United States District Court, S.D. New York
September 29, 2004.
DAN GAVISH, TRICIA FONTAN, WALTER FONTAN, individually and on behalf of all others similarly situated, Plaintiffs,
REVLON, INC., REV HOLDINGS INC., RONALD O. PERELMAN, GEORGE FELLOWS, and FRANK J. GEHRMANN, Defendants.
The opinion of the court was delivered by: SIDNEY STEIN, District Judge
OPINION & ORDER
Plaintiffs have brought this class action alleging that
defendants violated sections 10(b) and 20(a) of the Securities
Exchange Act of 1934 ("the 1934") and Rule 10b-5 promulgated
thereunder. Defendants have moved pursuant to Rule 12(b)(6) of
the Federal Rules of Civil Procedure to dismiss the amended
complaint for failure to plead fraud with sufficient
particularity as required by Fed.R. Civ. P. 9(b), for failure to
comply with the pleading requirements set forth in the Private
Securities Litigation Reform Act of 1995, Pub.L. No. 104-67, 109
Stat. 737 (codified in various sections of 15 U.S.C.) ("PSLRA"),
and for failure to state a claim upon which relief can be
granted. For the reasons set forth below, defendants' motion to
dismiss the amended complaint is granted. I. BACKGROUND
Plaintiffs' Amended Class Action Complaint alleges the
following relevant facts, which the Court presumes to be true for
the purposes of this motion.
A. The Parties
The plaintiffs are individual investors who bring this action
on their own behalf and as a class action on behalf of all
persons who purchased Revlon, Inc. securities from October 2,
1998 through September 30, 1999 (the "Class Period").*fn1 In
an amended complaint, they allege that they purchased Revlon
stock at an artificially high price created by material
misstatements and omissions in defendants' representations to the
Revlon is a Delaware corporation and a leading manufacturer of
cosmetic, skin care, fragrance, and personal, hair and nail care
products. (Compl. ¶ 15). Defendant REV Holdings, Inc., as of the
date of the complaint, owned approximately 83.0% of the
outstanding shares of capital stock of Revlon, representing
approximately 97.4% of the voting power of those outstanding
shares. (Compl. ¶ 16). Plaintiffs name a variety of individual
defendants who were involved with Revlon in various capacities as
follows: Ronald O. Perelman indirectly owns and controls REV
Holdings, Inc. and was Chairman of Revlon's Board of Directors
during the Class Period (Compl. ¶¶ 16-18); George Fellows was
Revlon's President, Chief Executive Officer, and Director (Compl.
¶ 17); and Frank J. Gehrmann was Revlon's Executive Vice
President and Chief Financial Officer. (Compl. ¶ 17).
B. The Scheme to Artificially Inflate Revlon's Stock Price Perelman acquired Revlon in 1986 through a leveraged buy-out.
(Compl. ¶ 2). The buy-out saddled Revlon with substantial debt, a
large portion of which was secured by twenty million Revlon
shares pledged by Perelman. (Compl. ¶ 2).
During the Class Period, defendants believed that Revlon's debt
would have to be alleviated either through refinancing or the
sale of the company. (Compl. ¶¶ 2, 104). In order to refinance or
sell the company on favorable terms, defendants needed to
maintain for Revlon the "appearance of a healthy company."
(Compl. ¶ 104). According to the complaint, defendants could not
honestly maintain such an appearance, however, given their
knowledge and exacerbation of the "bloated retail inventory
imbalances which, throughout the Class Period, kept Revlon from
realizing the full amount of customer acceptance of Revlon
products." (Compl. ¶¶ 2, 8).
In order to maintain Revlon's ability to refinance its debt,
defendants allegedly tried to make Revlon appear to be in better
financial health than it actually was. Specifically, plaintiffs
allege that defendants fraudulently: (1) overstated Revlon's
sales through accounting practices that violated generally
accepted accounting principles or Revlon's own revenue
recognition policy; (2) failed to disclose and falsely denied the
"trend" that Revlon, in order to prop up short-term sales, was
selling more merchandise to retailers than retailers were selling
to consumers; and (3) hid or downplayed the extent to which
Revlon's retail channels remained bloated with merchandise.
Potential buyers, refinanciers, and the stock market were thereby
misled by material misstatements and omissions into believing the
company was much healthier than it was until Revlon revealed the
true state of its finances.
The complaint alleges that on October 1, 1999 Revlon revealed
the true state of its finances when it "shocked the market" by "admitt[ing]" that "it
had not previously reduced the amount of its inventory of Revlon
product in the channel as it had represented and had `decided to
accelerate the reduction of U.S. retailers' warehouse inventory
levels.'" (Compl. ¶¶ 79-80). Plaintiffs further quote Revlon's
October 1 press release as "admitt[ing]" that "`instead of the
originally planned gradual reduction, the Company plans to
achieve the accounts' new, lower inventory targets by reducing
the level of shipments through year end.[']" (Compl. ¶ 80).
Revlon also announced an "operating loss before restructuring
charges of between $70 million and $80 million for 1999 and a
third quarter net loss before restructuring charges of
approximately $3.10 to $3.20." (Compl. ¶ 80). The complaint
alleges that, as a result of this press release, Revlon stock
declined "even further" to "below $12 per share." (Compl. ¶ 80).
C. The Fraud Allegations
Plaintiffs allege a series of actions taken by defendants to
show that they were intentionally inflating Revlon's revenue and
manipulating its accounting.
The complaint lists these specific allegations regarding
Revlon's sales and accounting practices during the Class Period
(Compl. ¶¶ 20-32):
1. Aggressively Selling Products
According to the complaint, "[a] former Special Projects
Manager at Revlon" reports that "during 1998 and 1999" Revlon was
"forcing an excessive amount of products" on its retailers.
(Compl. ¶ 21(d)). Revlon maintained difficult-to-meet quarterly
sales quotas that frustrated its huge sales force and upset its
overstocked retail clients. (Compl. ¶ 21(d), (o), (r)). In
particular, "[a]t one point," a customer named Sally Beauty
Supply ordered Revlon to cease product shipments because it did
not have any room to store excess Revlon products. (Compl. ¶ 21
(e)). A former Revlon Territory Sales Manager who believed that
Revlon's quotas were "excessive and unrealistic" reported that
managers in Miami were told in 1998 and 1999 to "load" their
retail customers with inventory at the end of each quarter and at
year's end. (Compl. ¶ 21(g)). Those customers in turn would use
Revlon's desire to sell great quantities at quarter's end to
negotiate better deals. (Compl. ¶ 21(g), (p), (q), (r)).
Plaintiffs allege that, as a result of this practice, quarters
during the Class Period became "more and more back-end loaded."
(Compl. ¶ 21(f)).
2. Offering Promotions, Discounts, Rebates
The complaint alleges that Revlon oversupplied its retailers by
"offering promotions, special deals, rebates and marketing
incentives." (Compl. ¶¶ 5, 21(o)-(r), 29, 91). In particular,
plaintiffs allege that during relevant time periods, one
Territorial Sales Manager stated that she "was advised to offer
retail customers discounts . . . to encourage large orders,"
something "she did not think . . . was standard practice within
the industry." (Compl. ¶ 21(g)). Indeed, "[i]t was widely known
in the industry that large retail chains, such as Rite-Aid and
CVS, would receive a cash discount for agreeing to purchase large
amounts of product before the end of the quarter." (Compl. ¶
21(o)). "[L]ater in 1998," the complaint alleges, retail
customers "could buy one Revlon item and receive a second Revlon
item free." (Compl. ¶ 29).
3. Shipping Products Early
Revlon allegedly disregarded shipment dates requested by
customers and shipped products earlier. (Compl. ¶ 21(b), 22(a)).
In particular, plaintiffs allege that, at some unspecified time,
Safeway received "many shipments" that Safeway had either not
even ordered or "requested to be shipped at a later date."
(Compl. ¶ 22(a)). As a result, "at a later date," Safeway posted signs at its stores stating, "`Do not accept shipments
from Revlon.'" (Compl. ¶ 22(a)). Still "[l]ater in 1998,"
Safeway's southern California stores stopped purchasing from
Revlon altogether. (Compl. ¶ 22(a)). Moreover, "[i]n December
1998, Revlon shipped to the Fred Meyer Co. . . . orders which
Fred Meyer Co. had asked to be shipped in January and February
1999." (Compl. ¶ 21(b)).
4. Granting Rights of Return
Revlon is further said to have provided "unlimited rights of
return" that would allow retail customers to keep excess product
that they received at the end of quarters and return it at a
later date. (Compl. ¶¶ 21(h), 22(c), 89). Specifically, "[d]uring
the Class Period,"*fn2 Revlon allegedly "rolled out [its new
Ultima II line] to Longs Drugstores" with "a right to return the
merchandise after one year." (Compl. ¶ 21(h)). In 1999, Longs
Drugstores returned "much of the Ultima II merchandise" it had
purchased. (Compl. ¶ 21(h)).
5. Delaying Issuing Credits to Customers
Plaintiffs charge Revlon with delaying issuance of credit to
customers who returned products. (Compl. ¶¶ 21(i), 22(a), 24-26).
In particular, "a former employee stated that credits to
customers were often delayed, particularly if a merchandise
return was made in October or November." (Compl. ¶ 21(i)).
