The opinion of the court was delivered by: Lechner, District Judge.
f. The 17 November 1997 Press Release
On 17 November 1997, Milestone reported over the Business
Wire that since its introduction, the Wand has been met with
tremendous excitement and acceptance (the "17 November 1997 Press
Release"). See Amended Complaint at ¶ 45. The Amended Complaint
relied on the 17 November 1997 Press Release which quoted Osser
Id. (quoting the 17 November 1997 Press Release) (bolding
added). Again, counsel for Plaintiffs conceded at oral argument
that nothing in this statement was false. See 2 March 2000 Tr.
at 52:10-12 (The court: "Paragraph 45, anything in that quote
that [was] false?" Counsel: "No.").
h. The 19 February 1998 Press Release
The Plaintiffs allege that on 19 February 1998, Milestone
issued a press release (the "19 February 1998 Press Release")
over the Business Wire indicating Milestone would exhibit the
Wand at the Chicago Mid-winter Dental Conference beginning on 19
February 1998 and ending on 22 February 1998. See Amended
Complaint at ¶ 51. The Plaintiffs relied, in part, on the 19
February 1998 Press Release which also contained significant
financial data regarding Milestone:
See id. (quoting the 19 February 1998 Press Release). Again,
counsel for Plaintiffs
conceded at oral argument that nothing in the quoted portion of
the 19 February 1998 Press Release was false. See 2 March 2000
Tr. at 52:23-24 (The court: "[Anything in Paragraph] Fifty-one
[that was false]?" Counsel: "No.").
i. The 1998 Compendium Article
In February 1998, Michael Krochak ("Krochak"), a director of
the Dental Phobia Clinic at Mount Sinai Medical Center in New
York City, authored an article appearing in the Compendium (the
"1998 Compendium Article") and published by the NYSDJ, stating
the Wand reduced patient anxiety. See Amended Complaint at ¶
52. The Plaintiffs allege the 1998 Compendium Article was
materially misleading when issued in February 1998 because
Milestone did not disclose the options it granted to Krochak.
See id. at ¶ 53.
Again, counsel for Plaintiffs conceded at oral argument that
nothing in the quoted portion of the 1998 Compendium Article
about the Wand reducing patient anxiety was false. See 2 March
2000 Tr. at 52:25, 53:1-3 (The court: "Paragraph 52, the comment
by Krochak in his article stating that the [W]and would reduce
patient anxiety, anything about that which [was] false?" Counsel:
j. The 30 March 1998 Press Release
Milestone issued a press release on 30 March 1998 (the "30
March 1998 Press Release") over the Business Wire announcing
its fourth quarter and year ended results for the period ended 31
December 1997. See Amended Complaint at ¶ 55. The 30 March 1998
Press Release contained significant financial data concerning
Its revenues, net loss and loss per share were
$2,854,000, $7,438,000 and $1.21 in the year ended
December 31, 1997 as compared to $302,000, $1,950,000
and $0.43 in the prior year. In the fourth quarter
ended December 31, 1997 revenues, net loss and loss
per share were $551,000, $4,262,000 and $0.52 as
compared to $147,000, $582,000 and $0.13 in the prior
The principal reason for the increase in losses were
costs associated with research and development in
connection with the completion of the Wand(TM),
marketing and personnel costs relating to the launch
of the Wand(TM) and, to a lesser extent, the "Splater
Free" prophy angle and a non-cash charge in
connection with the acquisition of the minority
interest in Princeton PMC, a joint venture marketing
affiliate established in 1996. After reflecting these
losses, Milestone's financial position continues to
be strong with more than $15,000,000 in cash, cash
equivalents and treasury bills at year-end and
virtually no debt.
Leonard Osser, Chairman and Chief Executive officer,
stated "1997 represents a year of tremendous progress
for the Company. Development work was completed on
the Want(TM), the product was launched and marketing
efforts commenced. Milestone also established
distribution for the Wand(TM) through leading
domestic distributors of dental products including
Henry Shein (Sullivan), Patterson Dental, Meer Dental
and the American Dental Cooperative (ADC) Member
Companies. The Company is currently operating ahead
of budget and on a profitable basis."
Id. (quoting the 30 March 1998 Press Release). Again, counsel
for Plaintiffs conceded at oral argument that nothing in this
statement on which they relied was false. See 2 March 2000 Tr.
at 53:7-9 (The court: "Paragraph 55, there are three quoted
paragraphs there. Anything false?" Counsel: "No.").
k. The 31 December 1997 SEC Form 10-K
As mentioned, Milestone filed its 31 December 1997 Form 10-K,
signed by Osser and Mele, with the SEC on 31 March 1998.
