirmative misstatements," but "merely a failure
to disclose" information. 264 F.3d at 144. Even assuming that the
investing public miraculously overlooked all the public
information concerning the RAL litigation, such a turn of events
would be so highly improbable given all the public information
available that it could not possibly be deemed "so obvious that
the defendant must have been aware of it." Carter-Wallace, 220
F.3d at 39. Defendants' failure to discuss publicly the RAL
litigation at length and defendants did discuss it publicly in
some detail, as discussed above can hardly be characterized as
"an extreme departure from the standards of ordinary care." Id.
Plaintiffs further allege that "Defendants only disclosed good
news about" the RAL litigation, and that "they failed to disclose
that most of those actions were ongoing, or that the plaintiffs
in some of those actions had overcome motions to dismiss or that
some had obtained class certification." (Compl. ¶ 77) However,
"as long as the public statements are consistent with reasonably
available data, corporate officials need not present an overly
gloomy or cautious picture of current performance and future
prospects." Novak, 216 F.3d at 309. "The fact that management's optimism about a prosperous future turned
out to be unwarranted is not circumstantial evidence of conscious
fraudulent behavior or recklessness." Rothman, 220 F.3d at 90.
"[A]llegations that defendants should have anticipated future
events and made certain disclosures earlier than they actually
did do not suffice to make out a claim of securities fraud.
Novak, 216 F.3d at 309. "Corporate officials need not be
clairvoyant; they are only responsible for revealing those
material facts reasonably available to them." Id.
Defendants' positive statements about Block's success in the
RAL litigation was consistent with the data available pertaining
to the RAL litigation. For example, Block won a summary judgment
in RAL litigation in South Carolina which was affirmed by the
Fourth Circuit on appeal. See Cade, 1993 U.S. Dist. LEXIS
19042. Block won a series of dismissal motions in both state and
federal courts in Illinois. See Beckett, 1994 U.S. Dist.
LEXIS 17714, aff'd by, 714 N.E.2d 1033. Block won a summary
judgment in Pennsylvania. See Basile, 897 F. Supp. 194. Block
defeated class certification in Georgia, a holding affirmed by
the Eleventh Circuit on appeal, and plaintiffs then voluntarily
dismissed the action. See Buford, 168 F.R.D. 340, aff'd by,
Jones, 117 F.3d 1433. Block won a summary judgment in multiple
actions in Illinois, one of which was affirmed on appeal. See
Peterson, 971 F. Supp. 1204; Peterson, 22 F. Supp.2d 795; Washington, 716 N.E.2d 882. Block won dismissal against
all but one claim in New York and defeated class certification as
to the remaining claim. See Carnegie, 703 N.Y.S.2d 27. This
is just a sample of Block's repeated success in the RAL
In view of this success, Block did not act unreasonably in
stating that management believed that the RAL litigation would
"not have a material adverse effect on the company's consolidated
results of operations or financial position." (Compl. ¶ 69)
Indeed, Block acted reasonably in "not present[ing] an overly
gloomy or cautious picture of" the RAL litigation. Novak, 216
F.3d at 308-09. The Second Circuit has "refused to allow
plaintiffs to proceed with allegations of `fraud by hindsight,'"
and plaintiffs will not be permitted to do so here. See
Novak, 216 F.3d at 308-09.
Additionally, plaintiffs claim that defendants should have
reserved at least $1 billion for potential liability in the RAL
litigation. (Compl. ¶ 84) However, plaintiffs do not allege that
Block has actually suffered any liability in the RAL litigation.
The closest Block has come to actual liability according to
plaintiffs' own allegations was when "a Texas court said that it
would order Block to repay nearly $75 million in tax service fees
to clients in an RAL class action lawsuit," but there is no
allegation that any such order was ever entered by that Court or
that Block actually repaid any such fees. (Compl. ¶ 72) In fact, plaintiffs themselves allege that the Texas
lawsuit was nearly settled, but that this settlement was
ultimately rejected by the Court and the case is apparently
ongoing. (Id. at ¶¶ 73, 75) Therefore, based on plaintiffs'
allegations, Block has not paid the plaintiffs in the Texas
action or any other action anything. It appears that Block
continues to enjoy success in the RAL litigation, and thus the $1
billion reserve demanded by plaintiffs would appear unreasonable.
But even assuming arguendo that Block should have reserved $1
billion for the RAL litigation, defendants' decision not to do so
would be nothing more than poor business judgment on the facts
alleged by plaintiffs, and "poor business judgment is not
actionable under section 10(b) and Rule 10b-5." Rothman, 220
F.3d at 90 (2d Cir. 2000).