Moreover, Revlon allegedly contracted with Genco Distribution
System ("Genco"), a third-party return center located in
Maryland, to process and hold returned product. (Compl. ¶ 24). A Revlon employee named Stan Hirsh, who
spent several days per week on site at Genco, directed Genco to
hold pristine product returns for long periods of time before
shipping them back to Revlon manufacturing centers for
redistribution, thus delaying the issuance of credits by Revlon.
(Compl. ¶ 25). In October 1998, Genco received thirty pallets of
Revlon merchandise from Marc Glassman, Inc., a return allegedly
containing enough product to supply the needs of more stores than
were in the Glassman chain. This return was held at Genco for
months before it was shipped to a Revlon manufacturing center, as
was a trailer load of lipstick returned from Israel in "early
1999." (Compl. ¶ 26).
6. Bill and Hold: Shipping Products After Billing
According to the complaint, not only did Revlon ship products
early, it shipped them late, after the end of the quarter in
which the sales were booked. (Compl. ¶ 21(a)). This allegation is
based on statements of former Revlon employees that Revlon
"rented storage facilities and loaded its semi trailers with
merchandise which had not been ordered by its customers" and then
engaged in "`bill and hold' practices pursuant to which customers
were billed for product which had not been shipped and which
remained in Revlon's control." (Compl. ¶¶ 21(a),(c)).
7. Booking Non-Existent Sales
The complaint also claims that Revlon booked as sales shipments
that no one had ordered. (Compl. ¶¶ 22(a), 89). This allegedly
may have occurred in recordings of sales to Safeway at some
unidentified time in 1998. (Compl. ¶ 22(a)).
Plaintiffs turn all of the alleged conduct, set forth above,
into a mantra of fraud repeated at the end of each paragraph of
the complaint which arguably contains a "statement" in an attempt
to meet the PSLRA requirement that the complaint "specify . . .
the reason or reasons why the statement is misleading." 15 U.S.C. § 78u-4(b)(1). The
paragraph that repeats those allegations, based on the allegedly
fraudulent conduct, is as follows:
These statements were materially false and
misleading, and were known by the Defendants to be
materially false and misleading at the time of their
publication, or were recklessly disregarded as such,
because the Defendants were manipulating the
Company's reported revenue, operating income, net
income, and EBIDTA [earnings before interest, taxes,
depreciation, and amortization], by actively stuffing
the channel with inventory that customers had not
ordered, recording as sales shipments to Revlon's own
warehouses, delaying recording credits being issued
to the customers, realizing "sales" that did not
qualify as recognizable revenue, and engaging in
improper bill and hold transactions.
(Compl. ¶¶ 36, 39, 45, 50, 52, 54, 56, 58, 60, 65, 68, 72, 74,
D. Misleading Statements
As set forth above, in order to state a claim for violation of
the securities laws based on fraudulent misstatements or
omissions, plaintiffs are required to "specify each statement
alleged to have been misleading." PSLRA, 15 U.S.C. § 78u-4(b)(1).
Plaintiffs have provided a farrago of statements, allegedly
rendered misleading in light of the defendants various fraudulent
practices with respect to manipulating revenue, by quoting at
length from the "reported revenue, operating income, net income,
and EBITDA" contained in Revlon's SEC filings during the Class
Period and the commentary in those filings, company press
releases, and articles from the business and popular press,
occasionally using boldfaced type to emphasize those allegations.
Below, the Court has summarized the statements that plaintiffs
have attributed to defendants in chronological order. Where
appropriate, the Court has placed the statements in their
original context. See San Leandro Emergency Med. Group Profit
Sharing Plan v. Philip Morris Cos., 75 F.3d 801, 808-09 (2d Cir.
1996); Kramer v. Time Warner, Inc., 937 F.2d 767, 773-74 (2d
Cir. 1991). In addition to these alleged misstatements, plaintiffs have
identified one specific omission which they believe Revlon had a
duty to disclose to the market: the Class Period "trend" that
"sales by Revlon to its customers (into the channel) greatly
exceeded sell-through (sales by its customers out of the
channel)." (Compl. ¶ 98(d)).
1. October 2, 1998 Press Release: Statements 1-5
The consensus analyst estimate for the third quarter of 1998
was that Revlon would have $635 million in net sales and $0.73 in
earnings per diluted share. (Compl. ¶ 33). On the first day of
the Class Period, October 2, 1998, Revlon announced that third
quarter results would fall materially short of those
expectations. (Compl. ¶ 3). Revlon would have only $540 million
in net sales and only $0.07 in earnings per diluted share.
(Compl. ¶ 3).
Fellows explained in Revlon's press release that a "number of
factors" had adversely affected Revlon's domestic business:
Among them are a slowdown in the rate of growth in
the mass market color cosmetics category as well as a
greater than expected seasonal flattening of share
caused by a shift in advertising and promotional
activity and delays in some product introductions. At
the same time, retailers, particularly chain
drugstores, driven by recent consolidation, are
pursuing efficiencies by reducing inventory levels.
The other factors mentioned by Fellows were "the aggregate effect
of the weak international economic environment" and "weakness in
foreign currencies." (Glekel Decl. Ex. A).
The company announced a $50 million restructuring to include
"the closing of three international plants, a reorganization of
the Company's workforce principally outside of the U.S., and
other actions designed to reduce costs." Fellows estimated that
the restructuring would "result in annual benefits in the range
of $25 to $30 million." (Glekel Decl. Ex. A).
Fellows, while acknowledging that "the anticipated results for
the second half of the year are very disappointing," nevertheless maintained that "the
longer-term outlook for our Company continues to be extremely
positive, despite significant challenges in the marketplace"
("Statement 1"). He asserted that "[t]he business fundamentals of
our Company are strong" ("Statement 2") and noted, in that
respect, the strength of the company's Revlon and Almay brands,
that the company's "program to broaden distribution of our Ultima
II line is showing significant strength" ("Statement 3"), and
that Revlon "expect[s] that as retail inventories are stabilized,
our growth will again outpace category growth" ("Statement 4").
Fellows concluded by reaffirming Revlon's business strategy:
"[d]espite the challenges we now face," he was quoted, "we are
confident that our long-term outlook remains positive and we
intend to pursue the fundamental business strategy that fueled
our success to date" ("Statement 5"). (Compl. ¶ 3; Glekel Decl.
The October 2 press release labeled some statements therein as
"forward-looking statements" made pursuant to the safe harbor
provisions of the PSLRA, including "the Company's expectation
that once retailer efficiencies have been achieved, growth will
outpace category growth." Revlon also noted several factors that
"could cause actual results to differ materially from those
expressed in the forward-looking statements," including "less
than expected growth after retailer efficiencies have been
realized." (Glekel Decl. Ex. A).
2. October 28, 1998 Press Release: Statements 6 and 7
On October 28, 1998, another Revlon press release confirmed
third quarter results in line with the October 2 estimates.
(Compl. ¶ 38). "Net sales," Revlon reported, "were $548.6 million
for the third quarter of 1998, compared to $581.0 million for the
third quarter of 1997," a decline of 3.5% on a constant U.S.
dollar basis. (Glekel Decl. Ex. B). Fellows reiterated that Revlon's "business fundamentals are
strong and our outlook for the future continues to be positive"
("Statement 6"). He said, again, that Revlon would address the
challenges it faced including the "slowdown," the "seasonal
flattening," "delays in some product introductions," and
retailers' reductions of inventory levels "by pursuing the same
business strategy that fueled our success for the prior 19
quarters and through restructuring efforts we have already
announced . . ." ("Statement 7"). The release also warned that
Revlon "expects retail inventory balancing and reductions to
affect sales in the fourth quarter and in 1999." (Compl. ¶ 38;
Glekel Decl. Ex. B).
The October 28 release identified "the effect on sales of
retail inventory balancing and reductions" as a "forward-looking
statement" made pursuant to the safe harbor provisions of the
PSLRA. Revlon warned that "lower than expected sales as a result
of a longer than expected duration of retail inventory balancing
and reductions" might "cause actual results to differ materially
from those expressed" in the statement. (Glekel Decl. Ex. B).
3. Third-Quarter 1998 10-Q
Revlon filed its third quarter Form 10-Q on November 17, 1998.
The filing repeated the figures for net sales, EBIDTA, operating
income, and net income quoted in Revlon's October 28 press
release. It identified "the affect on sales of retail inventory
balancing and reductions" as a forward-looking statement whose
predictive value could be undermined by, among other things,
"lower than expected sales as a result of a longer than expected
duration of retail inventory balancing and reductions." (Glekel
Decl. Ex. C at 18).
4. January 11, 1999 Press Release: Statements 8 and 9
On January 11, 1999, Revlon announced that it was "expanding
its restructuring program, originally announced in October, to further increase efficiencies
and enhance the Company's competitive positioning." (Glekel Decl.
Ex. D). The "[a]dditional restructuring" announced that day
"include[d] manufacturing reconfigurations, personnel
realignments and reductions, the disposition of resultant excess
real estate, realignment and consolidation of regional activities
and other cost saving measures." (Compl. ¶ 48).
Fellows commented that Revlon was taking "major steps to
re-engineer" Revlon: "By realigning our resources to more closely
match the changing needs of our customers, we are building our
business for the future" ("Statement 8"). (Compl. ¶ 48). Fellows
blamed "a number of factors" for 1998 results, "including
weaknesses in the international economic environment and
continued domestic inventory consolidations." (Compl. ¶ 48).
