United States District Court, S.D. New York
January 20, 2015
In re FAIRWAY GROUP HOLDING CORP. SECURITIES LITIGATION
For Jacksonville Police & Fire Pension Fund, Lead Plaintiff: Adam David Hollander, Gerald H. Silk, John Christopher Browne, Lauren Amy Ormsbee, LEAD ATTORNEY, Bernstein Litowitz Berger & Grossmann LLP, New York, NY.
For Renee Blumstein, Individually and On Behalf of All Others Similarly Situated, Plaintiff: Jeremy Alan Lieberman, Pomerantz LLP, New York, NY.
Bruce H. Paul, Consolidated Plaintiff, Pro se.
For Kevin Lind, Movant: Kim Elaine Miller, LEAD ATTORNEY, Kahn Swick & Foti, LLC, Madisonville, LA.
For Joe Felcher, Movant: Phillip C. Kim, LEAD ATTORNEY, The Rosen Law Firm P.A., New York, NY.
For Austin Power, Movant: Gregory M. Egleston, Thomas James McKenna, Gainey McKenna & Egleston, New York, NY.
For William Fassbender, Gregory Bradley Linkh, Movant: Gregory Bradley Linkh, LEAD ATTORNEY, Glancy Binkow & Goldberg LLP (NYC2), New York, NY.
For Martin Bertisch, M.D. David Amar, Movants: Jeremy Alan Lieberman, Pomerantz LLP, New York, NY.
For Fairway Group Holdings Corp., Herbert Ruetsch, Edward C Arditte, Kevin McDonnell, Defendants: Joseph S. Allerhand, Stacy Nettleton, LEAD ATTORNEY, Weil, Gotshal & Manges LLP (NYC), New York, NY.
For Sterling Investment Partners L.P., Sterling Investment Partners II, L.P., Sterling Investment Partners Side-by-Side, L.P., Sterling Investment Partners Advisers, LLC, Defendants: Joseph S. Allerhand, LEAD ATTORNEY, Weil, Gotshal & Manges LLP (NYC), New York, NY.
For Linda M. Siluk, charles w santoro, Howard Glickberg, William Selden, Stephen Key, Consolidated Defendants: Joseph S. Allerhand, Weil, Gotshal & Manges LLP (NYC), New York, NY.
REPORT AND RECOMMENDATION
Andrew J. Peck, United
States Magistrate Judge.
To the Honorable Lewis A. Kaplan, United States District Judge:
Plaintiff Jacksonville Police and Fire Pension Fund alleges that defendants made material misstatements and omissions in order to make the Fairway Group Holdings Corp. IPO more attractive to investors. (See generally Dkt. No. 59: Am. Compl.) The misstatements and omissions concern three primary issues: (1) Fairway's expansion to new stores (Am. Compl. ¶ ¶ 53-58); (2) Fairway's sales growth at existing store locations (Am. Compl. ¶ ¶ 59-63); and (3) Fairway's deferred tax asset and adjusted earnings before interest, taxes, depreciation and amortization (Am. Compl. ¶ ¶ 64-69). Plaintiff brings claims under Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, and Sections 11, 12(a)(2) and 15 of the Securities Act of 1933. (Am. Compl. ¶ ¶ 18, 24-36, 205-13, 283-304.)
Presently before the Court are the defendants' motions to dismiss. (See Dkt. No. 61: Underwriters Notice of Motion; Dkt. No. 63: Fairway & Sterling Notice of Motion; see also Dkt. No 62: Underwriters Br.; Dkt. No. 64: Fairway & Sterling Br; Dkt. No. 71: Underwriters Reply Br.; Dkt. No. 72: Fairway & Sterling Reply Br.) The Underwriter Defendants move to dismiss the amended complaint pursuant to Rules 8(a), 12(b)(1) and 12(b)(6) of the Federal Rules of Civil Procedure. (Underwriters Notice of Motion; see also Underwriters Br. at 1.) The Fairway and Sterling Defendants move to dismiss the amended complaint pursuant to Rules 8, 9(b) and 12(b)(6) of the Federal Rules of Civil Procedure, and the Private Securities Litigation Reform Act of 1995. (Fairway & Sterling Notice of Motion; see also Fairway & Sterling Br. at 1.)
For the reasons set forth below, the defendants' motions to dismiss (Dkt. Nos. 61 & 63) should be GRANTED dismissing plaintiff's Exchange Act Section 20(a) claim and Securities Act Section 15 claim against defendant Sterling Advisors, and dismissing plaintiff's Securities Act Section 12(a)(2) claim, and in all other respects should be DENIED.
Lead plaintiff Jacksonville Police and Fire Pension (" Jacksonville P& F") is a public pension plan established for police and firefighters in Jacksonville, Florida. (Dkt. No. 59: Am. Compl. ¶ 23.) Plaintiff purchased shares of Fairway securities between April 17, 2013 and February 7, 2014 (the " Class Period"). (Am. Compl. Intro. & ¶ 23.) Plaintiff brings this claim on behalf of itself and all others who purchased or acquired Fairway common stock during the Class Period. (Am. Compl. Intro.)
Defendant Fairway Group Holdings Corp. is a food retailer in the greater New York City Area. (Am. Compl. ¶ 24.) Fairway became a publicly traded company through an April 2013 IPO. (Id.)
Defendant Charles W. Santoro was Fairway's Executive Chairman of the Board. (Am. Compl. ¶ 25.) Santoro is a co-founder and managing partner of Sterling Investment Partners and is a member and general partner of the Sterling Funds discussed below. (Id.) Defendant Herbert Ruetsch was Fairway's Chief Executive Officer until his resignation on February 6, 2014. (Am. Compl. ¶ 26.) Defendant Edward C. Arditte was Fairway's Executive Vice President and Chief Financial Officer, and served as a consultant to Fairway in October and November 2012. (Am. Compl. ¶ 27.) According to Fairway's SEC filings, Santoro, Ruetsch and Arditte were " key personnel" during the Class Period, and were " primarily responsible for determining the strategic direction of [Fairway's] business and for executing [Fairway's] growth strategy." (Am. Compl. ¶ 28.) Fairway, Ruetsch, Arditte, and Santoro are defendants to both the Exchange Act claims and the Securities Act claims. (Am. Compl. ¶ ¶ 24-27, 220-25.)
The Sterling Defendants acquired an 80.1 percent stake in Fairway on January 24, 2007 pursuant to an original equity investment of approximately $150 million. (Am. Compl. ¶ 29.) The Sterling Funds collectively sold 1, 898, 909 shares of Fairway Class A common stock in the IPO for approximately $23 million. (Am. Compl. ¶ ¶ 29-33.)
Defendant Sterling Advisors, a Sterling affiliate, entered into a management agreement with Fairway in 2010. (Am. Compl. ¶ 34.) Sterling Advisors consulted with Fairway's Board of Directors and management on business and financial matters, including Fairway's corporate strategy and the IPO. (Id.) Between 2010 and the April 17, 2013 IPO, Fairway paid Sterling Advisors approximately $20 million for these services. (Id.) Sterling Advisors also received $9.2 million in the IPO as a fee to terminate the management agreement. (Id.) Sterling Advisors and the four Sterling Funds (collectively the " Sterling defendants") are defendants to the Exchange Act claims and the Securities Act claims. (Am. Compl. ¶ ¶ 29-34, 242-49.)
Defendant Linda M. Siluk served as Fairway's Vice President-Finance and Chief Accounting Officer since October 2011. (Am. Compl. ¶ 223.) Defendant Michael Barr is a principal of Sterling Investment Partners and has served as a Fairway director since 2007. (Am. Compl. ¶ 226.) Defendant Howard Glickberg has served as a Fairway director since January 2007 and as Fairway's Vice Chairman of Development since January 1, 2012. (Am. Compl. ¶ 227.) Defendant Stephen L. Key has served as a Fairway director since August 2012 and has served as a member of the Senior Executive Advisory Board of Sterling Investment Partners. (Am. Compl. ¶ 228.) Defendant William Selden is a co-founder and managing partner of Sterling Investment Partners, and has served as a Fairway director since January 2007. (Am. Compl. ¶ 229.) Defendant Farid Suleman has served as a Fairway director since August 2012 and has served as a member of the Senior Executive Advisory Board of Sterling Investment Partners. (Am. Compl. ¶ 230.) Siluk, Barr, Glickberg, Key, Selden and Suleman are defendants only to the Securities Act claims. (Am. Compl. ¶ ¶ 223, 226-30.)
Defendants Credit Suisse Securities (USA) LLC, Merrill Lynch, Pierce, Fenner & Smith Inc., Jefferies LLC, William Blair & Company L.L.C., BB& T Capital Markets, Guggenheim Securities, LLC, Oppenheimer & Co. Inc., Wolfe Trahan Securities, and Morgan Joseph TriArtisan LLC (collectively, the " Underwriter Defendants") each acted as an underwriter in the Fairway IPO; they are defendants only to the Securities Act claims. (Am. Compl. ¶ ¶ 232-41.)
