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In re Suprema Specialties, Inc. Securities Litigation

334 F.Supp.2d 637 (D. N.J. 2004)

SECURITIES LAW; FRAUD—A court analyzes a shareholders’ securities lawsuit against a corporation’s officers and board and rejects all claims because they could not convince the court that the individual defendants knew of the falsity of the allegedly fraudulent statements.

A manufacturing company’s shareholders sued the CEO, CFO, and various members of its board of directors after it was discovered that the corporation was a “sham.” The shareholders claimed the board violated Sections 11, 12, and 15 of the Securities Act, and Sections 10(b), 18, and 20 of the Exchange Act. To prove each of the claims being made by the shareholders, it was necessary to prove a material misstatement or omission. To be actionable, a statement or omission must be misleading at the time it was made. Each of the alleged violated securities fraud provisions required proof that the board made untrue or misleading statements or omissions of material fact.

The shareholders claimed the board did the following: (a) inflated the company’s sale in an annual report and other SEC filings through the use of fictitious transactions; (b) misstated the nature of the company’s business by claiming it was a manufacturer when it was actually in the “brokering” or “invoicing” business; (c) failing to reveal in the annual report that several of the company’s largest customers were “interrelated”; and (d) misrepresented that the company’s financial statements were prepared in accordance with GAAS and GAAP.

The District Court held that because Sections 11 and 12 of the Securities Act are based on allegations of fraud, the heightened pleading requirements of Court Rule 9(b) applied. Consequently, a plaintiff must plead; a specific false representation of material fact; knowledge by the person who made it of its falsity; ignorance of its falsity by the person to whom it was made; the intention that it should be acted upon; and that the plaintiff was damaged by acting upon it. Plaintiffs must accompany their legal theory with factual allegations that make their theoretically viable claim plausible.

Here, the shareholders contended that their claims were not based on fraud. The District Court disagreed. The Class Complaint alleged that the case arose from a “massive fraud” that resulted in “materially false and misleading” Registration Statements under the Securities Act. It also alleged that four “individuals admitted that certain of the [company’s] public statements relating to its financial results and the nature of its business were untrue” because they were based on “transactions that never actually took place.” The District Court also noted that the shareholders were claiming that the company’s total aggregate sales “were overstated by including sales ... that never actually occurred.” Thus, because the claims “sound[ed] in fraud,” the District Court held that the heightened pleadings requirements had to be satisfied. After making this determination, it held that the shareholders had failed to allege knowledge of the falsity by the person who made it or any intention that it be relied on. In fact, the shareholders had specifically stated that their Securities Acts claims were not based on any knowing or reckless misconduct on the part of the defendants. For those reasons, the District Court held that the shareholders’ Section 11 and 12 claims failed under Court Rule 9(b).

A complaint that asserts an Exchange Act Section 10(b) claim must state facts with particularity giving rise to a strong inference that the defendant acted with the required state of mind. Here, the shareholders attributed misstatements or omissions of material facts to the CEO and CFO based on their signatures on the registration statements and other filed documents. To their disappointment, the District Court held that one’s position in a company is not enough to show knowledge or recklessness. The shareholders failed to allege specific circumstances where the CEO and CFO had access to, and received information about, the alleged fraudulent transactions. Rather, the shareholders were asking the District Court to infer scienter from the two individual’s position’s with the company.

In addition, the shareholders’ complaint merely stated that the CEO and CFO had the responsibility to review the company’s financial reporting, external audits, and internal controls and compliance procedures, but never alleged that the directors failed to carry out their monitoring duties. Their complaint merely concluded that the directors were reckless, but the Complaint did not set forth specific facts from which a court could infer motive, opportunity or recklessness. Consequently, the shareholders’ Section 10 claim was defective.

Section 18 of the Exchange Act requires allegations of actual reliance on false or misleading statements. Here, the shareholders identified misrepresentations in documents filed with the SEC under the Exchange Act, but merely alleged that they relied on the documents that contained misstatements. They failed to allege actual reliance on any specific misrepresentations. For that reason, the District Court dismissed their Section 18 claim.

The elements of controlling-persons claims under Section 20 of the Exchange Act and Section 15 of the Securities Act are identical. To state a claim for control-person liability, a plaintiff must allege a primary violation of the federal securities laws by a controlled person. The District Court held that since the shareholders failed to state a claim under Sections 11 or 12 of the Securities Act or under Section 10(b) of the Exchange Act, their Section 15 and 20 control-person claims failed. For all of those reasons, the District Court dismissed all of the shareholders’ complaints.

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