Noting that "[w]e expect results in the first half of 1999 to
continue to be affected by inventory reductions and uncertainty
in the international economic environment," he also expressed
confidence "that 1999 will show improved growth after customer
inventories are reduced to targeted levels during the first half"
("Statement 9"). (Compl. ¶ 48). The January 11 release tagged the
statement about expected 1999 results as forward-looking and
cautioned that "delays in achieving or lower than expected growth
after customer inventories are reduced to target levels" could
upset that expectation. (Glekel Decl. Ex. D).
5. January 12, 1999 Statement: Statement 10
On January 12, 1999, an article in Capital Cities Media, Inc.
quoted Fellows. (Compl. ¶ 51). According to the article, Fellows
"said that during the course of mapping out last fall's
retrenchment [of Revlon], `opportunities presented themselves to
make some additional savings and allow us to realign our supply
chain to more closely relate to our customers. Not only can we save money but service our customers better'" ("Statement
10"). (Compl. ¶ 51).
6. January 28, 1999 Press Release: Statements 11-13
On January 28, 1999, Revlon announced full-year and fourth
quarter results for 1998. (Compl. ¶ 53). The company reported net
sales in the fourth quarter of $630.5 million, "a decrease of
1.5% compared with the fourth quarter of 1997 on a reported basis
or a decrease of 0.4% on a constant U.S. dollar basis." (Compl. ¶
53). Full-year 1998 sales were reported to have "increased 0.6%
to $2.25 billion on a reported basis, or 2.7% on a constant U.S.
dollar basis." (Glekel Decl. Ex. E at 5).
The January 28 announcement also confirmed that "Revlon
continues to implement its previously announced restructuring
program" which, it said, "is expected to provide estimated
annualized savings in the range of $30 million to $40 million."
It stated that Revlon "is realigning the ways it does business to
better serve its customers" ("Statement 11") by, "among other
items," developing a "new strategic plan to maximize the
potential of the Revlon brand equity, build the Company's
portfolio of brands, and expand its relationships with key
retailers." Fellows, citing increased market share and the
success of the Revlon, Almay, and Ultima II brands, was quoted as
assuring the market that "Revlon's fundamentals remain strong"
("Statement 12"). Finally, Fellows expressed "confiden[ce] that
our recently announced restructuring program will better align
our business processes with a dynamic market" ("Statement 13").
(Compl. ¶ 53).
7. January 1999 to March 1999: Statements 14 and 15
On January 29, 1999, Capital Cities Media, Inc. reported that
Revlon's fourth quarter 1998 earnings per share were ahead of
Wall Street's average estimate. (Compl. ¶ 55). The complaint alleges that Fellows was quoted in the article as
follows: "`The second half of 1998 was an aberration. . . . with
[sic] this restructuring, we've been bettering the processes of
the company. If you plan it properly, it tends to fall into
place, [sic] At the end of the day, you end up with a better
operation. . . .'" ("Statement 14"). (Compl. ¶ 55). In addition,
the March edition of Soap, Perfumery & Cosmetics reported that
Fellows had "attributed some of Revlon's problems to a slowing of
sales, citing numbers from October that revealed industry growth
had slowed from double digits to 8%" ("Statement 15"). (Compl. ¶
8. 1998 Form 10-K
On March 3, 1999, Revlon filed its 1998 Form 10-K, in which it
repeated the figures for net sales, EBITDA, operating income, and
net income that it had set forth in its January 28, 1999 press
release. (Compl. ¶ 59). Under the heading "Net Sales," Revlon
warned that it "expects retail inventory balancing and reductions
to continue to affect sales in 1999." (Glekel Decl. Ex. F. at
16). Revlon identified any statement as to the "effect on sales
of retail inventory balancing and reductions" as a
forward-looking statement whose accuracy could be undercut by
"lower than expected sales as a result of a longer than expected
duration of retail inventory balancing and reductions." (Glekel
Decl. Ex. F. at 25-26).
9. April 7, 1999 Announcement
On April 7, 1999, Revlon announced that it would undertake "a
review of strategic alternatives available to it to maximize
shareholder value." One alternative it said it would look into
was the sale of one or more businesses of the company. Revlon
anticipated using the proceeds of such a sale to pay down
indebtedness. (Compl. ¶ 61).
10. April 26, 1999 Interview with Fellows: Statements 16-18 Chain Drug Review interviewed Fellows on April 26, 1999.
Fellows reportedly said that "Revlon is going to continue to
drive category growth, and we believe it's going to continue to
gain share as it has for so long" ("Statement 16"). He also
allegedly maintained that "[t]he Company is well on the way to
overcoming the inventory problems many of which were beyond our
control that set us back last year, leaving us to pursue chain
drug, discount and supermarket sales with our proven formula for
success" ("Statement 17"). Fellows did not think that the sale of
one or more parts of Revlon's business was "imperative" for
Revlon to "convince Wall Street to get the valuation of the
company back where it belongs" ("Statement 18"). (Compl. ¶ 64).
11. April 29, 1999 Press Release: Statement 19
On April 29, 1999, Revlon released its financial results for
the first quarter of 1999. (Compl. ¶ 66). "In the first quarter,"
the company reported, "net sales were $441.1 million, a decrease
of 11.4% compared with the first quarter of 1998 on a reported
basis or a decrease of 8.8% on a constant U.S. dollar basis."
(Compl. ¶ 66). Fellows explained that, "[a]s expected, our sales
were adversely impacted by continuing reductions of retailer
inventories, as well as slower than anticipated category growth
through most of the quarter." (Glekel Decl. Ex. G). The press
release also contained the following paragraph ("Statement 19"):
"Our fundamentals are strong: Revlon is one of the
world's best known brand names in cosmetics. It
stands for high-quality, innovative products and
marketing expertise that has helped to create one of
the strongest cosmetics franchises in the world,"
said Fellows. "These fundamental strengths will
continue to fuel growth for Revlon."
(Compl. ¶ 66). The release identified "the Company's expectations
that its fundamental strength will continue to fuel growth" as a
forward-looking statement subject to "difficulties or delays in realizing future growth from the Company's fundamental
strengths." (Glekel Decl. Ex. G).
12. First Quarter 1999 10-Q
On May 17, 1999, Revlon filed its Form 10-Q for the first
quarter of 1999, which repeated the figures for net sales,
EBIDTA, operating income, and net income announced in its April
29 press release. (Compl. ¶ 67). Revlon warned that it
"expect[ed] retail inventory balancing and reductions to continue
to affect sales in 1999." (Glekel Decl. Ex. H at 9). It also
identified "the effect on sales of retail inventory balancing and
reductions" as a forward-looking statement subject to "lower than
expected sales as a result of a longer than expected duration of
retail inventory balancing and reductions." (Glekel Decl. Ex. H.
13. July 27, 1999 Press Release
Revlon announced its results for the second quarter of 1999 on
July 27, 1999. (Compl. ¶ 71). "Net sales in the second quarter,"
according to the company, "were $553.4 million, a decrease of
3.8% compared with the second quarter of 1998 on a reported basis
or a decrease of 1.2% on a constant U.S. dollar basis." (Compl. ¶
71). Revlon warned that slow category growth and lowered
inventory targets established by the trade in the United States
"will extend the time needed to absorb the effects of inventory
rebalancing." (Glekel Decl. Ex. I). The company also identified
its "assessment of retailers' inventory targets and the time
needed to reverse the effects of inventory rebalancing and the
Company's anticipation of a stronger second half of 1999" as
forward-looking statements subject to several contingencies.
(Glekel Decl. Ex. I).
In the same press release, Revlon stated that it was "actively
engaged in ongoing discussions with potential purchasers of all
or part of the Revlon business." (Compl. ¶ 71).
14. Second Quarter 1999 10-Q Revlon recapitulated its second quarter results on August 16,
1999, when it filed its second quarter Form 10-Q:
Net sales [in millions] were $553.4 and $575.3 for
the second quarters of 1999 and 1998, respectively, a
decrease of $21.9, or 3.8% on a reported basis (a
decrease of 1.2% on a constant U.S. dollar basis),
and were $994.5 and $1,073.1 for the first half of
1999 and 1998, respectively, a decrease of $78.6, or
7.3% on a reported basis (a decrease of 4.7% on a
constant U.S. dollar basis).
(Compl. ¶ 76). Revlon explained that, in the United States,
"[n]et sales for the second quarter and first half of 1999 were
adversely affected by continuing adjustments in inventory levels
by retailers, slower than anticipated category growth and
competitive activities." (Glekel Decl. Ex. J at 9). The company
warned that it "expects retail inventory balancing and reductions
to continue to affect sales in 1999." (Glekel Decl. Ex. J at 9).
15. The October 1, 1999 Disclosure
On October 1, 1999, Revlon allegedly "shocked the market" by
issuing a press release which announced (1) that Revlon had
"determined not to sell its remaining cosmetics, personal care,
fragrances and skin treatment businesses," (2) that Revlon did
intend to pursue the sale of its worldwide Professional Products
business and its non-core Latin American brands, and (3) the
following, which concerns retailer inventory imbalances:
[W]orking with its customers, the Company has decided
to accelerate the reduction of U.S. retailers'
warehouse inventory levels. Instead of the originally
planned gradual reduction, the Company plans to
achieve the accounts' new, lower, inventory targets
by reducing the level of shipments through year end.
During this process, the Company intends to maintain
its previously announced step up in second half
spending, designed to drive consumer purchasing and
facilitate the inventory reduction process.
