1
EXHIBIT 99.3
UNITED STATES DISTRICT COURT
SOUTHERN DISTRICT OF TEXAS
HOUSTON DIVISION
)
)
IN RE SERVICE CORPORATION )
INTERNATIONAL ) CIVIL ACTION NO. H-99-0280
) (Judge Lynn N. Hughes)
)
)
DEFENDANTS' MOTION TO DISMISS THE
CONSOLIDATED CLASS ACTION COMPLAINT
J. Clifford Gunter III
Andrew M. Edison
Bracewell & Patterson, L.L.P.
South Tower Pennzoil Place
711 Louisiana, Suite 2900
Houston, Texas 77002-2781
Telephone: (713) 223-2900
Facsimile: (713) 221-1212
COUNSEL FOR DEFENDANTS
2
TABLE OF CONTENTS
PAGE
----
INTRODUCTION......................................................................................................1
NATURE AND STAGE OF PROCEEDINGS...................................................................................3
PLAINTIFFS' ALLEGATIONS...........................................................................................4
STATEMENT OF FACTS................................................................................................5
I. GENERAL BACKGROUND..............................................................................5
II. THE PRENEED FUNERAL BUSINESS....................................................................6
III. THE "PRENEED STUDY."............................................................................7
IV. ACQUISITION, EXPANSION AND MERGER...............................................................8
V. THE SCI-ECI MERGER CLOSES AND FOURTH QUARTER
EARNINGS ARE ANNOUNCED..........................................................................9
ARGUMENT AND AUTHORITIES.........................................................................................10
I. THE CONSOLIDATED CLASS ACTION COMPLAINT DOES
NOT STATE THE BASIS FOR PLAINTIFFS' INFORMATION
AND BELIEF.....................................................................................10
II. PLAINTIFFS FAIL TO PLEAD FRAUD WITH PARTICULARITY..............................................13
A. Plaintiffs Do Not Plead Specific Facts Showing That The
SCI Defendants' Statements Were False When Made.......................................13
B. Plaintiffs' References to the Preneed Study Are Insufficient to
Show That the SCI Defendants' Statements Were False
When Made.............................................................................17
C. Allegations Based on Internal Corporate Documents are
Insufficient to Satisfy the Reform Act................................................21
III. MANY OF THE ALLEGED MISSTATEMENTS ARE NOT
ACTIONABLE AS A MATTER OF LAW..................................................................23
-i-
3
PAGE
----
A. General Statements of Optimism Do Not Support a Fraud Claim...........................23
B. Statements of Historical Fact Do Not Support a Fraud Claim............................25
C. The SCI Defendants' Forward-Looking Statements are Protected
by The Safe Harbor....................................................................25
IV. PLAINTIFFS DO NOT ADEQUATELY ALLEGE SCIENTER...................................................26
A. Under the Reform Act, Plaintiffs Must Allege Specific
Facts Creating a Strong Inference of Scienter that the SCI
Defendants Acted Knowingly or Recklessly, Not Just That
They Had a Motive and Opportunity to Commit Fraud.....................................28
B. Plaintiffs' Allegations Do Not Support a Strong Inference
of Scienter...........................................................................32
1. Plaintiffs' Allegations that the SCI Defendants Made
Misstatements to Maintain SCI's Bond Rating Fails
to Create the Required Inference of Scienter.................................33
2. Plaintiffs' Allegation that the SCI Defendants Made
Misstatements to Facilitate Consummation of the
SCI-ECI Merger Fails to Create the Required Inference
of Scienter..................................................................34
3. The Individual Defendants' Lack of Trading in SCI Stock
Negates Any Inference of Scienter............................................35
CONCLUSION.......................................................................................................38
CERTIFICATE OF SERVICE...........................................................................................40
-ii-
4
TABLE OF AUTHORITIES
PAGE
----
CASES
Bryant v. Avado Brands, Inc., 1999 WL 688050 (11th Cir. 1999)....................................................31
Duncan v. Pencer, 1996 WL 19043 (S.D. N.Y. 1996).................................................................35
Ernst v. Hockfelder, 425 U.S. 185 (1976).........................................................................27
Ferber v. Travelers Corp., 785 F. Supp. 1101 (D. Conn. 1991).....................................................12
Friedberg v. Discreet Logic, Inc., 959 F. Supp. 42 (D.Mass. 1997)................................................30
Garcia v. United States, 469 U.S. 70 (1984).......................................................................1
Grossman v. Novell, Inc., 120 F.3d 1112 (10th Cir. 1997).........................................................24
Gulf Oil Corp. v. Copp Paving Co., 419 U.S. 186 (1974)...........................................................30
Haft v. Eastland Fin. Corp., 772 F. Supp. 1315 (D.R.I. 1991).....................................................12
Harris v. Ivax Corp., 998 F. Supp. 1449 (S.D. Fla. 1998),
aff'd, 182 F.3d 799 (11th Cir. 1999)...................................................................26
Hausberg v. Comp USA, Inc., 1995 U.S. Dist.
LEXIS 20333 (N.D. Tex. 1995).............................................................................2
Head v. NetManage, Inc., 1998 WL 917794 (N.D. Cal. 1998).........................................................36
In re 1993 Corning Sec. Litig., 1996 WL 257603 (S.D.N.Y. 1996)...................................................34
In re Advanta Corp. Sec. Litig., 1998 WL 387595 (E.D. Pa. 1998),
aff'd, 180 F.3d 525 (3d Cir. 1999)......................................................................21
In re Advanta Corp. Sec. Litig., 180 F.3d 525 (3d Cir. 1999).....................................................31
In re Burlington Coat Factory Sec. Litig., 114 F.3d 1410 (3d Cir. 1997)..........................................35
In re Caere Corp. Sec. Litig., 837 F. Supp. 1054 (N.D. Cal. 1993)................................................24
In re Cirrus Logic Sec. Litig., 946 F. Supp. 1446 (N.D. Cal. 1996)...............................................34
-iii-
5
In re Comshare Sec. Litig., 1997 WL 1091468 (E.D. Mich. 1997),
aff'd, 183 F.3d 542 (6th Cir. 1999).....................................................................37
In re Comshare Sec. Litig., 183 F.3d 542 (6th Cir. 1999).........................................................31
In re Convergent Techs, Sec, Litig., 948 F.2d 507 (9th Cir.1991).................................................25
In re Credit Acceptance Corporation Securities Litigation,
50 F. Supp.2d 662 (E.D. Mich. 1999).....................................................................37
In re Crown Am. Realty Trust Sec. Litig., 1997 WL 599299
(W.D. Pa. 1997).........................................................................................34
In re Cypress Semiconductor Sec. Litig., 891 F. Supp. 1369
(N.D. Cal. 1995)........................................................................................25
In re Gleaner Technologies, Inc. Sec. Litig., 1998 WL 915907
(S.D.N.Y. 1998).........................................................................................37
In re Glenfed, Inc. Sec. Litig., 42 F.3d 1541 (9th Cir. 1994)....................................................28
In re Health Mgmt. Sys. Sec. Litig., 1998 WL 283286 (S.D.N.Y. 1998)..........................................16, 37
In re Health Management, Inc. Sec. Litig., 970 F. Supp. 192
(E.D.N.Y.1997)..........................................................................................34
In re Mobile Telecommunication Techs. Corp. Sec. Litig.,
915 F. Supp. 828 (S.D. Miss. 1995)......................................................................24
In re Oak Tech. Sec. Litig., 1997 WL 448168 (N.D. Cal. 1997).................................................13, 15
In re Paracelsus Corp. Sec. Litig., 1998 WL 1108373
(S.D. Tex. 1998)....................................................................................29, 32
In re Silicon Graphics, Inc. Sec. Litig., 970 F. Supp. 746
(N.D. Cal. 1997) ...................................................................................10, 12
In re Silicon Graphics Sec. Litig., 183 F.3d 970 (9th Cir. 1999)......................3, 11, 22, 23, 29, 30, 31, 32
In re Stac Elecs. Sec. Litig., 89 F.3d 1399 (9th Cir. 1996),
cert. denied, 117 S.Ct. 1105 (1997)..................................................................5, 13
In re Stratosphere Corp. Sec. Litig., 1997 WL 581032 (D.Nev. 1997)...............................................13
-iv-
6
In re VeriFone Sec. Litig., 784 F. Supp. 1471 (N.D. Cal. 1992),
aff'd, 11 F.3d 865 (9th Cir. 1993).....................................................................24
In re Worlds of Wonder Sec. Litig., 35 F.3d 1407 (9th Cir. 1994),
cert. denied, 116 S.Ct. 185 (1995)...................................................................4, 38
INS v. Cardoza-Fonseca, 480 U.S. 421 (1987)......................................................................30
L.L. Capital Partners, L.P. v. Rockefeller Center Properties, Inc.,
939 F. Supp. 294 (S.D.N.Y. 1996).......................................................................33
Leonard v. Netframe Sys., Inc., 1995 WL 798923 (N.D. Cal. 1995)..................................................14
Leventhal v. Tow, 48 F. Supp. 2d 104 (D. Conn. 1999).........................................................34, 35
Lovelace v. Software Spectrum Inc., 78 F.3d 1015 (5th Cir. 1996)..............................................5, 28
Malin v. Ivax, 17 F. Supp.2d 1345 (S.D. Fla. 1998)...............................................................35
McNamara v. Bre-X Minerals Ltd., 1999 WL 507441
(E.D. Tex. 1999)........................................................................................14
Melder v. Morris, 27 F.3d 1097, 1100 (5th Cir. 1994).................................................13, 17, 29, 33