Factual Allegations in the Amended Complaint
Stated briefly, plaintiff alleges that during the Class Period defendants made material misstatements and omissions regarding Fairway's growth potential to make Fairway's IPO attractive to investors. (See generally Dkt. No. 59: Am. Compl.) The misstatements and omissions concern three primary issues: (1) Fairway's expansion to new stores; (2) Fairway's sales growth at existing store locations; and (3) Fairway's deferred tax asset (" DTA") and adjusted earnings before interest, taxes, depreciation and amortization (" EBITDA"). (Am. Compl. ¶ ¶ 53-69.) Plaintiff's allegations are based upon SEC and other regulatory filings, press releases, statements made by Fairway's directors and officers during conference calls and the IPO roadshow, and analysts' reports. (Am. Compl. ¶ ¶ 51-79.) Plaintiff's allegations also are based upon the knowledge of seven confidential witnesses who are former Fairway employees (Am. Compl. ¶ ¶ 84-93, 123, 127), including: manager of financial planning (" CW 1"); assistant controller (" CW 2"); employee in the accounts payable department (" CW 3"); supervisor of several stores (" CW 4"); store controller (" CW 5"); assistant general manager (" CW 6"); and director of internal audit (" CW 7). (Am. Compl. ¶ ¶ 84-93, 123, 127.)
The amended complaint is voluminous and its specific factual allegations will be discussed in conjunction with the relevant legal analysis.
I. LEGAL STANDARDS GOVERNING MOTIONS TO DISMISS
A. The Standard Pursuant to Fed.R.Civ.P. 12(b)(6)
1. The Twombly-Iqbal " Plausibility" Standard
In the Twombly and Iqbal decisions in 2007 and 2009, the Supreme Court significantly clarified the standard for a motion to dismiss, as follows:
Under Federal Rule of Civil Procedure 8(a)(2), a pleading must contain a " short and plain statement of the claim showing that the pleader is entitled to relief." As the Court held in Twombly, the pleading standard Rule 8 announces does not require " detailed factual allegations, " but it demands more than an unadorned, the-defendant-unlawfully-harmed-me accusation. A pleading that offers " labels and conclusions" or " a formulaic recitation of the elements of a cause of action will not do." Nor does a complaint suffice if it tenders " naked assertion[s]" devoid of " further factual enhancement."
To survive a motion to dismiss, a complaint must contain sufficient factual matter, accepted as true, to " state a claim to relief that is plausible on its face." A claim has facial plausibility when the plaintiff pleads factual content that allows the court to draw the reasonable inference that the defendant is liable for the misconduct alleged. The plausibility standard is not akin to a " probability requirement, " but it asks for more than a sheer possibility that a defendant has acted unlawfully. Where a complaint pleads facts that are " merely consistent with" a defendant's liability, it " stops short of the line between possibility and plausibility of 'entitlement to relief.'"
Two working principles underlie our decision in Twombly. First, the tenet that a court must accept as true all of the allegations contained in a complaint is inapplicable to legal conclusions. Threadbare recitals of the elements of a cause of action, supported by mere conclusory statements, do not suffice. Rule 8 marks a notable and generous departure from the hyper-technical, code-pleading regime of a prior era, but it does not unlock the doors of discovery for a plaintiff armed with nothing more than conclusions. Second, only a complaint that states a plausible claim for relief survives a motion to dismiss. Determining whether a complaint states a plausible claim for relief will . . . be a context-specific task that requires the reviewing court to draw on its judicial experience and common sense. But where the well-pleaded facts do not permit the court to infer more than the mere possibility of misconduct, the complaint has alleged--but it has not " show[n]" --" that the pleader is entitled to relief."
In keeping with these principles a court considering a motion to dismiss can choose to begin by identifying pleadings that, because they are no more than conclusions, are not entitled to the assumption of truth. While legal conclusions can provide the framework of a complaint, they must be supported by factual allegations. When there are well-pleaded factual allegations, a court should assume their veracity and then determine whether they plausibly give rise to an entitlement to relief.
Ashcroft v. Iqbal, 556 U.S. 662, 677-79, 129 S.Ct. 1937, 1949-50, 173 L.Ed.2d 868 (2009) (citations omitted & emphasis added) (quoting Bell A. Corp. v. Twombly, 550 U.S. 544, 556-57, 570, 127 S.Ct. 1955, 1965-66, 1974, 167 L.Ed.2d 929 (2007) (retiring the Conley v. Gibson, 355 U.S. 41, 45-46, 78 S.Ct. 99, 102, 2 L.Ed.2d 80 (1957), pleading standard that required denying a Rule 12(b)(6) motion to dismiss " unless it appears beyond doubt that the plaintiff can prove no set of facts in support of his claim which would entitle him to relief")).
Even after Twombly and y, the Court's role in deciding a motion to dismiss " is merely to assess the legal feasibility of the complaint, not to assay the weight of the evidence which might be offered in support thereof." Bison Capital Corp. v. ATP Oil & Gas Corp., 10 Civ. 0714, 2010 WL 2697121 at *5 (S.D.N.Y. June 24, 2010) (Peck, M.J.) (quotations omitted), report & rec. adopted, 2010 WL 3733927 (S.D.N.Y. Sept. 16, 2010).
2. Consideration of Documents Attached to the Amended Complaint
A Rule 12(b)(6) motion to dismiss challenges only the face of the pleading. Thus, in deciding such a motion to dismiss, " the Court must limit its analysis to the four corners of the complaint." Vassilatos v. Ceram Tech Int'l, Ltd., 92 Civ. 4574, 1993 WL 177780 at *5 (S.D.N.Y. May 19, 1993) (citing Kopec v. Coughlin, 922 F.2d 152, 154-55 (2d Cir. 1991)). The Court, however, may consider documents attached to the complaint as an exhibit or incorporated in the complaint by reference. E.g., ATSI Commc'ns, Inc. v. Shaar Fund, Ltd., 493 F.3d 87, 98 (2d Cir. 2007);
Chambers v. Time Warner, Inc., 282 F.3d 147, 153 (2d Cir. 2002) (" Because this standard has been misinterpreted on occasion, we reiterate here that a plaintiff's reliance on the terms and effect of a document in drafting the complaint is a necessary prerequisite to the court's consideration of the document on a dismissal motion; mere notice or possession is not enough.");
Rothman v. Gregor, 220 F.3d 81, 88 (2d Cir. 2000) (" For purposes of a motion to dismiss, we have deemed a complaint to include any written instrument attached to it as an exhibit or any statements or documents incorporated in it by reference . . . .").
" However, before materials outside the record may become the basis for a dismissal, several conditions must be met. For example, even if a document is 'integral' to the complaint, it must be clear on the record that no dispute exists regarding the authenticity or accuracy of the document. It must also be clear that there exists no material disputed issue of fact regarding the relevance of the document." Faulkner v. Beer, 463 F.3d at 134 (citations omitted). In this case, the documents that plaintiff incorporated by reference in the amended complaint may be considered on the motions to dismiss, subject to the Faulkner v. Beer proviso.
B. The Standard Pursuant to Fed.R.Civ.P. 12(b)(1)
The " standards for dismissal under [Rule] 12(b)(6) and 12(b)(1) are substantively identical." Lerner v. Fleet Bank, N.A., 318 F.3d 113, 128 (2d Cir.) (Sotomayor, C. J.), cert. denied, 540 U.S. 1012, 124 S.Ct. 532, 157 L.Ed.2d 424 (2003); see also, e.g., Moore v. PaineWebber, Inc., 189 F.3d 165, 169 n.3 (2d Cir. 1999); Pearl River Union Free Sch. Dist. v. Duncan, 12 Civ. 2938, 2014 WL 4387235 at *10 (S.D.N.Y. Sept. 5, 2014); Bishop v. Porter, 02 Civ. 9542, 2003 WL 21032011 at *3 (S.D.N.Y. May 8, 2003); Tennant v. U.S. Bureau of Prisons, No. 02 CV 00558, 2003 WL 1740605 at *1 (D. Conn. Mar. 29, 2003).
C. Pleading Requirements for Securities Fraud
A complaint alleging securities fraud must satisfy the heightened pleadings requirements of Federal Rule of Civil Procedure 9(b) by stating with " particularity the circumstances constituting fraud." Fed.R.Civ.P. 9(b); see, e.g., ATSI Commnc'ns, Inc. v. Shaar Fund, Ltd., 493 F.3d 87, 99 (2d Cir. 2007);
Ganino v. Citizens Utils. Co., 228 F.3d 154, 168 (2d Cir. 2000) (" It is well-settled in this Circuit that a complaint alleging securities fraud must satisfy the pleading requirements of Rule 9(b) of the Federal Rules of Civil Procedure."). Federal Rule of Civil Procedure 9(b) states:
In alleging fraud or mistake, a party must state with particularity the circumstances constituting fraud or mistake. Malice, intent, knowledge, and other conditions of a person's mind may be alleged generally.
