The opinion of the court was delivered by: LAWRENCE McKENNA, District Judge
This action is part of a multi-district securities litigation
pending before this Court. In re Adelphia Commc'ns Corp. Sec.
and Derivative Litig., No. 03 MDL 1529.
In the instant case, the Wellsville Group has brought a
securities fraud class action on behalf of itself and all
stockholders of Adelphia Business Solutions, Inc. who purchased
their securities between January 6, 2000 and March 27, 2002
(collectively "plaintiffs").*fn1 (Compl. ¶¶ 1, 12-20.) In
their Consolidated Amended Class Action Complaint ("Complaint"),
plaintiffs have named as defendants John J. Rigas, Michael J.
Rigas, Timothy J. Rigas, and James P. Rigas (collectively "the
Rigases" or "defendants"), all of whom were directors and/or
senior officers of Adelphia Business Solutions ("ABIZ") between
2000 and 2002. (Id. ¶¶ 21-23.) ABIZ was a telecommunications
company providing local phone service, long distance service,
high-speed data transmission, and internet connectivity to business, government,
and educational customers. (Id. ¶ 2.) Plaintiffs have not named
ABIZ in this action, as it has filed for Chapter 11 bankruptcy.
(Id. ¶ 7.)*fn2
Plaintiffs claim violations of Sections 10(b) and 20(a) of the
Securities Exchange Act of 1934, 15 U.S.C. § 78j;
15 U.S.C. § 78t(a). (See also Compl. ¶¶ 1, 90-99.) Plaintiffs contend that
from January 2000 to January 2002 ABIZ engaged in various
fraudulent schemes in order to artificially inflate the price of
ABIZ securities by including misrepresentations and fraudulent
statements in various publicly filed documents and press
releases. (Compl. ¶¶ 4-6, 23-26, 35-37.) These schemes include:
falsely reporting statistics relating to new customers; falsely
reporting corporate overhead expenses; and failing to disclose
debt for which it and its parent corporation, Adelphia
Communications Corp. ("ACC"), were liable. (Id. ¶¶ 38-62.)
Plaintiffs allege they would not have purchased or acquired ABIZ
at these artificially inflated prices if they had known of
defendants' misrepresentations. (Id. ¶¶ 81-83, 94.) In March
2002, it was revealed that ACC owed $2.3 billion in debt, for
which it and ABIZ were jointly obligated and which was not
reported on their balance sheets. (Id. ¶¶ 65, 66.) ABIZ also
announced that it would default on $15.3 million in secured
notes. (Id. ¶ 64.) Plaintiffs allege that, as a result, ABIZ
filed for bankruptcy. (Id. ¶¶ 6, 63-68.) ABIZ, now renamed
Telcove, is undergoing a reorganization that would allegedly
leave plaintiffs with no value for their shares of ABIZ stock.
(Id. ¶ 69.)*fn3 Plaintiffs allege that they have lost the total value of their investments in ABIZ, resulting in a
collective injury of $3,308,608. (Id. ¶¶ 6, 12.)
Defendants have filed a Motion to Dismiss both the 10(b) and
20(a) claims that are alleged in plaintiffs' Complaint, pursuant
to Federal Rules of Civil Procedure 12(b)(6) and 9(b). For the
reasons set forth below, the motion is granted in part and denied
in part. Plaintiffs, however, will be given limited leave to
amend their Complaint.
Under Federal Rule of Civil Procedure 12(b)(6), a complaint
will be dismissed if there is a "failure to state a claim upon
which relief can be granted." Fed.R.Civ.Proc. 12(b)(6). A
court must read the complaint generously accepting the truth of
and drawing all reasonable inferences from well-pled factual
allegations. See Mills v. Polar Molecular Corp.,
12 F.3d 1170, 1174 (2d Cir. 1993). A court's function on a motion to
dismiss is "not to weigh the evidence that might be presented at
trial but merely to determine whether the complaint itself is
legally sufficient." Goldman v. Belden, 754 F.2d 1059, 1067 (2d
Cir. 1985). A court should dismiss a complaint only if "`it
appears beyond doubt that the plaintiff can prove no set of facts
in support of his claim which would entitle him to relief.'"
Valmonte v. Bane, 18 F.3d 992, 998 (2d Cir. 1994) (quoting
Conley v. Gibson, 355 U.S. 41, 45-46 (1957)).
To state a claim under Section 10(b) and Rule 10b-5, a
plaintiff must allege that the defendant: "(1) made misstatements
or omissions of material fact; (2) with scienter; (3) in
connection with the purchase or sale of securities; (4) upon
which plaintiffs relied; and (5) that plaintiff's reliance was the proximate cause of
their injury." In re IBM Corp. Sec. Litig., 163 F. 3d 102, 106
(2d Cir. 1998).*fn4
An allegation of securities fraud under Section 10(b) and Rule
10b-5 is subject to the heightened pleading requirements of
Federal Rule of Civil Procedure 9(b).*fn5 Rule 9(b) requires
a complaint alleging fraud to: "(1) specify the statements that
the plaintiff contends were fraudulent, (2) identify the speaker,
(3) state where and when the statements were made, and (4)
explain why the statements were fraudulent." Mills,
12 F.3d at 1175. In examining a complaint for compliance with Rule 9(b), a
court must "read the complaint generously, and draw all
inferences in favor of the pleader." Pompano-Windy City
Partners, Ltd. v. Bear Stears & Co., 794 F. Supp. 1265, 1280 (S.D.N.Y. 1992) (citation and quotations omitted). The purposes
of Rule 9(b) are: "(1) to provide a defendant with fair notice of
the claims against it; (2) to protect a defendant from harm to
its reputation or goodwill by unfounded allegations of fraud; and
(3) to reduce the number of strike suits." In re Livent, Inc.