Northwest Forest Resource Council v. Glickman,
82 F.3d 825 (9th Cir. 1996)..............................................................................1
Novak v. Kasaks, 997 F. Supp. 425 (S.D.N.Y. 1998)............................................................12, 15
Press v. Chemical Investment Services Corp., 166 F.3d 529
(2d Cir. 1999)..........................................................................................31
Raab v. General Physics Corp., 4 F.3d 286 (4th Cir. 1993)........................................................24
Robertson v. Strassner, 32 F. Supp.2d 443 (S.D. Tex. 1998).......................................................32
Ronconi v. Larkin, 1998 WL 230987 (N.D. Cal. 1998)...........................................................16, 17
San Leandro Emergency Med. Group Profit Sharing Plan v. Philip
Morris Companies, 75 F.3d 801 (2d Cir. 1996)........................................................32, 33
Shields v. Citytrust Bancorp, Inc., 25 F.3d 1124 (2d Cir. 1994)..................................................28
Snowden v. Hughes, 321 U.S. 1 (1944).........................................................................20, 21
Tuchman v. DSC Communications Corp., 14 F.3d 1061 (5th Cir. 1994)................................................27
-v-
7
Wenger v. Lumisys, Inc., 2 F. Supp.2d 1231 (N.D. Cal. 1998)..............................................14, 22, 25
Williams v. WMX Techs., Inc., 112 F.3d 175 (5th Cir.),
cert. denied, 118 S.Ct. 412 (1997)......................................................................32
Zeid v. Kimberley, 930 F. Supp. 431 (N.D. Cal. 1996).........................................................14, 22
STATUTES/RULES
Fed. R. Civ. P. 9(b)...........................................................................1, 2, 12, 13, 28, 33
Fed. R. Evid. 201(b)..............................................................................................2
15 U.S.C. Section 78u-4(b)(1)................................................................................10, 11
15 U.S.C. Section 78u-4(b)(1)(B).................................................................................11
15 U.S.C. Section 78u-4(b)(2)....................................................................................29
15 U.S.C. Section 78u-4(b)(3)(A)..................................................................................2
15 U.S.C. Section 78u-5(c)(1)(A)(i)..............................................................................25
OTHER
H.R. Conf. Rep. No. 104-369, 104th Cong., 1st Sess. 31 (1995),
reprinted in 1995 U.S.C.C.A.N. 730........................................................1, 2, 28, 29, 30
H.R. Doc. No. 104-150 (1995).....................................................................................30
-vi-
8
UNITED STATES DISTRICT COURT
SOUTHERN DISTRICT OF TEXAS
HOUSTON DIVISION
)
)
IN RE SERVICE CORPORATION )
INTERNATIONAL ) CIVIL ACTION NO. H-99-0280
) (Judge Lynn N. Hughes)
)
)
DEFENDANTS' MOTION TO DISMISS THE
CONSOLIDATED CLASS ACTION COMPLAINT
Pursuant to Fed. R. Civ. P. 9(b), 12(b)(6) and the Private Securities
Litigation Reform Act of 1995, Defendants Service Corporation International
("SCI"), R. L. Waltrip, L. William Heiligbrodt and George R. Champagne
(collectively "the SCI Defendants")(1) file this Motion to Dismiss the
Consolidated Class Action Complaint.
INTRODUCTION
This securities fraud class action is governed by the Private
Securities Litigation Reform Act of 1995, Pub. L. No. 104-67 (the "Reform Act").
In enacting the Reform Act, Congress found "significant evidence of abuse in
private securities lawsuits." H.R. Conf. Rep. No. 104-369, 104th Cong., 1st
Sess. 31 (1995), reprinted in 1995 U.S.C.C.A.N. 730.(2) Specifically, Congress
noted that these abusive practices included "the routine filing of lawsuits
against issuers of securities and others whenever there is a significant change
in an issuer's stock price, without regard to any underlying
- --------
(1) Waltrip, Heiligbrodt and Champagne are referred to as the
"Individual Defendants."
(2) The Conference Report is the "authoritative source for finding the
Legislature's intent." Garcia v. United States, 469 U.S. 70, 76 (1984). See also
Northwest Forest Resource Council v. Glickman, 82 F.3d 825, 835 (9th Cir. 1996)
("[A] congressional conference report is recognized as the most reliable
evidence of congressional intent because 'it represents the final statement of
the terms agreed to by both houses'").
9
culpability of the issuer, and with only faint hope that the discovery process
might lead eventually to some plausible cause of action[.]" Id. Congress further
found that the standard for pleading fraud under Fed. R. Civ. P. 9(b) "has not
prevented abuse of the securities laws by private litigants." Id. at 41.
Among other things, the Reform Act requires plaintiffs to state with
particularity the facts -- not speculation -- that supports their belief that a
fraud really has taken place. Plaintiffs now must convince the court that they
have facts to support a fraud action, and not just a vivid imagination and hope
that the discovery process will be fruitful. Unlike a traditional Rule 12(b)(6)
motion, a motion to dismiss under the Reform Act does not permit a plaintiff to
rest on presumptions or require the Court to draw inferences in plaintiffs'
favor. The Reform Act authorizes courts to scrutinize complaints for the
requisite factual basis at the outset, and requires dismissal of cases that are
deficient. 15 U.S.C. Section 78u-4(b)(3)(A).
This securities fraud class action is exactly the type of case that
prompted Congress to reform the federal securities laws, for Plaintiffs have
brought this action solely on the basis that SCI experienced a significant drop
in its stock price during the Class Period, going from a closing price of 43-3/8
on July 17, 1998 to 19-1/2 on January 26, 1999.(3) Although Plaintiffs accuse
SCI and its three highest ranking officers of engaging in a fraud of the
greatest magnitude, there are no facts to substantiate this serious charge.
Reminiscent of pre-Reform Act pleadings, Plaintiffs simply recite a
litany of statements by the SCI Defendants covering all aspects of SCI's
business - including operating challenges,
- --------
(3) In rendering its decision on a motion to dismiss, the Court may
consider matters of public record involving historical stock prices. Fed. R.
Evid. 201(b); Hausberg v. Comp USA, Inc., 1995 U.S. Dist. LEXIS 20333, at *31
n.14 (N.D. Tex. 1995).
-2-
10
acquisitions and financial results. The Consolidated Class Action Complaint
("CCAC") then summarily concludes that these statements were false or misleading
when made because SCI did not disclose that its preneed funeral business was
causing a sharp erosion in its profit margins. This type of pleading simply does
not satisfy the Reform Act.
It is noteworthy that Plaintiffs conveniently forget to mention that
the Individual Defendants in this case -- the purported masterminds of this
fraud -- did not sell any shares of SCI stock during the Class Period. This
completely negates any inference of scienter.
The CCAC should be dismissed for the following reasons:
1. The CCAC does not satisfy the Reform Act requirement
that allegations made on "information and belief"
state with particularity the facts on which the
belief is formed;
2. The CCAC does not allege, with the particularity
required by the Reform Act, that the SCI Defendants'
statements concerning SCI's preneed funeral business
were false when made;
3. The statements alleged to be false or misleading were
in fact innocuous, non-actionable statements of
general optimism or historical fact. Courts have long
held that such statements cannot serve as the basis
for a securities claim; and
4. The CCAC fails to allege with particularity facts
giving rise to a strong inference that the SCI
Defendants acted with, at a minimum, deliberate
recklessness. See In re Silicon Graphics Sec. Litig.,
183 F.3d 970 (9th Cir. 1999) (Silicon Graphics II).
Far from meeting that standard, the CCAC even fails
to meet lower scienter standards applied by other
courts interpreting the Reform Act.
NATURE AND STAGE OF PROCEEDINGS
In January and February 1999, more than 20 virtually identical class
action lawsuits were filed in the Southern District of Texas against SCI and
certain of its present and former officers and directors. Two class action
lawsuits were brought in the Eastern District of Texas and transferred
-3-
11
to the Southern District of Texas. All of these actions have been consolidated
before this Court under Cause No. H-99-0280; In Re Service Corporation
International.
On June 9, 1999, this Court appointed Rujira Srisythep, Carl Helwig and
Allan Lisse to serve as Lead Plaintiffs. This Court also appointed Roger
Greenberg to serve as Lead Plaintiffs' Counsel. On August 25, 1999, this Court
certified the Lead Plaintiffs as class representatives. The Class Period is from
July 17, 1998 to January 26, 1999.
On September 3,1999, Plaintiffs filed the CCAC, alleging claims against
the SCI Defendants under Sections 11, 12(a)(2), and 15 of the Securities Act of
1933, Sections 10(b), 20(a) and 20A of the Securities Exchange Act of 1934, and
Rule 10b-5 promulgated by the Securities and Exchange Commission ("SEC").(4)
PLAINTIFFS' ALLEGATIONS
The allegations contained in the CCAC focus entirely on SCI's preneed
funeral business. According to Plaintiffs, the SCI Defendants were aware that
SCI's preneed funeral business was unprofitable but failed to disclose that
information to the public. This elaborate ruse is alleged to have been
perpetrated so that SCI could inflate its stock price in order to maintain high
credit ratings on debt securities and obtain favorable terms in connection with
a stock-for-stock transaction.
- --------
(4) There can be no violation of Section 15 of the Securities Act of
1933 and Section 20(a) of the Securities Exchange Act of 1934 without a primary
violation. See In re Worlds of Wonder Sec. Litig., 35 F.3d 1407, 1428 n.9 (9th
Cir. 1994), cert. denied, 116 S.Ct. 185 (1995). Because Plaintiffs have not
stated a claim under Section 10(b) or Rule 10b-5, they have no claim under
Sections 20(a) and 20A. Similarly, because Plaintiffs have not stated a claim
under Sections 11 or 12(a)(2), they have no claim under Section 15 either.
