The opinion of the court was delivered by: Rodriguez, Senior District Judge
This matter has come before the Court on Defendants' Motion to Dismiss the Complaint for failure to state a claim, pursuant to Fed. R. Civ. P. 12(b)(6). Because Plaintiffs' claims are not actionable under the federal securities laws, Defendants' motion will be granted.
This action arises from the sale of businesses and related equipment, and leases of property by Plaintiff Robyn Meredith, Inc. ("RMI") to DonnKenny Apparel, Inc. ("DKAI"). DKAI is not a party to this action, nor is DKAI's parent company, DonnKenny, Inc. ("DK"). Named as Defendants are Daniel H. Levy, former Chief Executive Officer of DK, and Maureen D. Schimmenti, former Chief Financial Officer, Vice President-Finance, Secretary, and Principal Financial and Accounting Officer of DK.
Plaintiffs allege that the Defendants fraudulently and negligently misrepresented facts concerning DK's financial condition to induce Plaintiffs to enter into long-term sales and employment contracts with DKAI in the Fall of 2003, and to accept DKAI securities. They allege that the Defendants intentionally ignored industry-accepted methods for valuing inventory in an effort to create the appearance of financial security on behalf of DKAI. In February 2005, no longer capable of meeting its financial obligations, DK filed for bankruptcy and, as a wholly-owned subsidiary of DK, DKAI entered into bankruptcy proceedings as well.
Prior to being de-listed as a result of the bankruptcy, DK had been a publicly traded company on the NASDAQ stock exchange. In the apparel wholesale business, DK financed several subsidiaries, including DKAI. In accordance with securities laws, DK filed quarterly and annual financial statements with the United States Securities and Exchange Commission ("SEC").
On October 1, 2003, RMI entered into an asset purchase agreement ("the Agreement") with DK, selling substantially all of its business to DK, through its subsidiary DKAI. The terms of the Agreement included the following:
(1) $3,404,363 cash consideration for assets of RMI;
(2) $1,200,000 in the form of a Note payable by DKAI over three years, also consideration for the assets of RMI;
(3) A three-year employment contract at DKAI for Plaintiff Alan Wallace, the former President and a principal shareholder of RMI, with a base salary of $300,000 per year;
(4) A three-year employment contract at DKAI for non-party Harris Snyder, a shareholder of RMI and partner of Plaintiff H&W Partnership, with a base salary of $225,000 per year;
(5) A three-year employment contract at DKAI for non-party Matthew Wallace, a shareholder of RMI, with a base salary of $275,000 per year.
(6) Assumption by DKAI of computer equipment and machinery leases to RMI, and an agreement that DKAI would lease real property from Plaintiff H&W Partnership for a three year period, at a rate of $113,850 per year.
Additionally, Defendant Levy, on behalf of DK, separately agreed that for $270,000 an affiliate of DK would assume all assets of Plaintiff Robyn Meredith (H.K.) Ltd. ("H.K."), a Hong Kong corporation established for facilitating apparel imports to the United States from China.
Before entering into the contracts described above, Plaintiff Alan Wallace allegedly performed due diligence on DKAI and DK. He reviewed DK's Form 10-K for the year 2002 and Forms 10-Q for the first two quarters of 2003. Each form had been filed with the SEC, and each was signed by both defendants, Daniel H. Levy and Maureen D. Schimmenti. Plaintiffs allege that Wallace relied on the representations in the Form 10-K and Forms 10-Q when he decided to enter into the Agreement. Further, Wallace relied upon Defendants' representation that DK practiced the "lower of cost or value" method of valuing inventory, which is customary in the apparel business and required by Generally Accepted Accounting Principles (GAAP). According to the Plaintiffs, clothing loses value at the end of each retail season. Thus, last season's clothing ordinarily must be liquidated at prices below cost. It follows that out of season inventory valued at cost would not provide an accurate assessment of a company's finances and worth. Further, the more out of season the apparel is, the higher the difference would be between the reported value at cost and the actual value. After observing substantial amounts of inventory in DK's warehouses, and after consulting his accountant, Wallace authorized Plaintiffs to enter into the Agreement.
After the Agreement closed on October 1, 2003, the principals of RMI, including Alan Wallace and Harris Snyder, joined DKAI as employees. Wallace and Snyder, in their duties as employees of DKAI, were asked to liquidate much of DKAI's inventory in 2004 and 2005. During that liquidation, Wallace allegedly discovered that substantially all of the back inventory consisted of previous seasons' fashions, but was valued on DK's books at cost, significantly above market value. Further, Wallace found that DKAI had no way to value existing inventory appropriately, but valued all inventory at cost. DKAI continued to liquidate inventory in the second half of 2004 to meet capital ...