Sec. Litig., 78 F. Supp. 2d 194, 213 (S.D.N.Y. 1999) (citing
DiVittorio v. Equidyne Extractive Indus., Inc., 822 F.2d 1242,
1247 (2d Cir. 1987)).
An allegation of a 10(b) violation is also subject to the
requirements of the Private Securities Litigation Reform Act of
1995 ("PSLRA"), 15 U.S.C. § 78u-4(b). The PSLRA requires that a
complaint "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."
15 U.S.C. § 78u-4(b)(1). Further, the PSLRA requires a plaintiff to
"state with particularity facts giving rise to a strong inference
that the defendant acted with the required state of mind." Id.
at § 78u-4(b)(2). "Under the heightened pleading requirements of
Rule 9(b) and the PLSRA, plaintiffs must allege the first two
elements of a securities fraud claim fraudulent acts and
scienter with particularity." Gabriel Capital, L.P. v. NatWest
Fin., Inc., 94 F. Supp. 2d 491, 500 (S.D.N.Y. 2000).
Defendants argue that plaintiffs have not met any of the four
requirements of 9(b) or the PSLRA. The court will first address
the second prong whether plaintiffs have adequately identified
the speaker of the alleged fraudulent or misleading statements.
(Defs.' Mem. at 3-7; Defs.' Reply at 1-6.) The court will then
address the remaining three prongs together as they all relate to the particularity of
the statements themselves. Third, the court will address the
issue of causation.
1. Identification of Speaker
Defendants argue that under Rule 9(b) and the PSLRA, plaintiffs
are required to specifically identify the role of each defendant
in the alleged fraud, and cannot simply "lump the Rigas
defendants together without specifying their roles in the alleged
fraud." (Defs.' Mem. at 4; Defs.' Reply at 4-6.) However, the
group pleading doctrine is an exception to the requirement that a
complaint identify each defendant's fraudulent acts. Under this
doctrine, plaintiffs may "`rely on a presumption that statements
in prospectuses, registration statements, annual reports, press
releases, or other group-published information, are the
collective works of those individuals with direct involvement in
the everyday business of the company.'" In re Emex Corp. Sec.
Litig., No. 01 Civ. 4886, 2002 WL 31093612, at *7 (S.D.N.Y.
Sept. 18, 2002) (quoting In re Oxford Health Plans, Inc.,
187 F.R.D. 133, 142 (S.D.N.Y. 1999)). Here, plaintiffs can rely on
the group pleading exception because the Rigas defendants are
identified as holding positions that qualify them as "corporate
insiders with active daily roles," Polar Int'l Brokerage Corp.
v. Reeve, 108 F. Supp. 2d 225, 237 (S.D.N.Y. 2000), or as
members of the Board of Directors with equity interests in ABIZ
and access to information concerning the company's day-to-day
business.*fn6 See In re Oxford Health,
187 F.R.D. at 142-43. (See also Compl. ¶¶ 21-23, 97-98.) 2. Particularity as to Each Misstatement or Fraudulent
Defendants also argue that plaintiffs have not specified which
statements are false or misleading, when and where the statements
were made, and why the statements are misleading or fraudulent.
(Defs.' Mem. at 4-7; Defs.' Reply at 1-4.)
Plaintiff's allegations fall into three general categories.
Plaintiffs allege that defendants made false or misleading
statements regarding ABIZ's: (a) line counts (Compl. ¶¶ 38-53);
(b) corporate overhead expenses (id. ¶¶ 54-58); and (c)
exposure to off-balance sheet liabilities of its parent
corporation, ACC (id. ¶¶ 59-62). Plaintiffs allege that due to
these false statements, investors were lured into purchasing
stock in a company that appeared to be growing, which therefore
artificially inflated the stock price. In March 2002, when the
public finally became aware of the past misleading statements and
ABIZ filed for bankruptcy, investors were left holding worthless
stock. (Id. ¶¶ 63-69.)
a) Defendants Overstated Line Counts (Compl. ¶¶ 38-53)
ABIZ was a competing local exchange carrier ("CLEC") trying to
break into pre-existing local telephone markets. Plaintiffs
allege that the Rigases falsely portrayed ABIZ as a successful
CLEC, when it was actually failing, by overstating its "line
counts," which lured investors into purchasing ABIZ stock and
caused the price of ABIZ stock to rise. This resulted in
plaintiffs purchasing ABIZ stock at inflated prices. (Compl. ¶¶
2, 33-35, 52.) (1) Which statements were misleading and when and where the
statements were made.