See e.g. Amended Complaint at ¶ 56. The Amended Complaint
alleges the 31 December 1997 SEC Form 10-K reiterates the results
previously announced in the 30 March 1998 Press Release. See
id. The 31 December 1997 SEC Form 10-K states:
The Company began shipping system kits consisting of
the Wand(TM) driver unit, 100 disposable hand pieces,
an instructional video tape and other instructional
material in January 1998. Prior thereto
pre-production prototype of the Wand(TM) had been
clinically tested in over 1,000 patients.
Ninety-six percent of those tested reported a
"painless" or significantly less painful procedure
than standard procedures. Three separate additional
studies were conducted on various aspects of the
Wand(TM) operation. These have been published in
major dental publications and have helped establish
acceptance and credibility within the dental
Id. (quoting the 31 December 1997 SEC Form 10-K) (emphasis in
the Amended Complaint, bolding added). Significantly, Counsel for
Plaintiffs conceded at oral argument that nothing in this
statement was false. See 2 March 2000 Tr. at 53:10-12 (The
court: "Paragraph 56 in the quoted paragraph, anything false?"
The Amended Complaint, however, alleges the 31 December 1997
SEC Form 10-K and the 30 March 1998 Press Release were materially
misleading because the "acceptance" and "credibility" referenced
in the statements failed to disclose the studies which were so
helpful to Milestone were actually "bought and paid for
promotional materials."*fn11 See Amended Complaint at ¶ 57.
In addition, the 31 December 1997 SEC Form 10-K indicated
Milestone retained the services of various consultants and
compensated the consultants with Milestone stock options. See
id. at ¶ 58. The Amended Complaint alleges the 31 December 1997
SEC Form 10-K stated:
During 1996 and 1997, the Company granted stock
option to a director and various consultants to
purchase 35,000 and 164,000 shares of common stock,
respectively, at prices ranging from $5.125 to $6.50
per share. The options expire in three to five years
depending on the option, vest over two to three years
and contain certain antidilution provisions.
See id. Again, counsel for Plaintiffs conceded at oral argument
that nothing in this statement was false. See 2 March 2000 Tr.
at 53:21-22 (The court: "Paragraph 58, anything false?" Counsel:
It is alleged the statements concerning the retention of
consultants in exchange for stock options was materially
misleading because the statements did not disclose Friedman,
Hochman and Krochak were the individuals who received the
Milestone common stock options. See Amended Complaint at ¶ 59.
l. The 4 May 1998 Press Release and 4 May 1998 Conference Call
Milestone issued a press release on 4 May 1998 (the "4 May 1998
Press Release") over the Business Wire announcing its results
for the first fiscal quarter ended 31 March 1998. See id. at ¶
64. The 4 May 1998 Press Release stated:
Revenues for the three months ended March 31, 1998
were $5,260,149 compared to $760,123 for the same
period a year ago. The net income for the first
quarter ended March 31, 1998 was $358,079, or $0.04
per share on weighted average
shares outstanding of 8,733,373, compared to a loss
of $(696,028), or $(0.14) per share on weighted
average shares outstanding of 4,840,527 for the
comparable period a year earlier. During the first
quarter of 1998 the Company delivered 7,311 Wand(TM)
system kits to distributors and 817,000 disposable
components. This represents net sales of $4,760,069
for the first three months of the fiscal year.
The Company has a number of letters-of-intent from
foreign distributors who are interested in bringing
the Wand to the European, South American and Pacific
Mr. Daniel R. Martin, President and COO of Milestone
Scientific, said, "we are pleased with the demand and
reorders from our distributors. The additional
manufacturing capacity for the disposable units is in
place and production levels are now at 2.5 million
Mr. Leonard A. Osser, Chairman and CEO of Milestone
Scientific, noted, "the Wand's acceptance by the
dental community has been extremely gratifying and
resulted in the need to significantly increase our
production capacity. Milestone now has in place the
resources to assure the dentist of prompt delivery of
his order. The production ramp up has proceeded
smoothly and by mid-year we expect to have in place
the production capacity to produce enough system
kits and disposable components to satisfy our
aggressive placement projections. The confidence that
this revolutionary approach to painless dentistry
will be an integral part of the dentist's practice in
years to come."
Id. (quoting the 4 May 1998 Press Release) (bolding added).
Again, counsel for Plaintiffs conceded at oral argument that
nothing in this quote upon which Plaintiffs relied was false.
See 2 March 2000 Tr. at 54:23-25, 54:1 (The court: "Paragraph
64, anything false in that quote? That's a long quote, it goes on
to the next page." Counsel: "Right, no.").
Milestone also conducted a conference call on 4 May 1998 (the
"4 May 1998 Conference Call") with investors to discuss first
quarter results. See Amended Complaint at ¶ 65. It is alleged
that during the 4 May 1998 Conference Call, Martin falsely
represented the full 5,000 backlog of orders, placed as of 31
March 1998, had been shipped. See id. The Amended Complaint
alleges this representation was false and misleading because the
5,000 backlog of orders had not been shipped and many of the
previously placed orders had been cancelled. See id.