Although Rule 9(b) must be read together with Rule 8(a), which requires only a " 'short and plain statement' of the claims, " Ouaknine v. MacFarlane, 897 F.2d 75, 79 (2d Cir. 1990), the fraud allegations in the complaint must be specific enough to allow the defendant " a reasonable opportunity to answer the complaint, " Ross v. A. H. Robins Co., 607 F.2d 545, 557 (2d Cir. 1979), cert. denied, 446 U.S. 946, 100 S.Ct. 2175, 64 L.Ed.2d 802 (1980). Furthermore, the complaint must give the defendant " adequate information" to allow the defendant " to frame a response." Ross v. A. H. Robins Co., 607 F.2d at 557-58; Miller v. Holtzbrinck Publishers, LLC, 08 Civ. 3508, 2009 WL 528620 at *2 (S.D.N.Y. Mar. 3, 2009), aff'd, 377 F.App'x 72 (2d Cir. 2010); Kermanshah v. Kermanshah, 580 F.Supp.2d 247, 257 (S.D.N.Y. 2008) (Peck, M.J.); Ryan v. Hunton & Williams, No. 99-CV-5938, 2000 WL 1375265 at *6 (E.D.N.Y. Sept. 20, 2000) (" Allegations of fraud . . . must be specific enough to provide a defendant with 'a reasonable opportunity to answer the complaint and . . . adequate information to frame a response.'").
Because the amended complaint asserts a claim for securities fraud, Rule 9(b)'s requirements are supplemented by the parallel requirements of the Private Securities Litigation Reform Act (" PSLRA"). See, e.g., ECA, Local 134 IBEW Joint Pension Trust v. JP Morgan Chase Co., 553 F.3d 187, 196 (2d Cir. 2009); Lentell v. Merrill Lynch & Co., 396 F.3d at 168; Rombach v. Chang, 355 F.3d at 172; Novak v. Kasaks, 216 F.3d 300, 306-07 (2d Cir.), cert. denied, 531 U.S. 1012, 121 S.Ct. 567, 148 L.Ed.2d 486 (2000); Freedman v. Weatherford Int'l Ltd., 12 Civ. 2121, 2013 WL 5299137 at *4 (S.D.N.Y. Sept. 20, 2013) (Kaplan, D.J.); In re AOL, Inc. Repurchase Offer Litig., 966 F.Supp.2d 307, 311 (S.D.N.Y. 2013). The PSLRA provides:
(b) Requirements for securities fraud actions
(1) Misleading statements and omissions
In any private action arising under this chapter in which the plaintiff alleges that the defendant --
(A) made an untrue statement of a material fact; or
(B) omitted to state a material fact necessary in order to make the statements made, in the light of the circumstances in which they were made, not misleading;
the complaint shall 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).
Even before the PSLRA, in order to satisfy the Rule 9(b) pleading requirement for fraud under § 10(b) and Rule 10b-5, the Second Circuit required that the 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.
Acito v. IMCERA Grp, Inc., 47 F.3d 47, 51 (2d Cir. 1995). This requirement continues after passage of the PSLRA. E.g., ATSI Commc'ns, Inc. v. Shaar Fund, Ltd., 493 F.3d 87, 99 (2d Cir. 2007); Novak v. Kasaks, 216 F.3d at 306; Gordon v. Sonar Capital Mgmt. LLC, 11 Civ. 9665, 2014 WL 3900560 at *2 (S.D.N.Y. Aug. 1, 2014); Fishoff v. Coty Inc., No. 09 Civ. 628, 2009 WL 1585769 at *3 (S.D.N.Y. June 8, 2009); In re Optionable Sec. Litig., 577 F.Supp.2d 681, 688 (S.D.N.Y. 2008) (Kaplan, D.J.);
In re Parmalat Sec. Litig., 383 F.Supp.2d at 622.
The Second Circuit, both before and after passage of the PSLRA, requires that " a plaintiff alleging fraud in connection with a securities transaction must specifically allege the acts or omissions upon which his claim rests. It will not do merely to track the language of Rule 10b-5 and rely on such meaningless phrases as 'scheme and conspiracy' or 'plan and scheme and course of conduct to deceive.'" Ross v. A.H. Robins Co., 607 F.2d at 557; see, e.g., Slayton v. Am. Exp. Co., 604 F.3d 758, 773 (2d Cir. 2010) (" plaintiffs must 'state with particularity both the facts constituting the alleged violation, and the facts evidencing scienter'"); Novak v. Kasaks, 216 F.3d at 306-11 (discussing particularity and scienter requirements); Rich v. Maidstone Fin., Inc., 2001 WL 286757 at *7.
Furthermore, a complaint alleging fraud against multiple defendants must state the allegations specifically attributable to each individual defendant. E.g., In re DDAVP Direct Purchaser Antitrust Litig., 585 F.3d 677, 695 (2d Cir. 2009), cert. denied, 561 U.S. 1038, 130 S.Ct. 3505, 177 L.Ed.2d 1114 (2010); Mills v. Polar Molecular Corp., 12 F.3d 1170, 1175 (2d Cir. 1993); DiVittorio v. Equidyne Extractive Indus., 822 F.2d 1242, 1247 (2d Cir. 1987); IKB Int'l S.A. v. Bank of Am., 12 Civ. 4036, 2014 WL 1377801 at *5 (S.D.N.Y. Mar. 31, 2014) (Kaplan, D.J.), aff'd, 584 F.App'x 26 (2d Cir. 2014); In re Parmalat Sec. Litig., 479 F.Supp.2d 332, 340 (S.D.N.Y. 2007) (Kaplan, D.J.) (" [W]here, as here, 'multiple defendants are asked to respond to allegations of fraud, the complaint should inform each defendant of the nature of his [or her] alleged participation in the fraud.'"); Rich v. Maidstone Fin., Inc., 2001 WL 286757 at *6 (" when fraud is alleged against multiple defendants, a plaintiff must set forth separately the acts complained of by each defendant. A complaint may not simply clump defendants together in vague allegations to meet the pleading requirements of Rule 9(b)." (quotations, citations, & alterations omitted; collecting cases)).
II. PLAINTIFF ADEQUATELY ALLEGES VIOLATIONS OF EXCHANGE ACT SECTION 10(B) AND SEC RULE 10B-5
A. Elements of § 10(b) and Rule 10b-5 Claims
Exchange Act Section 10(b) and SEC Rule 10b-5 prohibit fraudulent activities in connection with the purchase or sale of securities, whether or not those securities are registered.
In order to state a prima facie case of a violation of § 10(b) and Rule 10b-5, a plaintiff must allege: " (1) a material misrepresentation or omission by the defendant; (2) scienter; (3) a connection between the misrepresentation or omission and the purchase or sale of a security; (4) reliance upon the misrepresentation or omission; (5) economic loss; and (6) loss causation." Carpenters Pension Trust Fund v. Barclays PLC, 750 F.3d 227, 232 (2d Cir. 2014). The failure to establish any element is fatal to a section 10(b)/Rule 10b-5 claim. See, e.g., Central Bank of Denver, N.A. v. First Interstate Bank of Denver, N.A., 511 U.S. 164, 190-91, 114 S.Ct. 1439, 1455, 128 L.Ed.2d 119 (1994); First N.Y. Sec. LLC v. United Rentals Inc., 391 F.App'x 71, 74 (2d Cir. 2010) (unnecessary to address materiality where plaintiff failed to establish scienter); Wilson v. Comtech Telecomm. Corp., 648 F.2d 88, 94 (2d Cir. 1981) (" Because we find that [plaintiff] has failed to demonstrate his reliance on any actions by appellees, we need not reach the other elements of his 10b-5 claim.").
Defendants argue that plaintiff has failed adequately to allege a material misstatement or omission, scienter, or loss causation, and instead pleads only " fraud by hindsight." (Dkt. No. 64: Fairway & Sterling Br. at 15;
see id. at 15-33.)
B. Plaintiff Adequately Has Alleged Material Misstatements and Omissions
When a plaintiff alleges " 'a statement or omission that a reasonable investor would have considered significant in making investment decisions, '" such a misstatement or omission is material. Litwin v. Blackstone Grp. L.P., 634 F.3d 706, 716-17 (2d Cir.), cert. denied, 132 S.Ct. 242, 181 L.Ed.2d 138 (2011); see also, e.g., Carpenters Pension Trust Fund v. Barclays PLC, 750 F.3d 227, 235 (2d Cir. 2014); ECA, Local 134 IBEW Joint Pension Trust v. JP Morgan Chase Co., 553 F.3d 187, 197 (2d Cir. 2009); Caiola v. Citibank, N.A., 295 F.3d 312, 329 (2d Cir. 2002) (" [T]o fulfill the materiality requirement there must be a substantial likelihood that the disclosure of the omitted fact would have been viewed by the reasonable investor as having significantly altered the total mix of information made available." (quotations omitted)); Ganino v. Citizens Utils. Co., 228 F.3d 154, 161-62 (2d Cir. 2000); City of Roseville Emps. Ret. Sys. v. Energysolutions, Inc., 814 F.Supp.2d 395, 410 (S.D.N.Y. 2011).
An omission is actionable " only when the [defendant] is subject to a duty to disclose the omitted facts." In re Time Warner Inc. Sec. Litig., 9 F.3d 259, 267 (2d Cir. 1993); accord, e.g., Kleinman v. Elan Corp., 706 F.3d 145, 153 (2d Cir. 2013); City of Roseville Emps. Ret. Sys. v. Energy Solutions Inc., 814 F.Supp.2d at 410. Although Rule 10b-5 imposes no affirmative duty to disclose all material, non-public information, " once a party chooses to speak, it has a 'duty to be both accurate and complete.'" Plumbers' Union Local No. 12 Pension Fund v. Swiss Reinsurance Co., 753 F.Supp.2d 166, 180 (S.D.N.Y. 2010) (quoting Caiola v. Citibank, N.A., 295 F.3d 312, 331 (2d Cir. 2002)).