-4-
12
STATEMENT OF FACTS
I. GENERAL BACKGROUND.
SCI is a Texas corporation founded in 1962 by R.L. Waltrip. From a
single funeral home in the Heights, SCI has grown into the largest provider of
death care services and products in the world. See CCAC at Paragraph 19. As of
December 31, 1998, SCI and its subsidiary and affiliate companies operated 3,442
funeral service locations, 433 cemeteries and 191 crematoria located in 20
countries on five continents. Id. SCI performs approximately 11 percent of the
funeral services in North America, 28 percent of the funeral services in France,
14 percent of the funeral services in the United Kingdom and 25 percent of the
funeral services in Australia. See SCI's Form 10-K for the Fiscal Year ended
December 31, 1998, attached as Exhibit A, at p. 2.(5) SCI's common stock is
listed on the New York Stock Exchange.
Historically, SCI's growth has been largely attributable to
acquisitions.(6) During the 1990s alone, SCI added more than 2,800 funeral homes
worldwide. See CCAC at Paragraph 20.
During the Class Period, Waltrip served as SCI's Chief Executive
Officer, Heiligbrodt served as SCI's Chief Operating Officer and Champagne
served as SCI's Chief Financial Officer. Id. at Paragraphs 7-9.
- --------
(5) All exhibits attached to this Motion to Dismiss are referenced in
the CCAC or are public documents filed with the SEC. It is well-settled that the
Court may take judicial notice on a motion to dismiss of those documents which
are referenced in the Complaint or are public documents filed with the SEC. See
In re Stac Elecs. Sec. Litig., 89 F.3d 1399, 1405 n.4 (9th Cir. 1996), cert.
denied, 117 S. Ct. 1105 (1997); Lovelace v. Software Spectrum Inc., 78 F.3d
1015, 1018 (5th Cir. 1996).
(6) SCI revolutionized the funeral industry through its innovative
"clustering" concept. SCI believed that by sharing facilities, vehicles,
equipment and personnel, several funeral homes within a given area or "cluster"
could operate more efficiently and lower combined overhead costs, thus achieving
economies of scale unavailable to them as independent operators. See CCAC at
Paragraph 17.
-5-
13
II. THE PRENEED FUNERAL BUSINESS.
Preneed funeral contracts are arrangements where individuals select and
purchase their funeral arrangements prior to their death, and funeral homes
agree to perform the funeral services in the future. Id. at Paragraph 22. For
SCI, preneed funeral contracts provide an opportunity to protect current market
share and lock-in future market share. Id. at Paragraph 126 ("only 30 percent of
the people who buy preneed through an SCI facility would be an SCI at need
customer"). For consumers, by planning ahead, they avoid forcing family and
friends from having to make costly and difficult funeral decisions during a
period of peak emotional strain.
SCI's SEC filings fully disclose how its preneed funeral business
operates:
SCI sells price guaranteed prearranged funeral contracts
through various programs providing for future funeral services
at prices prevailing when the agreements are signed. Payments
under these contracts are placed in trust accounts (pursuant
to applicable law) or are used to pay premiums on life
insurance policies. Earnings on trust funds and increasing
benefits under insurance funded contracts also increase the
amount of cash to be received upon performance of the funeral.
See SCI's Form 10-K for the Fiscal Year Ended December 31, 1997, attached as
Exhibit B, at p. 16.(7) As SCI purchased additional funeral homes, it acquired
both the obligation to perform preneed funerals and the mortuary trust assets
that eventually are used to pay for the preneed funerals. See CCAC at Paragraph
22.
- --------
(7) SCI's SEC filings also note the accounting treatment given to
prearranged funerals:
Amounts paid by a customer under a prearranged funeral
contract are recognized in funeral revenue at the time the
funeral service is performed. Trust earnings and increasing
insurance benefits are accrued and deferred until the services
are performed, at which times these funds are also recognized
in funeral revenues....
See Exhibit A at p.36.
-6-
14
SCI's trust funds are invested to "cover future increases in the cost
of providing a price guaranteed funeral service." See Exhibit A at p.18. Recent
years have seen SCI's trust funds perform very well. In fact, SCI's "North
American prearranged trust portfolio earned a return of 18.0% in 1998 and 12.5%
in 1997 (including realized gains)." Id. As of December 31, 1998, the total
value of unperformed prearranged funeral contracts expected to be recognized by
SCI in future periods was $3.75 billion (up from $3.37 billion as of December
31, 1997).(8) Id.
III. THE "PRENEED STUDY."
To determine how to optimize the performance of trust investments, SCI
undertook during 1996 and 1997 a "review of the prearranged trust investment
process which included an asset/liability study." See Exhibit B at p.16. The
CCAC refers to this review as the "Preneed Study." (9) See CCAC at Paragraph 32.
At the time the Preneed Study was initiated, SCI invested its funeral
trust funds approximately 21 percent in equity and 79 percent in fixed income.
See Exhibit C-1 at SCI0009. The Preneed Study looked at five different asset
allocation mixes available to SCI (including the 21 percent equity/79 percent
fixed income asset allocation mix in effect at the time), and found that SCI
could increase the trust rate of return through adoption of a new asset
allocation mix. See Exhibit C-4 at SCI0062-63. In light of this conclusion, SCI,
during 1997, reallocated its trust portfolio to
- --------
(8) The total value of unperformed prearranged funeral contracts are
trust funded or insurance funded and represent the original contract price plus
accumulated trust earnings or increasing insurance benefits. See Exhibit A at
p.36.
(9) True and correct copies of the various documents comprising the
Preneed Study are attached as Exhibits C-1 to C-7. The Preneed Study is
authenticated by the Declaration of Mary Beth Russo, attached as Exhibit C. The
"asset/liability" study referred to in SCI's Form 10-K is part of the Preneed
Study and is attached as Exhibit C-1. For simplicity sake, all pages of the
Preneed Study have been stamped with a "SCI" bates-stamp.
-7-
15
achieve a "new asset allocation of approximately 65 percent equity and 35
percent fixed income." See Exhibit B at p.16. SCI also implemented "a new
investment program which entail[ed] the consolidation of multiple trustees, the
use of institutional managers with differing investment styles and consolidated
performance monitoring and tracking." Id.
The Preneed Study was fully disclosed in SCI's numerous SEC filings.
See, e.g., Exhibit B at pp. 16-17; SCI's Form 10-K for the Fiscal Year Ended
December 31, 1996, attached as Exhibit D, at p. 17.
IV. ACQUISITION, EXPANSION AND MERGER.
The summer of 1998 was a busy time for SCI. On July 17, 1998, SCI
announced that it had acquired American Memorial Life Insurance Company, the
preneed funeral services division of American Annuity Group, Inc. See CCAC at
Paragraph 73. Also on July 17, 1998, SCI announced that it had formed a new
financial services subsidiary, SCI Financial Services, Inc., to facilitate the
expansion of SCI's preneed businesses and financial activities worldwide. Id. A
week later, SCI announced its second quarter revenues and earnings. Id. at
Paragraph 78. For the three months ended June 30, 1998, SCI reported revenues of
$671.9 million, net income of $90.9 million and diluted earnings per share of
$.35. Id.
On August 6, 1998, SCI announced that it had reached a definitive
agreement with Equity Corporation International ("ECI"), the nation's fourth
largest publicly traded death care company, to acquire ECI in a merger
transaction. Id. at Paragraph 80. In an interesting twist to the merger,
urban-oriented SCI and rural-oriented ECI were part of the same company until
1990 when ECI was spun off and relocated its headquarters to Lufkin, Texas. Id.
-8-
16
On October 22, 1998, SCI announced its third quarter revenues. Id. at
Paragraph 94. For the three months ended September 30, 1998, SCI reported
revenues of $712.5 million, net income of $83.2 million and earnings per share
of $.32. Id. These results were significantly higher as compared to the same
period for the year before. Id.
V. THE SCI-ECI MERGER CLOSES AND FOURTH QUARTER EARNINGS ARE ANNOUNCED.
The SCI-ECI merger closed on January 19, 1999 with ECI shareholders
receiving .71053 of a share of SCI common stock for each share of ECI common
stock. Id. at Paragraph 69.
On January 26, 1999, SCI issued a press release, announcing that it
expected diluted earnings per share for the fourth quarter of 1998 would be
lower than analysts' expectations (10) See Exhibit E. For the three months ended
December 31, 1998, SCI said it expected diluted earnings per share in the range
of $.22-$.24 as compared to the First Call earnings estimate of $0.42 per share
(11) Id. The stock market reacted swiftly to the news. SCI's stock price dropped
from 34 7/16 to 19 1/2, a
- --------
(10) SCI explained in a press release the reasons for the lower than
expected earnings included:
o Reduced mortality rates in the Company's major
markets resulting in fewer funerals performed at the
Company's locations.
o Cemetery revenues below anticipated levels.
o Increased operating costs and field overhead expenses
associated with necessary investment in newly
acquired operations, information technology systems
and training programs.
o Fewer acquisitions during the quarter than were
previously expected due to higher than anticipated
acquisition pricing.
o Disappointing results from selected foreign
operations.
See Exhibit E.
(11) While SCI did not meet analyst's expectations, it should be noted
that, for the year ended December 31, 1998, SCI still earned $1.31 a share on
net income of $342.1 million. See Exhibit A at p.7.
-9-
17
single day loss of almost 44 percent. See CCAC at Paragraph 124. Today, SCI's
common stock trades at around $8.(12)
ARGUMENT AND AUTHORITIES
I. THE CONSOLIDATED CLASS ACTION COMPLAINT DOES NOT STATE THE BASIS FOR
PLAINTIFFS' INFORMATION AND BELIEF
The Reform Act adopted several procedural requirements designed to weed
out non-meritorious cases at the pleading stage. It forbids conclusory or
generalized allegations of fraud, and commands that a complaint "shall specify
each statement alleged to have been misleading, the reason or reasons why the
statement is misleading, and, if an allegation regarding the statement or
omission is made on information and belief, the complaint shall state with
particularity all facts on which that belief is formed." 15 U.S.C. Section
78u-4(b)(1) (emphasis added). A complaint that does not meet these criteria
"shall" be terminated at the pleading stage. 15 U.S.C. Section 78u-4(b)(3)(A)
(emphasis added).