"Line counts" are the number of new customers that a company
assigns to its available access lines (lines assigned to specific
phone numbers) in its various regions of service; line counts are
an indicator of growth in the CLEC market. The number of
customers retaining their lines is an indicator in calculating a
net line count (new lines minus disconnected lines) for ABIZ.
(Id. ¶ 38.) Plaintiffs allege defendants issued press releases
and filed financial statements with the Securities and Exchange
Commission that misrepresented ABIZ's customer base by
systematically inflating line counts.
Specifically, plaintiffs allege that defendants included
artificially inflated line count statistics in ABIZ's January 6,
2000 press release (Compl. ¶ 39); March 1, 2000 press release
(id. ¶ 41); Form 10-K filed with the SEC on March 30, 2000
(id. ¶ 43); Form 10-Q filed with the SEC on May 15, 2000 (id.
¶ 44); Form 10-Q filed with the SEC on August 14, 2000 (id. ¶
45); and Form 10-Q filed with the SEC on November 14, 2000 (id.
The court finds that these allegations sufficiently specify
which statements were misleading and when and where these
statements were made.
(2) Why the statements were misleading.
Plaintiffs allege defendants sought to create the perception
that ABIZ was a growing company by publicly reporting inflated
line count statistics in order to ensure that the company stayed
in business and to lure investors into purchasing stock.
Plaintiffs allege defendants knew or were deliberately reckless
in disregarding the actual level of line counts when publicly
reporting these statistics. (Id. ¶ 47). Plaintiffs allege that defendants inflated line counts through the entire class period
by using or approving certain practices. (Id. ¶¶ 39-53.)
Specifically, plaintiffs allege that ABIZ engaged in the practice
of "cramming" by adding hundreds of lines to existing customers
who never ordered them and then disconnecting the lines within
the same month without reporting the disconnections. Plaintiffs
allege that affected customers were not aware of the additional
lines in most cases and that this practice artificially inflated
line counts. (Id.) Plaintiffs also allege that ABIZ engaged in
the practice of "slamming" by entering "new" customer names into
its systems although the customers had never signed up for
service with ABIZ or had poor credit and could not afford new
service and then disconnected the lines in the same month without
reporting the disconnections. (Id.) Additionally, plaintiffs
allege that ABIZ entered businesses with poor credit as "new"
lines although they had not ordered new service or could not
afford new service, and ABIZ retained these customers in its
systems although they had disconnected their lines. (Id.)
Plaintiffs allege that ABIZ did not disclose any of these false
and deceptive sales practices or their effect on the company's
financial position. (Id. ¶¶ 47, 52-53.) Plaintiffs also allege
the inflation of line counts violates generally accepted
accounting principles ("GAAP"), which must be followed when
filing any documents with the Securities and Exchange Commission.
Specifically, plaintiffs allege that the inflation of line counts
violates Financial Accounting Standard No. 5 and Statement of
Financial Accounting Concept No. 6, which prohibit improper
recognition of fictitious revenues. (Id. ¶¶ 70-72.)
Plaintiffs make many specific allegations regarding the
inflation of line counts. For example, plaintiffs allege that
ABIZ's "Louisville and Philadelphia offices were particularly
aggressive in reporting line counts." (Id. ¶ 48.)Plaintiffs also
point to two specific incidents when the inflation came to light. Plaintiffs
allege that in November 2000 personnel in the operations unit
notified the corporate accounting department and top ABIZ
executives that "the line counts being reported to the public . . .
were grossly overstated and inaccurate." Plaintiffs allege the
executives told the operations unit personnel "not to speak about
the issue to anyone" and that they "would take care of this."
(Id. ¶ 51.) Plaintiffs also allege that in April 2001 ABIZ's
Philadelphia office could not fill a legitimate large line order
because its system reported an insufficient number of available
lines; the seemingly occupied lines, however, were actually
available and were improperly reported as active. (Id. ¶ 50.)
Defendants argue that plaintiffs have not alleged by how much
defendants inflated the line counts. (Defs.' Mem. at 5-6; Defs.'
Reply at 2-3.) The PSLRA, however, "does not require that
plaintiffs plead with particularity every single fact" when
plaintiffs plead "on information and belief." Novak v. Kasaks,
216 F.3d 300, 313 (2d Cir. 2000). As plaintiffs' allegations
regarding inflation of line counts are very specific in other
respects, the Court finds plaintiffs' allegations sufficiently
particular despite plaintiffs' failure to allege by how much the
line counts were inflated.
b) Defendants Falsely Reported Corporate Overhead Expenses
(Compl. ¶¶ 54-58)
Plaintiffs allege that ABIZ entered into agreements with its
parent company, ACC, under which ABIZ was obligated to share
corporate overhead services and other business expenses with ACC
and other companies owned by the Rigases. Plaintiffs allege
defendants arbitrarily decided how to allocate expenses and
payment obligations among the various Adelphia companies based,
not on any actual expenses incurred by the companies, but rather on the financial needs ...