The opinion of the court was delivered by: Michael A. Telesca United States District Judge
Plaintiffs bring this class-action lawsuit against Bausch & Lomb Incorporated ("B&L"), and various individual*fn1 and corporate defendants,*fn2 (collectively "defendants") pursuant to sections 10(b) of the Securities Exchange Act of 1934, as amended, 15 U.S.C. §§ 78j(b), Rule 10b-5 promulgated thereunder, 17 C.F.R. § 240.10b-5 and section 20(a) of the Securities Exchange Act of 1934, 15 U.S.C. § 78t(a).*fn3 Plaintiffs allege B&L overstated its net income from 2003 through 2005 due to accounting fraud perpetrated by B&L subsidiaries which affected B&L's consolidated financial statements. As a result of these overstatements, plaintiffs allege that B&L's quarterly and annual reports during the class period, January 29, 2004 through May 3, 2006 (the "Class Period"), and its quarterly press releases announcing quarterly annual results were materially false and misleading. Plaintiffs claim that when B&L finally disclosed its subsidiaries' fraud and B&L's grossly deficient internal controls, the price of B&L stock dropped and plaintiffs suffered economic losses. Plaintiffs also claim accounting fraud with respect to B&L's product, ReNu with MoistureLoc ("MoistureLoc"). In addition, plaintiffs allege that B&L made false and misleading statements regarding the economic status and business prospects of B&L as it related to MoistureLoc in an effort to artificially inflate the price of B&L stock. Plaintiffs claim that they purchased B&L stock at inflated prices, and suffered economic losses when the stock rapidly lost value in 2006 when the truth about MoistureLoc became known to the market.
By motion dated March 7, 2008, defendants move to dismiss plaintiffs' Amended Complaint pursuant to Rules 9(b) and 12(b)(6) of the Federal Rules of Civil Procedure, and the Private Securities Litigation Reform Act of 1995 ("PSLRA"). Defendants claim that the plaintiffs' Amended Complaint fails to state a claim upon which relief may be granted. Moreover, defendants contend that the claims against BLIO should be dismissed as time barred under the relevant statute of limitations. Further, defendants claim that the allegations against defendant Singh should be dismissed because the Court lacks personal jurisdiction over him.*fn4 For the reasons set forth below, I hereby grant defendants' motion to dismiss, and dismiss plaintiffs' Complaint with prejudice.
Unless otherwise noted, the following facts are taken from plaintiffs' First Consolidated Amended Complaint For Violations of the Federal Securities Laws ("Complaint"), including documents incorporated by reference or upon which plaintiffs relied in drafting the Complaint, as well as from public documents which B&L filed with the Securities and Exchange Commission ("SEC").*fn5
Plaintiffs claim that they bought B&L stocks and bonds and are suing on behalf of a putative class of investors who purchased publicly traded B&L securities between January 29, 2004 and May 3, 2006 (the "Class Period").*fn6 B&L is a corporation that develops, manufactures and markets eye health products and whose headquarters are located in Rochester, New York. The products by B&L are sold in over 100 countries, including through numerous wholly or partly owned subsidiaries.
At all relevant times, defendant Zarrella was B&L's Chief Executive Officer ("CEO") and defendant McCluski was its Chief Financial Officer ("CFO"). Defendant Loughlin was Senior Vice President and President of B&L's Asia Division until May 2006 when he became a Senior Vice President of B&L. Defendant Hahs was B&L's Senior Vice president - Global Operations and Engineering from 2000 through May 2006. In addition, defendant Panzarella was B&L's Corporate Vice President, Global Vision Care and Robert B. Stiles was Senior Vice President and General Counsel of B&L. Further, defendant Ide was B&L's Vice President and President of Japan Operations from 1999 to 2005 and defendant Singh was the Managing Director of BL India. Defendant, BLIO is B&L's Brazilian subsidiary. While B&L owns 80% of BL Korea and BL India is owned by B&L through its subsidiary Bausch & Lomb South Asia Holding Company. In addition, BL Japan is B&L's wholly-owned Japanese subsidiary and BL China is B&L's joint venture in China.
II. Accounting Irregularities Leading to B&L's Restatement of Financial Earnings
On October 25, 2005, B&L announced that in September, its Audit Committee began an independent investigation into alleged misconduct by local managers at BLIO, which had been reported to B&L's senior management by a BLIO employee.*fn7 The investigation revealed that BLIO's general manager, controller and other employees had mischaracterized $600,000 in expenses to fund an unauthorized pension arrangement for themselves; avoided payroll tax obligations; and misused corporate assets for personal benefit. In addition, the investigation found that Brazilian tax authorities made assessments of $33 million in unpaid taxes, penalties and interest in prior periods that BLIO's local managers failed to report to B&L and thus were not properly reserved on BLIO's books.