In addition, during the 4 May 1998 Conference Call, Milestone
indicated sales to distributors would have been higher had
Milestone been able to fill the back orders placed by those
distributors. See id. The Amended Complaint alleges the
statement regarding inventory was materially false and misleading
because sales to distributors could not have been higher due to
an actual "glut of inventory" rather than a low level of
inventory on the part of the distributors. See id. at ¶ 66. The
Amended Complaint further alleges the statement pertaining to
inventory was materially false and misleading because Milestone
was "aware or recklessly disregarded that dentists double and
triple-ordered from various distributors in an effort to cut down
the month-long wait it took to receive the product." Id.
Finally, during the 4 May 1998 Conference Call, Martin stated
Milestone did not know the rate of returns for the Wand because
it was "hard to keep track of returns to distributors." See id.
(citing the 4 May 1998 Conference Call). Despite not knowing the
total percentage of Wand returns, it is alleged Martin further
stated that only approximately 200 Wands had been returned to
Milestone in the first fiscal quarter. See id. In addition, the
Amended Complaint alleges Martin indicated Milestone had reserves
for 10% of Wand returns and the reserves were carried as a
reduction in revenue. See id. at ¶ 67. See also 2 March 2000
Tr. at 68:5-11 (The court: "Paragraph 67, second sentence,
`although he did not know the total percentage of returns,
Defendant Martins stated that only approximately 200[W]ands had
been returned to the company in the first quarter and of those,
25% were returned unopened,' anything false in that [sentence]?"
Counsel: "In that sentence, no, Your Honor.")
m. The 4 June 1998 Press Release
The Plaintiffs allege that on or about 4 June 1998, Harriot
Tabuteau, an analyst for NationsBanc Montgomery Securities,
changed a previous estimate for the sales and income loss of
Milestone because distributor Henry Schein, Inc. reduced
purchases for the Wand from 2,600 to 900 for the fiscal quarter
ended 30 June 1998 (the "4 June 1998 Report"). See Amended
Complaint at ¶ 69. The Amended Complaint also alleges the 4 June
1998 Report predicted a revenue shortfall of approximately $1
million dollars.*fn12 See id.
On or about 4 June 1998, Milestone issued a press release (the
"4 June 1998 Press Release") over the Business Wire confirming
Wand order cancellations would cost Milestone $1.2 million in
sales. See id. The Amended Complaint alleges that in an attempt
to soften the impact of the 4 June 1998 Report, Milestone issued
the 4 June 1998 Press Release which quoted Martin as stating:
"Sullivan-Schein, Patterson Dental, Meer Dental and
the American Dental Cooperative are promoting the
Wand to their customers and have been publicly very
positive about the product. In fact additional
distributors have asked to distribute the Wand. We
believe any delays are short term and are not
indicative of the eventual success of the Wand."
"Milestone is now in the position of providing the
Wand to distributors in a just-in-time fashion. This
is the result of our success in ramping up the supply
of Wand system kits and disposable components towards
the end of the first quarter. Having product readily
accessible from the Company allows distributors to
maintain small stocks of product, while using
Milestone's warehouse instead of their own."
Id. at ¶ 70 (quoting the 4 June 1998 Press Release). As
mentioned, Counsel for Plaintiffs conceded at oral argument that
the statements concerning the distributors were not false. See
2 March 2000 Tr. at 52:23-24 (The court: "[Anything in Paragraph]
Fifty-one [that is false]?" Counsel: "No."). See also id. at
68:14-16 (The court: "We already covered Paragraph 70, didn't we?
Is there anything false in 70?" Counsel: "I believe we covered
it, Your Honor."); See also id. at 65:21-23 (The court:
"Paragraph 70, is there anything wrong in that quoted paragraph?"
Counsel: "No there isn't. . . .").
n. The 5 June 1998 Conference Call
On 5 June 1998, Milestone conducted a conference call with
investors to discuss the recent volatility of the pricing of
Milestone common stock (the "5 June 1998 Conference Call"). See
Amended Complaint at ¶ 71. During the 5 June 1998 Conference
Call, Milestone stated it had shipped 2,600 units of the Wand by
April 1998. See id. at ¶ 73. In addition, Milestone stated that
as of May 1998, it had shipped an additional 1,100 units, for a
total of 3,700 units rather than the full 5,000 backlog of orders
as previously indicated during the 4 May 1998 Conference Call.
See id. Finally, Milestone acknowledged its prior statements
had "certainly contributed to investor confusion and
Id. (citing the 5 May 1998 Conference Call).