Because materiality is a mixed question of law and fact, a complaint may not 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." ECA, Local 134 IBEW Joint Pension Trust v. JP Morgan Chase Co., 553 F.3d at 197 (quotations omitted).
1. Material Misstatements Regarding New Store Growth
Plaintiff alleges that defendants made material misstatements concerning Fairway's ability to achieve new store growth. (Dkt. No. 59: Am. Compl. ¶ ¶ 53-58, 82-93.) In support of this allegation, plaintiff contrasts statements in the IPO Prospectus highlighting Fairway's " 'scalable infrastructure'" and " 'proven ability to replicate [its] store model'" with statements from CW 2 and CW 3 that Fairway's infrastructure, including its IT department and its warehousing and distribution facilities, could not support Fairway's current stores, let alone a significant expansion. (Am. Compl. ¶ ¶ 82-85, 138.) Plaintiff contrasts Arditte's statement on a June 6, 2013 conference call that " 'it should be true on an annual basis [that] sales contributions from new store openings grows faster than our [general and administrative] expense'" with Fairway's balance sheet and income statements, which, after three years of rapid expansion, reflected over $200 million in debt and $124 million of net operating losses. (Am. Compl. ¶ ¶ 158-60.) Plaintiff contrasts Ruetsch's June 6, 2013 statement that " 'the story about Fairway is adding new locations'" and defendant Santoro's remarks of the same date (" '[w]e have the capacity in the context of our infrastructure to open more stores than this plan provides for'") with the contemporaneous reality of what CW 1, who had direct access to Fairway's financials and business strategy prior to the IPO, states was a struggling business model that lost money each quarter prior to the IPO. (Am. Compl. ¶ ¶ 90-92, 158.)
Plaintiff alleges that the IPO Prospectus and Registration Statement stated that Fairway had a " 'proven ability to replicate [its] store model'" and " 'scalable infrastructure.'" (Am. Compl. ¶ ¶ 138, 297.) Similar statements were made in the 2013 10-K, a June 6, 2013 press release and Form 8-K filed with the SEC, and on a June 6, 2013 quarterly earnings call. (Am. Compl. ¶ ¶ 150-51, 158.).
Defendants argue that these statements are " forward-looking statements, " and thus protected by the PSLRA safe harbor and the Second Circuit's " bespeaks caution" doctrine. (Dkt. No. 64: Fairway & Sterling Br. at 17-19; Dkt. No. 72: Fairway & Sterling Reply Br. at 4-7.) Neither the PSLRA nor the bespeaks caution doctrine protect misstatements or omissions of present or historical fact. 15 U.S.C. § 77z-2(c)(1)(B)(ii); see, e.g., Iowa Pub. Emps. Ret. Sys. v. MF Global, Ltd., 620 F.3d 137, 142, 144 (2d Cir. 2010);
Rombach v. Chang, 355 F.3d 164, 173 (2d Cir. 2004) (" 'The doctrine of bespeaks caution provides no protection to someone who warns his hiking companion to walk slowly because there might be a ditch ahead when he knows with near certainty that the Grand Canyon lies one foot away.'" (quoting In Re Prudential Sec. Inc. P'ship Litig., 930 F.Supp. 68, 72 (S.D.N.Y. 1996)).
Characterizations of Fairway's infrastructure as " scalable" and capacity as greater than provided for invite the conclusion that the company will expand with ease. Insofar as those statements communicate present facts about Fairway's business they are not protected by the PSLRA or the bespeaks caution doctrine. See, e.g., Iowa Pub. Emps. Ret. Sys. v. MF Global, Ltd., 620 F.3d at 144; In re Bear Stearns Co., Sec., Derivative, & ERISA Litig., 763 F.Supp.2d 423, 491-92 (S.D.N.Y. 2011); In re Regeneron Pharms., Inc. Sec. Litig., 03 Civ. 3111, 2005 WL 225288 at *13 (S.D.N.Y. Feb. 1, 2005) (" Statements that might arguably have some forward-looking aspect are unprotected by the PSLRA safe harbor provision to the extent that they are premised on representations of present fact.").
The statements plaintiff includes in the amended complaint were assurances that Fairway had the present capacity to support its growth plan, not puffery or forward looking optimism as defendants contend. (Fairway & Sterling Br. at 21-22; Fairway & Sterling Reply Br. at 8-9.) The historical fact that Fairway was heavily indebted and operating at a loss posed a serious obstacle to sales contributions from new store openings outpacing expenses. (Am. Compl. ¶ ¶ 159-60.) Prefacing such a statement with " it should be true" does not change the assertive nature of the statement, or the implication that it rests on a factual basis regarding the potential for profitability at new Fairway stores. See, e.g., In re Bear Stearns Co., Sec., Derivative, & ERISA Litig., 763 F.Supp.2d at 492; In re Oxford Health Plans, Inc., 187 F.R.D. 133, 141 (S.D.N.Y. 1999) (" 'Statements regarding projections of future performance may be actionable under section 10(b) or Rule 10b-5 if they are . . . supported by specific statements of fact . . . or if the speaker does not genuinely or reasonably believe them.'" (quoting In re IBM Corp. Sec. Litig., 163 F.3d 102, 107 (2d Cir.1998)).
Defendants argue that plaintiff's confidential witnesses did not directly participate in developing the growth plans at issue. (Fairway & Sterling Reply Br. at 7.) The amended complaint identifies the confidential witnesses by their positions and dates of employment. (See pages 4-5 above.) This information is sufficient to support the probability that someone in their position would possess the information they each have alleged. Novak v. Kasaks, 216 F.3d 300, 314 (2d Cir.), cert. denied, 531 U.S. 1012, 121 S.Ct. 567, 148 L.Ed.2d 486 (2000); Freudenberg v. E*Trade Fin. Corp., 712 F.Supp.2d 171, 196-97 (S.D.N.Y. 2010).
Plaintiff has specified fraudulent statements, identified the speakers, stated when and where the statements were made, and explained why the statements were fraudulent. Novak v. Kasaks, 216 F.3d at 306; see also cases cited at pages 11-12 above. Accordingly, plaintiff has sufficiently pled that defendants made actionable misstatements with regard to new store growth.
2. Material Omission Regarding Same Store Sales Growth
Plaintiff alleges that the IPO prospectus, Registration Statement, June 6, 2013 10-K and August 8, 2013 10-Q contained a material omission regarding same store sales growth. (Dkt. No. 59: Am. Compl. ¶ ¶ 59-63, 141-43, 153, 168, 276.) Each document contained a statement that after Hurricane Sandy, Fairway " 'experienced business disruptions due to inventory delays as a result of transportation issues, loss of electricity at certain of our locations and the inability of some of our employees to travel to work due to transportation issues.'" (Am. Compl. ¶ ¶ 141, 153, 168.) The Prospectus and June 6, 2013 10-K further stated that Fairway " 'temporarily closed all [Fairway] stores'" as a result of the storm. (Am. Compl. ¶ ¶ 62, 141, 153.) Plaintiff states that it was reasonable for investors to expect that Fairway's same store sales would increase in subsequent years, absent the unusual disruptions caused by Sandy, but that in fact Fairway experienced record high sales before and after Hurricane Sandy. (Am. Compl. ¶ ¶ 63, 113.) The IPO prospectus stated that Fairway tracked " sales on a daily basis." (Am. Compl. ¶ 142.) Plaintiff alleges that despite this practice, defendants did not disclose until November 7, 2013 that Hurricane Sandy had been a boon to business. (Am. Compl. ¶ 113.)
Rule 10b-5 imposes no affirmative duty to disclose all material, non-public information; however, once a party chooses to speak, it has a " duty to be both accurate and complete." Caiola v. Citibank, N.A., 295 F.3d 312, 331 (2d Cir. 2002);
see, e.g., Freudenberg v. E*Trade Fin. Corp., 712 F.Supp.2d 171, 179 (S.D.N.Y. 2010) (" [O]nce corporate officers undertake to make statements, they are obligated to speak truthfully and to make such additional disclosures as are necessary to avoid rendering the statements misleading."); see also cases cited at page 16 above. " 'Even an entirely truthful statement may provide a basis for liability, '" if it misleads investors. In re Sanofi-Aventis Secs. Litig., 774 F.Supp.2d 549, 561 (S.D.N.Y. 2011).
Defendants put the topic of Hurricane Sandy's impact on Fairway's business at issue through their statements. Having done so, they had a duty to disclose additional information if a reasonable investor might find it " would significantly alter the mix of available information." Freudenberg v. E*Trade Fin. Corp., 712 F.Supp.2d at 180. Plaintiff alleges that defendants' statements about the impact of Hurricane Sandy led investors to believe that Fairway's future sales would improve over sales in 2012. (Am. Compl. ¶ 63.) Plaintiff alleges that this information was material to investors who were concerned that the New York market could not support expanded Fairway locations and continued same store sales growth. (Am. Compl. ¶ 59.) The omission is not " so obviously unimportant to a reasonable investor that reasonable minds could not differ on the question of [its] importance." ECA, Local 134 IBEW Joint Pension Trust v. JP Morgan Chase Co., 553 F.3d 187, 197 (2d Cir. 2009); see also cases cited at page 16 above. Accordingly, plaintiff sufficiently has pled that defendants made an actionable omission concerning sales growth at existing Fairway stores.
