In Re Humphrey Hospitality Trust, Inc. Securities Litigation

Citations: 219 F. Supp. 2d 675; 2002 U.S. Dist. LEXIS 16157; 2002 WL 1988272Docket: CIV.A. WMN-01-1662

Court: District Court, D. Maryland; May 7, 2002; Federal District Court

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A class action securities fraud lawsuit was filed against Humphrey Hospitality Trust, Inc. (HHT) and three executive officers: Paul J. Schulte, James I. Humphrey, Jr., and Steven H. Borgmann. The plaintiffs, representing all individuals or entities who purchased HHT securities from November 14, 2000, to March 29, 2001, allege that during this period, the defendants made false and misleading statements regarding HHT's financial condition to artificially inflate the stock price, violating Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and SEC Rule 10b-5. HHT, a Virginia-incorporated self-administered real estate investment trust (REIT) since 1994, merged with Supertel Hospitality, Inc. in 1999. After the merger, the new management structure included the creation of Supertel Hospitality Management, Inc. (SHM) to manage the Supertel hotels. The defendants, who became significant shareholders of HHT post-merger, previously held executive roles at their respective companies. Notably, HHT maintained a monthly dividend during the class period, reflecting a high yield based on its stock price. The court, having reviewed the motion to dismiss and associated pleadings, determined that no hearing was necessary and granted the defendants' motion.

As of December 31, 2000, the Company owned 92 limited service hotels and one office building. Plaintiffs allege fraud based on several announcements from late 2000 and early 2001, particularly three press releases from November 14, 2000, which they claim contained false or misleading statements regarding the Company's financial condition. 

The first press release disclosed the Company’s third quarter results, revealing a 6% decrease in funds from operations per share (FFO) for the quarter and an 11% increase for the nine months compared to the previous year. Defendant Schulte claimed continued FFO growth excluding non-recurring charges, while also acknowledging lower-than-expected lease revenue growth due to increased competition.

The second press release announced the acquisition of five Super 8 Hotels, with Schulte stating that using preferred operating partnership units for the acquisition benefits both the Company and the sellers by diversifying risk and allowing for tax deferral.

The third press release outlined a restructuring of agreements with the Lessee, which included transferring property tax and insurance responsibilities to the Lessee, reducing lease payments by approximately $4 million annually, and modifying payment structures to improve monthly cash flow. It also expanded the Company’s service agreement with the Lessee for additional compensation. Schulte asserted that these changes would not adversely affect future cash flows or dividends, emphasizing a focus on hotel profitability and acquisition growth.

Additionally, Plaintiffs allege that misleading statements were made on the Company's website in early 2001, particularly regarding the acquisition of five hotels in October 2000, which was described as having a "13% Anticipated Return."

Plaintiffs reference a section from the "Investors' Overview" on the Humphrey Hospitality Trust website, affirming the company's focus on acquiring limited-service properties in secondary and tertiary markets, which historically yield higher profit margins than full-service properties. The company intends to maintain a conservative debt-to-value ratio below 60% to avoid over-leveraging and aims for a dividend payout of approximately 60% of funds from operations (FFO), allowing for reinvestment and supporting a secure dividend. 

Additionally, Plaintiffs claim that Defendants issued misleading statements in a March 2, 2001 press release regarding the company's financial performance, including a reported growth in FFO despite declining revenue per available room (REVPAR) and increased operational costs. The press release indicated that aggressive measures were being taken to enhance property performance and maintain dividend rates amidst challenging market conditions.

However, on March 29, 2001, the company disclosed that its lessee could not sustain the current rent under the leases due to significant losses incurred in 2000, projecting a net loss of approximately $2.4 million. This led to the formation of an independent committee to consider options such as restructuring leases, reducing rents, and selling properties, while also indicating a decline in FFO and a reduction in the company’s dividend effective March 30, 2001.

The market response to HHT’s press release was significant, with the stock opening at $7.0938 and closing at $4.7812, on a trading volume approximately seven times the average. From March 30 to June 29, 2001, the stock price averaged around $3.00. Plaintiffs allege that Defendants did not require advisement from the Lessee, as they had direct access to "Flash Reports" detailing the Lessee's operating results, including occupancy, revenue, and corporate account rentals. These reports, provided by property general managers to HHT's headquarters, were consolidated into weekly and monthly summaries sent to executive officers. Plaintiffs claim that between June and October 2000, these reports indicated a failure to meet financial goals and that by October 2000, the integration of hotel services was not yielding expected efficiencies, leading to reported losses.

The Plaintiffs argue that the Defendants misrepresented the financial condition of HHT by failing to disclose this adverse information, asserting that Defendants Schulte, Borgmann, and Humphrey acted with intent or recklessness in making misleading statements. They present several supporting points: full access to performance data, personal financial incentives to present the merger positively, Humphrey's interest as a majority shareholder in the Lessee, and Borgmann's sale of HHT shares prior to the stock price decline.

Regarding legal standards, a motion to dismiss under Rule 12(b)(6) should only be granted if the plaintiff cannot prove any set of facts that would entitle them to relief. The court must accept the allegations in the Complaint as true and view them favorably towards the plaintiff. To sustain a claim under Section 10(b) and Rule 10b-5, a plaintiff must demonstrate a false statement or omission by the defendant, with scienter, justifiable reliance by the plaintiff, and a direct causal link to the plaintiff's damages.