The Reform Act's information and belief provision is a significant new
requirement. In this case, Plaintiffs do not profess to have personal knowledge
of their allegations; hence, they are pleading on information and belief. See In
re Silicon Graphics, Inc. Sec. Litig., 970 F. Supp. 746, 763 (N.D. Cal. 1997)
(Silicon Graphics I) (noting that a complaint based on "investigation of
counsel" is the same as a complaint based upon "information and belief"), aff'd,
In re Silicon Graphics, Inc.
- --------
(12) SCI is not the only company in the death care industry to see its
stock tumble in the last year. Operating challenges have severely impacted the
funeral industry as a whole. Loewen Group (NYSE: LWN), the nation's second
largest death care firm, is now mired in Chapter 11 bankruptcy proceedings. Its
stock is currently trading at around 1/2 (52 week high: 15-3/8). Another major
force in the industry, Stewart Enterprises, Inc., (NASDAQ: STEI) recently warned
of lower than expected earnings for the rest of this year and its stock dropped
as well. It is currently trading at around 5-1/32 (52 week high: 24-3/4).
-10-
18
Graphics, Inc. Sec. Litig., 183 F.3d 970 (9th Cir. 1999). Plaintiffs must
therefore "state with particularity all facts" that support their belief that
the SCI Defendants committed fraud. See 15 U.S.C. Section 78u-4(b)(1).
The only attempt to comply with the Reform Act -- other than
Plaintiffs' specious reference to the Preneed Study, discussed more fully below
- -- is a boilerplate paragraph entitled "Plaintiff's [sic] Investigation," which
alleges:
Plaintiff's [sic] allegations set forth herein are based on a
thorough investigation conducted by and through their
attorneys. Such investigation included a review and analysis
of:
a. SCI's filings with the SEC both prior to and
throughout the Class Period;
b. the Company's Annual Reports to shareholders both
prior to and during the Class Period;
c. the Company's press releases and other publicly
disseminated statements made by defendants prior to,
during, and following the Class Period;
d. reports, articles, and other written materials
concerning the Company and the subject matter of this
complaint;
e. analyst reports and investor advisory service
reports; and
f. consultations with forensic accountants, former
company employees and other individuals knowledgeable
about the Company's business, operations and
services.
See CCAC at Paragraph 128.
Courts applying the Reform Act have held repeatedly that this type of
conclusory pleading does not comply with the statutory requirement to "state
with particularity all facts" that form plaintiffs' belief that the defendants
committed fraud. See 15 U.S.C. Section 78u-4(b)(1)(B). Indeed, complaints with
virtually identical "Basis of Allegations" paragraphs have been routinely
dismissed. See, e.g., Silicon Graphics II, 183 F.3d 985 (rejecting a rote basis
of allegations paragraph, stating that "a plaintiff must provide, in great
detail, all the relevant facts forming the basis of her belief");
-11-
19
Novak v. Kasaks, 997 F. Supp. 425, 431 (S.D.N.Y. 1998) (virtually identical
"Basis of Allegations" paragraph coupled with allegations of negative internal
reports insufficient).
Plaintiffs' assertion that their allegations are based in part on
unspecified "consultations with forensic accountants, former company employees
and other individuals knowledgeable about the Company's business, operations and
services" (CCAC at Paragraph 128) is especially flawed. "If, in fact, these
unnamed 'consultants' provided information forming the basis for these
allegations, then the consultants should have been named in the complaint."
Novak, 997 F. Supp. at 431 (dismissing complaint); see also Silicon Graphics I,
970 F. Supp. at 763 (Reform Act legislative history suggests plaintiffs must
identify "confidential informants, employees, competitors, Government employees,
members of the media, and others who have provided information leading to the
filing of the case"). Plaintiffs do not identify any single discussion with
anyone upon which they formed their supposed "belief." There are no facts in the
CCAC that would suggest that Plaintiffs' allegations are derived from anything
more than their counsel's surmise and speculation.(13)
- --------
(13) Plaintiffs cite an August 12, 1999 article from The Death Care
Business Advisor that does not even purport to quote SCI executives. Under the
Reform Act, such an article does not support a claim for fraud. Ferber v.
Travelers Corp., 785 F. Supp. 1101, 1108 (D. Conn. 1991) ("The strictures of
Rule 9(b) are not satisfied by indirect quotes taken from a newspaper reporter's
notebook"); Haft v. Eastland Fin. Corp., 772 F. Supp. 1315, 1319 (D.R.I. 1991)
(news article "fail[ed] to provide the underlying factual support required by
Rule 9(b)" because "[i]t is not a direct quote from the defendants, it is merely
an analysts' opinion ").
-12-
20
II. PLAINTIFFS FAIL TO PLEAD FRAUD WITH PARTICULARITY
A. PLAINTIFFS DO NOT PLEAD SPECIFIC FACTS SHOWING THAT THE SCI
DEFENDANTS' STATEMENTS WERE FALSE WHEN MADE.
Despite its length and complexity, the CCAC does not satisfy the Reform
Act's rigorous pleading standard.(14) The CCAC contains no facts detailing when,
where, and how the SCI Defendants knew the challenged statements were false when
made (15) "Apparently, plaintiffs believe that the sheer volume of their
allegations gives credibility to their claims." In re Oak Tech. Sec. Litig.,
1997 WL 448168, at *4 (N.D. Cal. 1997).
Plaintiffs' allegations are based on the conclusory assumption that at
the time statements were made concerning SCI's financial condition and preneed
funeral business, the opposite of what was said was true. This type of
conclusory, fraud-by-hindsight pleading was routinely rejected even under the
less rigorous pre-Reform Act pleading standard:
Plaintiff's conclusory attempt to plead as "facts" the
converse of the positive statements made by defendants does
not satisfy [the] requirement that a plaintiff identify
particular facts indicating the falsity of defendants'
statements. Essentially, plaintiff points to a positive
statement by defendants,
- --------
(14) As an aside, the CCAC also does not satisfy the requirements of
Fed. R. Civ. P. 9(b). See Melder v. Morris, 27 F.3d 1097 (5th Cir. 1994).
(15) These standards apply equally to securities fraud claims brought
under Sections 10(b) and 20A of the 1934 Act and Sections 11 and 12(2) of the
1933 Act where, as here, the gravamen of each claim is fraud. See, e.g., In re
Stac Elecs. Sec. Litig., 89 F.3d at 1404-05 (holding that "the particularity
requirements of Rule 9(b) apply to claims brought under Section 11 when, as
here, they are grounded in fraud"); Melder, 27 F.3d at 1100 n.6 (holding that
Rule 9(b) applies to 1933 Act claims when they are grounded in fraud rather than
negligence, and applying the rule to Section 11 and 12(2) claims). Here,
Plaintiffs' Section 11 and 12(2) claims sound in fraud. Plaintiffs' effort to
distinguish between negligence and fraud are not successful because Plaintiffs'
Section 11 and 12(2) claims are based on the same predicate facts. See In re
Stratosphere Corp. Sec. Litig., 1997 WL 581032 at *7-8 (D.Nev. 1997) (holding
that "[p]laintiffs cannot avoid the more stringent requirements of Rule 9(b) by
merely inserting boilerplate language into their Complaint stating that claims
are based in negligence, not fraud, or try to plead both fraud and negligence by
stating Defendants 'knew or should have known' of the alleged falsity").
-13-
21
such as, "We are very pleased with growth through the second
quarter and look forward to the opportunities and challenges
ahead," and, in a conclusory manner, states the opposite, such
as "the Company expected a material decline in its
profitability." These are not specific "facts" indicating that
the first statement was false; these are simply allegations
that the opposite was true without any supporting facts or
circumstances. Plaintiff does not specify dates, places,
amounts, transactions, etc. Plaintiff does not point to any
inconsistent contemporaneous statements or information (such
as internal reports) which were made by or available to
defendants at the time of the positive statements which would
suggest that the positive statements were false or misleading.
. . . Because of this, plaintiff's allegations must be
dismissed.
Leonard v. Netframe Sys., Inc., 1995 WL 798923, at *6 (N.D. Cal. 1995)
(citations omitted).
Not surprisingly,"post-Reform Act cases have emphasized [that] without
references to specific facts demonstrating that the statements at issue were
false or misleading when made, allegations regarding adverse information
supposedly known to defendants are merely 'speculation and conclusions drawn
from hindsight.'" Wenger v. Lumisys, Inc., 2 F. Supp.2d 1231, 1250 (N.D. Cal.
1998) (citation omitted). See also Zeid v. Kimberley, 930 F. Supp. 431, 436
(N.D. Cal. 1996) (conclusory allegations insufficient to support securities
fraud claim where complaint did not plead contemporaneous facts tending to show
that the allegedly misleading statements were false when made); In re Oak Tech
Sec. Litig., 1997 WL 448168, at *5 (insufficient for plaintiffs to merely allege
that defendants made certain representations even though they were aware of
contrary adverse information; plaintiffs must provide supporting contemporaneous
factual allegations, including allegations of when defendants learned of adverse
information); McNamara v. Bre-X Minerals Ltd., 1999 WL 507441, at *20 (E.D. Tex.
1999) (same).