George Fellows, President and CEO, said, "For the
past year, the issue of retail inventory imbalances
has kept the Company from realizing the full benefit
of the continuing consumer acceptance of Revlon
products. In order to allow the efficient
introduction of new products into the marketplace, we
decided to work with our retail partners to put this
issue behind us now by foregoing planned sales of
both new and established products amounting to approximately $280
million for the third and fourth quarters of 1999 to
reduce inventories in accordance with our accounts'
months' supply target levels."
These actions adversely affected third quarter
results and will also adversely impact the fourth
quarter. Because of this, combined with lower than
expected volume and worsening economic conditions in
key international markets, the Company said it now
expects a 1999 full year operating loss before
restructuring charges of between $70 million and $80
million versus earlier forecasts. The Company now
expects a third quarter 1999 net loss before
restructuring charges of approximately $3.10 to $3.20
per diluted share, net sales of approximately $435 to
$450 million, and operating loss before restructuring
charges of approximately $120 to $125 million. As a
result, the Company will not be in compliance with
certain of the financial covenants under its existing
Credit Agreement. The Company has begun discussions
with its bank lenders and is confident of amending
the Agreement on satisfactory terms. . . .
(Compl. ¶ 79).
A. Standard of Review
In most civil cases, a complaint will survive a Rule 12(b)(6)
motion to dismiss for failure to state a claim upon which relief
can be granted unless, after accepting all of the well-pleaded
facts as true and drawing all reasonable inferences in favor of
the plaintiffs, "it appears beyond doubt that the plaintiff can
prove no set of facts in support of his claim which would entitle
him to relief." Conley v. Gibson, 355 U.S. 41, 45-46 (1957).
"However, bald contentions, unsupported characterizations, and
legal conclusions are not well-pleaded allegations, and will not
suffice to defeat a motion to dismiss." Citibank, N.A. v. Itochu
Intern. Inc. 2003 WL 1797847, *1 (S.D.N.Y., 2003) (citing Leeds
v. Meltz, 85 F.3d 51, 53 (2d Cir. 1996)).
In deciding a motion to dismiss, the Court may deem a complaint
to include "any written instrument attached to it as an exhibit
or any statements or documents incorporated in it by reference, as well as public disclosure documents required by law
to be, and that have been, filed with the SEC, and documents that
the plaintiffs either possessed or knew about and upon which they
relied in bringing the suit." Rothman v. Gregor, 220 F.3d 81,
88-89 (2d Cir. 2000) (internal citations omitted).
B. Section 10(b) Claims
To state a claim for relief pursuant to Section 10(b) of the
Exchange Act and Rule 10b-5 promulgated thereunder, a plaintiff
must allege that "the defendant, in connection with the purchase
or sale of securities, made a materially false statement or
omitted a material fact, with scienter, and that the plaintiff's
reliance on the defendant's action caused injury to the
plaintiff." Ganino v. Citizens Utils. Co., 228 F.3d 154, 161
(2d Cir. 2000); accord Suez Equity Investors, L.P. v. Toronto
Dominion Bank, 250 F.3d 87, 95 (2d Cir. 2001). Moreover, a
plaintiff alleging securities fraud in violation of those
provisions must satisfy the heightened pleading requirements of
the PSLRA and Fed.R.Civ.P. 9(b). In re Scholastic Corp. Sec.
Litig., 252 F.3d 63, 69-70 (2d Cir. 2001). Rule 9(b) provides
that in all averments of fraud "the circumstances constituting
fraud . . . shall be stated with particularity." This means that
a securities fraud complaint "must `(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.'" Novak v.
Kasaks, 216 F.3d 300, 306 (2d Cir. 2000) (internal citations
omitted). Moreover, read together, Rule 9(b) and the PSLRA
mandate that "plaintiffs must allege . . . fraudulent acts and
scienter . . . with particularity." Elliott Assocs. L.P. v.
Hayes, 141 F.Supp.2d 344, 353 (S.D.N.Y. 2000); see also
Rombach v. Chang 355 F.3d 164, 172 (2d Cir. 2004); In re
Bristol-Myers Squibb Sec. Litig., 312 F.Supp.2d 549, 556-557
(S.D.N.Y. 2004). The PSLRA "does not require that plaintiffs plead every single
fact upon which their beliefs concerning false or misleading
statements are based." Novak, 216 F.3d at 313. However, it does
require the facts alleged to be "sufficient to support a
reasonable belief as to the misleading nature of the statement or
omission." Id. at 314 n. 1; In re Scholastic Corp. Sec.
Litig., 252 F.3d 63, 75 (2d Cir. 2001) (plaintiffs must "plead
with particularity sufficient facts to justify [their] beliefs");
see also ABC Arbitrage Plaintiffs Group v. Tchuruk,
291 F.3d 336, 354-59 (5th Cir. 2002); Rothman v. Gregor, 220 F.3d 81,
89-92 (2d Cir. 2000).
Plaintiffs must also comply with the pleading requirements of
Rule 9(b) and the PSLRA when alleging that defendants acted with
scienter, or fraudulent intent, in order to show "why the
statements were fraudulent." Novak v. Kasaks, 216 F.3d at 306.
Plaintiffs can establish the requisite "strong inference of
fraudulent intent" either (a) by demonstrating "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." Kalnit v. Eichler,
264 F.3d 131, 138-39 (2d Cir. 2001) (quoting Novak,
216 F.3d at 307, and Acito v. IMCERA Group, Inc., 47 F.3d 47, 52 (2d Cir.
1995), respectively) (quotation marks omitted).
In this case, the Court construes the complaint to allege that
Revlon misled the market in three ways: (1) by inflating Revlon's
reported sales and revenue through various improper accounting
techniques; (2) by failing to disclose that Revlon's improper
short-term revenue inflation practices and channel stuffing were
causing retailers' inventory imbalances to grow and would, in the
longer run, force the company to forego significant sales; and
(3) by using optimistic public statements to mask the retailer
Defendants agree with plaintiffs that there was an inventory
problem during the Class Period; indeed, defendants are eager to point out that they
repeatedly warned the market that the inventory problem might
continue to affect sales. Therefore, defendants deny that they
made material false statements. Specifically, defendants argue
that the complaint fails to state with sufficient particularity
facts that support a reasonable belief that Revlon (1) overstated
sales by engaging in improper accounting and (2) exacerbated the
inventory problem through its short-term revenue inflation
practices. With respect to the inventory problem itself, the
defendants contend (3) that, as a matter of law, their public
statements were simply too immaterial to have misled the market.
1. Improper Revenue Recognition
The improper accounting allegations relate to the sales figures
(and reported revenue, operating income, net income, and EBITDA)
that Revlon reported in its press releases and SEC filings. The
complaint claims that Revlon overstated its sales during the
Class Period by engaging in practices that breached Generally
Accepted Accounting Principles ("GAAP") or its own stated revenue
recognition policy. Because plaintiffs make this allegation on
information and belief, the PSLRA requires them to state facts
with a degree of particularity sufficient to support a reasonable
belief that Revlon was in fact overstating sales through improper
accounting. Rombach v. Chang 355 F.3d 164, 170 (2d Cir. 2004)
(Thus, plaintiff must "specify each statement alleged to have
been misleading, the reason or reasons why the statement is
misleading, and, if an allegation regarding the statement or
omission is made on information and belief, the complaint shall
state with particularity all facts on which that belief is
formed.") (quoting 15 U.S.C. § 78u-4(b)(1)) (quotation marks
omitted). In addition, they must state with sufficient
particularity facts constituting strong circumstantial evidence
that defendants were overstating sales with scienter. See Rothman,
220 F.3d at 90-91 (citing 15 U.S.C. § 78u-4(b)(2)). Because defendants are
unlikely to have overstated sales in the manner alleged without
being aware of it, the misrepresentation and scienter inquiries
are essentially combined. See id. at 90.
The Rothman case provides some guidance as to the degree of
particularity required to support a reasonable belief that a
defendant has engaged in misleading accounting. In Rothman, the
defendant corporation, GT Interactive Software Corp. ("GT"),
underwrote the software development costs of small independent
software developers by advancing them the royalty payments they
expected to earn on future sales of software. See id. at
84-85. The plaintiffs alleged that GT misleadingly inflated its
earnings by not expensing advances for particular software titles
even after concluding that royalty advances for those titles were
unlikely to be recouped by future sales. See id. at 89. With
respect to the PSLRA's particularity requirements, the court held
that GT's public financial statements which themselves
indicated that GT's total capitalized royalty advances increased
by the same amount as its new royalty advances sufficiently
supported the inference that GT was not expensing any royalty
advances at all. See id. Moreover, the court held that three
other allegations were sufficiently particularized to support the
inference that GT was at least reckless to the fact that royalty
advances were not likely to be recouped through sales: (1) poor
sales of most of GT's software, in comparison with the amount of
royalties advanced (as demonstrated by domestic sales figures
from a market research firm and the names and sales figures for
several front-line software titles); (2) GT's efforts to collect
royalty advances from the software developers (as demonstrated by
four lawsuits in which GT sought to recover almost forty-four
percent of the royalty advances it had capitalized); and (3) GT's
sudden decision at the end of the class period to expense over
eighty-four percent of the royalty advances it had previously capitalized.
See id. at 90-92.