A complaint alleging violations under Section 10(b) and Rule 10b-5 must comply with the heightened pleading standards of Rule 9(b) and the Private Securities Litigation Reform Act of 1995 (PSLRA). To meet Rule 9(b) requirements, plaintiffs must specify the allegedly fraudulent statements, identify the speaker, detail when and where the statements were made, and explain why they are fraudulent. The PSLRA further mandates that plaintiffs provide specific facts supporting their allegations of fraud, including reasons why statements are misleading, particularly when based on information and belief. It also introduces a "Safe Harbor" for forward-looking statements, protecting them from liability if they are deemed immaterial or accompanied by meaningful cautionary language. Additionally, plaintiffs must establish a "strong inference" that defendants acted with scienter, or intent to deceive. Complaints failing to meet PSLRA standards are subject to dismissal.

The Fourth Circuit has clarified that "soft" or "puffing" statements typically lack materiality as they do not inflate share prices. Consequently, many statements cited by plaintiffs, including general expressions of optimism and performance projections, are not actionable. Predictions of future performance that are not guarantees are generally protected under federal securities laws, as imposing liability could hinder companies from providing valuable forward-looking information, contrary to the aims of full disclosure in securities regulation.

Several forward-looking statements made by Plaintiffs are deemed non-actionable due to their nature. Key examples include expectations regarding cash flow improvements and dividends, as articulated in various press releases and a website excerpt. These statements are similar to prior cases where courts found such assertions immaterial. The Defendants assert that these statements qualify for Safe Harbor protection under the PSLRA, as they are accompanied by cautionary language outlining risks and uncertainties that could impact the projections. The cautionary language in HHT's press releases indicates that actual results may vary due to known and unknown risks, which are detailed in the Company's SEC filings. Additionally, the recent Form 10-K specifically warned of risks affecting lease payments and subsequent dividend distributions. Plaintiffs have not successfully demonstrated that Defendants had actual knowledge of the falsehood of these statements at the time they were made, which is necessary to escape Safe Harbor protections. Their claims largely rely on conclusory assertions regarding the implications of internal reports, lacking the specificity required to support their allegations.

Plaintiffs claim that from June to October 2000, monthly reports indicated HHT was failing to meet financial goals and that by October, integration of limited service hotels was not achieving economies of scale, resulting in losses for the Lessee. However, these assertions lack sufficient specific facts to demonstrate what the Defendants knew, when they knew it, and how that knowledge rendered their statements false or misleading, which does not satisfy the heightened pleading requirements under the PSLRA (15 U.S.C. 78u-4(b)(1)). Even if the pleading requirements were met, the Amended Complaint would still be subject to dismissal due to insufficient allegations supporting scienter. While the Fourth Circuit has not set a definitive standard for pleading scienter under the PSLRA, it emphasizes that plaintiffs must prove intentional conduct or recklessness, with the PSLRA increasing the burden for pleading such state of mind. The PSLRA requires specific facts that create a strong inference of the required state of mind for each act or omission, yet does not define this state of mind. There is significant disagreement among courts regarding the PSLRA’s pleading standards, particularly in relation to the Second Circuit's approach, which allows for pleading scienter through circumstantial evidence of conscious or reckless behavior or by establishing motive and opportunity for fraud. However, despite these standards, the Plaintiffs have not sufficiently alleged facts to meet even the most lenient standards. They failed to demonstrate that many or all of the statements were false, which also means they did not create a strong inference that the Defendants knew or should have known about the falsehoods.

Plaintiff has not sufficiently pleaded facts demonstrating that Defendants acted with conscious or reckless intent to defraud. Recklessness is defined as a significant deviation from ordinary care that could mislead the plaintiff, and the allegations do not show that Defendants knew the merger would negatively impact cash flow or dividends when they made statements in November 2000 and March 2001. Even when viewing facts favorably to Plaintiffs, the Court cannot infer fraudulent intent or extreme negligence aimed at inflating HHT stock prices. 

While Defendants had access to financial information that could allow for potential fraud, Plaintiffs' claims of motive are weak. To establish motive, concrete benefits from the alleged false statements must be demonstrated. Commonly, motive is shown through suspicious stock sales; however, Plaintiffs rely mainly on Mr. Borgmann's sale of 5% of his holdings, which is insufficient, especially as the other two Defendants did not sell stock during the Class Period, and Defendant Schulte even purchased shares. This undermines any inference of scienter. Additionally, Borgmann's sale is minimal compared to other defendants’ sales deemed suspicious in prior cases. Plaintiffs’ assertions that Defendants aimed to present a successful merger to protect their positions and compensation are too general and do not support an inference of fraudulent intent.

Corporate executives generally aim to act in the best interests of their companies. Allegations from stockholders that are based on motivations common to all corporations fail to establish scienter, as stated in Phillips, 190 F.3d at 623. In this case, the argument regarding Defendant Humphrey's motive to protect the Lessee, of which he had majority ownership, is weakened by the fact that he did not sell stock and is not implicated in making the questioned statements during the Class Period. Consequently, the Court concludes that the Plaintiffs have not adequately stated a claim under Section 10(b) of the Securities Exchange Act of 1934 (Count I). A failure to establish a primary securities fraud violation precludes claims of control person liability under Section 20(a) (Count II), leading to the dismissal of Count II as well. The Court will grant Defendants' motion to dismiss entirely. Additional notes clarify that the action was initially filed in the Eastern District of Virginia and later transferred, and that statements about financial performance were misrepresented in the pleadings but clarified in attached exhibits. The Court acknowledges the complexities surrounding forward-looking statements and the need to assess statements in the context of the total mix of information available to investors, referencing legal precedents. Furthermore, while not mentioned in the complaint, the Court can take judicial notice of Defendants' SEC trading reports, which Plaintiffs do not dispute regarding Defendant Schulte's stock purchase.