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September 29, 2004.

DAN GAVISH, TRICIA FONTAN, WALTER FONTAN, individually and on behalf of all others similarly situated, Plaintiffs,

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.

  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 market.

  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, 77).

  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. Ex. A).

  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 ...

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