                                                                                                                           Opinions of the United
2004 Decisions                                                                                                             States Court of Appeals
                                                                                                                              for the Third Circuit


7-9-2004

In Re: Great Atl
Precedential or Non-Precedential: Non-Precedential

Docket No. 03-4100




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                                               NOT PRECEDENTIAL


                       UNITED STATES COURT OF APPEAL
                           FOR THE THIRD CIRCUIT


                                      No. 03-4100


                 IN RE: THE GREAT ATLANTIC & PACIFIC TEA
                   COMPANY, INC. SECURITIES LITIGATION

                   Leonard Brody, on behalf of himself and all others
                  similarly situated; Stanley E. Blyskal; Larry Heying;
                             Paul Buback; Leola H.B. Zintl,

                                                         Appellants

                  *(Caption Amended Per Clerk’s Order of 2/25/04)


                   On Appeal from the United States District Court
                          for the District of New Jersey
                          (D.C. Civil No. 02-cv-02674)
                         District Judge: Faith S. Hochberg


                                 Argued May 27, 2004

BEFORE: RENDELL and COW EN, Circuit Judges and SCHW ARZER*, District Judge

                                  (Filed July 9, 2004)




*Honorable William W Schwarzer, Senior United States District Judge for the Northern
District of California, sitting by designation.
Katharine M. Ryan, Esq.
Schiffrin & Barroway
Three Bala Plaza East, Suite 400
Bala Cynwyd, PA 19004

Gary S. Graifman, Esq.
Kantrowitz, Goldhamer & Graifman
210 Summit Avenue
Montvale, NJ 07645

Marcus N. Bozeman, Esq. (Argued)
S. Gene Cauley, Esq.
James A. Carney, Esq.
Tiffany M. Wyatt, Esq.
Cauley, Geller, Bowman & Rudmam
11001 Executive Center Drive
P.O. Box 25438, Suite 200
Little Rock, AR 72221-5438

Counsel for Appellants Leonard Brody,
Stanley E. Blyskal, Larry Heying,
Paul Buback and Leola H.B. Zintl

Robert A. Alessi, Esq. (Argued)
Cahill, Gordon & Reindel
80 Pine Street
New York, NY 10005

John L. Thurman, Esq.
Farrell & Thurman
172 Tamarack Circle
Skillman, NJ 08558

Counsel for Appellees Great Atlantic &
Pacific Tea Co., Inc.; Christin W.E. Haub;
Elizabeth Culligan; Fred Corrado;
Mitchell Goldstein and Kenneth A. Uhl




                                             2
                                            OPINION


COWEN, Circuit Judge.

          This securities class action was brought on behalf of investors who purchased

securities issued by The Great Atlantic & Pacific Tea Company (“A&P”) during the

period between May 19, 1999 and July 5, 2002, inclusive (“the class period”). The lead

plaintiffs appeal the District Court’s Order dismissing the Amended Complaint for failing

to adequately plead scienter. We find no error in the District Court’s analysis and will

affirm.

                                          Background

          As we only write for the parties, we will briefly explain the relevant facts

underlying this appeal. A&P is a Montvale, New Jersey company which operates various

food and drug stores, conventional supermarkets, and limited assortment food stores in

the United States and Canada. During the years preceding and including the class period,

A&P filed reports with the Securities & Exchange Commission (“SEC”), which misstated

the amounts of vendor allowances, income from subleased stores, and self insurance

reserve accounts. The financial statements included representations from management

that they had been prepared in accordance with Generally Accepted Accounting

Procedures (“GAAP”). According to the Amended Complaint, however, these

misstatements occurred as a result of violations of GAAP.

                                                3
       On March 28, 2000, Christian Haub, the CEO and Chairman of the Board of

Directors of A&P issued a press release regarding a detailed study of A&P’s business

processes and infrastructure, in which A&P compared itself to other leading companies,

both inside and outside the supermarket industry. The press release indicated that A&P’s

“Project Great Renewal” would improve profitability over the next four years. In various

conference calls with the market, the individual defendants made various representations

that the balance sheets were being strengthened and profitability was increasing.