Here, Plaintiffs allege that the SCI Defendants "knew" that the
independent funeral homes acquired by SCI had failed to actively manage their
funeral trust assets (CCAC at Paragraph 44); "knew" that SCI had failed to
actively invest its existing mortuary trust assets (Paragraph 74); "knew" that
funeral trust
-14-
22
funds were inadequately funded to cover the cost of providing a funeral
(Paragraph 91); and "knew" that SCI's preneed funeral business was a drain on
SCI's profitability. (Paragraphs 12, 44).
These conclusory allegations are not sufficient to meet Plaintiffs'
pleading burden. The CCAC does not plead what specific information the SCI
Defendants knew, how they knew it, and why it rendered their statements false.
Plaintiffs have failed to point to particular contemporaneous, inconsistent
statements by the SCI Defendants or to show specific information available to
the SCI Defendants revealed something different than what the SCI Defendants
stated or failed to state. Conclusory pleadings that "'adverse material facts
were in existence or known by Defendants at the time the allegedly misleading
statements were made" are not enough. In re Oak Tech. Sec. Litig., 1997 WL
448168, at *4.
In Novak, 997 F. Supp. 425, the court dismissed plaintiffs' securities
fraud action for failing to plead "facts underlying the complaint's allegations
as to the information that was available to the individual defendants" or to
"direct the Court to where those facts might be found." Id. at 431. Plaintiffs'
allegations here, like those in the Novak case, are based on unnamed consultants
and other unspecified sources, and do not identify any basis for concluding that
any SCI Defendant knew of any adverse fact concerning SCI's preneed funeral
business.
Throughout the CCAC's 77 pages, Plaintiffs point to a number of
statements made by the SCI Defendants and claim, without providing any factual
support, that the opposite of what the SCI Defendants said was true. For
example:
o SCI said in public filings that preneed funeral
contracts are sold at prices prevailing when the
agreements are signed. See CCAC at Paragraph 88.
o Plaintiffs claim this is not true.
Id. at Paragraph 89.
-15-
23
o SCI said that its financial services subsidiary would
coordinate the investment of all funeral trust
assets. Id. at Paragraph 73.
o Plaintiffs blithely assert this is
not true. Id. at Paragraph 74.
o SCI coordinated investments of all of the company's
funeral trust funds. Id. at Paragraph 94.
o Plaintiffs claim this is not the
case. Id. at Paragraph 95.
o SCI said that the operational systems of SCI and ECI
were similar. Id. at Paragraph 82.
o Plaintiffs claim this is not true.
Id. at Paragraph 83.
o SCI said in 1997 that it had implemented a new
investment program for its funeral trust funds
targeting "a real return in excess of the amount
necessary to cover future increases in the cost of
providing a price guaranteed funeral." Id. at
Paragraph 90.
o Plaintiffs allege this is not true.
Id. at Paragraph 91.
o SCI said it had purchased American Memorial Life
Insurance Company to facilitate the expansion of SCI
pre-need business and financial activities worldwide.
Id. at Paragraph 92.
o Plaintiffs say this is not true.
Id. at Paragraph 93.
"[T]he conclusory allegation that the opposite of a statement in a press release
is true, without further factual elaboration, is insufficient." In re Health
Mgmt. Sys. Sec. Litig., 1998 WL 283286, at * 6 (S.D.N.Y. 1998). Without specific
factual detail, this type of pleading certainly does not satisfy the Reform Act.
Ronconi v. Larkin, 1998 WL 230987 (N.D. Cal. 1998) is directly on
point. In that case, the court dismissed a securities fraud claim based upon
purported misstatements made in connection with an announced merger. In an
observation applicable to this case, the court noted that "plaintiffs'
allegations of falsity really amount to the following: defendants said X. X was
false. X was false
-16-
24
because the opposite of X was true. Or X was false because X did not later come
true." Id. at *4. The court continued: "While such a syllogism might be a
sufficient statement of falsity in ordinary expression, it is not adequate under
the standards of law for pleading violations of the Securities Exchange Act of
1934." Id. The same is the case here. Plaintiffs' failure to allege a factual
basis for their claims requires a dismissal. This is not a technical defect.
This issue prompted securities litigation reform legislation: plaintiffs are no
longer allowed to base their claims on guesswork, with the "faint hope" that
discovery might prove the guess correct.
B. PLAINTIFFS' REFERENCES TO THE PRENEED STUDY ARE INSUFFICIENT
TO SHOW THAT THE SCI DEFENDANTS' STATEMENTS WERE FALSE WHEN
MADE.
Plaintiffs attempt to satisfy the Reform Act's strict pleading
requirements by alleging that the SCI Defendants were aware through the Preneed
Study that SCI's preneed funeral business was unprofitable. Specifically,
Plaintiffs claim that the Preneed Study confirmed that:
o a "significant number of independent funeral homes
acquired by SCI had failed to actively manage their
mortuary trust assets and, as a result, a material
number of SCI's funeral services had been and would
continue to be, performed at significant losses to
SCI, severely cutting into SCI's profit margins."
CCAC at Paragraph 44. See also CCAC at Paragraphs 32,
35, 74(a); and
o "SCI's trust funds had not been managed to grow at a
rate equal to or greater than the increase in the
cost of funeral services." CCAC at Paragraph 53
(emphasis included in original).
The problem with Plaintiffs' reliance on the Preneed Study is twofold. FIRST,
THE STATEMENTS IN THE CCAC ABOUT THE ALLEGED CONTENTS OF THE PRENEED STUDY ARE
OUTRIGHT FALSEHOODS.(16) The Preneed
- --------
(16) As in Melder, 27 F.3d at 1101 fn. 8, "if plaintiffs' counsel had
been bound under the same strictures concerning veracity as were the
[defendants] under governing securities law standards, their complaint would
have to be labeled misleading."
-17-
25
Study simply does not in any respect say what Plaintiffs claim it says. By way
of example, a thorough review of the Preneed Study will not find one sentence,
chart or graph supporting Plaintiffs' baseless accusations that a "significant
number of independent funeral homes acquired by SCI had failed to actively
manage their mortuary trust assets" or that "SCI's trust funds had not been
managed to grow at a rate equal to or greater than the increase in the cost of
funeral services."
SECOND, THE PRENEED STUDY ACTUALLY REBUTS EACH OF PLAINTIFFS'
UNSUBSTANTIATED ALLEGATIONS, COMPLETELY UNDERMINING THE CREDIBILITY OF THE
CLAIMS RAISED IN THE CCAC. For example, contrary to Plaintiffs' bald assertion
that the Preneed Study demonstrates that "SCI's trust funds had not been managed
to grow at a rate equal to or greater than the increase in the cost of funeral
services" (CCAC at Paragraph 53), the Preneed Study shows that SCI's return on
mortuary trust assets has considerably outpaced inflation. The Preneed Study
indicated that the "current actual" return of SCI's mortuary trust assets was 2
percent over inflation. See Exhibit C-4 at SCI0064. The Preneed Study also
estimated that a 65 percent equity/35 percent fixed income asset allocation mix
would, on an annual basis, return more than five percent over inflation.(17) Id.
In 1997, SCI selected the 65 percent equity/35 percent fixed income asset
allocation. The fully disclosed results have been even better than expected, as
SCI's "North American prearranged trust portfolio earned a return of 18.0% in
1998 and 12.5 % in 1997 (including realized gains)." See Exhibit A at p.18.
Far from showing that "a material number of SCI's funeral services had
been and would continue to be, performed at significant losses," the Preneed
Study actually demonstrates that the preneed funeral business is profitable.
Indeed, the asset/liability study (which was part of the
- --------
(17) The 65 percent equity/35 percent fixed income asset allocation mix
was mix #2 in the asset/liability study. See Exhibit C-1 at SCI0009.
-18-
26
Preneed Study) conducted by Coopers & Lybrand, L.L.P. looked at three states -
Florida, Texas and California -- and established that the preneed funeral
contracts in those states alone had a present value of more than $210 million in
company net income. See Exhibit C-1 at SCI0020. The Preneed Study also found
that "The Five Asset Allocation Mixes Reviewed All Resulted in Significant Net
Cash Flow to SCI" and "Given Any Reasonable Time Frame (Longer than One Year),
The More Aggressive Asset Mixes Provide Great Upside Potential With No
Measurable Downside." See Exhibit C-4 at SCI0063.
The notion that the Preneed Study "confirmed" the unprofitability of
SCI's preneed funeral business is belied by the clear and unequivocal charts and
graphs of the Preneed Financing Option Report, which was also prepared by
Coopers & Lybrand, L.L.P. and is part of the Preneed Study. See Exhibit C-3.
This Report looked at the various opportunities available to fund preneed
funerals such as trust funds, insurance and bonding. Id. This model forecasted
cash flows forward for 40 years and discounted them back to the present using
present value techniques. Id. At-need funerals were forecast in the same way in
this model as a comparison point. Id. The states of Florida, Texas, California
and Missouri were modeled. Id. In all four states, profits generated by preneed
contracts were more profitable than the at-need contracts, even using very
conservative inflation assumptions. Id. at SCI0040, SCI0051, SCI0054,
SCI0056-57.
Not surprisingly, the Preneed Study also demonstrates that many of the
other allegations raised by Plaintiffs regarding SCI's preneed funeral business
are without any merit whatsoever. For example:
o While Plaintiffs claim that "the vast majority of the
preneed assets that SCI had previously acquired in
connection with its purchase of independent funeral
homes were not, and would not be, invested in
accordance with the terms of the "new investment
program" (CCAC
-19-
27
at Paragraph 36, 44, 45), the Preneed Study
demonstrates this is not the case. The truth is that
the "new investment program" included all North
American funeral trust assets, whether acquired in a
purchase or not. SCI had established procedures in
place to quickly move the trust funds it acquired to
SCI's preferred trustees for investment in accordance
with the new asset allocation mix. See Exhibit C-7
(When SCI acquires a funeral home, it takes steps to
"amend the trust agreement or to have the trust adopt
the master agreement for that state, assignment of an
account number, verification of assets, and
transferring of the trust to a new trustee"); Id.