The Amended Complaint alleges the Defendants were "fully aware,
or were reckless in failing to know" that Milestone had
overstated acceptance of the Wand. See id. at ¶ 75. The
Plaintiffs contend the Defendants were similarly "fully aware, or
were reckless in failing to know" Milestone common stock was
trading at inflated prices. Finally, the Amended Complaint
alleges Defendants issued the allegedly false and misleading
statements in order to maintain "substantial salaries, earn
bonuses and long term compensation based upon the fictitious
results they created." See id.
3. The Asserted Violations of GAAP
The Amended Complaint, moreover, alleges Milestone violated
GAAP, and therefore filed materially false and misleading
financial statements with the SEC for the fiscal first quarter
ended 31 March 1998. See generally id. at ¶¶ 78-89.
a. The 5 May 1998 SEC Form 10-Q
On or about 5 May 1998, Milestone filed with the SEC its Form
10-Q for the first quarter ended 31 March 1998 (the "5 May SEC
Form 10-Q"). See id. at ¶ 78. The Amended Complaint alleges the
5 May 1998 SEC Form 10-Q failed to disclose the reserve policy of
Milestone for returns of the Wand. See id. at ¶ 79. In
addition, the Plaintiffs allege, inter alia, because of the
limited sales experience of Milestone and the limited time the
Wand was available on the market, Milestone was required to
disclose in the 31 March 1998 SEC Form 10-Q that the arbitrary
10% reserve figure used for the fiscal first quarter ended 31
March 1998, could not be relied upon for the fiscal second
quarter ended 30 June 1998.*fn13 See id.
Specifically, the Amended Complaint alleges "SEC Regulation SX"
requires all financial statements filed with the SEC conform with
GAAP and financial statements not in conformity with GAAP are
"presumed to be misleading or inaccurate." See id. at ¶ 83
(citing 17 C.F.R. § 210.401(a)(1)). In addition, the Amended
Complaint alleges the Statements of Financial Accounting
Standards No. 48 ("FAS 48"), issued by the Financial Accounting
Standards Board, is encompassed in GAAP. See id. at ¶ 85. It
appears FAS 48 governs the disclosure of revenue based on future
returns of a product. FAS 48 states:
If an enterprise sells its product but gives the
buyer the right to return the product, revenue from
the sales transaction shall be recognized at the time
of sale only if all of the following conditions are
f. The amount of future returns can be reasonably
The ability to make a reasonable estimate of the
amount of future returns depends on many factors and
circumstances that will vary from one case to the
next. However, the following factors may impair the
ability to make a reasonable estimate:
c. Absence of historical experience with similar
types of sales of similar products, or inability to
apply such experience because of changing
for example, changes in the selling enterprise's
marketing policies or relationships with its
Id. at ¶ 86 (quoting ¶¶ 6 & 8 respectively, of FAS 48).
The Amended Complaint alleges Milestone violated FAS 48 and,
therefore, violated GAAP by recognizing sales of the Wand system
kits to distributors in the 31 March 1998 SEC Form 10-Q. See
id. at ¶ 88. In this regard, the Plaintiffs allege Milestone
admitted it could not predict the number of returns from Wand
system kits shipped in the fiscal first quarter ended 31 March
1998. See id. In addition, Milestone did not have the
"historical experience with similar types of sales" to make a
reasonable estimate of future returns because shipment of the
Wand began in or about January 1998, and ramp-up occurred in or
about March 1998. See id. The Amended Complaint alleges the 31
March 1998 SEC Form 10-Q failed to "disclose that defendants had
used a reserve for Wand returns of 10% and what the basis for
that reserve was, and that the reserve would likely be
insufficient for returns in the second quarter. . . ." Id.
Finally, the Amended Complaint alleges that during the Class
Period, the financial statements of Milestone violated the
following principles of fair financial reporting:
(1) The principal that financial reporting should
provide information that is useful to present and
potential investors and creditors and other users in
making rational investment, credit and similar
decisions. (citing Financial Accounting Standards
Board ("FASB") Concepts No. 1).
(2) The principle that financial reporting should
provide information about an enterprise's financial
performance during a period (citing FASB Statement of
Concepts No. 1).
(3) The principle that financial reporting should be
reliable in that it represents what it purports to
represent (citing FASB Statement of Concepts 2).
(4) The principle of completeness, which means that
nothing material is left out of the information that
may be necessary to ensure that it validly represents
underlying events and conditions (Id.).
(5) The principle that conservatism be used as a
prudent reaction to uncertainty to try to ensure that
uncertainties and risks inherent in business
situations are adequately considered. (Id.).
(6) The principle that disclosure of accounting
policies should identify and describe the accounting
principles followed by the reporting entity and the
methods of applying those principles that materially
affect the financial statements. (Accounting
Principles Board Opinions ("APB"), Opinion No. 22).