       On May 24, 2002, A&P announced that it would delay the filing of its annual

report in order to investigate “improper acts occurring in certain of its operating regions

related to the ‘appropriate timing for the recognition of allowances and the accounting for

inventory.’” (App. at 72.) A&P also requested an extension for filing its annual report

from the SEC, explaining that it was investigating “certain irregularities relating to the

appropriate timing for the recognition of vendor allowances and the accounting for

inventory.” (Id.) On July 5, 2002, A&P filed its annual report, in which it restated its

income statements from fiscal years 1999 and 2000, and the quarterly income statements

from the first three quarters of fiscal year 2001. A&P issued a press release explaining

that it had discovered certain irregularities relating to vendor allowances, which had

prompted it to review all of its accounting procedures. A&P fired at least nine high level

employees within days of the restatement. Three months after the restatement, another

high level employee resigned.



                                              4
       On June 5, 2002, Leonard Brody filed this action on behalf of himself and

investors like him. The District Court consolidated Brody’s action with several others,

appointed Brody and four others as lead plaintiffs, and permitted the filing of an amended

complaint. The complaint alleges that A&P and several of its corporate officers and high-

level employees (“the individual defendants”) knowingly issued false statements about its

business, in violation of Section 10(b) of the Securities and Exchange Act and Securities

Exchange Commission Rule 10b-5. It also alleges that certain of the individual

defendants could be held liable for these actions as “controlling persons” under Section

20(a) of the Exchange Act. A&P filed a motion to dismiss the amended complaint,

arguing, inter alia, that it failed to adequately plead scienter. The District Court granted

A&P’s motion and Brody now appeals.

                                         Discussion

       We exercise plenary review over the District Court’s decision to grant a motion to

dismiss under Rule 12(b)(6). Broselow v. Fisher, 319 F.3d 605, 607 (3d Cir. 2003). We

must accept as true all well-pleaded facts alleged in the complaint, and draw all

reasonable inferences in favor of the non-moving party. In re Rockefeller Center

Properties, Inc. Sec. Litig., 311 F.3d 198, 215 (3d Cir. 2002). A motion to dismiss may

only be granted when it appears beyond doubt that the plaintiffs can prove no set of facts

that would entitle them to relief. Id. We are not required, however, to credit bald

assertions or legal conclusions. Id. We also exercise plenary review over the District



                                              5
Court’s interpretation of federal securities laws. Id.

       Section 10(b) of the Securities and Exchange Act makes it unlawful “to use or

employ, in connection with the purchase or sale of any security registered on a national

securities exchange . . . any manipulative or deceptive device or contrivance in

contravention of such rules and regulations as the Commission may prescribe as

necessary or appropriate in the public interest or for the protection of investors.” 15

U.S.C. §78j(b). Rule 10b-5, promulgated under Section 10(b), provides:

       It shall be unlawful for any person, directly or indirectly, by the use of any
       means or instrumentality of interstate commerce, or of the mails or of any
       facility of any national securities exchange

       ....

       (b) To make any untrue statement of a material fact or to omit to state a
       material fact necessary in order to make the statements made, in the light of
       the circumstances under which they were made, not misleading, or

       (c) To engage in any act, practice, or course of business which operates or
       would operate as a fraud or deceit upon any person,

       in connection with the purchase or sale of any security.