("Once the [trust] assets are moved to the new
trustee...the Corporate Investment Department will
forward a package reflecting the asset allocation
that is designated for the trust funds they hold").
(18)
o While Plaintiffs claim that SCI did not have any
program to manage the assets associated with preneed
funeral trusts prior to the creation of SCI Financial
Services, Inc. in 1998 (See CCAC at Paragraph 95),
the Preneed Study shows this is not the case. The
Preneed Study expressly states that "[a]lthough SCI
previously had an overall asset allocation policy for
these trusts, the new allocation has been developed
based upon on [sic] a more scientific, analytical
approach, focused on meeting SCI's financial
objectives." See Exhibit C-5 at SCI0070 (emphasis
added).
o While Plaintiffs claim that SCI's "backlog of
prearranged funeral contracts included a material
number of contracts that were not sold at prices
prevailing when the agreements were signed" (CCAC at
P. 89), the Preneed Study establishes the falsity of
Plaintiffs' claim. See Exhibit C-5 at SCI0068 ("At
the time the [preneed] contract is signed, the
contract's goods and services are priced at the
current retail price").
o While Plaintiffs claim that SCI failed to disclose
during the Class Period that it had not
"establish[ed] any means of actively managing the
mortuary trust assets that would eventually be used
to pay for these acquired preneed funeral contracts"
(CCAC at Paragraph 30), this is
- --------
(18) SCI's Form 10-Ks further demonstrate that SCI moved a considerable
amount of the trust assets it acquired to its new investment program. In 1996,
the year before SCI's new investment program went into effect, $276 million (or
31.8 percent) of the $866 million in funeral trust assets were in cash
equivalents. By the end of 1997, after a year of SCI's new investment program,
only $134 million (or 12.6 percent) of the $1.070 billion in funeral trust
assets were in cash equivalents. See Exhibit B at p. 30.
-20-
28
simply not true. As noted above, in 1997 SCI
implemented a "new investment program which entailed
the consolidation of multiple trustees, the use of
institutional managers with differing investment
styles and consolidated performance monitoring and
tracking." See Exhibit B at p. 16. The Preneed Study
details the components of this "new investment
program" in great detail. See Exhibit C-5 at
SCI0066-71.
A district court's central task in evaluating a motion to dismiss is to
determine whether the complaint alleges facts sufficient to state a cause of
action. In conducting that inquiry, the court need not accept a complaint's
"bald assertions" or "unsupportable conclusions." See Snowden v. Hughes, 321
U.S. 1, 10 (1944). In this case, the Preneed Study speaks for itself. Plaintiffs
should not be permitted to base a complaint solely on disingenuous and false
references to the Preneed Study.
C. ALLEGATIONS BASED ON INTERNAL CORPORATE DOCUMENTS ARE
INSUFFICIENT TO SATISFY THE REFORM ACT.
Aside from the Preneed Study, the Plaintiffs allege no facts for their
claim that SCI encountered troubles in its preneed funeral business.(19)
Plaintiffs allege only that SCI's executives had access to unspecified internal
adverse information showing the "true" state of affairs. See CCAC at Paragraph
12 (the SCI Defendants were aware of true facts through "internal corporate
documents," "conversations and communications with other corporate officers and
employees," and "attendance at management and/or meetings of the Board and
committees"). Courts across the United States have expressly rejected
allegations of fraud based on unspecified allegations of negative "internal
- --------
(19) Plaintiffs claim that the Individual Defendants, as a result of
their high-ranking positions with SCI, had access to "undisclosed adverse
information." This is not sufficient to satisfy the Reform Act's pleading
standards. See, e.g, In re Advanta Corp. Sec. Litig., 1998 WL 387595, at *7
(E.D. Pa. 1998), aff'd, 180 F.3d 525 (3d Cir. 1999) (allegations that
defendants' positions within the company rendered them knowledgeable about
adverse conditions is an "unsupported conclusion;" plaintiffs must point "to
specific reports, circulated among defendants, which contained the adverse
information defendants are charged with knowing").
-21-
29
company documents." See, e.g., Wenger, 2 F. Supp.2d at 1250-51 (rejecting
unsubstantiated allegation that defendants were aware of the "true facts" and
had access to "internal corporate documents"); Zeid, 930 F. Supp. at 436
(without any reference to particular corporate documents or other information,
the Court can only conclude that Plaintiffs' allegations are based purely on
speculation and conclusions drawn from hindsight). If the mere allegation that
internal reports were "negative" were sufficient, any public company could be
sued for fraud whenever its stock price dropped -- precisely what the Reform Act
was intended to prevent.(20)
Silicon Graphics II is instructive. In that case, plaintiffs alleged
that the company ("SGI") and six of its top officers made a series of misleading
statements, or withheld information, to inflate the value of SGI's stock while
they engaged in massive insider trading, realizing nearly $14 million. See 183
F.3d at 982. Plaintiffs alleged that internal memorandum showed: (1) the
company's product was not shipping in volume; (2) sales were slow in North
America and Europe; and (3) SGI would not meet its revenue and growth targets.
Id. at 984. Plaintiffs contended that these reports notified officers that SGI
was suffering, but the officers did not disclose the information to the public.
Id. Rather, according to the plaintiffs' allegations, the officers entered into
a "conspiracy of silence" whereby they agreed to downplay the seriousness of
SGI's problems while they dumped their SGI stock. Id.
The Ninth Circuit ruled that where plaintiffs rely on such allegations,
they must set forth "the sources of [their] information with respect to the
[negative internal] reports," how plaintiffs "learned of the report[s]," "who
drafted them," "which officers received them," and "an adequate description
- --------
(20) In any event, the Individual Defendants' access to the Preneed
Study gave them no reason to believe SCI had encountered troubles of the sort
asserted by the Plaintiffs in SCI's preneed funeral business.
-22-
30
of their contents" which should include "specifics." Id. at 985. As the Reform
Act requires, a plaintiff must state "with particularity all facts on which
[her] belief is formed." Id.
The CCAC lacks any specific factual allegations. As in Silicon Graphics
II, Plaintiffs here rely on the Individual Defendants' positions and allege
participation in the day-to-day management and overall direction of the Company
allowed them access to "undisclosed adverse information." See CCAC at Paragraph
12. Without such "corroborating details," the Court simply "cannot determine
whether there is any basis for alleging that the [Individual Defendants] knew
that their statements were false at the time they were made." Silicon Graphics
II, 183 F.3d at 985.
Plaintiffs' cursory allegation that the Individual Defendants had
access to "undisclosed confidential information" through reports generated by
SCI's Falcon computer system and "Call In Reports" is not sufficient. See CCAC
at Paragraph 12. The problem with the CCAC is that it fails to provide details
such as when these reports were allegedly generated, who prepared them, to whom
they were directed, the sources from which Plaintiffs obtained this information
or the contents of such reports. See Silicon Graphics II, 183 F.3d at 985.(21)
In short, the CCAC does not comply with the Reform Act. It should therefore be
dismissed.
III. MANY OF THE ALLEGED MISSTATEMENTS ARE NOT ACTIONABLE AS A MATTER OF LAW
A. GENERAL STATEMENTS OF OPTIMISM DO NOT SUPPORT A FRAUD CLAIM.
The CCAC challenges numerous inactionable, vague statements of puffery
and general optimism, a natural consequence of Plaintiffs' decision to include
in the CCAC virtually every public statement SCI made during the Class Period.
Even before the Reform Act, courts consistently held
- --------
(21) Moreover, Plaintiffs' claims are contradicted by the very document
which they reference -- The Preneed Study. See Exhibit C.
-23-
31
that general statements of corporate optimism cannot support liability for
securities fraud. Raab v. General Physics Corp., 4 F.3d 286, 290 (4th Cir. 1993)
(vague statements of opinion are not actionable under the federal securities
laws because they are considered immaterial and discounted by the market as mere
"puffing"); In re VeriFone Sec. Litig., 784 F. Supp. 1471, 1481 (N.D. Cal. 1992)
("investors . . . know how to devalue the optimism of corporate executives"),
aff'd, 11 F.3d 865 (9th Cir. 1993).
As would be expected, SCI made a number of general statements
concerning the growth of its business, its acquisition strategy and its
potential for profitability in the future. Here are a few examples of the types
of vaguely optimistic statements Plaintiffs challenge.
o "The acquisition [of American Memorial Life Insurance
Company] is a way for [SCI] to expand its profit
base." See CCAC at Paragraph 75.
o The acquisition of American Memorial Life Insurance
Company "will allow SCI to better compete for and
serve customers." Id. at Paragraph 84.
o "We're adding another dimension to make sure we're
picking up all the value we can for our
shareholders." Id. at Paragraph 75.
o "The fundamentals of the funeral industry remain
strong". Id. at Paragraph 78.
o "We've long been the leaders in the prearranged
funeral business." Id. at Paragraph 84.
o SCI "used its strategy of acquisitions...[to] add
value to SCI today and long term." Id. at Paragraph
96.
These statements are not actionable because they cannot reasonably be relied
upon by an investor making an investment decision. See Grossman v. Novell, Inc.,
120 F.3d 1112, 1121-22 (10th Cir. 1997) (dismissing as puffing a statement that
the merger presented a "compelling set of opportunities"); In re Mobile
Telecommunication Techs. Corp. Sec. Litig., 915 F. Supp. 828, 834 (S.D. Miss.
1995) (dismissing as inactionable the statement that: "[w]e are highly
optimistic that we
-24-
32
will be profitable in 1993 as demand for nationwide and international wireless
messaging services continues to grow both in the U.S. and in the international
countries we serve"); In re Caere Corp. Sec. Litig., 837 F. Supp. 1054, 1057-58
(N.D. Cal. 1993) (dismissing as inactionable the statement that the company was
"well-positioned for growth").