Finally, plaintiffs allege that Block's public filings violated
GAAP principles. (Compl. ¶¶ 66-67) However, "allegations of GAAP
violations or accounting irregularities, standing alone, are
insufficient to state a securities fraud claim. Only where such
allegations are coupled with evidence of `corresponding
fraudulent intent' might they be sufficient." Novak, 216 F.3d
at 309. Because plaintiffs have failed to demonstrate fraudulent
intent, as discussed above, their allegations of GAAP violations
are insufficient alone to state a securities fraud claim. Plaintiffs have not pleaded facts which show that "defendants
knew or, more importantly, should have known that they were
misrepresenting material facts related to the corporation."
Novak, 216 F.3d at 308. Plaintiffs' conclusory claims do not
establish "the stronger inference of recklessness" required to
state a securities fraud claim. See Kalnit, 264 F.3d at
142-143. Accordingly, plaintiffs have failed to plead scienter,
and defendants' motion to dismiss plaintiffs' claim under Section
10(b) and Rule 10b-5 is granted.
"An omission is material if there is `a substantial likelihood
that the disclosure of the omitted fact would have been viewed by
the reasonable investor as having significantly altered the
"total mix" of information made available.'" Halperin v.
eBanker USA.com, Inc., 295 F.3d 352, 357 (2d Cir. 2002)
(quoting Basic Inc. v. Levinson, 485 U.S. 224, 231-32
(1988)). "Material facts include those that affect the probable
future of the company and that may affect the desire of investors
to buy, sell, or hold the company's securities." Castellano v.
Young & Rubicam, Inc., 257 F.3d 171, 180 (2d Cir. 2001)
(internal quotation marks omitted). "The Supreme Court has
expressly stated that in such circumstances no single event or
factor is necessarily determinative of the materiality inquiry."
Id. In their motion to dismiss, defendants argue that plaintiffs
are relying on the "fraud-on-the-market" theory, and plaintiffs
do not dispute this in their response. The "fraud-on-the-market"
theory holds that "the market price of shares traded on
well-developed markets reflects all publicly available
information, and, hence, any material misrepresentations."
Basic, 485 U.S. at 246 (emphasis added). The Second Circuit,
among others, has recognized a corollary to the
fraud-on-the-market theory called the "truth-on-the-market"
defense. See Ganino v. Citizens Utilities Co.,
228 F.3d 154, 167 (2d Cir. 2000). The Court of Appeals explained in
Under this corollary, a misrepresentation is
immaterial if the information is already known to the
market because the misrepresentation cannot then
defraud the market. A defendant may rebut the
presumption that its misrepresentations have affected
the market price of its stock by showing that the
truth of the matter was already known. However, the
corrective information must be conveyed to the public
`with a degree of intensity and credibility
sufficient to counter-balance effectively any
misleading information created by' the alleged
Id. Defendants argue that under the truth-on-the-market theory,
defendants' alleged misstatements are immaterial because there
was a wealth of information on the RAL litigation publicly
available in the market from as early as 1993. See, supra,
notes 1, 2, 3. "The truth-on-the-market defense is intensely fact-specific and
is rarely an appropriate basis for dismissing a § 10(b) complaint
for failure to plead materiality." Id. However, "rarely
appropriate" is not the same as "never appropriate," and
"[m]ateriality is a mixed question of law and fact." Id. at
162. As already discussed above, the facts here show that all the
information plaintiffs claim was concealed by defendants was
publicly available, see, supra, at 12-16, and on these facts
the law renders defendants' purported misstatements immaterial.
The RAL litigation involved public lawsuits brought by public
filings in public courts, and the litigation was the subject of
extensive press coverage, especially around June 25, 2000, as
well as press releases and SEC filings from Block itself. Id.
In short, the truth was all over the market.
Further, the truth was available in the market with more
intensity and credibility than was any purported misstatement
from defendants. The truth about the RAL litigation was available
from the courts themselves, where the lawsuits were filed. See,
supra, note 1. Plaintiffs claim that investors should not be
obligated to "scour county court houses across the country." (Pl.
Mem. 20) But, as defendants point out, the market is comprised of
more than ordinary investors; it is also comprised of market
professionals, such as Avalon, and Avalon apparently had little trouble scouring these courthouses to
gather information for its report on the RAL litigation which
sparked this lawsuit against Block. (Compl. ¶ 68) Additionally,
plaintiffs themselves characterize defendants' misstatements
concerning the RAL litigation as "oblique" and "cryptic," and
they allege that some of these misstatements were "buried" in
"obscure portions of certain of the Company's public filings."
(Pl. Mem. 5, 22, 23) Plaintiffs' argument that these "oblique"
and "cryptic" misstatements entered the market with greater
intensity than did numerous articles in such
nationally-recognized publications as The New York Times makes
no sense. See, supra, notes 2, 3.