In other words, plaintiffs must provide at the very least some
level of detail about the improper accounting alleged to underlie
misleading statements, and their materiality, in order to survive
the motion to dismiss phase. See e.g. In re AOL Time Warner,
Inc. Sec. and "Erisa" Litig., 2004 WL 992991, *12 (S.D.N.Y. May
5, 2004) (Allegations sufficiently particular to survive a motion
to dismiss where "the Amended Complaint contains the date of the
transaction at issue, the amount of the allegedly overstated
revenue, preliminary details of the accounting for the
transaction, and a basis for believing the accounting may have
a. Misrepresentation and Scienter
Here, plaintiffs ground their allegations that defendants made
material misrepresentations on claims that defendants took
certain actions to inflate sales and reported revenue. Thus,
plaintiffs conclude that because Revlon intentionally inflated
sales figures, defendants knew that their statements about sales,
based on the inflated figures, were false.
Plaintiffs are attempting to meet the scienter requirement by
pleading circumstantial evidence of defendants' knowledge that
the information in its misstatements were false. "To meet this
strong circumstantial evidence standard, plaintiffs must
`specifically alleg[e] defendants' knowledge of the facts or
access to information contradicting their public statements." In
re Bristol-Myers Squibb Securities Litigation,
312 F. Supp. 2d 549, 562 (S.D.N.Y. 2004) (quoting Faulkner v. Verizon
Communications, Inc., 189 F. Supp. 2d 161, 172 (S.D.N.Y. 2002)
(alteration in original).
The allegation that Revlon overstated sales through improper
accounting is supported through the juxtaposition of two "facts"
which they allege on information and belief: first, as demonstrated by certain transactions identified in the complaint,
the fact that Revlon engaged in a series of sales practices that
are susceptible to misleading accounting, and, second, as
demonstrated by Revlon's October 1, 1999 announcement, the fact
that Revlon was forced to forego $280 million in sales at the end
of the Class Period. Plaintiffs vaguely suggest that the ultimate
sales shortfall, when considered in light of the sort of sales
transactions in which Revlon was engaging, indicates that Revlon
must have been engaging in the improper accounting. There is no
question that the existence of the sales drop-off can reasonably
be inferred from the October 1, 1999 announcement. Even so, the
accounting abuses, and the manner in which they contributed to
the sales drop-off, are not alleged with a degree of detail
sufficient to support a reasonable belief that Revlon actually
engaged in them during the Class Period. See Greebel v. FTP
Software, Inc., 194 F.3d 185, 203 (1st Cir. 1999); cf.
Aldridge v. A.T. Cross Corp., 284 F.3d 72, 80-81 (1st Cir.
The first allegedly fraudulent practice mentioned in the
complaint is the shipping and booking of unordered sales.
Plaintiffs support the allegation that Revlon engaged in this
practice only with the statement that Revlon's customer Safeway,
at some unspecified time in 1998 (but apparently prior to "later
in 1998"), "received many shipments which had not been ordered or
which had been requested to be shipped at a later date." (Compl.
¶¶ 21(a), 22(a), 89). This allegation is deficient for at least
two reasons. First, the complaint's use of the disjunctive "or"
greatly diminishes its probative value, as shipping a shipment
early is entirely different than shipping an unordered shipment.
Second, although plaintiffs are not necessarily required to
reveal the identity of the personal sources of their factual
allegations, see Novak, 216 F.3d at 312-13; In re Philip
Services Corp. Securities Litigation, No. 98 CIV. 0835, 2004 WL
1152501, at *12-13 (S.D.N.Y. May 24, 2004), the factual allegations must
themselves, in their particularity, "provide an adequate basis
for believing that the defendants' statements were false,"
Novak, 216 F.3d at 314. This allegation, supported only by the
one detail as to the identity of the customer, also fails to
provide an adequate basis for believing that Revlon acted
knowingly in such a way as to enable it to materially overstate
its sales by recognizing sales that had never even occurred.
A second practice that plaintiffs believe circumvented GAAP or
Revlon's stated revenue recognition policy is the practice of
billing customers for product and then holding the product in
Revlon warehouses for a period of time before shipping it (the
"bill and hold" allegation). Plaintiffs suspect that this
occurred based on the following information: "[f]ormer Revlon
employees have stated that," at some unspecified date, "Revlon
engaged in `bill and hold' practices pursuant to which customers
were billed for product which had not been shipped and which
remained in Revlon's control." (Compl. ¶¶ 21(c), 21(a)). However,
affixing the phrase "former employees have stated" to this
otherwise totally unparticularized allegation does not transform
it into an allegation that meets the particularity requirements
of the PSLRA. In order for plaintiffs to rely upon confidential
sources to meet the pleading requirements of the PSLRA, those
sources must be "described in the complaint with sufficient
particularity to support the probability that a person in the
position occupied by the source would possess the information
alleged." Novak, 216 F.3d at 314; In re Atlas Air Worldwide
Holdings, Inc. Sec. Litig., 324 F.Supp.2d 474, 493 (S.D.N.Y.
July 7, 2004). This case is unlike In re Initial Public Offering
Sec. Litig., 220 F.R.D. 30, 32 n. 4 (S.D.N.Y. Oct 30, 2003)
where plaintiffs were permitted to rely on confidential sources,
but the allegations were also supported by overwhelming
corroboration in statements alleged by plaintiffs. Here, the absence of any
particulars "is indicative of . . . excessive generality."
Greebel, 194 F.3d at 204.
A third practice alleged in the complaint that gave Revlon the
ability to engage in accounting abuse is that Revlon allowed
customers the right to return excess product. For example, Revlon
allegedly "rolled out [its new Ultima II line] to Longs
Drugstores" with "a right to return the merchandise after one
year," a right which Longs exercised in 1999 for "much" of the
Ultima II merchandise it had purchased. (Compl. ¶ 21(h), 22(c)).
Granting a right of return, however, is not fraudulent unless the
seller fails to disclose the practice or, if it is disclosed,
fails to maintain adequate reserves for expected returns in
accordance with GAAP or the company's stated revenue recognition
policy. See Greebel, 194 F.3d at 205. Plaintiffs' allegations
that Revlon's returns contractor, Genco, received "extremely high
levels of returns" in "late 1998 and 1999," including a large
return from Marc Glassman, Inc. in October 1998, (Compl. ¶¶
24-26), do not raise a sufficient inference that Revlon's overall
reserves for returns were recklessly inadequate. Nor does the
complaint contain an allegation that Revlon acted to inflate its
revenues knowingly or intentionally when establishing the return
Finally, plaintiffs allege that, after receiving returns,
Revlon would delay issuing credits to the retailers. A source
states that an identified Revlon employee instructed Genco to
hold large shipments of returned products (specifically, returns
from Marc Glassman, Inc. in October 1998 and from Israel in
"early 1999") for long periods of time before shipping them back
to Revlon manufacturing centers for redistribution. (Compl. ¶¶
24-26). Plaintiffs suspect that this delay in issuing credits
which in and of itself would not constitute a fraud on the market
was accompanied by a corresponding delay in recognizing the
accrual of returns because "[a] former employee" stated that "her supervisor specifically advised the
sales employees to stop writing credits [for returns] between
October and December" of an unidentified year. (Compl. ¶ 21(i)).
Plaintiffs also fail to meet the pleading requirements of the
PSLRA because this source is not "described in the complaint with
sufficient particularity to support the probability that a person
in the position occupied by the source would possess the
information alleged." Novak, 216 F.3d at 314.
If the foregoing series of improper accounting allegations were
accompanied by other, more particularized and less inferentially
attenuated allegations of material fraudulent conduct, they would
perhaps suffice to raise a sufficient inference of wrongdoing.
See, e.g., In re Revlon, No. 99 Civ. 10192, 2001 WL 293820,
at *8 (S.D.N.Y. Mar. 27, 2001). However, "offering incentives to
meet sales or earnings goals is a common practice, and, without
additional allegations not present here, the allegation that the
sales at issue were made pursuant to incentives to meet goals set
by management is an insufficient basis on which to infer
conscious misbehavior or recklessness." In re Bristol-Myers
Squibb Sec. Litig., 312 F. Supp. 2d 549, 566 (S.D.N.Y. 2004).
Absent more particularized allegations of knowingly fraudulent
conduct, however, the particularized aspects of the complaint in
this action plead little more than neutral facts which happen to
be consistent with plaintiffs' theory of how Revlon fraudulently
overstated its sales, and "a general allegation that the
practices at issue resulted in a false report of company [sales]
is not a sufficiently particular claim of misrepresentation."