Plaintiffs claim that BLIO's failure to reserve for tax assessments and penalties was related to BLIO's illegal practice of purchasing tax credits in Brazil from other entities. According to CW1 (BLIO's former general manager), beginning in 2000, BLIO purchased tax credits associated with soy bean exports from a broker even though BLIO had nothing to do with soy bean exports. This practice was allegedly known to B&L headquarters in Rochester where lawyers modified BLIO's legal operating documents to include the business of soy beans. B&L's managers in its regional and headquarters offices endorsed the practice of using "soy bean" related tax credits as a means of improving BLIO's profitability and increasing B&L's rate of return on its Brazilian operations.
The $33 million tax assessment, which was later reduced by Brazilian tax authorities to approximately $11 million, was small compared to B&L's net sales for 2004, as restated, of more than $2,223 million; and BLIO's sales accounted for just 0.9% of that amount. Further, B&L voluntarily reported the BLIO matter to the Securities and Exchange Commission ("SEC")*fn8 and terminated the BLIO general manager and controller responsible for the misconduct. See Affidavit of Won S. Shin ("Shin Aff.") Ex. 7. B&L disclosed that it would consider, in consultation with its independent auditor, whether the Generally Accepted Accounting Principles ("GAAP") required any restatement of prior-period financial results and whether there were material weaknesses in B&L's internal controls.
B&L issued a press release on December 22, 2005 stating that the Audit Committee investigation had not found any evidence that anyone outside BLIO knew or was involved in the misconduct in Brazil, and that it had discovered evidence showing that BLIO's former general manager and controller caused misleading records to be created in order to prevent B&L's senior management from detecting their misconduct. See Shin Aff. Ex. 8. The Board of Directors concluded that the company should restate its financial results for fiscal year 2000 through the second quarter of 2005. On February 7, 2007, B&L filed its Form 10-K for 2005. The 10-K presented restated financial data for 2001 through 2005 and reported the final results of the accounting investigation and review. According to the Complaint, during the Class Period, B&L overstated its 2003 net income by 18%, 2004 net income by 4%, first quarter 2005 net income by 4% and second quarter 2005 net income by 20%.
As discussed above, pursuant to B&L's employee hotline, in the Fall of 2005 employees reported possible accounting problems at BL Korea. As a result, B&L's December 22, 2005 press release also revealed that the Audit Committee started investigating revenue recognition practices at BL Korea. Similar to BLIO, BL Korea represented only a small portion of B&L's consolidated business, generating approximately $33 million, which is $1.5% of B&L's 2004 net sales of $2,233 million. In accordance with B&L's existing compliance program, on October 26, 2005 Zarrella sent a communication to all B&L employees urging them to continue to use all available channels to report any possible violations of B&L policies. Accordingly, in November 2005 employees at BL Korea reported certain concerns. B&L made a disclosure that it had voluntarily reported the BL Korea matter to the SEC and would consider whether GAAP required additional adjustments to prior-period financial statements.
By March 17, 2006, B&L reported that, due to the BLIO and BL Korea investigations, it had undertaken an expanded review of revenue recognition practices at other foreign subsidiaries. See Shin Aff. Ex. 9. Moreover, B&L revealed that the review included issues related to transactions with distributors in Japan and India, which might result in additional adjustments to the restated financials. See id. B&L further reported on May 11, 2006 that it had started examining sales-related reserves in China. See id. Ex. 10. In the following months, B&L filed reports with the SEC disclosing the evolving scope of its ongoing accounting review. See id. Exs. 11-12.
B. B&L's Internal Controls
Plaintiff claims that in its 2003 and 2004 10-K forms, B&L and defendants Zarrella and McCluski stated that "the Company's Chairman and [CEO] and the Company's Senior Vice President and [CFO] have concluded that as of the end of the period covered by this report, the Company's disclosure controls and procedures were effective in timely alerting them to material information relating to the Company (including its consolidated subsidiaries) required to be included in the Company's periodic filings with the [SEC]." Moreover, in the 2003 and 2004 10-K forms, Zarrella and McCluski certified that they were responsible for establishing and maintaining disclosure controls and procedures and that they had done the following:
Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation;
Disclosed to its auditors and audit committee "[a]ll significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information" and "[a]ny fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting."
