Thomas E. Acito, on Behalf of Himself and All Others Similarly Situated and Neil Blinderman v. Imcera Group, Inc. George D. Kennedy Blakeman M. Ingle Raymond F. Bentele and Boyd D. Wainscott

Citations: 47 F.3d 47; 31 Fed. R. Serv. 3d 581; 1995 U.S. App. LEXIS 2184Docket: 367

Court: Court of Appeals for the Second Circuit; January 31, 1995; Federal Appellate Court

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Plaintiffs-appellants Thomas E. Acito and Neil Blinderman, on behalf of a class, appeal a judgment from the Southern District of New York that dismissed their securities fraud complaint against defendants-appellees IMCERA Group, Inc. and its executives, citing failure to meet the specificity requirements under Rule 9(b) and 12(b)(6) of the Federal Rules of Civil Procedure. The court found the complaint insufficient in alleging facts to support a claim under Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5. Acito and Blinderman, who purchased IMCERA shares in late 1991 and early 1992, alleged that the defendants disseminated materially false information and failed to correct earlier misleading statements. IMCERA, a corporation involved in multiple sectors, faced delays in FDA approval for new animal health products due to identified deficiencies during inspections of its Kansas City plant, although no sanctions were imposed. The plaintiffs' request to amend their pleadings was denied as the additional allegations did not address the court's concerns. The appellate court affirmed the lower court's decisions.

In September 1991, IMCERA released its annual report for the fiscal period ending June 30, 1991, showcasing progress in its subsidiaries and expressing optimism about future earnings. The report indicated that Pitman's market position was bolstered by the acquisition of Coopers and reiterated positive earnings projections on its Form 10-K filed with the SEC. A press release on September 26 confirmed management's comfort with earnings estimates of $0.85 to $0.90 per share for the upcoming quarter and a full-year estimate of $5 per share, later adjusted to $1.67 due to a stock split.

In October 1991, IMCERA reported earnings of $0.89 per share, a 22% increase from the prior year, and noted Pitman's earnings growth. By December 3, IMCERA maintained its annual earnings projections, while the FDA began a third inspection of its Kansas City plant. On January 16, 1992, CEO Ingle announced a 5% increase in Pitman's operating earnings for the second quarter, continuing the company's optimistic outlook.

However, on January 17, an FDA inspector revealed 85 deficiencies at the Kansas City plant, leading Pitman to suspend production on seven products without informing the public until February 18. IMCERA then estimated a potential after-tax charge of up to $0.06 per share and retracted its earlier earnings forecast, causing a nearly 12% stock price drop the following day.

The plaintiffs alleged that IMCERA should have anticipated negative outcomes from the FDA inspection, arguing that representations regarding earnings projections and the acquisition's benefits were misleading. They claimed that insiders profited from knowledge of adverse information, particularly pointing out that defendant Kennedy sold over 380,000 shares during a period when the company had not disclosed the inspection findings to the public.

Defendants successfully moved to dismiss the action under Federal Rules of Civil Procedure 9(b) and 12(b)(6), with the court determining that the inspections of IMCERA's plant were not material to the case as they did not lead to adverse impacts on earnings. The initial inspections indicated deficiencies but showed improvement, failing to support a strong inference of defendants' knowledge of negative outcomes from a subsequent inspection. Claims regarding optimistic statements about earnings predictions and the acquisition of Coopers were deemed hindsight-based. The court found no substantial evidence of intent to defraud investors. Plaintiffs' motion to amend their complaint was denied, as the new information was insufficient to address the original deficiencies, leading to an appeal.

In reviewing the dismissal, the court accepted the complaint's allegations as true and noted that a claim can only be dismissed if no facts could support relief. For fraud allegations, Rule 9(b) necessitates specific details about the fraudulent statements, including the identity of the speaker and context. While intent and knowledge can be generally alleged, plaintiffs must still present facts indicating a strong inference of fraudulent intent, which can be demonstrated through motive and opportunity or circumstantial evidence of reckless behavior.

To establish a cause of action under Rule 10b-5, a plaintiff must demonstrate that, in relation to securities transactions, the defendant acted with scienter and made false material representations or omitted material information, leading to the plaintiff's injury due to reliance on the defendant's actions. The plaintiffs in this case assert that reports from the first two FDA inspections contained material information that should have been disclosed. They argue that these inspections indicated potential negative outcomes from a forthcoming third inspection and that the defendants' positive statements about future earnings were therefore misleading.