(7) The principle that losses be accrued for when a
loss contingency, then disclosure of the contingency
shall be made when there is at least a reasonable
possibility that a loss or an additional loss may
have been incurred. (citing Statement of Financial
Accounting Standards No. 5).
(8) The principle that contingencies and other
uncertainties that affect the fairness of
presentation of financial data at an interim date
shall be disclosed in interim reports in the same
manner required for annual reports (citing APB
Opinion No. 28).
(9) The principle that management should provide
commentary relating to the effects of significant
events upon the interim financial results (citing APB
Opinion No. 28).
(10) The principle that management should provide
commentary relating to the effects of significant
events upon the interim financial results (APB
Opinion No. 28).
Id. at ¶ 89 (citing various principles of GAAP).
4. The Asserted Misrepresentations, Omissions and Scienter
The Amended Complaint alleges the Defendants knew or recklessly
disregarded the fact that the public documents and statements
they issued on behalf of Milestone were materially false and
misleading. See id. at ¶ 95. The Amended Complaint further
alleges the Defendants knew or recklessly disregarded that public
statements and, or, documents would be issued or disseminated to
the investing public. See id. The Plaintiffs also contend the
Defendants knowingly or recklessly participated in, or
acquiesced, the issuance and, or, dissemination of said
statements and, or, documents. See id.
In addition, the Amended Complaint alleges the Defendants had
motive and opportunity to inflate the price of Milestone stock.
For example, the Amended Complaint alleges Osser sold 500,000
shares of Milestone stock during the Class Period in excess of
5.3 million dollars. See id. at ¶ 91. In addition, following
the completion of the financial statements for each year,
commencing with 1998, Milestone would grant Osser an additional
option to purchase up to 50,000 shares of Milestone common stock,
in 10,000 share increments, for each $400,000 of net income in
excess of $2,500,000. See id. at ¶ 92.
Finally, the Plaintiffs contend the Defendants knew or
recklessly failed to know Milestone granted thousands of options
to purchase Milestone common stock to practitioner consultants
Friedman, Malamed, Hochman and Krochak. See id. at ¶ 94. The
Amended Complaint further alleges the Defendants knew or
recklessly failed to know the "reserve policy" set for the Wand
returns would be inaccurate for the second quarter ended 30 June
1998.*fn14 See id.
A. Standard For Dismissal Under Rule 12(b)(6), Rule 9(b) and
15 U.S.C. § 78u-4 et seq.
A court may dismiss a complaint pursuant to Rule 12(b)(6) for
failure to state a claim where it appears beyond doubt that no
relief could be granted under any set of facts which could be
proved consistent with the allegations. See Hartford Fire Ins.
Co. v. California, 509 U.S. 764, 811, 113 S.Ct. 2891, 125
L.Ed.2d 612 (1993); Hishon v. King & Spalding,
104 S.Ct. 2229, 81 L.Ed.2d 59 (1984); Conley v. Gibson,
, 45-46, 78 S.Ct. 99, 2 L.Ed.2d 80 (1957); Weiner v.
Quaker Oats Co.,
, 315 (3d Cir. 1997); Unger v.
National Residents Matching Program,
, 1395 (3d
Cir. 1991); Markowitz v. Northeast Land Co.,
(3d Cir. 1990); Ransom v. Marrazzo,
, 401 (3d Cir.
Because granting a motion under Rule 12(b)(6) can result in a
dismissal at an early stage of a case, all allegations of a
plaintiff must be taken as true and all reasonable factual
inferences drawn in his or her favor. See Gomez v. Toledo,
446 U.S. 635, 636, 100 S.Ct. 1920, 64 L.Ed.2d 572 (1980); Weiner,
129 F.3d at 315; In re Burlington Coat Factory Sec. Litig.,
114 F.3d 1410, 1420 (3d Cir. 1997); Piecknick v. Pennsylvania,
36 F.3d 1250, 1255 (3d Cir. 1994); Jordan v. Fox, Rothschild,
O'Brien & Frankel, 20 F.3d 1250, 1261 (3d Cir. 1994); Shapiro
v. UJB Fin. Corp., 964 F.2d 272, 279-80 (3d Cir.), cert.
denied, 506 U.S. 934, 113 S.Ct. 365, 121 L.Ed.2d 278
(1992); Schrob v. Catterson, 948 F.2d 1402, 1405 (3d Cir.