17 C.F.R. § 240.10b-5. In order to state a claim under section 10b and Rule 10b-5,

plaintiffs must allege that the defendants “(1) made a misstatement or an omission of a

material fact (2) with scienter (3) in connection with the purchase or the sale of a security

(4) upon which the plaintiff reasonably relied and (5) that the plaintiff’s reliance was the

proximate cause of his or her injury.” In re Ikon Office Solutions, Inc. Sec. Litig., 277



                                              6
F.3d 658, 666 (3d Cir. 2002).

       A securities fraud claim is subject to heightened pleading requirements. Under

Federal Rule of Civil Procedure 9(b), “in all averments of fraud . . . the circumstances

constituting fraud . . . shall be stated with particularity. Malice, intent, knowledge, and

other condition of mind of a person may be averred generally.” Fed. R. Civ. P. 9(b). The

Private Securities Litigation Reform Act (“PSLRA”), 15 U.S.C. § 78u, adds an additional

requirement, providing that “the complaint shall, with respect to each act or omission

alleged to violate this chapter, 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). “[U]nless Plaintiffs in securities fraud actions allege facts supporting their

contentions of fraud with the requisite particularity mandated by Rule 9(b) and the

[PSLRA], they may not benefit from inferences flowing from vague or unspecific

allegations – inferences that may arguably have been justified under a traditional Rule

12(b)(6) analysis.” In re Rockefeller Center, 311 F.3d at 224. The failure to meet these

requirements will result in the dismissal of the complaint. In re Advanta Corp. Sec.

Litig., 180 F.3d 525, 534-35 (3d Cir. 1999).

       Plaintiffs may establish a “strong inference” that defendants acted with the

requisite scienter in one of two ways. They may either allege facts that establish that

defendants had the motive and opportunity to commit fraud, or they may set forth facts

that constitute circumstantial evidence of reckless or conscious misbehavior. Id. at 531.



                                               7
As with the other allegations of fraud, the facts that give rise to a strong inference of

scienter must be alleged with particularity, meaning that plaintiffs must plead “the who,

what, where, when, and how: the first paragraph of any newspaper story.” Id. at 534

(quoting DiLeo v. Ernst & Young, 901 F.2d 624, 627 (7th Cir. 1990)).

       The District Court found that Brody made six allegations regarding scienter: (1)

that A&P recognized vendor allowances in a manner that violated GAAP; (2) that A&P

recognized self-insurance reserves in a manner that violated GAAP; (3) that A&P

recognized closed-store subleases in a manner that violated GAAP; (4) a former senior

accounting manager stated that corporate account officers of A&P were aware of and

directed the methods used to recognize vendor allowances, self-insurance reserves, and

closed-store subleases; (5) A&P made a sale of over $275 million in senior notes during

the class period; and (6) after the discovery of the accounting irregularities, A&P fired

nine employees and Defendant Culligan resigned. The District Court held that Brody

failed to plead any of these allegations with the particularity required to give rise to a

strong inference of scienter, and failed to connect any of these allegations to each other in

a manner permitting a strong inference of scienter.

       Brody argues that the District Court erred in failing to discuss whether A&P and

the individual defendants had the motive and opportunity to commit fraud. He further

argues that such a motive existed, because A&P wished to facilitate the sale of the $275

million in Senior Notes to institutional investors. The complaint alleges that A&P was



                                               8
able to sell these notes “on terms they would not otherwise have been able to receive had

the truth about its accounting violations been known.” (App. at 94.) The complaint did

not make specific allegations regarding the sale of the notes, however, and the District

Court was not required to credit this bald assertion. “In every corporate transaction, the

corporation and its officers have a desire to complete the transaction, and officers will

usually reap financial benefits from a successful transaction. Such allegations alone

cannot give rise to a ‘strong inference’ of fraudulent intent.” GSC Partners CDO Fund v.

Washington, 368 F.3d 228, 237-38, (3d Cir. 2004).

       Brody also points to A&P’s desire to manage its earnings in order to meet analyst

and market expectations as a possible motive. (Appellant’s Br. at 35.) Again, this is a

general corporate motive, and is not sufficient to give rise to a strong inference of

scienter. Because the complaint does not allege sufficient facts to establish motive, the

District Court did not err in discussing only the circumstantial evidence approach to

pleading scienter. This approach requires a showing of either recklessness or conscious

wrongdoing.