Plaintiffs further attack certain public statements that are vague
expressions of optimism about the merger between SCI and ECI. Specifically,
Plaintiffs seek to hold the SCI Defendants liable for stating that the merger
"should further enhance SCI's leading domestic market position" (CCAC at
Paragraphs 80, 82), and that the merger "will create a combined North American
operation with unparalleled resources" (CCAC at Paragraphs 80, 82). These
statements are also not actionable because no reasonable investor would rely
upon such obvious "puffery."
B. STATEMENTS OF HISTORICAL FACT DO NOT SUPPORT A FRAUD CLAIM.
Of the statements made by the SCI Defendants, a number report
historical facts regarding SCI's business, such as the results of the second and
third quarters of 1998. See CCAC at Paragraphs 78, 86, 96. However, Plaintiffs
do not allege that these results were false or inaccurate. Moreover, the
announcement of past financial results cannot in itself imply that such results
will continue. See, e.g., In re Convergent Techs, Sec, Litig., 948 F.2d 507,
512-13 (9th Cir.1991); Wenger, 2 F. Supp. 2d at 1245 ("disclosure of accurate
historical data does not become misleading even if less favorable results might
be predictable by the company in the future"). Thus, none of these statements
are actionable on the grounds they were false or misleading. See, e.g., In re
Cypress Semiconductor Sec. Litig., 891 F. Supp. 1369, 1379 (N.D. Cal. 1995)
(accurate statements of historical fact are not actionable).
-25-
33
C. THE SCI DEFENDANTS' FORWARD-LOOKING STATEMENTS ARE PROTECTED
BY THE SAFE HARBOR.
The Reform Act's safe harbor provides that a person "shall not be
liable" for any forward-looking statement accompanied by a "meaningful
cautionary statement identifying important factors that could cause actual
results to differ materially from those in the forward-looking statement...." 15
U.S.C. Section 78u-5(c)(1)(A)(i). This is true even if the cautionary statement
fails "to include the particular factor that ultimately causes the
forward-looking statement not to come true . . . ." H.R. Conf. Rep. No. 104-369,
at 44.
Plaintiffs have purposefully tried to mischaracterize forward-looking
statements as statements of historical fact by alleging that the statements were
made with knowledge of their falsity. This disingenuous effort to avoid the safe
harbor should be rejected. Statements concerning a strategy yet to be fully
implemented and yet to be completed are, by definition, forward looking in
nature. Harris v. Ivax Corp., 998 F. Supp. 1449, 1453 (S.D. Fla. 1998) (although
couched in present tense, allegations regarding business conditions were forward
looking because "[r]epresentations regarding the state of a business' position
in a changing market or the soundness of its growth strategies are necessarily
forward-looking"), aff'd, 182 F.3d 799 (11th Cir. 1999).
Plaintiffs assert that the SCI Defendants failed to warn investors of
various factors -- including an allegedly unprofitable preneed funeral business
- - that could have an adverse impact on earnings. However, SCI's August 6, 1998
and October 22, 1998 press releases, both of which Plaintiffs assert contain
misleading statements, are accompanied by cautionary statements and specific
risk factor disclosures. See Exhibits F and G.(22) Plaintiffs also complain that
statements
- -----------------
(22) SCI's cautionary statement under the Reform Act provides as
follows:
(continued...)
-26-
34
contained in the Forms 10-Q filed by SCI on August 14, 1998 and November 16,
1998 misled investors about the expected growth in revenues and profitability of
SCI. The Forms 10-Q, however, also contained safe harbor language. See Exhibit H
at p.21 and Exhibit I at pp.22-23. In light of these ample risk disclosures, the
Reform Act's safe harbor provision renders it impossible for Plaintiffs to claim
that SCI's forward looking statements were misleading.
IV. PLAINTIFFS DO NOT ADEQUATELY ALLEGE SCIENTER
"Scienter is a crucial element" in claims of securities fraud. Tuchman
v. DSC Communications Corp., 14 F.3d 1061, 1067 (5th Cir. 1994).(23) This is so
"because not every misstatement or omission in a corporation's disclosures gives
rise to a Rule 10b-5 claim." Id. Only when a plaintiff can show that the
defendant acted with "a mental state embracing intent to deceive, manipulate, or
defraud" does an alleged misstatement or omission raise a legitimate claim of
securities fraud. Id. (quoting Ernst v. Hockfelder, 425 U.S. 185, 193 n.12
(1976)).
- --------
(22) (...continued)
Certain matters discussed in this release are forward-looking
statements that are subject to risks and uncertainties that
could cause actual results to differ materially from those
projected. Such risks and uncertainties include, but are not
limited to, the following: The company maintaining its high
level of acquisition activity and achieving expected
performance from these acquired businesses, and the ability to
manage internal growth of existing operations; the economy,
competition and death rates in the company's geographic areas
of operations; and sufficient availability of capital
resources to fund future acquisitions and planned levels of
capital expenditures which will depend on prevailing market
conditions, interest rates, and the financial condition of the
company.
See Exhibits F and G (emphasis added).
(23) To establish a securities fraud claim under Section 10(b) of the
Securities Exchange Act of 1934 and Rule 10b-5, a plaintiff must plead and prove
a (1) material misstatement or omission (2) of material fact (3) made with
scienter (4) on which the plaintiff relied (5) that proximately caused the
plaintiff's injury. Tuchman, 14 F.3d. at 1067. Scienter is not an element of
Plaintiffs' Section 11 and 12(a)(2) claims.
-27-
35
Plaintiffs attempt to satisfy the heightened scienter requirement of
the Reform Act in two ways. First, Plaintiffs contend that the SCI Defendants
made false and misleading statements "to obtain and maintain favorable ratings
on the debt securities that SCI had registered with the SEC but not yet issued."
See CCAC at Paragraph 113. Second, Plaintiffs allege that the SCI Defendants
made misstatements to facilitate the consummation of the SCI-ECI merger. See
CCAC at Paragraphs 110, 112. As shown below, neither of these scienter
allegations pass muster.
A. UNDER THE REFORM ACT, PLAINTIFFS MUST ALLEGE SPECIFIC FACTS
CREATING A STRONG INFERENCE OF SCIENTER THAT THE SCI
DEFENDANTS ACTED KNOWINGLY OR RECKLESSLY, NOT JUST THAT THEY
HAD A MOTIVE AND OPPORTUNITY TO COMMIT FRAUD.
Before the Reform Act, the courts used a range of standards governing
the degree of specificity needed to plead a defendant's state of mind for a
securities fraud claim. Some circuits found a general allegation of scienter
sufficient under Fed. R. Civ. P. 9(b), e.g., In re Glenfed, Inc. Sec. Litig., 42
F.3d 1541, 1545 (9th Cir. 1994), while others, including the Fifth Circuit, held
that plaintiffs "must set forth specific facts to support an inference of
fraud." Lovelace, 78 F.3d at 1018. The Second Circuit employed a standard
requiring plaintiffs to plead specific facts that would support "a strong
inference of fraud." Shields v. Citytrust Bancorp, Inc., 25 F.3d 1124, 1128 (2d
Cir. 1994). Under this "strong inference" standard, a plaintiff had to allege
specific facts that would either "constitute strong circumstantial evidence of
conscious misbehavior or recklessness" or "show that defendants had both motive
and opportunity to commit fraud." Id.
In enacting the Reform Act, Congress sought to reduce the volume of
abusive federal securities litigation by erecting procedural barriers to prevent
plaintiffs from asserting baseless securities fraud claims. See H.R. Conf. Rep.
104-369, at 31. An important component of the Reform Act's new standard is its
heightened pleading requirement for scienter. Under this heightened
-28-
36
standard, plaintiffs must "state with particularity facts giving rise to a
strong inference that the defendant acted with the required state of mind," and
do so "with respect to each act or omission alleged." 15 U.S.C. Section
78u-4(b)(2) (emphasis added). This new standard augments and reinforces the
Fifth Circuit's existing mandate under Fed. R. Civ. P. 9(b) that the
circumstances allegedly constituting fraud must be spelled out in great detail.
See Melder, 27 F.3d at 1100 (setting forth Rule 9(b) requirements for pleading
securities fraud).
The Reform Act's new standard no longer permits plaintiffs to plead
scienter by merely alleging facts showing defendants' "motive and opportunity"
to commit fraud. See, e.g., Silicon Graphics II, 183 F.3d at 977-79. Congress
soundly rejected Second Circuit case law that allegations of "motive and
opportunity" could suffice to provide the required strong inference of
scienter.(24) In fact, the Conference Report, which is the authoritative source
for finding the Legislature's intent, expressly stated that Congress declined to
adopt the "motive and opportunity" test:
The Conference Committee language is based in part on the
pleading standard of the Second Circuit. . . .Regarded as the
most stringent pleading standard, the Second Circuit
requirement is that the plaintiff state facts with
particularity, and that these facts, in turn, must give rise
to a "strong inference" of the defendant's fraudulent intent.
Because the Conference Committee intends to strengthen
existing pleading requirements, it does not intend to codify
the Second Circuit's case law interpreting this pleading
standard. FN 23/
FN 23/ For this reason, the Conference Report chose not to
include in the pleading standard certain language relating to
motive, opportunity, or recklessness.
- --------
(24) The legislative history of this provision of the Reform Act is set
out in great detail in In re Paracelsus Corp. Sec. Litig., 1998 WL 1108373, at
*5-6 (S.D. Tex. 1998) (Werelin, J.).
-29-
37
H.R. Conf. Rep. 104-369, at 41 n.23. See also S. Rep. 104-98, at 15 ("The
Committee does not intend to codify the Second Circuit's case law interpreting
[the strong inference] pleading standard, although courts may find this body of
law instructive").