1991); Unger, 928 F.2d at 1395; Markowitz v. Northeast Land
Co., 906 F.2d 100, 103 (3d Cir. 1990); Melikian v. Corradetti,
791 F.2d 274, 277 (3d Cir. 1986).
A complaint should not be dismissed unless it appears beyond
doubt that "the facts alleged in the complaint, even if true,
fail to support the claim." Ransom, 848 F.2d at 401; see also
Shapiro, 964 F.2d at 279-80. Legal conclusions made in the guise
of factual allegations, however, are given no presumption of
truthfulness. See Papasan v. Allain, 478 U.S. 265, 286, 106
S.Ct. 2932, 92 L.Ed.2d 209 (1986); Morse v. Lower Merion Sch.
Dist., 132 F.3d 902, 906 (3d Cir. 1997) ("[A] court need not
credit a complaint's `bald assertions' or `legal conclusions'
when deciding a motion to dismiss"); Haase v. Webster,
807 F.2d 208, 215 (D.C.Cir. 1986), vacated on other grounds,
835 F.2d 902 (D.C.Cir. 1987); Briscoe v. LaHue, 663 F.2d 713, 723 (7th
Cir. 1981), aff'd, 460 U.S. 325, 103 S.Ct. 1108, 75 L.Ed.2d 96
(1983); Western Mining Council v. Watt, 643 F.2d 618, 626 (9th
Cir.), cert. denied, 454 U.S. 1031, 102 S.Ct. 567, 70 L.Ed.2d
474 (1981); Bermingham v. Sony Corp. of Am., 820 F. Supp. 834,
846 (D.N.J. 1992), aff'd, 37 F.3d 1485 (3d Cir. 1994).
A District Court reviewing the sufficiency of a complaint has a
limited role. "The issue is not whether a plaintiff will
ultimately prevail but whether the claimant is entitled to offer
evidence to support his [or her] claims." Scheuer v. Rhodes,
416 U.S. 232, 236, 94 S.Ct. 1683, 40 L.Ed.2d 90 (1974); In re
Burlington Coat Factory, 114 F.3d at 1420; Bermingham, 820
F. Supp. at 846. Generally, when conducting such an inquiry, a
District Court generally may not consider any material beyond the
pleadings. See In re Burlington Coat Factory, 114 F.3d at 1426;
Pension Benefit Guar. Corp. v. White Consol. Indus.,
998 F.2d 1192, 1196 (3d Cir. 1993), cert. denied, 510 U.S. 1042, 114
S.Ct. 687, 126 L.Ed.2d 655 (1994); Wallace v. Systems & Computer
Tech. Corp., No. 95-6303, 1997 WL 602808, at *5 (E.D.Pa. Sept.
23, 1997); Gannon v. Continental Ins. Co., 920 F. Supp. 566, 574
A District Court, however, may properly refer to the factual
allegations contained in other documents, such as documents
referred to in the complaint and matters of public record if the
claims in the complaint are based upon those documents. See In
re Burlington Coat Factory, 114 F.3d at 1426; In Re
Westinghouse, 90 F.3d 696, 707 (3d Cir. 1996); In re Donald
Trump Casino Securities Litigation, 7 F.3d 357, 368 n. 9 (3d
Cir. 1993), cert. denied, 510 U.S. 1178, 114 S.Ct. 1219, 127
L.Ed.2d 565 (1994); Pension Benefit Guar. Corp., 998 F.2d at
1196; Wallace, 1997 WL 602808, at *5; Weiner, 928 F. Supp. at
1380; Gannon, 920 F. Supp. at 574. In other words, such
documents must be "integral to or explicitly relied upon in the
complaint." In re Burlington Coat Factory, 114 F.3d at 1426
(quoting Shaw v. Digital Equip. Corp., 82 F.3d 1194, 1220 (1st
In re Burlington Coat Factory, 114 F.3d at 1426. Under these
circumstances, reference to documents outside of a complaint does
not convert a motion to dismiss into a motion for summary
judgment. See In re Burlington Coat Factory, 114 F.3d at 1426;
Pension Benefit Guar. Corp., 998 F.2d at 1196-97.
B. The Exchange Act
In general, the Exchange Act regulates post-distribution
trading. See Central Bank of Denver, N.A. v. First Interstate
Bank of Denver, N.A., 511 U.S. 164, 171, 114 S.Ct. 1439, 128
L.Ed.2d 119 (1994) (citing Blue Chip Stamps v. Manor Drug
Stores, 421 U.S. 723, 752, 95 S.Ct. 1917, 44 L.Ed.2d 539
(1975)). Together with the Securities Act, the Exchange Act
"embrace[s] a fundamental purpose . . . to substitute a
philosophy of full disclosure for the philosophy of caveat
emptor." See id. (quoting Affiliated Ute Citizens of Utah v.
United States, 406 U.S. 128, 151, 92 S.Ct. 1456, 31 L.Ed.2d 741
(1972)) (internal quotation marks omitted).