Plaintiffs' claim is undermined also by the theory upon which
it is based namely, fraud-on-the-market theory because the
market price of a stock is presumed to reflect "all publicly
available information." Basic, 485 U.S. at 246 (emphasis
added). Plaintiffs cannot use this presumption to argue that the
market price reflected defendants' purported misstatements but
not the true statements contained in Block's press releases and
SEC filings or, more importantly, in the numerous articles from
such publications as The New York Times. See, supra, notes
2, 3. If the market absorbed all public information, then it
must have absorbed all the information available from the articles published in newspapers from coast to
coast and the press releases and SEC filings of Block.
Finally, plaintiffs' claim that defendants should have reserved
at least $1 billion for potential liability from the RAL
litigation is meritless. "When contingent or speculative events
are at issue, the materiality of those events depends on `a
balancing of both the indicated probability that the event will
occur and the anticipated magnitude of the event in light of the
totality of the company activity.'" Castellano v. Young &
Rubicam, Inc., 257 F.3d 171, 180 (2d Cir. 2001) (quoting
Basic, 485 U.S. at 238). As discussed above, Block has enjoyed
repeated success in the RAL litigation over the last decade. The
probability that Block would face significant liability from the
RAL litigation during the Class Period was small, which means
that defendants' silence or limited discussion of the RAL
litigation during that time was immaterial.
On these facts, no reasonable juror could find "a substantial
likelihood that the disclosure of the omitted fact would have
been viewed by the reasonable investor as having significantly
altered the `total mix' of information made available."
Halperin, 295 F.3d at 357 (internal quotation marks omitted).
The "total mix" of available information included the very
information plaintiffs claim was concealed. Accordingly,
plaintiffs have failed to plead materiality, and defendants' motion to dismiss plaintiffs' claim under Section 10(b) and
Rule 10b-5 is granted.
B. Section 20(a) Claim
Plaintiffs have brought a second claim under Section 20(a) of
the Exchange Act, alleging that defendants Ernst, Cotroneo,
Salizonni, Engel, Givens, Wenich, and Petrie ("Individual
Defendants") were "controlling persons" of Block and caused Block
to engaged in the underlying fraud alleged in plaintiffs' Section
10(b) claim. "To make out a prima facie case under Section 20(a)
of the Exchange Act, a plaintiff must show a primary violation
[here, the alleged Rule 10b-5 violations] by the controlled
person . . . and control of the primary violator by the targeted
defendant [here, the individual defendants], and show that the
controlling person was in some meaningful sense a culpable
participant in the fraud perpetrated by the controlled person."
Ganino, 228 F.3d at 170 (bracketed text in original); see
also Marcus v. Frome, 275 F. Supp.2d 496, 503 (S.D.N.Y.
2003) (holding that individual defendant could not be culpable as
controlling person under section 20(a) because plaintiff had
failed to establish primary violation of controlled entity under
section 10(b)). For the reasons explained above, plaintiffs fail
to state a claim under Section 10(b) and Rule 10b-5 because they
fail to plead scienter and materiality, and therefore Individual
Defendants could not be held liable as controlling persons "because the allegations of the underlying liability of the
controlled entity are insufficient." Marcus, 275 F. Supp.2d at
503. Accordingly, defendants' motion to dismiss plaintiffs'
second claim under Section 20(a) is granted.
"[I]t is often appropriate for a district court, when granting
a motion to dismiss for failure to state a claim, to give the
plaintiff leave to file an amended complaint." Van Buskirk v.
The New York Times Co., 325 F.3d 87, 91 (2d Cir. 2003). "[A]
court granting a 12(b)(6) motion should consider a dismissal
without prejudice when a liberal reading of the complaint gives
any indication that a valid claim might be stated." Id.
(internal quotation marks omitted). In particular, regarding
claims of fraud, "[p]laintiffs whose complaints are dismissed
pursuant to Rule 9(b) are typically given an opportunity to amend
their complaint." Olsen, 136 F.3d at 276; see also Luce
v. Edelstein, 802 F.2d 49, 56 (2d Cir. 1986). "Where . . .
plaintiffs specifically request leave to amend in the event that
the court is inclined to dismiss on Rule 9(b) grounds, the
failure to grant leave to amend is an abuse of discretion unless
the plaintiff has acted in bad faith or the amendment would be
futile." Caputo, 267 F.3d at 191; see also Luce, 802 F.2d at 56-57 (finding abuse of discretion where
plaintiff requested leave to amend and court refused).
Plaintiffs have not requested leave to amend, and for good
reason. Each of plaintiffs' claims fails on grounds that cannot
be remedied by amendment. No amount of repleading could overcome
the legal effect of the public information available to
plaintiffs more than two years before they filed this action.
Indeed, plaintiffs would have to do more than merely amend their
complaint; they would have to erase numerous press articles,
court filings, press releases and SEC filings. Further, this case
already features six complaints, including two amended
complaints. For these reasons, amendment would be futile.
* * *
For the reasons set forth above, defendants' motion to dismiss
is granted and plaintiffs' complaint is dismissed.