Greebel, 194 F.3d at 203 (quoting Gross v. Summa Four, Inc.,
93 F.3d 987, 996 (1st Cir. 1996) (quoting Serabian v. Amoskeag
Bank Shares, Inc., 24 F.3d 357, 362 n. 5 (1st Cir. 1994))
(internal quotation marks omitted). The plaintiffs fail to make sufficient allegations that at the time
of the sales at issue the defendants knew or should have known
that the revenue from those sales should have been treated
differently and, thus, that the contemporaneous financials were
incorrect. See Faulkner, 189 F. Supp. 2d at 172.
b. Materiality of Alleged Overstatements
Even if the complaint's allegations did establish a sufficient
inference of improper accounting, the Court agrees with
defendants that plaintiffs have failed to adequately allege that
the financial results reported in Revlon's public statements and
SEC filings were misleading to a material degree. The test of
whether a statement is materially misleading is "whether the
defendants' representations, taken together and in context, would
have misled a reasonable investor." Rombach v. Chang,
355 F.3d 164, 172 n. 7 (2d Cir. 2004) (internal citations omitted). At the
pleading stage of litigation, "a plaintiff satisfies the
materiality requirement of Rule 10b-5 by alleging a statement or
omission that a reasonable investor would have considered
significant in making investment decisions." Ganino,
228 F.3d at 161-62 (citing Basic Inc. v. Levinson, 485 U.S. 224, 231
(1988)). "`[A] complaint may not properly be dismissed . . . on
the ground that the alleged misstatements or omissions are not
material unless they are so obviously unimportant to a reasonable
investor that reasonable minds could not differ on the question
of their importance.'" Id. at 162 (quoting Goldman v. Belden,
754 F.2d 1059, 1067 (2d Cir. 1985)); see also In re Revlon,
2001 WL 293820, at *9.
Nevertheless, given the particularity requirements of
securities fraud pleading, the materiality of allegedly false
financials may not be pled in a conclusory or general fashion; a
complaint must contain allegations tending to demonstrate the
materiality of the alleged overstatements in light of the defendant's total financial
picture. See Decker v. Massey-Ferguson, Ltd., 681 F.2d 111,
116 (2d Cir. 1982) (citing Jacobson v. Peat, Marwick, Mitchell &
Co., 445 F. Supp. 518, 522 (S.D.N.Y. 1977)); see also Gross,
93 F.3d at 996; Shushany v. Allwaste, Inc., 992 F.2d 517, 522
(5th Cir. 1993); Coates v. Heartland Wireless Communications,
Inc., 55 F. Supp. 2d 628, 639 (N.D. Tex. 1999); Schick v. Ernst
& Young, 141 F.R.D. 23, 27 (S.D.N.Y. 1992). In other words,
although there is no "numerical benchmark" for assessing the
materiality of misstatements in financial reports, Ganino,
228 F.3d at 162-65, defendants (and the court) are still "entitled to
be appraised of the approximate amount of overstatement
involved." Jacobson, 445 F. Supp. at 522.
The complaint here describes the financial misstatements it
alleges as "material." It fails, however, to even attempt to
approximate the magnitude or degree of those misstatements in
relation to Revlon's total financial picture. Cf. In re
Revlon, 2001 WL 293820, at *10. None of the complaint's
allegations of improper sales practices contain a specific
allegation of monetary consequence at all, let alone one large
enough to have been reflected in Revlon's financial statements.
In these circumstances, plaintiffs' conclusory allegations of
materiality cannot withstand a motion to dismiss. Cf. Ganino,
228 F.3d at 166; Novak, 216 F.3d at 303-04; Cohen v. Koenig,
25 F.3d 1168, 1173 (2d Cir. 1994); In re Revlon, 2001 WL
293820, at *10.
Plaintiffs point to the section of the complaint which
generally pleads GAAP violations, (Compl. ¶¶ 85-96), and argue
that it entitles them to a presumption that the alleged
overstatements of sales were material "even in the absence of any
quantification." (Pls.' Opp. at 7 (citing
17 C.F.R. § 210.4-01(a)(1))). The complaint's general GAAP allegations,
however, are no more particular with respect to the materiality
of Revlon's alleged accounting shenanigans than the rest of the complaint, and plaintiffs therefore still
face a materiality problem. See SEC Staff Accounting Bulletin
No. 99, 64 Fed. Reg. 45150, 45151 (1999) (citing FASB Statement
of Financial Accounting Concepts No. 2, Qualitative
Characteristics of Accounting Information, 132 (1980)). Indeed,
"[m]inor adjustments in a company's gross revenues are not, as a
rule, deemed material by either accountants or the securities
law." In re Segue Software, Inc. Sec. Litig.,
106 F.Supp.2d 161, 170 (D. Mass. 2000) (citing Greebel, 194 F.3d at 206);
see also Recupito v. Prudential Sec., Inc.,
112 F. Supp. 2d 449, 459 (D. Md. 2000) ("[T]here is a distinction between
misleading financial statements . . . and ones that are
2. Exacerbation of the Inventory Problem Channel Stuffing
Plaintiffs allege that, in addition to dishonest revenue
recognition, Revlon engaged in aggressive sales campaigns,
especially at the end of quarters. That practice is said to have
created a house of cards comprised of overstocked retailers and
increasingly back-ended quarters. According to the amended
complaint, the house of cards collapsed in the third quarter of
1999 when retailers returned merchandise and refused to make new
orders, thereby forcing Revlon to forego material amounts of
sales. Plaintiffs allege that Revlon misled the stock market with
respect to this situation by breaching its regulatory duty to
disclose a "known trend" that was reasonably expected to have a
material unfavorable impact on net sales specifically, that,
during the Class Period, "sales by Revlon to its customers (into
the channel) greatly exceeded sell-through (sales by its
customers out of the channel)." (Compl. ¶ 98(d)). See
17 C.F.R. § 229.30; Scholastic, 252 F.3d at 70; In re Campbell Soup Co.
Sec. Litig., 145 F.Supp. 2d 574, 590-91 (D.N.J. 2001). In
addition, plaintiffs allege that Revlon falsely assured the
market through its public statements that it was working down the
inventory problem when in fact it was exacerbating it through its continued efforts to stuff inventory
into the channel. (Compl. ¶¶ 49, 59). For instance, when Fellows
expressed confidence on January 11, 1999, that "1999 will show
improved growth after customer inventories are reduced to
targeted levels during the first half," (Compl. ¶ 48), he implied
that Revlon was in the process of decreasing the excess inventory
in the channel. However, plaintiffs have not set forth with
particularity sufficient facts to support this allegation.
Plaintiffs make their allegation of an undisclosed channel
stuffing trend on information and belief. They must therefore
state with particularity facts sufficient to support a reasonable
belief that the trend existed. See Novak, 216 F.3d at 314 n.
1; see also Scholastic, 252 F.3d at 70-74. To be clear, the
ultimate "falsity" question here is not whether plaintiffs have
raised a sufficient inference that Revlon aggressively pursued
end-of-quarter sales during the Class Period. As the U.S. Court
of Appeals for the First Circuit has noted, "[t]here is nothing
inherently improper in pressing for sales to be made earlier than
in the normal course. . . ." Greebel, 194 F.3d at 202. Nor is
the question whether "more inventory was in the hands of
retailers than commercially warranted." Aldridge,
284 F.3d at 81. Revlon repeatedly warned the market that there was. Cf.
Scholastic, 252 F.3d at 76-77. Rather, the question is whether
the information stated in the complaint is sufficiently
particularized to support a reasonable belief that, during the
Class Period, Revlon was exacerbating this inventory imbalance by
selling more inventory to retailers than retailers were selling
to consumers and then making misstatements or failing to disclose
information about that practice.
The decision of the U.S. Court of Appeals for the Second
Circuit in Scholastic provides some guidance as to the sort of information that can reasonably
support a belief in the existence of a particular sales trend.
See 252 F.3d at 70-74. In that case, the plaintiffs alleged
that the defendant, Scholastic, recklessly failed to disclose
that sales of its "Goosebumps" books to distributors and
consumers were declining and that, as a result, returns were
increasing. See id. The court held that the trend was
adequately alleged because information in the complaint which
"cover[ed] over two-thirds of Scholastic's trade business in
Goosebumps" "specifically set out the distributors through
which Goosebumps books were sold, and allege[d] declines in sales
as of specific dates, some in terms of percentage and others in
terms of quantity." Id. at 70-71.
In evaluating whether the complaint adequately alleges that
total sales into Revlon's channel exceeded total sell-through
from October 1998, the fact that retailers found themselves
carrying substantially more inventory than was commercially
necessary has some probative value. See Novak,
216 F.3d at 312-13. The complaint, however, fails to grapple with Revlon's
aggregate reported quarterly sales or any measure of
sell-through. See In re Trex Co. Sec. Litig.,
212 F.Supp. 2d 596, 610 & n. 12 (W.D. Va. 2002). Moreover, the following
allegations, on their own, tend to be either unspecific,
innocuous, or both: that (1) some Revlon sales managers faced
great pressure to make sales (Compl. ¶ 21); (2) some Revlon sales
managers were told to offer promotions, special deals, rebates,
return rights and large discounts to retailers to induce large
orders (Compl. ¶¶ 5, 21(o)-(r), 29, 91); (3) at some unspecified
time (but prior to "later in 1998") Revlon shipped "many
shipments" to Safeway that Safeway had not ordered "or" had
"requested to be shipped at a later date" (Compl. ¶ 22(a)); (4)
in December 1998 Revlon shipped to Fred Meyer Co. "orders" which
Fred Meyer had requested be shipped in early 1999 (Compl. ¶
21(b)); (5) Genco received "extremely high levels of returns" in "late
1998 and 1999," specifically 30 pallets from Marc Glassman in
October 1998 and a trailer load of lipstick from Israel in "early
1999" (Compl. ¶ 26); and (6) "in 1999" Longs Drugstores returned
"much of the Ultima II merchandise" it had purchased earlier
"[d]uring the Class Period" (Compl. ¶ 21(h)).
Assuming without deciding that the facts stated in the
complaint provide a sufficient basis to suspect the existence of
the trend of growing inventories, the complaint would still have
to state with particularity facts giving rise to a strong
inference of defendants' scienter, i.e., that defendants were at
least reckless to the fact that Revlon's future sales were being
sacrificed for short-term sales.