3. Material Misstatement Regarding the Deferred Tax Asset (" DTA")
Plaintiff alleges that defendants reported a $26 million DTA in the IPO prospectus and June 6, 2013 10-K although they did not subjectively believe future income would justify doing so. (Dkt. No. 59: Am. Compl. ¶ ¶ 94-103.) Under Financial Accounting Standards No. 109, a DTA may be claimed only if it is " more likely than not" that it will be used to offset taxable income in future years. See, e.g., In re MF Global Holdings Ltd. Secs. Litig., 982 F.Supp.2d 277, 293, 313-15 (S.D.N.Y. 2013); Kuriakose v. Fed. Home Loan Mortg. Corp., 897 F.Supp.2d 168, 180-81 (S.D.N.Y. 2012), aff'd sub nom.Cent. States, Se. & Sw. Areas Pension Fund v. Fed. Home Loan Mortg. Corp., 543 F.App'x 72 (2d Cir. 2013); In re Scottish Re Grp. Sec. Litig., 524 F.Supp.2d 370, 377, 388-90 (S.D.N.Y. 2007). Plaintiff alleges that defendants' financial forecasts projecting sufficient income to justify reporting the DTA had no basis in objective figures. (Am. Compl. ¶ ¶ 94-103.) CW 1 stated that defendant Santoro set financial targets as necessary to make Fairway seem an attractive IPO prospect, and that defendant Arditte manipulated business models to reach those targets. (Am. Compl. ¶ ¶ 103, 124-26.) According to CW 1, Fairway's internal audit manager played no role in developing projected earnings. (Am. Compl. ¶ 127.) Rather, at Sterling's direction Santoro and Arditte, with input from Ruetsch, " came up" with a number of new stores and growth rate, and modeled around those figures without regard to Fairway's verifiable financial metrics or continued losses. (Am. Compl. ¶ ¶ 103, 125-26.)
Defendants argue that statements estimating the fair market value of assets, such as a DTA, reflect management's judgment and opinion, not matters of objective fact. (Dkt. No. 64: Fairway & Sterling Br. at 22-24; Dkt. No. 72: Fairway & Sterling Reply Br. at 9-10.) Statements of opinion that are objectively false or disbelieved at the time they are expressed are actionable under the securities laws.
Fait v. Regions Fin. Corp., 655 F.3d 105, 112 (2d Cir. 2011) (" Requiring plaintiffs to allege a speaker's disbelief in, and the falsity of, the opinions or beliefs expressed ensures that their allegations concern the factual components of those statements."); IKB Int'l S.A. v. Bank of America, 12 Civ. 4036, 2014 WL 1377801 at *1 (S.D.N.Y. Mar. 31, 2014) (Kaplan, D.J.) (a fraud claim based on an expression of opinion may be actionable " because the speaker either did not in fact hold the opinion stated or because the speaker subjectively was aware that there was no reasonable basis for it"), aff'd, 584 F.App'x 26 (2d Cir. 2014); In re Gen. Elec. Co. Sec. Litig., 856 F.Supp. 2d. 645, 653 (S.D.N.Y. 2012).
Under the relevant accounting standards, Fairway could not report the $26 million DTA unless defendants believed that Fairway would have taxable income greater than $26 million within five years. (Am. Compl. ¶ ¶ 96-99.) The Court has already found it plausible that defendants knew Fairway did not have the capacity to grow as projected, and thus that Fairway's cumulative losses would continue. (See pages 17-21 above.) Such finding is consistent with knowledge that a $26 million profit within five years was unlikely. Although a write down " does not stand for the proposition that values stated before the write-down were inaccurate, " coupled with Fairway's history of losses and plaintiff's allegation that Fairway's financial modeling was not rooted in actual sales data, it raises the inference that defendants knew they would not have the necessary income. Yu v. State St. Corp., 686 F.Supp.2d 369, 380 (S.D.N.Y.), vacated on other grounds, 08 Civ. 8235, 2010 WL 2816259 (S.D.N.Y. July 14, 2010). Accordingly, plaintiff sufficiently has pled that defendants had no basis to believe, and subjectively did not believe, that they would have income to justify reporting the DTA.
C. Plaintiff Adequately Has Alleged Scienter
1. Legal Standard
Scienter is " 'a mental state embracing intent to deceive, manipulate, or defraud.'" Tellabs, Inc. v. Makor Issues & Rights, Ltd., 551 U.S. 308, 319, 127 S.Ct. 2499, 2507, 168 L.Ed.2d 179 (2007). Under the PSLRA, a complaint must state with particularity facts giving rise to a " strong inference" that the defendant acted with the required state of mind. 15 U.S.C. § 78u-4(b)(2). In Novak v. Kasaks, the Second Circuit concluded that the PSLRA " effectively raised the nationwide pleading standard to that previously existing in this circuit." Novak v. Kasaks, 216 F.3d 300, 310 (2d Cir.), cert. denied, 531 U.S. 1012, 121 S.Ct. 567, 148 L.Ed.2d 486 (2000). Previously, the Second Circuit had accepted allegations of " motive and opportunity" or allegations " constituting strong circumstantial evidence of conscious misbehavior or recklessness" as means of demonstrating scienter, and both methods have been used in this Circuit subsequent to the PSLRA's enactment. See, e.g., Stratte McClure v. Morgan Stanley, No. 13-0627, 2015 WL 136312 at * 10 (2d Cir. Jan. 12, 2015); Kalnit v. Eichler, 264 F.3d 131, 138-39 (2d Cir. 2001); City of Brockton Ret. Sys. v. Avon Prods., Inc., 11 Civ. 4664, 2014 WL 4832321 at *18 (S.D.N.Y. Sept. 28, 2014); In re Pfizer, Inc. Sec. Litig., 538 F.Supp.2d 621, 635 (S.D.N.Y. 2008) (Kaplan, D.J.).
The Second Circuit has further explained that a strong inference of scienter, sufficient to meet the PSLRA's standards, may arise where the complaint alleges that defendants (1) " benefitted in a concrete and personal way from the 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 a duty to monitor." Novak v. Kasaks, 216 F.3d at 311; see also, e.g., ECA, Local 134 IBEW Joint Pension Trust v. JP Morgan Chase Co., 553 F.3d 187, 199 (2d Cir. 2009); In re JP Morgan Chase & Co. Sec. Litig., 12 Civ. 3852, 2014 WL 1297446 at *6 (S.D.N.Y. Mar. 31, 2014); U.S. S.E.C. v. Subaye, Inc., 13 Civ. 3114, 2014 WL 448414 at *6 (S.D.N.Y. Feb. 4, 2014).
The Supreme Court has held that to qualify as strong, an " inference of scienter must be more than merely plausible or reasonable--it must be cogent and at least as compelling as any opposing inference of nonfraudulent intent." Tellabs, Inc. v. Makor Issues & Rights, Ltd., 551 U.S. at 314, 127 S.Ct. at 2504-05. In determining whether an inference of scienter can be drawn, the Court should consider " all of the facts alleged, taken collectively . . . not whether any individual allegation, scrutinized in isolation, meets that standard." Id. at 323, 127 S.Ct. at 2509.
2. Motive and Opportunity
Plaintiff advances several allegations to demonstrate the defendants' adequate motive to commit fraud. Briefly, plaintiff argues that defendants sought to recoup their investment in Fairway by inflating share prices and selling their own stake through the IPO. (Dkt. No. 59: Am. Compl. ¶ ¶ 128-32.) According to plaintiff, 15, 697, 500 shares were offered in the IPO. (Am. Compl. ¶ 9.) Plaintiff alleges that Sterling generated $95 million in the IPO: $23 million in stock sales, $63 million in dividend payments and $9.2 million for the termination of Fairway's management agreement with Sterling Advisors. (Am. Compl. ¶ 9.) Plaintiff argues that from the time of their initial investment in Fairway, the Sterling defendants' intention was to " cash out" in an IPO. (Am. Compl. ¶ 41.)
Numerous CWs, from different levels of Fairway's hierarchy, allege that Fairway's financial projections were baseless, and that income statement line items such as existing stores payroll were cut to manipulate numbers as a means of " painting over" problems prior to the IPO. (Am. Compl. ¶ ¶ 85-90.) Plaintiff contends that in selling a portion of their holdings at inflated prices (1, 898, 909 shares), the Sterling defendants were able to limit the risk on their investment and generate a significant return in the IPO. (Am. Compl. ¶ ¶ 41, 130-31.)
As to the individual defendants, plaintiff alleges that Santoro, as a cofounder and managing partner of the Sterling Funds, is deemed the beneficial owner of shares owned by the Sterling Funds and thereby benefits directly from the Funds' $23 million profit on stock sales. (Am. Compl. ¶ ¶ 130-31; Dkt. No. 65-4: Allerhand Aff. Ex. 4 at 23-24.) Plaintiff also alleges that defendant Ruetsch sold 23, 077 shares in the IPO, ten percent of his overall holdings, and received an IPO related bonus for total IPO proceeds of over $1 million. (Am. Compl. ¶ 132; see Dkt. No. 64: Fairway & Sterling Br. at 28.)
