The opinion of the court was delivered by: SIDNEY STEIN, District Judge
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.
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).
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,
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 ...