"Strong inference that the defendant acted with the required
state of mind," required by the PSLRA to state a securities fraud
claim, may arise when the complaint sufficiently alleges that the
defendants: "(1) benefited in concrete and personal way from
purported fraud; (2) engaged in deliberately illegal behavior;
(3) knew facts or had access to information suggesting that their
public statements were not accurate; or (4) failed to check
information they had duty to monitor." Novak v. Kasaks,
216 F.3d 300, 311 (2000) (internal citations omitted).
In Scholastic, for example, the court concluded that a
publisher's scienter as to sell-through to consumers was
adequately alleged where there were "detailed allegations as to
what defendants knew on a daily, weekly and monthly basis about
the retail trade," including the defendants' electronic access to
retailers' point-of-sale data. Scholastic, 252 F.3d at 76; see
also In re Trex Co., 212 F.Supp. 2d at 60.
Here, the aggressive sales practices attributed to Revlon do
not by themselves raise a strong inference of scienter as to the existence of the alleged
channel stuffing trend. Simply put, "there may [have been] any
number of legitimate reasons for attempting to achieve sales
earlier," none of which would have necessarily entailed knowledge
of the trend. Greebel, 194 F.3d at 203. Moreover, the
complaint's allegations provide no reason to believe that the
aggressive sales campaigns as opposed to some other factor out
of defendants' control which they were less likely to have been
aware of, such as retailer consolidation or elimination of
already-existing overstock, demand, or competition constituted
the factor that rendered channel inflow greater than channel
outflow during the Class Period. These allegations are very
similar to the claims in In re Bristol-Myers Squibb Securities
Litigation, 312 F.Supp. 2d 549, 568 (S.D.N.Y. 2004), in which
the court held, on the basis of similar facts that: "where it is
alleged that (i) management set aggressive targets, (ii)
incentives were given to wholesalers to buy product before they
actually needed it, (iii) in order to meet earnings estimates,
(iv) it was known that wholesaler inventories were higher than
usual, and (v) real products were shipped to real customers who
paid real money, there is no strong inference that Defendants
knew or should have known that the sales should have been
accounted for in some way other than the Company's historical
revenue recognition upon shipment model, and, therefore,
conscious misbehavior or recklessness cannot be inferred." See
Kalnit, 264 F.3d at 142-43 (discussing Novak,
216 F.3d at 304, and Rothman v. Gregor, 220 F.3d 81, 90-91 (2d Cir. 2000)).
Finally, the complaint's totally conclusory allegations regarding
defendants' omniscient awareness of traffic into and out of the
channel, (Compl. ¶ 7), are insufficiently particularized to
support a strong inference of defendants' scienter. See e.g.,
Johnson v. Tellabs, Inc., 303 F.Supp. 2d 941, 966 (N.D. Ill.
2004) (collecting cases where allegations of channel stuffing
alone were held insufficient to show scienter); In re Trex, 212 F.Supp.2d at 608; cf.
Scholastic, 252 F.3d at 76; Rombach v. Chang, 355 F.3d at 176
("[A] `pleading technique [that] couple[s] a factual statement
with a conclusory allegation of fraudulent intent' is
insufficient to `support the inference that the defendants acted
recklessly or with fraudulent intent.'" (internal citations
3. Misrepresentations as to the Remaining Size of the Inventory
Plaintiffs allege that the optimistic statements they have
culled from defendants' commentary on Revlon's condition masked
(1) improper accounting, (2) the channel stuffing trend, and (3)
the impact that the inventory problem would have on future sales.
As established above, however, the improper accounting and
channel stuffing trend have not been adequately alleged;
therefore, the Court will now address only whether the statements
were misleading with respect to the inventory problem. Moreover,
as the existence of that problem was revealed to the market from
the beginning of this Class Period, the only viable contention
that plaintiffs can make is that defendants' statements lulled
the market into believing that the problem was smaller than it in
As a preliminary matter, some of the more specific statements
identified in the complaint are simply not actionable as
currently pled. The specific facts the statements proclaim to be
true are not alleged to have been false and are not inconsistent
with what is alleged to have been true. See In re Nokia Corp.
Sec. Litig., No. 96 Civ. 3752, 1998 WL 150963, at *9 (S.D.N.Y.
April 1, 1998) ("Plaintiffs simply fail to allege how these
statements are false."). In this regard, the complaint does not
state a claim with respect to Statement 3 because it fails to
allege the falsity of the fact asserted in that statement B that
the Ultima II line was "showing significant strength." Similarly,
the complaint does not allege the falsity of the fact asserted in
Statement 16 that slowing industry sales growth was responsible for "some" of
Revlon's inventory problems. These relatively specific statements
are simply "outside the [broad] sphere of the plaintiffs'
allegations of falsehood." Harris v. Ivax Corp., 182 F.3d 799,
804 (11th Cir. 1999).
With respect to the remaining statements, defendants argue that
they are so vague or unspecific or bespoke such caution that they
did not alter the "total mix" of information made available to
the market, Ganino, 228 F.3d at 162, and therefore did not give
rise to any duty to disclose the precise severity of the downturn
in sales that defendants allegedly foresaw with certainty. In
other words, defendants argue that the statements were immaterial
as a matter of law. Similarly, defendants contend that the
statements cannot serve as the basis of a Rule 10b-5 fraud claim
because they are moored within the safe harbor for
forward-looking statements created by the statutory breakwater of
"Materiality is a mixed question of law and fact." Ganino,
228 F.3d at 162. "In most circumstances," therefore, "disputes
over the materiality of allegedly false or misleading statements
must be reserved for the trier of fact." Shaw v. Digital
Equipment Corp., 82 F.3d 1194, 1217 (1st Cir. 1996) (citing
Basic, 485 U.S. at 236). In fraud-on-the-market cases, however,
"courts have demonstrated a willingness to find immaterial as a
matter of law a certain kind of rosy affirmation commonly heard
from corporate managers and numbingly familiar to the marketplace
loosely optimistic statements that are so vague, so lacking in
specificity, or so clearly constituting the opinions of the
speaker, that no reasonable investor could find them important to
the total mix of information available." Id.; see also
Novak, 216 F.3d at 315 ("statements containing simple economic
projections, expressions of optimism, and other puffery are
insufficient"), San Leandro, 75 F.3d at 811; In re Time Warner
Inc. Sec. Litig., 9 F.3d 259, 266 n. 3 (2d Cir. 1993); Raab v. General Physics Corp.,
4 F.3d 286, 289-90 (4th Cir. 1993); Hoxworth v. Blinder, Robinson &
Co., 903 F.2d 186, 200-01 (3d Cir. 1990); Zerman v. Ball,
735 F.2d 15, 20-21 (2d Cir. 1984); In re Nokia Corp. Sec. Litig.,
1998 WL 150963, at *6. This is because "[a]nalysts and
arbitrageurs rely on facts in determining the value of a
security," Raab, 4 F.3d at 290, and are not duped by "easily
recogniz[able] . . . self-directed corporate puffery," Shaw,
82 F.3d at 1218.
"Expressions of puffery and corporate optimism do not give rise
to securities violations." Rombach v. Chang, 355 F.3d at 174.
Immaterial optimistic statements are protected by the "bespeaks
caution" doctrine and the PSLRA's safe harbor provision. Under
the bespeaks caution doctrine, "alleged misrepresentations in a
stock offering are immaterial as a matter of law [if] it cannot
be said that any reasonable investor could consider them
important in light of adequate cautionary language set out in the
same offering." Halperin v. eBanker USA.com. Inc.,
295 F.3d 352, 357 (2d Cir. 2002). The Second Circuit clarified the scope
of the bespeaks caution doctrine as follows: "[w]hen cautionary
language is present, we analyze the allegedly fraudulent
materials in their entirety to determine whether a reasonable
investor would have been misled. The touchstone of the inquiry is
not whether isolated statements within a document were true, but
whether defendants' representations or omissions, considered
together and in context, would affect the total mix of
information and thereby mislead a reasonable investor regarding
the nature of the securities offered." Id.
The PSLRA's "safe harbor was modeled in part after, but not
meant to displace, the judicial bespeaks caution doctrine."
Credit Suisse First Boston Corp. v. ARM Financial Group, Inc.,
No. 99 Civ. 12046, 2001 WL 300733, at *5 (S.D.N.Y. Mar. 28,
2001). As in the bespeaks caution doctrine, it may provide protection from liability based
on a "forward-looking statement," 15 U.S.C. § 78u-5(c)(1), a term
defined at 15 U.S.C. § 78u-5(i)(1). Pursuant to the safe harbor,
liability may not be imposed with respect to a forward-looking
statement if either (1) the statement was "immaterial,"
15 U.S.C. § 78u-5(c)(1)(A)(ii); (2) the statement was "identified as a
forward-looking statement" and "accompanied by meaningful
cautionary statements identifying important factors that could
cause actual results to differ materially from those in the
forward-looking statement," 15 U.S.C. § 78u-5(c)(1)(A)(i); or (3)
the plaintiff fails to prove that the statement was made with
"actual knowledge" that it was false or misleading,
15 U.S.C. § 78u-5(c)(1)(B). See In re Independent Energy Holdings PLC Sec.
Litig., 154 F.Supp.2d 741, 755 (S.D.N.Y. 2001), abrogated on
other grounds by In re IPO, 241 F.Supp.2d 281 (2003). The
first two inlets of the safe harbor "look to the statement
itself," while the third "looks to the state of mind of the
person making the disclosure. . . ." Credit Suisse First Boston
Corp., 2001 WL 300733, at *4; see also Harris,
182 F.3d at 803, 807 n. 10.
The statements from the October 2, 1998 press release
(Statements 1 through 5) ought to be considered together, in
context. (Compl. ¶ 35). Statement 3*fn3 touting the
strength of the program to broaden distribution of the Ultima II
line is, as noted above, not alleged to be false at all.