However, plaintiffs allege that defendants B&L, Zarrella, and McCluski admitted in the 2005 10-K form, which was filed on February 7, 2007 that B&L assurances were false and the internal controls were incapable of detecting the frauds at numerous subsidiaries.*fn9 In addition, plaintiffs contend that B&L, Zarrella and McCluski summed up these deficiencies by commenting that "as of December 31, 2005, the Company's internal control over financial reporting was not effective based on the criteria in Internal Control-Integrated Framework issued by the COSO" and admitted that these deficiencies "could result in a material misstatement to the Company's interim or annual consolidated financial statements and disclosures which would not be prevented or detected." Of significance to the subsidiaries' fraud are the following alleged admissions by B&L, Zarrella and McCluski:
"[T]he Company did not adequately and consistently reinforce the importance of adherence to controls and the Company's code of conduct, which contributed to certain of the restatement items that occurred across a broad range of the Company's operational and functional area."
"[T]he Company did not establish and maintain effective corporate and regional management oversight and monitoring of operations to detect subsidiaries' managements' override of established financial controls and accounting policies, execution of improper transaction and accounting entries to impact revenue and earnings, and reporting of these transactions to the appropriate finance personnel[.]"
"[T]he Company did not maintain effective controls to provide reasonable assurance that customer arrangements were adequately reviewed by the appropriate persons at such sub sidiariesto identify and provide reasonable assurance regarding the proper application of the appropriate method of revenue recognition in accordance with GAAP."
The Complaint includes allegations relating to two individuals whom plaintiffs identify as confidential witnesses. Confidential Witness #1 (CW1), the former general manager of BLIO, was one of the people who was fired by B&L for BLIO's accounting improprieties. CW1 states that B&L's actual oversight over BLIO was deficient and that B&L's internal auditors in Rochester had not visited BLIO since 2001, conducted internal controls merely by sending questionnaires to local managers, and that it was only after problems at BLIO began to surface publicly that the Rochester auditors spent any time examining BLIO. CW1 alleges that had the internal auditors adequately examined BLIO's financial records, they would have discovered the misappropriations since it was recorded over a multi-year period.
B&L claims that each year from 2000 through 2004, B&L's independent auditor, Pricewaterhouse-Coopers ("PwC"), conducted an audit of the Company's books and records, including audits of subsidiary records, and opined that B&L's financial statements "present[ed] fairly, in all material respects, the financial position of B&L and its subsidiaries "in conformity with [GAAP]." See Shin Aff. Exs. 1-5. After the Sarbanes-Oxley Act's internal control regulations came into force, B&L's management conducted an evaluation of the company's internal control over financial reporting and concluded that at year-end 2004 these controls were effective. Based on an evaluation of management's assessment and its own audit, PcW opined that management's assessment was fair and that B&L's internal controls were effective.*fn10
C. Disclosures Regarding BLIO
B&L filed a form 8-K on October 26, 2005 disclosing that it might delay the filing of its 10-Q for the third quarter pending the results of an investigation into allegations of improper conduct by BLIO management. In addition, the 8-K revealed that BLIO management had "engaged in improper management and accounting practices, including, among other things, the mischaracterization of approximately $600,000 in expenses to fund an approximately $1.5 million, unauthorized local pension arrangement for the benefit of themselves and other members of local management, the avoidance of Brazilian payroll tax obligations, the amount of which has not yet been determined, and the misuse of Company assets for personal benefit." Moreover, "Brazilian tax authorities have made tax assessments relating to or arising from Brazilian VAT, social contribution, income and certain import-related taxes against BLIO for unpaid taxes totaling approximately $5 million, interest of approximately $7 million, plus approximately $21 million in claimed penalties which relate back to various earlier periods."
Further, B&L revealed that it was considering whether any restatement of prior-period financial statements would be required and would assess its internal control over financial reporting, "including, in particular, its control over foreign tax matters, and whether there has been any material weakness in the Company's internal controls." In response to these announcements, the price of B&L stock dropped $2 per share. On December 22, 2005, B&L filed Form 8-K that disclosed the following:
B&L expected to restate its financial results for the fiscal years 2000 through 2004 and the first and second quarters of 2005 due to the BLIO matters.
B&L had "preliminarily identified a material weakness relating to detection and prevention of management fraud causing the override of existing controls, particularly in the area of tax reporting in the Company's Brazilian subsidiary.
B&L's assurances for the 2004 fiscal year that its internal controls were effective "should no longer be relied upon."
The Audit Committee was investigating revenue recognition practices in BL Korea.
Plaintiffs claim that as a result of these disclosures, the price of B&L stock dropped by 15%. According to the Complaint, most of that price decline occurred on December 23, which was the first trading day following the disclosures, from $79.07 per share to $72.00 per share, which was a drop of 8.9%. On the next trading day, December 27, the stock dropped another 4.3% to $68.90. See Declaration of Wallace Showman ("Showman Decl.") Ex. A.