Defendants argue that plaintiff's allegations are not sufficient to satisfy the motive prong of the scienter inquiry. (Fairway & Sterling Br. 27-29; Dkt. No. 72: Fairway & Sterling Reply Br. at 11-13.) Defendants state that Sterling sold only eight percent of its interest in Fairway in the IPO, and a large post-IPO holding negates any showing of a plausible motive. (Fairway & Sterling Br. at 27; Fairway & Sterling Reply Br. at 12.) Defendants further state that of the Individual Defendants, only defendant Ruetsch sold stock during the class period. (Fairway & Sterling Br. at 28.)
To raise a strong inference of scienter under the Second Circuit's " motive and opportunity" standard, plaintiff must allege that defendants " benefitted in some concrete and personal way from the purported fraud." Novak v. Kasaks, 216 F.3d 300, 307-08 (2d Cir.), cert. denied, 531 U.S. 1012, 121 S.Ct. 567, 148 L.Ed.2d 486 (2000). Motives common to all corporate officers, such as the desire for the corporation to appear profitable, or the desire to keep stock prices high to increase officer compensation, do not suffice for purposes of this inquiry. Novak v. Kasaks, 216 F.3d at 307; Kalnit v. Eichler, 264 F.3d 131, 139 (2d Cir. 2001); In re Refco., Inc. Sec. Litig., 503 F.Supp.2d 611, 645 (S.D.N.Y. 2007) (Lynch, D.J.).
The motive showing is generally met when it is alleged that corporate insiders made material misrepresentations to the public about the corporation's performance or prospects in order to keep the stock price artificially high while they sold their own shares at a profit. ECA, Local 134 IBEW Joint Pension Trust v. JP Morgan Chase Co., 553 F.3d 187, 198 (2d Cir. 2009) (" [T]he 'motive' showing is generally met when corporate insiders allegedly make a misrepresentation in order to sell their own shares at a profit."); In re Refco., Inc. Sec. Litig., 503 F.Supp.2d at 646; Duncan v. Pencer, 94 Civ. 321, 1996 WL 19043 at * 14 (S.D.N.Y. Jan. 18, 1996) (misstatements that inflate stock price in advance of a public offering are sufficient to support an inference of scienter).
The opportunity showing is met by demonstrating " the means and likely prospect of achieving concrete benefits by the means alleged." Shields v. Citytrust Bancorp, Inc., 25 F.3d 1124, 1130 (2d Cir. 1994). The opportunity to commit fraud may be assumed when the defendant is a corporation or corporate officer or director. See, e.g., Kalnit v. Eichler, 264 F.3d 131, 139 (2d Cir. 2001); In re MF Global Holdings Ltd. Secs. Litig., 982 F.Supp.2d 277, 306 (S.D.N.Y. 2013); Rolin v. Spartan Mullen Et Cie, 10 Civ. 1586, 2011 WL 5920931 at *8 (S.D.N.Y. Nov. 23, 2011); In re AstraZeneca Sec. Litig., 559 F.Supp.2d 453, 468 (S.D.N.Y. 2008), aff'd sub nom. State Univs. Ret. Sys. v. AstraZeneca PLC, 334 F.App'x 404 (2d Cir. 2009);
Pension Comm. of Univ. of Montreal Pension Plan v. Banc of Am. Sec., LLC, 446 F.Supp.2d 163, 181 (S.D.N.Y. 2006) (" Regarding the 'opportunity' prong, courts often assume that corporations, corporate officers, and corporate directors would have the opportunity to commit fraud if they so desired.").
The Court finds that the April 2013 IPO provides a motive for fraud. Plaintiff alleges that in misrepresenting and concealing the state of Fairway's business, defendants were able to raise millions of dollars in the offering, nearly recouping their entire $150 million investment in Fairway, " that they otherwise would not have been able to if they presented a more complete and accurate financial snapshot." Van Dongen v. CNinsure Inc., 951 F.Supp.2d 457, 474 (S.D.N.Y. 2013). Fairway and the Sterling Funds, as corporations, and Santoro and Ruetsch, as corporate officers, had sufficient opportunity to commit fraud. In re AstraZeneca Sec. Litig., 559 F.Supp.2d at 468. Each of the individual officers was in a position to approve statements made to the public regarding the health of Fairway's business, and cannot " seriously dispute that '[s]uch senior executives have the opportunity to commit fraud.'" In re Refco, Inc. Sec. Litig., 503 F.Supp.2d at 648.
Plaintiff has pled scienter by demonstrating motive and opportunity to commit fraud on the part of Santoro, Ruetsch, Fairway, and the Sterling Defendants, all of whom stood to benefit in a direct, personal and concrete way from the fraud. Plaintiff has not pled facts sufficient to demonstrate that defendant Arditte had motive to commit fraud, but as discussed below, plaintiff has alleged scienter as to Arditte by other means.
3. Circumstantial Evidence of Conscious Misbehavior or Recklessness
Plaintiff has put forth numerous allegations to support the contention that the defendants' behavior was reckless. First, plaintiff argues that defendants knew or had access to information that contradicted their public statements regarding Fairway's growth and growth prospects. (Dkt. No. 59: Am. Compl. ¶ ¶ 82-93.) Second, plaintiff alleges that defendants violated GAAP principles in keeping the DTA on their balance sheet when they knew they would not have sufficient income to justify doing so. (Am. Compl. ¶ ¶ 94-102.) Third, plaintiff alleges that defendant Ruetsch's resignation is suspicious, as it came on the eve of the February 6, 2014 disclosure that Fairway had experienced a reduction in same store sales growth, would write off its entire DTA and would cut its Fiscal Year 2015 earnings outlook by approximately half. (Am. Compl. ¶ ¶ 128-29.)
To support an inference of recklessness plaintiffs must allege that defendant's conduct was " 'highly unreasonable, '" representing " 'an extreme departure from the standards of ordinary care.'" Novak v. Kasaks, 216 F.3d 300, 308 (2d Cir.), cert. denied, 531 U.S. 1012, 121 S.Ct. 567, 148 L.Ed.2d 486 (2000). The Second Circuit has defined " recklessness" as an " 'egregious refusal to see the obvious, or to investigate the doubtful.'"
Chill v. Gen. Elec. Co., 101 F.3d 263, 269 (2d Cir. 1996). " [S]ecurities fraud claims typically have sufficed to state a claim based on recklessness when they have specifically alleged defendants' knowledge of facts or access to information contradicting their public statements." Novak v. Kasaks, 216 F.3d at 308; Freudenberg v. E*Trade Fin. Corp., 712 F.Supp.2d 171, 197 (S.D.N.Y. 2010). Additionally, " [k]nowledge of the falsity of a company's financial statements can be imputed to key officers who should have known of facts relating to the core operations of their company that would have led them to the realization that the company's financial statements were false when issued." In re Atlas Air Worldwide Holdings, Inc. Sec. Litig., 324 F.Supp.2d 474, 490 (S.D.N.Y. 2004).
The amended complaint recounts numerous statements regarding Fairway's capacity for growth and sales volume that plaintiff alleges were contradicted by deficient infrastructure and actual sales data. (Dkt. No. 59: Am. Compl. ¶ ¶ 53-92.) Plaintiff also alleges that defendants' misstatements concerned a core operation of their company, as Fairway's ability to support growth was a key selling point emphasized on the IPO roadshow and in earnings calls with investors. (Am. Compl. ¶ ¶ 51-69.) Individual defendants Santoro, Ruetsch and Arditte were high level corporate executives with responsibility for the financial statements that plaintiff adequately has alleged contained false or misleading statements. (Am. Compl. ¶ ¶ 25-28, 135-89.) The alleged access to facts contradicting defendants' positive public statements supports an inference of scienter.
Plaintiff's additional allegations further support a finding of scienter (at the pleading stage). Although GAAP violations standing alone are not sufficient, when coupled with allegations of fraudulent intent they may support an inference of scienter. See, e.g., ECA, Local 134 IBEW Joint Pension Trust v. JP Morgan Chase Co., 553 F.3d 187, 200-01 (2d Cir. 2009); Freudenberg v. E*Trade Fin. Corp., 712 F.Supp.2d at 199; In re Vivendi Universal, S.A., 381 F.Supp.2d 158, 179 n.8 (S.D.N.Y. 2003); SEC v. DCI Telecomms., 122 F.Supp.2d 495, 500 (S.D.N.Y. 2000). The amended complaint alleges that defendants violated Financial Accounting Standards No. 109 by claiming a DTA despite year over year net losses. (Am. Compl. ¶ ¶ 94-102.) Plaintiff contends that defendants did not take a valuation allowance to reduce the DTA because doing so would have alerted investors to Fairway's unsupportable growth plans. (Am. Compl. ¶ 102.) Coupled with the alleged GAAP violation, the allegation that defendants' intent was to conceal negative financial prospects supports a finding of scienter.