1. The Exchange Act Claims
a. Section 10(b) and Rule 10b-5
Count I of the Amended Complaint alleges violations of Section
10(b) and Rule 10b-5. See Amended Complaint at ¶¶ 96-104.
Through Section 10(b), Congress prohibits manipulative or
deceptive acts in connection with the purchase or sale of
securities. Section 10(b) states:
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
(b) To use or employ, in connection with the purchase
or sale of any security registered on a national
securities exchange or any security not so
registered, any manipulative or deceptive device or
contrivance in contravention of such rules and
regulations as the [SEC] may prescribe.
15 U.S.C. § 78j et seq.
Rule 10b-5, adopted by the SEC in 1942, similarly prohibits
such fraudulent conduct in connection with the purchase or sale
of a security. Rule 10b-5 states:
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
(a) To employ any device, scheme, or artifice to
(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
(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 (1993).
To establish a claim under Section 10(b) and Rule 10b-5, a
plaintiff must plead (1) a false representation, or omission, of
a material fact, (2) knowledge or reckless disregard of its
falsity by a defendant and the intention that a plaintiff rely on
the falsity, (3) reasonable reliance thereon by a plaintiff, and
(4) a resultant loss. See In re Advanta Sec. Litig., 180
452 F.3d 525, 537 (3d Cir. 1999); Newton v. Merrill, Lynch, Pierce,
Fenner & Smith, Inc., 135 F.3d 266, 269 (3d Cir. 1998); Kline
v. First Western Gov't Sec., Inc., 24 F.3d 480, 487 (3d Cir.),
cert. denied, 513 U.S. 1032, 115 S.Ct. 613, 130 L.Ed.2d 522
(1994); Hayes v. Gross, 982 F.2d 104, 106 (3d Cir. 1992)
(citation omitted); Shapiro, 964 F.2d at 280; Lewis v.
Chrysler Corp., 949 F.2d 644, 649 (3d Cir. 1991) (citation
omitted); In re Phillips Petroleum, 881 F.2d 1236, 1244 (3d
Cir. 1989); Zlotnick, 836 F.2d at 821 (citing Peil v.
Speiser, 806 F.2d 1154, 1160 & n. 9 (3d Cir. 1986) (citing
Eisenberg v. Gagnon, 766 F.2d 770, 785 (3d Cir.), cert. denied
sub nom. Wasserstrom v. Eisenberg, 474 U.S. 946, 106 S.Ct. 342,
88 L.Ed.2d 290 (1985))).
The reliance of a plaintiff on alleged misstatements or
omissions must be reasonable; the burden of proof is upon the
defendant to show reliance was not reasonable. See Kline, 24
F.3d at 493 (citing Straub v. Vaisman & Co., 540 F.2d 591, 598
(1976)). Where the security involved is traded in an open and
efficient market, a plaintiff need not show individual and
specific reliance on the misrepresentation of a defendant. A
plaintiff may instead rely upon the fraud on the market theory
and claim only that he or she suffered injury in the capacity as
a purchaser or seller of a security in such a market.
"`The fraud on the market theory is based on the hypothesis
that, in an open and developed securities market, the price of a
company's stock is determined by the available material
information regarding the company and its business.'" See Cammer
v. Bloom, 711 F. Supp. 1264, 1276 (D.N.J. 1989) (quoting Basic
v. Levinson, 485 U.S. 224, 108 S.Ct. 978, 99 L.Ed.2d 194
(1988)). See also Hayes, 982 F.2d at 106.
In Peil, the Circuit held a showing of a fraud on the market
may result in a rebuttable presumption of reliance by a plaintiff
who purchases a security in an open and developed market. See
806 F.2d at 1161; see also Zlotnick, 836 F.2d at 821. Where a
purchaser of a stock establishes he or she made the purchase in
an "`open and developed market'" and the defendant had made a
material misrepresentation, it "`will [be] presume[d] that the
misrepresentations occasioned an increase in the stock's value
that, in turn, induced the plaintiffs to purchase the stock.'"
Zlotnick, 836 F.2d at 821 (quoting Peil, 806 F.2d at 1161).
Because a Rule 10-5 claim is a "fraud" claim, a Section 10(b)
plaintiff must satisfy the pleading requirements of Rule 9(b).
See In re Advanta, 180 F.3d at 530-35; In re Burlington, 114
F.3d at 1417; In Re Westinghouse, 90 F.3d at 710; Wallace,
1997 WL 602808, at *8. Rule 9(b) requires that "[i]n all
averments of fraud or mistake, the circumstances constituting
fraud or mistake shall be stated with particularity."