Statements 1,*fn4 4,*fn5 and 5*fn6 are
forward-looking statements accompanied by language warning that Revlon's "growth will outpace category growth" only
"as" or "once" "retail inventories are stabilized." As such, they
bespeak caution as to the negative eventuality that allegedly
came to pass and are immaterial. Statement 4, additionally, is
specifically identified as a forward-looking statement and
therefore certainly within the safe harbor of
15 U.S.C. § 78u-5(c)(1)(A)(i). Although Statements 1 and 5 are not precisely
labeled as forward-looking statements, they are forward-looking
statements, and are so vague, general, and hedged that they
qualify for the PSLRA's safe harbor for "immaterial"
forward-looking statements codified at
15 U.S.C. § 78u-5(c)(1)(A)(ii), see also Colby v. Hologic, Inc.,
817 F.Supp. 204, 211 (D.Mass. 1993), if not that codified at
15 U.S.C. § 78u-5(c)(1)(A)(i).
Statement 2 "[t]he business fundamentals of our Company are
strong" is more problematic, but nevertheless immaterial. The
statement contains a present tense verb, and could be read
literally to state a "current fact," however vaguely and loosely.
In context, however, the word "fundamentals" clearly refers to
specific statements of fact that are not alleged to be false
the touting of the strength of the Revlon and Almay brands and
the program to broaden distribution of the Ultima II line.
Moreover, the last sentence of the paragraph in which Statement 2
appeared cautioned that Revlon's growth would exceed category
growth only "as retail inventories are stabilized," and that is
the very problem that plaintiffs allege Statement 2 fraudulently
downplays. In these circumstances, Statement 2 is "too patently
immaterial" to support these plaintiffs' particular fraud-on-the-market claim.
Shaw, 82 F.3d at 1219.
Statements 6*fn7 and 7*fn8 from the October 28, 1998
press release fare no better. Both are forward-looking statements
accompanied by language that bespeaks caution with respect to the
continuing "challenge" presented by the inventory problem, to
wit: "the Company expects retail inventory balancing and
reductions to affect sales in the fourth quarter and in 1999" and
"lower than expected sales as a result of a longer than expected
duration of retail inventory balancing and reductions" is a
factor "that could cause actual results to differ materially."
Statement 7 is specifically identified as a forward-looking
statement, and is thus protected by the PSLRA safe harbor as
well. See 15 U.S.C § 78u-5(c)(1)(A)(i). The forward-looking
aspect of Statement 6 is so vague, general, and hedged that it
too is within the safe harbor because it is immaterial. See
15 U.S.C. § 78u-5(c)(1)(A)(ii). To the extent that Statement 6's
"business fundamentals" comment asserts a current fact, it is
patently immaterial on these facts for the same reasons that
Statement 2 is immaterial. The January 11, 1999 press release contained Statements
8*fn9 and 9.*fn10 Both statements are forward-looking.
Taken in context, Statement 8 is a vague prediction about the
impact of Revlon's specific plans for restructuring, and says
nothing remotely specific about the present or future of
inventory imbalances. Moreover, Statement 9 itself bespeaks
exactly the problem that plaintiffs allege to have been minimized
"[w]e expect results in the first half of 1999 to continue to
be affected by inventory reductions." There is, in addition,
language warning about "delays in achieving or lower than
expected growth after customer inventories are reduced to target
levels." Thus, Statements 8 and 9 are immaterial as a matter of
law. In addition, they qualify for the PSLRA safe harbor. See
15 U.S.C. § 78u-5(c)(1)(A)(i)-(ii).
Statement 10 the January 12, 1999 statement by Fellows
reported in Capital Cities Media, Inc. is oddly phrased.
Fellows reportedly stated that during the course of mapping out
the previous fall's retrenchment, "`opportunities presented
themselves to make some additional savings and allow us to
realign our supply chain to more closely relate to our customers.
Not only can we save money but service our customers better.'"
(Compl. ¶ 51). The complaint may simply fail to state a claim with respect to this statement, as
it does not allege that opportunities did not present themselves
to Revlon or that Revlon could not have realigned its supply
chain, saved money, or better served its customers. Yet, even
assuming that Statement 10's general optimism misleads vis-à-vis
the inventory problem, it only predicts the improved health of
Revlon looking forward. Given that there is no allegation that
Fellows controlled the full text of this statement and that
Revlon had warned investors the day before that "[w]e expect
results in the first half of 1999 to continue to be affected by
inventory reductions," the Court deems Statement 10 to have
bespoken caution with respect to persisting inventory imbalances.
Thus, it is immaterial under the bespeaks caution doctrine and is
protected by the safe harbor of the PSLRA.
Revlon announced its full-year and fourth quarter results and
put forth Statements 11, 12, and 13 on January 28, 1999.
Statement 12 is another bromide about how "Revlon's fundamentals
remain strong." As with Statements 2 and 6, the word
"fundamentals" clearly refers to specific statements of fact that
are not alleged to be false an increase in market share in the
U.S. mass market and the success of the Revlon, Almay and Ultima
II brands. Moreover, just two weeks before, in its January 11,
1999 press release, Revlon had made clear that it expected
"results in the first half of 1999 to continue to be affected by
inventory reductions." In these circumstances, Statement 12 is
too immaterial to support plaintiffs' claim that Revlon fooled
the market with respect to the size of its inventory problem.
Statements 11*fn11 and 13*fn12 are more specific,
positive comments about Revlon's "realign[ment]" and "restructuring" efforts. Assuming that the
generality of these comments could somehow mislead with respect
to the persistence and magnitude of the inventory problem alleged
in the complaint, they are nevertheless forward looking comments.
Moreover, when read in context, they quite clearly refer to
specific efforts that are not alleged to have fallen short of
expectations: with respect to Statement 11's "realign[ment]," the
"new strategic plan to maximize the potential of the Revlon brand
equity, build the Company's portfolio of brands, and expand its
relationships with key retailers;" and, with respect to Statement
13's "restructuring," the aspects of the restructuring program
outlined in Revlon's previous announcements. Given these
references and Revlon's previous warnings about the continued
impact of the inventory problem, Revlon's utterance of these
forward-looking statements did not alter the total mix of
information in the market so as to oblige Revlon to disclose what
it allegedly knew about the continuing magnitude of that problem.
See 15 U.S.C. § 78u-5(c)(1)(A)(ii).
Statement 14 consists, in relevant part, of Fellows's January
29, 1999 comment in Capital Cities Media, Inc. that "[t]he
second half of 1998 was an aberration. . . . with [sic] this
restructuring, we've been bettering the processes of the
company." Fellows' belief that the second half of 1998 "was" an
aberration was rendered immaterial for purposes of this complaint
by Revlon's repeated warnings in its own official statements
about the possible persistence of the inventory problem. Still,
the second portion of Statement 14 refers to an
already-accomplished "bettering [of] the processes" achieved through "this
restructuring." The word "restructuring," however, logically
refers to the "restructuring" that Revlon had trumpeted in its
prior statements to the market, not the disappearance of the
inventory problem. In these circumstances, the vague and loose
assertion that "processes" had been "bettered" is "too patently
immaterial" to support a claim that defendants misled the market
about the extent of their inventory problem. Shaw,
82 F.3d at 1219.
Statements 16 through 19 are from Fellows's April 26, 1999
interview with Chain Drug Review and Revlon's April 29, 1999
press release. Statements 16*fn13 and 18*fn14 are, at
best, vaguely optimistic forward-looking statements. They are
immaterial in light of Revlon's repeated warnings in its own
official statements about the possible persistence of the
inventory problem; specific warnings from Revlon at the beginning
of March and the middle of May sandwiched the April 26 Chain
Drug Review article. Statement 19 yet another "our
fundamentals are strong" comment is immaterial for the same
reasons as Statements 2, 6, and 12.
Statement 17 Fellows's comment in Chain Drug Review that
"`[t]he Company is well on the way to overcoming the inventory
problems . . . that set us back last year, leaving us to pursue
chain drug, discount, and supermarket sales with our proven
formula for success'" is the most problematic statement in the
complaint, as it seems to evaluate the current status of the
inventory problem. See Novak, 216 F.3d at 315. Assuming it is
the sort of statement which could be found too puffy, plaintiffs have nevertheless failed to
allege with sufficient particularity either that it was false
when made or that Fellows was reckless to its falsity when he
made it. Indeed, "as long as [their] 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. And
if "plaintiffs contend defendants had access to contrary facts"
as plaintiffs do here "they must specifically identify the
reports or statements containing this information." Id. (citing
San Leandro, 75 F.3d at 812).
C. Section 20(a) Claims
Plaintiffs allege that defendants Perelman, Fellows, and
Gehrmann are liable as "control persons" within the meaning
section 20(a) of the Securities Exchange Act of 1934. These
claims are dismissed because plaintiffs have failed to plead a
primary violation of section 10(b). See Jackson Nat'l Life
Ins. Co. v. Merrill Lynch & Co., 32 F.3d 697, 703 (2d Cir.
For the reasons set forth above, defendants' motion to dismiss
the amended complaint is granted without prejudice.