While not dispositive, Ruetsch's resignation, announced concurrently with the February 6, 2014 announcement of Fairway's reduced earnings outlook and complete valuation allowance, also supports an inference of scienter. (Am. Compl. ¶ ¶ 117-21.) See Van Dongen v. CNinsure, 951 F.Supp.2d 457, 474 (S.D.N.Y. 2013) (resignation of insiders alleged to have been involved in the scheme contributes to an inference of scienter); Ho v. Duoyon Global Water, Inc., 887 F.Supp.2d 547, 575 (S.D.N.Y. 2012) (executive's resignation, considered in conjunction with other allegations, adds to inference of scienter); Hall v. Children's Place Retail Stores, Inc., 580 F.Supp.2d 212, 233 (S.D.N.Y. 2008).
Finally, defendants' argument that the CWs allegations fail to support scienter because (with the exception of one CW) they did not have contact with the defendants is unavailing. (Dkt. No. 64: Fairway & Sterling Br. at 30; Dkt. No. 72: Fairway & Sterling Reply Br. at 13-14.) The CWs span a broad swath of Fairway's hierarchy, and corroborate each other's accounts, which supports a scienter finding. See, e.g., Freudenberg v. E*Trade Fin. Corp., 712 F.Supp.2d at 197. In accordance with Tellabs, in finding an inference of scienter, the Court should consider " all of the facts alleged, taken collectively." Tellabs, Inc. v. Makor Issues & Rights, Ltd., 551 U.S. 308, 323, 127 S.Ct. 2499, 2509, 168 L.Ed.2d 179 (2007);
accord, e.g., Freudenberg v. E*Trade Fin. Corp., 712 F.Supp.2d at 197 (" [I]n accordance with the Supreme Court's instruction in Tellabs, CWs' information must be viewed together."). Considered collectively with the other allegations in the complaint, the CWs' allegations that Fairway presented baseless valuations and growth projections, and intentionally concealed its shortcomings from the investing public, add to the circumstantial evidence of recklessness on the defendants' part.
The Court finds that plaintiff has alleged a strong inference of scienter based on both motive and opportunity and circumstantial evidence of the defendants' reckless behavior. This inference is at least as compelling as defendants' opposing theory that defendants believed Fairway's growth targets were achievable, and that Fairway merely experienced a challenging retail market in late fiscal 2013. (Dkt. No. 64: Fairway & Sterling Br. at 27; Fairway & Sterling Reply Br. at 1.)
D. Plaintiff Adequately Has Alleged Loss Causation
Loss causation is an essential element of a Section 10(b) and Rule 10b-5 claim, but the pleading requirement is not meant to impose a great burden on plaintiffs. See Dura Pharms., Inc. v. Broudo, 544 U.S. 336, 346-47, 125 S.Ct. 1627, 1633-35, 161 L.Ed.2d 577 (2005). To establish loss causation in a case involving allegations of material misrepresentations and omissions, " a plaintiff must allege . . . that the subject of the fraudulent statement or omission was the cause of the actual loss suffered." Suez Equity Investors, L.P. v. Toronto-Dominion Bank, 250 F.3d 87, 95 (2d Cir. 2001); accord, e.g., Lentell v. Merrill Lynch & Co., 396 F.3d 161, 173 (2d Cir.), cert denied, 546 U.S. 935, 126 S.Ct. 421, 163 L.Ed.2d 321 (2005); see also, e.g., Dura Pharms., Inc. v. Broudo, 544 U.S. at 344-45, 125 S.Ct. at 1633-34; ATSI Commc'ns, Inc. v. Shaar Fund, Ltd., 493 F.3d 87, 107 (2d Cir. 2007); Emergent Capital Inv. Mgmt., LLC v. Stonepath Grp., Inc., 343 F.3d 189, 197 (2d Cir. 2003). It is not enough for a plaintiff to merely allege that, at the time of plaintiff's purchase of a security, the price of that security was artificially inflated as a result of a defendant's misrepresentation. Dura Pharms., Inc. v. Broudo, 544 U.S. at 344-45, 125 S.Ct. at 1633-34; Lentell v. Merrill Lynch & Co., 396 F.3d at 174; Emergent Capital Inv. Mgmt., LLC v. Stonepath Group, Inc., 343 F.3d at 198; In re NTL, Inc. Sec. Litig., 2006 WL 330113 at *9. Instead, a plaintiff " may do one of two things to sufficiently allege loss causation. 'Where the alleged misstatement conceals a condition or event which then occurs and causes the plaintiff's loss, ' a plaintiff may plead that it is 'the materialization of the undisclosed condition or event that causes the loss.' Alternatively, a plaintiff may identify particular 'disclosing event[s]' that reveal the false information, and tie dissipation of artificial price inflation to those events." Catton v. Def. Tech. Sys., Inc., 05 Civ. 6954, 2006 WL 27470 at *5 (S.D.N.Y. Jan. 3, 2006) (quoting In re Initial Pub. Offering Sec. Litig., 399 F.Supp.2d 298, 307 (S.D.N.Y. 2005)). Allegations of loss causation are evaluated under the notice pleading standard in Federal Rule of Civil Procedure Rule 8, and a short plain statement that provides defendants with notice of the loss and its causal connection to the alleged misconduct is sufficient. Dura Pharms., Inc. v. Broudo, 544 U.S. at 346, 125 S.Ct. at 1633; see also, e.g., Van Dongen v. CNinsure Inc., 951 F.Supp.2d 457, 469 (S.D.N.Y. 2013);
Freudenberg v. E*Trade Fin. Corp., 712 F.Supp.2d at 202.
Plaintiff alleges that defendants made misstatements and omissions about Fairway's capacity to (1) meet new store growth targets; (2) increase sales at existing stores; and (3) generate sufficient income to justify maintaining the $26 million DTA. (See pages 17-23 above.) Plaintiff alleges that after defendants stated on a November 7, 2013 quarterly earnings call that Fairway would open fewer stores in 2015 than projected, and that sales at presently existing stores had experienced record high sales volume around the time of Hurricane Sandy, Fairway's stock price declined 21.6% in one day. (Dkt. No. 59: Am. Compl. ¶ 196.) Plaintiff further alleges that after defendants stated on a February 6, 2014 quarterly earnings call that sales had declined at existing stores, they were cutting growth projections for the upcoming fiscal year, and that Fairway would take a valuation allowance against the entire DTA, Fairway's share price dropped 29% in one day. (Am. Compl. ¶ ¶ 197-98.)
Plaintiff has pled that defendants made material misstatements and omissions, concealing risks that later materialized, and that " share price fell significantly after the truth became known." Dura Pharms., Inc. v. Broudo, 544 U.S. at 347, 125 S.Ct. at 1634. Accordingly, plaintiff adequately has alleged loss causation.
Defendants' motion to dismiss the Exchange Act § 10(b) and Rule 10b-5 claims should be DENIED.
III. PLAINTIFF ADEQUATELY HAS ALLEGED A VIOLATION OF EXCHANGE ACT SECTION 20(A)
In addition to the Section 10(b) and Rule 10b-5 claims, plaintiff also alleges that Santoro, Ruetsch, Arditte and the Sterling Defendants are liable as control persons under Section 20(a) of the Exchange Act (Dkt. No. 59: Am. Compl. ¶ ¶ 210-13), which provides:
Every person who, directly or indirectly, controls any person liable under any provision of this chapter or of any rule or regulation thereunder shall also be liable jointly and severally with and to the same extent as such controlled person to any person to whom such controlled person is liable . . . unless the controlling person acted in good faith and did not directly or indirectly induce the act or acts constituting the violation or cause of action.
15 U.S.C. § 78t(a). " To establish a prima facie case of control person liability, a plaintiff must show (1) a primary violation by the controlled person, (2) control of the primary violator by the defendant, and (3) that the defendant was, in some meaningful sense, a culpable participant in the controlled person's fraud." ATSI Commc'ns., Inc. v. Shaar Fund, Ltd., 493 F.3d 87, 108 (2d Cir. 2007).
Defendants' first argument for dismissal of the Section 20(a) claim is that plaintiff has not alleged a primary Exchange Act violation. (Dkt. No. 64: Fairway & Sterling Br. at 34.) That argument fails as the Court has found in Part II above that plaintiff adequately alleged a primary § 10(b) violation. For this reason, defendants' motion to dismiss the Section 20(a) claim on the part of the Individual Defendants and the Sterling Defendants (except Sterling Advisors) should be DENIED.
Defendants further argue that plaintiff fails to adequately plead that Sterling Advisors was a control person. (Fairway & Sterling Br. at 35). Control may be established by showing that a defendant, directly or indirectly, possessed " the power to direct or cause the direction of the management and policies of a person, whether through the ownership of voting securities, by contract, or otherwise." 17 C.F.R. § 240.12b-2; see also, e.g., In re China Valves Tech. Sec. Litig., 979 F.Supp.2d 395, 413-14 (S.D.N.Y. 2013) (Kaplan, D.J.). Also required for liability under Section 20(a) is " actual involvement in the making of the fraudulent statements by the putatively controlled entity." In re Refco, Inc. Sec. Litig., 503 F.Supp.2d 611, 663 (S.D.N.Y. 2007) (Lynch, D.J.).