Fed.R.Civ.P. 9(b). The purpose of the heightened pleading
requirement is to give defendants "notice of the claims against
them, provides an increased measure of protection for their
reputations, and reduces the number of frivolous suits brought
solely to extract settlements." In re Burlington Coat Factory,
114 F.3d at 1418.
In order to satisfy Rule 9(b) in connection with a Rule 10b-5
claim, a plaintiff must plead with particularity (1) a specific
misrepresentation of material fact, (2) the knowledge by
defendants of its falsity, (3) the ignorance by the plaintiff of
its falsity, (4) the intention of defendants that it should be
acted upon, and (5) that plaintiff acted upon it to his
detriment. See In Re Westinghouse, 90 F.3d at 710; Shapiro,
964 F.2d at 284.
Consequently, Rule 9(b) demands increased specificity in the
pleadings to establish violations of Section 10(b) and Rule
10b-5. Pursuant to Rule 9(b), allegations concerning
misrepresentations of material fact must be pleaded in greater
detail. See, e.g., In re Burlington Coat Factory, 114 F.3d at
1417-18 (Rule 9(b) requires "where plaintiffs allege that
distorted certain data disclosed to the public by using
unreasonable accounting practices, . . . plaintiffs [must] state
what the unreasonable practices were and how they distorted the
disclosed data"); Shapiro, 964 F.2d at 285 (citing Craftmatic
Sec. Litig. v. Kraftsow, 890 F.2d 628, 646 (3d Cir. 1989) (Rule
9(b) requires plaintiffs to "accompany the allegations with a
statement of fact upon which their allegation is based")).
The particularity requirement of Rule 9(b) is "relaxed somewhat
where the factual information is peculiarly within the
defendant's knowledge or control." See In re Burlington Coat
Factory, 114 F.3d at 1418; Shapiro, 964 F.2d at 285;
Craftmatic, 890 F.2d at 645. This is so because application of
the particularity requirement "may permit sophisticated
defrauders to successfully conceal the details of their fraud."
In re Burlington Coat Factory, 114 F.3d at 1418; see
Craftmatic, 890 F.2d at 645; Christidis v. First Pa. Mort.
Trust, 717 F.2d 96, 100 (3d Cir. 1983).
Even under a relaxed application of Rule 9(b), "boilerplate and
conclusory allegations will not suffice." In re Burlington Coat
Factory, 114 F.3d at 1418; see Shapiro, 964 F.2d at 285.
Instead, "[p]laintiffs must accompany their legal theory with
factual allegations that make their theoretically viable claim
plausible." In re Burlington Coat Factory, 114 F.3d at 1418;
see Shapiro, 964 F.2d at 285; Craftmatic, 890 F.2d at 645.
Complaints alleging securities fraud must also comply with the
Private Securities Litigation Reform Act (the "PSLRA"),
15 U.S.C. § 78u-4 et seq. See In re Advanta, 180 F.3d at 530; In re
Cendant Corp. Litig., 60 F. Supp.2d 354, 368-69 (D.N.J. 1999).
The PSLRA requires that a complaint, which asserts a Section
10(b) claim, 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) (bolding added). This
heightened scienter pleading requirement mirrors that of the
Second Circuit. See In re Advanta, 180 F.3d at 533 (noting the
adoption of the Second Circuit heightened pleading requirement).
See also H.R.Conf.Rep. No. 104-369, 104th Cong., 1st Sess. 41,
41 (1995), reprinted in 1995 U.S.C.C.A.N. 740, 740; S.Rep. 98,
104th Cong., 1st Sess. 15 (1995), reprinted in 1995 U.S.C.C.A.N.
As the Circuit recently announced: "Congress's use of the
Second Circuit's language compels the conclusion that the [PSLRA]
establishes a pleading standard approximately equal in stringency
to that of the Second Circuit." In re Advanta, 180 F.3d at 534.
To satisfy this pleading requirement, plaintiffs must state with
particularity facts which show that defendants had both motive
and opportunity to commit fraud or facts that constitute strong
circumstantial evidence of conscious misbehavior or recklessness.
See id. (observing the PSLRA pleading standard "echoes
precisely Fed.R.Civ.P. 9(b) and therefore requires plaintiffs to
plead `the who, what, when, where, and how: the first paragraph
of any newspaper story'") (citations omitted); In re Burlington
Coat Factory, 114 F.3d at 1418; Acito v. IMCERA Group, Inc.,
47 F.3d 47, 52 (2d Cir. 1995).
In connection with the PSLRA heightened pleading requirement
concerning scienter, the Circuit stated:
In any private action arising under this chapter in
which the plaintiff may recover money damages only on
proof that the defendant acted with a particular
state of mind [scienter], 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.
In re Advanta, 180 F.3d at 530 (quoting the PSLRA,
15 U.S.C. § 78u-4(b)(2)) (bolding added). By contrast, Rule 9(b) states
"malice, intent, knowledge, and other conditions of mind of a
person may be averred generally." Fed.R.Civ.P. 9(b).