The key issue is whether the reports from the first two inspections were indeed material. The standard for materiality requires that there be a significant likelihood that the omitted information would have altered the total mix of information available to a reasonable investor. The court found that the Kansas City plant, one of many operated by IMCERA, produced only a small fraction of the company's products, and no significant adverse actions arose from the first two inspections. Additionally, improvements in the plant's deficiencies suggested a positive trend, indicating that the inspection results were not material to investors. 

Furthermore, the plaintiffs' claim that the early inspections indicated a likely negative outcome from the third inspection was rejected. The court noted that the defendants' prior communication regarding production suspension and earnings projections did not necessitate early disclosure of the third inspection results. Overall, plaintiffs' arguments about the materiality of the first two inspections and the implications for the third inspection were found to lack merit.

Mere allegations that certain statements should have been included in earlier reports do not constitute a valid claim of securities fraud, as established in cases such as Denny v. Barber and DiLeo v. Ernst & Young. Conclusory fraud allegations fail to meet the heightened pleading standards of Rule 9(b); a defendant's inability to foresee future events does not equate to securities fraud, as reiterated in Denny. 

In this case, the inevitability of a third FDA inspection due to pending applications does not imply that the Kansas City plant's failure was a certain outcome. The first inspection revealed thirty-four deficiencies, but Pitman indicated corrective actions were underway. The second inspection showed improvement with only fourteen deficiencies noted. Although the third inspection identified numerous issues, the complaint essentially alleges mismanagement rather than securities fraud, as corporate mismanagement is not governed by section 10(b).

Additionally, the plaintiffs' assertion that IMCERA's positive earnings statements were misleading fails because the information regarding the first two inspections is deemed immaterial, and the complaint does not clarify how these statements were false or misleading. 

The core of the plaintiffs' claim is that IMCERA failed to promptly disclose negative information about the Kansas City plant, specifically between January 17 and February 18, 1992. While the allegations meet Rule 9(b)'s requirements, they must also establish a strong inference of scienter, which is essential for a 10b-5 claim. Plaintiffs must show facts indicating fraudulent intent or reckless behavior, but they have not done so convincingly.

Attempts to demonstrate motive include claims that IMCERA officers were incentivized to inflate stock value due to its impact on their compensation, and that defendant Kennedy benefited from selling shares during this period. Each of these points is set for further examination.

Plaintiffs' assertion that defendants aimed to defraud the public to inflate stock prices for increased compensation is deemed unsubstantiated. The court states that if such motivation alone could establish scienter, it would expose nearly all U.S. companies experiencing stock price declines to securities fraud claims. Executive compensation tied to stock value does not inherently imply fraudulent intent. Regarding defendant Kennedy, his stock sales, conducted after publicly announcing his intentions, do not suggest deceptive intent towards investors. Kennedy had retired as an officer prior to his stock transactions and disclosed his holdings, including plans to exercise options on 354,000 shares. The sales occurred before adverse FDA news and do not indicate wrongdoing. The plaintiffs also pointed to an additional sale of 30,000 shares by Kennedy, claiming it was timed to benefit from delayed negative news. However, these sales were not deemed unusual as they represented less than 11% of his holdings, and no other defendants sold shares during the relevant period, which weakens the plaintiffs' claims of coordinated deceit. The court concludes that the facts presented do not establish a strong inference of intent to deceive.

The plaintiffs argue that the district court improperly denied their Rule 59(e) motion to amend the judgment and allow them to revise their complaint. They assert that amendments should be granted liberally, particularly when the dismissal was based on Rule 9(b). However, the district court's discretion in allowing amendments requires valid justification for denial, with futility being a key reason. In this case, the court reviewed the plaintiffs' supplementary allegations and concluded they did not remedy the complaint's deficiencies. Specifically, the plaintiffs contended that warnings from FDA inspectors about potential penalties were significant, but these did not imply that management believed penalties would be incurred. The record showed that management was aware of the FDA's reinspection and was attempting to address noted deficiencies; mere mismanagement does not equate to fraud. Additionally, the plaintiffs' claims regarding IMCERA's fiscal year 1992 earnings being inflated through accounting manipulations did not strengthen their case, as the earlier inspection findings were deemed immaterial and the third inspection's results were not predictable. Consequently, the court affirmed the district's judgment.