The Second Circuit has held that the provision of advice and guidance does not raise a reasonable inference of the power to direct, rather than merely inform, an entity's ultimate decision. In re Lehman Bros. Mortg.-Backed Sec. Litig., 650 F.3d 167, 187 (2d Cir. 2011) (" Providing advice that the banks chose to follow does not suggest control."). Plaintiff has not alleged that Sterling Advisors did anything more than consult with and advise Fairway's board on business and financial matters. (Am. Compl. ¶ 34.) Accordingly, defendants' motion to dismiss the Section 20(a) claim as to Sterling Advisors should be GRANTED.
IV. PLAINTIFF'S SECURITIES ACT CLAIMS
Plaintiff brings Securities Act claims under 15 U.S.C.§ 77k (" Section 11") against Fairway, the Individual Defendants (all of whom are Fairway directors or officers), and the Underwriter Defendants alleging that the Registration Statement contained omissions and misstatements of material fact. (Dkt. No. 59: Am. Comp. ¶ ¶ 284-86.) Plaintiff brings claims under 15 U.S.C. § 77l(a)(2) (" Section 12(a)(2)") against Fairway and the Underwriter Defendants alleging that the Prospectus contained omissions and misstatements of material fact. (Am. Compl. ¶ ¶ 294-300.) Plaintiff also brings a claim against the Sterling Defendants and the Individual Defendants under 15 U.S.C. § 77o (" Section 15") alleging control person violations. (Am. Compl. ¶ ¶ 301-04.)
A. Legal Standards
Securities Act Section 11 establishes liability on the part of issuers of registration statements if " any part of the registration statement, when such part became effective, contained an untrue statement of a material fact or omitted to state a material fact required to be stated therein or necessary to make the statements therein not misleading." 15 U.S.C. § 77k(a); see also, e.g., In re UBS AG Sec. Litig., 07 Civ. 11225, 2012 WL 4471265 at *24 (S.D.N.Y. Sept. 28, 2012), aff'd sub nom. City of Pontiac Policemen's & Firemen's Ret. Sys. v. UBS AG, 752 F.3d 173 (2d Cir. 2014); In re Morgan Stanley Info. Fund. Sec. Litig., 592 F.3d 347, 358 (2d Cir. 2010).
Section 12(a)(2) imposes liability upon " any person" who " offers or sells a security . . . by means of a prospectus or oral communication, which includes an untrue statement of a material fact or omits to state a material fact necessary in order to make the statements, in light of the circumstances under which they were made, not misleading. . . ." 15 U.S.C. § 77l(a)(2); see, e.g., NECA-IBEW Health & Welfare Fund v. Goldman Sachs & Co., 693 F.3d 145, 156 (2d Cir. 2012), cert denied, 133 S.Ct. 1624, 185 L.Ed.2d 576 (2013).
Section 15 imposes liability on " [e]very person who, by or through stock ownership, agency, or otherwise, or who, pursuant to or in connection with an agreement or understanding with one or more other persons by or through stock ownership, agency, or otherwise, controls any person liable under" sections 11 or 12. 15 U.S.C. § 77o(a). To establish a claim for control-person liability under Section 15, plaintiff must allege " (a) a primary violation by a controlled person, and (b) control by the defendant of the primary violator." In re Refco, Inc. Sec. Litig., 503 F.Supp. 2d. 611, 637 (S.D.N.Y. 2007) (Lynch, D.J.); accord, e.g., Ho v. Duoyuan Global Water, Inc., 887 F.Supp.2d 547, 578 (S.D.N.Y. 2012); Fait v. Regions Fin. Corp., 712 F.Supp.2d 117, 125 (S.D.N.Y. 2010) (Kaplan, D.J.), aff'd, 655 F.3d 105 (2d Cir. 2011); In re CIT Grp., Inc. Sec. Litig., 349 F.Supp.2d 685, 688 (S.D.N.Y. 2004) (" Section 15 simply imposes derivative liability against those who control section 11 or 12 violators."); In re Vivendi Universal, S.A., 381 F.Supp.2d 158, 187-88 (S.D.N.Y. 2003).
1. Plaintiff Adequately Has Alleged a Violation of Section 11
Defendants argue that plaintiff has not alleged an actionable misstatement or omission in the Registration Statement. (Dkt. No. 64: Fairway & Sterling Br. at 34; Dkt. No. 62: Underwriters Br. at 3-12; Dkt. No. 71: Underwriters Reply Br. at 1-5.) Because the Court has found that plaintiff adequately alleged misleading statements and omissions in the Registration Statement and Prospectus (see pages 17-23 above), defendants' motions to dismiss the Section 11 claim should be DENIED.
2. Plaintiff Fails to Allege a Violation of Section 12(a)(2)
Defendants argue that plaintiff does not have standing under Section 12(a)(2). (Dkt. No. 62: Underwriters Br. at 12-14; Dkt. No. 64: Fairway & Sterling Br. at 34 n.23; Dkt. No. 71: Underwriters Reply Br. at 5; Dkt. No. 72: Fairway & Sterling Reply Br. at 15.) The Supreme Court has defined a prospectus as " a document that describes a public offering of securities." Gustafson v. Alloyd Co., 513 U.S. 561, 584, 115 S.Ct. 1061, 1073, 131 L.Ed.2d 1 (1995). Following that decision, the Second Circuit has determined that " a Section 12(a)(2) action cannot be maintained by a plaintiff who acquires securities through a private transaction, whether primary or secondary, " because a " private offering is not effected 'by means of a prospectus.'" Yung v. Lee, 432 F.3d 142, 149 (2d Cir. 2005). The amended complaint merely alleges that plaintiff " purchased shares of Fairway securities during the Class Period." (Dkt. No. 59: Am. Compl. ¶ 23.) As defendants correctly point out (Underwriters Br. at 13), plaintiff purchased Fairway stock on December 20, 2013 and January 4, 2014. (Dkt. No. 28: Silk Aff. Ex. A at 4.) Plaintiff does not allege that it purchased stock in the April 2013 initial public offering. Accordingly, defendants' motion to dismiss plaintiff's Section 12(a)(2) claim should be GRANTED.
3. Plaintiff Adequately Has Alleged a Violation of Section 15
Control under Section 15 entails " the power to direct or cause the direction of the management and policies of a person, whether through the ownership of voting securities, by contract, or otherwise.'" 17 C.F.R. § 240.12b-2; see also, e.g., In re China Valves Tech. Sec. Litig., 979 F.Supp.2d 395, 413-14 (S.D.N.Y. 2013) (Kaplan, D.J.). " Allegations of control under Section 15 are subject only to notice-pleading requirements, and accordingly survive motions to dismiss 'as long as it is at least plausible that the plaintiff could develop some set of facts that would pass muster.'" In re Refco, Inc. Sec. Litig., 503 F.Supp.2d 611, 637 (S.D.N.Y. 2007) (Lynch, D.J.); see also, e.g., Ho v. Duoyuan Global Water, Inc., 887 F.Supp.2d 547, 562 (S.D.N.Y. 2012).
Defendants argue that plaintiff's Section 15 control person claims fail because the amended complaint does not allege an underlying violation of the Securities Act. (Fairway & Sterling Br. at 34.) Because the Court has found that plaintiff adequately has alleged a violation of Section 11, the motion to dismiss on this ground fails as to all defendants except for Sterling Advisors, for the reasons set forth above. (See pages 34-35 above.)
For the reasons set forth above, the defendants' motions to dismiss (Dkt. Nos. 61 & 63) should be GRANTED dismissing plaintiff's Exchange Act Section 20(a) claim and Securities Act Section 15 claim as to defendant Sterling Advisors, and dismissing plaintiff's Securities Act Section 12(a)(2) claim, and DENIED in all other respects.
FILING OF OBJECTIONS TO THIS REPORT AND RECOMMENDATION
Pursuant to 28 U.S.C. § 636(b)(1) and Rule 72(b) of the Federal Rules of Civil Procedure, the parties shall have fourteen (14) days from service of this Report to file written objections. See also Fed.R.Civ.P. 6. Such objections (and any responses to objections) shall be filed with the Clerk of the Court, with courtesy copies delivered to the chambers of the Honorable Lewis A. Kaplan, 500 Pearl Street, Room 2240, and to my chambers, 500 Pearl Street, Room 1370. Any requests for an extension of time for filing objections must be directed to Judge Kaplan (with a courtesy copy to my chambers). Failure to file objections will result in a waiver of those objections for purposes of appeal. Thomas v. Arn, 474 U.S. 140, 106 S.Ct. 466, 88 L.Ed.2d 435 (1985); Ingram v. Herrick, 475 F.App'x 793, 793 (2d Cir. 2012); IUE AFL-CIO Pension Fund v. Herrmann, 9 F.3d 1049, 1054 (2d Cir. 1993), cert. denied, 513 U.S. 822, 115 S.Ct. 86, 130 L.Ed.2d 38 (1994); Frank v. Johnson, 968 F.2d 298, 300 (2d Cir.), cert. denied, 506 U.S. 1038, 113 S.Ct. 825, 121 L.Ed.2d 696 (1992); Small v. Sec'y of Health & Human Servs., 892 F.2d 15, 16 (2d Cir. 1989); Wesolek v. Canadair Ltd., 838 F.2d 55, 57-59 (2d Cir. 1988); McCarthy v. Manson, 714 F.2d 234, 237-38 (2d Cir. 1983).