       Recklessness is not simply negligence. “A reckless statement is a material

misrepresentation or omission ‘involving not merely simple, or even inexcusable

negligence, but an extreme departure from the standards of ordinary care, and which

presents a danger of misleading buyers or sellers that is either known to the defendant or

is so obvious that the actor must have been aware of it.’” Id. at 239 (quoting In re



                                              9
Advanta, 180 F.3d at 535).

       When the alleged fraud is based on non-disclosure of facts, evidence that the

defendants had actual knowledge of the facts is sufficient to show scienter. Id. When the

alleged fraud is based on misrepresentation or false statements, however, it is not enough

to merely allege that defendants knew or must have known that their statements were

false. Id. Instead, plaintiffs must support their allegations with specific facts that lay out

the “who, what, where, when, and how.” Id. (quoting In re Burlington Coat Factory Sec.

Litig., 114 F.3d 1410, 1422 (3d Cir. 1997)). The scienter threshold will be met “if a

plaintiff can show – by whatever means – that defendants ‘did not have an honest belief

in the truth of their statements . . . .’” In re Ikon, 277 F.3d at 667 n.7 (quoting McLean v.

Alexander, 599 F.2d 1190, 1198 (3d Cir. 1979)).

       The complaint alleges that A&P knew that the vendor allowances, self-insurance

reserves, and closed-store subleases were being recorded in a specific manner; these

allegations do not, however, show that A&P knew that the procedures used violated

GAAP. Each of A&P’s financial disclosures contained boilerplate language that the

procedures used in the reports conformed with GAAP. Brody points to this language as

proof that the GAAP violations were made with fraudulent intent. Again, however, this

language does not show that A& P knew that its procedures violated GAAP prior to its

restatement of earnings in July 2002. Finally, the former senior accounting manager

stated only that A&P knew of and directed the methods by which the vendor allowances



                                              10
were prematurely recognized. There is no allegation that A&P knew that such

recognition violated GAAP. As the District Court held, the allegations in the complaint

were not pled with sufficient particularity to establish scienter.

       The allegations regarding the discharged employees are similarly inadequate.

Other than a conclusory statement that nine employees were fired as a result of the

accounting irregularities, the complaint makes no specific allegations regarding how these

employees were involved in the accounting irregularities or whether they knew that the

accounting policies violated GAAP before the restatement was issued. It does not appear

that A&P made any public statement linking the firings to the accounting irregularities.

The complaint also alleges, without any factual basis, that Defendant Culligan resigned

from the company because of the accounting problems. As Defendant Culligan’s

resignation took place three months after A&P’s restatement, it is unclear that the

resignation was at all related to the restatement. Thus, the personnel changes do not

support a strong inference of scienter.

       Brody argues that the District Court did not consider the allegations as a whole in

determining that scienter had not been adequately pleaded. It does not appear, however,

that the District Court made any error in its analysis. The allegations in the complaint

simply do not meet the heightened standards required by Rule 9(b) and the PSLRA. As

such, dismissal was proper.

       Finally, the complaint alleges that certain of the individual defendants could be



                                              11
held liable for A&P’s actions as “controlling persons” under Section 20(a) of the

Exchange Act. Section 20(a) imposes liability on “any person who, directly or indirectly,

controls any person liable under any provision of this chapter or of any rule or regulation

thereunder . . .” 15 U.S.C. § 78t(a). In order to show controlling person liability,

plaintiffs must demonstrate that one person controlled another person (or in this case, the

corporation) and that the controlled person is liable under the Exchange Act. See In re

Alpharma, Inc. Sec. Litig., ___ F.3d ___, WL 1326013 (3d Cir. June 15, 2003). In this

case, the controlled person is A&P. Because plaintiffs failed to state a Rule 10b-5 claim

against A&P, and failed to allege any individual wrongdoing separate from the

allegations of ‘control,’ the Section 20(a) claim against the individual defendants fails as

well.

        For the foregoing reasons, the judgment of the District Court entered on September

18, 2003, will be AFFIRMED.




                                             12