Congress also rejected an amendment that would have codified the Second
Circuit standard, making "motive and opportunity" part of the statutory
language. See H.R. Conf. Rep. 104-369, at 41; 141 Cong. Rec. S9199, S9201.
Several courts have considered Congress' rejection of such proposed statutory
language to be persuasive evidence that Congress did not intend to leave alive
the "motive and opportunity" test. See, e.g., Friedberg v. Discreet Logic, Inc.,
959 F. Supp. 42, 48-9 (D.Mass. 1997). Indeed, "[f]ew principles of statutory
construction are more compelling than the proposition that Congress does not
intend sub silentio to enact statutory language that it has earlier discarded in
favor of other language." INS v. Cardoza-Fonseca, 480 U.S. 421, 442-43 (1987).
See also Gulf Oil Corp. v. Copp Paving Co., 419 U.S. 186, 200 (1974) (by
expressly declining to adopt proposed statutory language, Congress' action
"strongly militates against a judgment that Congress intended [the] result that
it expressly declined to enact").
"Congress further provided very strong evidence of its intent to go
beyond the Second Circuit standard when it overrode President Clinton's veto of
the [Reform Act]." Silicon Graphics II, 183 F.3d 979. President Clinton vetoed
the Reform Act, in part, because "the conferees make crystal clear...their
intent to raise the [pleading] standard even beyond [the Second Circuit] level,"
and "the conferees meant to erect a higher barrier to bringing suit than any now
existing." H.R. Doc. No. 104-150 (1995). By overriding the President's veto and
enacting this "higher barrier," Congress provided powerful evidence to elevate
the pleading standard to a level beyond that in the Second Circuit.
-30-
38
Accordingly, a number of courts addressing the issue have held that
following passage of the Reform Act, allegations of motive and opportunity,
without more, will no longer be presumed sufficient to support a strong
inference of scienter.(25) As the Ninth Circuit has explained:
[P]laintiffs proceeding under the [Reform Act] can no longer
aver intent in general terms of mere motive and opportunity or
"recklessness," but rather, must state specific facts
indicating no less than a degree of recklessness that strongly
suggests actual intent. Thus...the [Reform Act] requires
plaintiffs to plead, at a minimum, particular facts giving
rise to a strong inference of deliberate or conscious
recklessness.
- --------
(25) Three other circuit courts have agreed that the Reform Act raised
the scienter pleading standard to something more than just "motive and
opportunity." In In re Comshare, Inc. Sec. Litig., 183 F.3d 542, 549 (6th Cir.
1999), the Sixth Circuit held that plaintiffs "may plead scienter in Section
10(b) or Rule 10b-5 cases by alleging facts giving rise to a strong inference of
recklessness, but not by alleging facts merely establishing that a defendant had
the motive and opportunity to commit fraud." Similarly, the 11th Circuit has
recently held that ("[Congress] did not intend to codify the lesser-known,
lesser-accepted, and certainly not well-established notion that allegations of
motive and opportunity to commit fraud are sufficient to show scienter"). Bryant
v. Avado Brands, Inc., 1999 WL 688050, *12 (11th Cir. 1999). The Third Circuit
found that the "Reform Act establishes a pleading standard approximately equal
in stringency to that of the [pre-Reform Act] Second Circuit," (including
allegations of motive and opportunity), but recognized that "particularity"
language in the Reform Act resulted in a "heightened standard." In re Advanta
Corp. Sec. Litig., 180 F.3d 525, 534 (3d Cir. 1999).
By contrast, the Second Circuit, without any analysis of the statutory
language or the oft-cited legislative history, merely adopted the "motive and
opportunity" test used before the enactment of the Reform Act. Press v. Chemical
Investment Services Corp., 166 F.3d 529, 538 (2d Cir. 1999).
-31-
39
Silicon Graphics II at *21.(26) This interpretation follows from Congress'
intent as expressed in the legislative history of the Reform Act.(27)
B. PLAINTIFFS' ALLEGATIONS DO NOT SUPPORT A STRONG INFERENCE OF
SCIENTER.
Plaintiffs' scienter allegations amount to no more than an attempt to
plead motive alone and therefore fail to satisfy the Reform Act's heightened
pleading standard. On this ground alone, Plaintiffs' 10(b) and 10b-5 claims
should be dismissed. But whatever standard applies, the Reform Act requires
"facts giving rise to a strong inference" of scienter. The CCAC's scienter
allegations fall woefully short of the mark.
- --------
(26) The SCI Defendants expect the Plaintiffs to cite Williams v. WMX
Techs., Inc., 112 F.3d 175, 178 (5th Cir.), cert. denied, 118 S.Ct. 412 (1997)
for the proposition that the Fifth Circuit has adopted the "motive and
opportunity" test under the Reform Act. This argument is without merit as Judge
Werlein recently noted:
The Court notes the argument made by Plaintiffs that the Fifth Circuit
in Williams v. WMX Techs., Inc., 112 F.3d 175, 178 (5th Cir.), cert.
denied, 118 S.Ct. 412 (1997), stated that the [Reform Act] did not
change the strong inference pleading standard adopted by the Second
Circuit.... In Williams, however, the Fifth Circuit was not discussing
the standard for pleading scienter under Section 10(b); instead, the
court cited a Second Circuit case that discussed the particularity with
which the elements of fraud had to be pled under Rule 9(b) (i.e., the
"who, what, when, and where"). See Williams, 112 F.3d at 177-78 (citing
Mills v. Polar Molecular Corp., 12 F.3d 1170 (2d Cir.1993) (setting
forth the specificity with which the elements of fraud must be pled)).
The Fifth Circuit in Williams did not discuss the new requirement for
pleading scienter under Section 10(b), nor did it rely upon the Second
Circuit's contrary decision in Shields, which had held that pleading
motive and opportunity was sufficient from which to infer scienter.
Maldonado v. Dominguez,137 F.3d 1, 9 n.5 (1st Cir.1998), which made a
similar statement to the one in Williams, is distinguishable on the
same basis as Williams.
In re Paracelsus Corp., 1998 WL 1108373, at *6 fn.2.
(27) The two courts in the Southern District of Texas that have
construed this section of the Reform Act are divided in their interpretations.
Compare In re Paracelsus Corp., 1998 WL 1108373 (holding that the Reform Act
imposes a heightened pleading standard and eliminates the ability to plead
scienter solely by alleging evidence of a defendant's motive and opportunity)
with Robertson v. Strassner, 32 F. Supp.2d 443 (S.D. Tex. 1998) (Atlas, J.)
(adopting "motive and opportunity" test).
-32-
40
1. PLAINTIFFS' ALLEGATIONS THAT THE SCI DEFENDANTS MADE
MISSTATEMENTS TO MAINTAIN SCI'S BOND RATING FAILS TO
CREATE THE REQUIRED INFERENCE OF SCIENTER.
Plaintiffs' conclusory allegation that the SCI Defendants made false
and misleading statements "to obtain and maintain favorable ratings on the debt
securities that SCI had registered with the SEC but not yet issued" (CCAC at
Paragraph 113) fails to support an inference of motive even under the pre-
Reform Act pleading standards for scienter. Applying only Rule 9(b), courts,
including the Fifth Circuit, repeatedly refused to infer "motive" from similar
allegations that misstatements were made to maintain a high bond or credit
rating. See, e.g., Melder, 27 F.3d at 1102;(28) L.L. Capital Partners, L.P. v.
Rockefeller Center Properties, Inc., 939 F. Supp. 294, 300 (S.D.N.Y. 1996)
(holding under Rule 9(b) that allegations that misrepresentations were made to
facilitate $21 million offering insufficient to establish motive).
Post-Reform Act cases looking to motive as a relevant factor equally
reject such allegations as a basis for inferring scienter. In San Leandro
Emergency Med. Group Profit Sharing Plan v. Philip Morris Companies, 75 F.3d
801, 813-14 (2d Cir. 1996), for example, the plaintiffs attempted to establish
motive by alleging that an inflated stock price maintained the company's bond or
credit rating at the highest possible level, so as to maximize the marketability
of $700 million of debt securities. The Second Circuit held:
We do not agree that a company's desire to maintain a high
bond or credit rating qualifies as a sufficient motive for
fraud in these circumstances, because "if scienter could be
pleaded on that basis alone, virtually every
- --------
(28) The Fifth Circuit, in Melder, affirmed the dismissal of
plaintiffs' section 10(b) claims where plaintiffs alleged that defendants
engaged in securities fraud "so that they could inflate the price of the
Company's common stock in order to . . . successfully bring to fruition the
[initial and secondary public] offering." 27 F.3d at 1102. The Melder court held
that plaintiffs' allegations "did not set out facts sufficient to allow for a
proper inference of scienter." Id.
-33-
41
company in the United States that experiences a downturn in
stock price could be forced to defend securities fraud
actions."
San Leandro, 75 F.3d at 814 (citation omitted).
Courts have quite correctly interpreted the San Leandro decision as an
"unequivocal rejection of the concept of motive predicated upon desire to
maximize the marketability of debt securities and to minimize interest rates."
In re 1993 Corning Sec. Litig., 1996 WL 257603, at * 6 (S.D.N.Y. 1996) (holding
that allegations of company's desire to complete bond offering and maximize
ongoing marketability of debt securities insufficient to plead scienter). See
also In re Crown Am. Realty Trust Sec. Litig., 1997 WL 599299, at *25 (W.D. Pa.
1997) (holding that allegations of "desire to improve [defendant's] financial
picture to enhance its ability to finance further capital improvements" is
insufficient to plead scienter). Accordingly, even if this Court is prepared to
accept "motive and opportunity" allegations as a sufficient basis for scienter,
the allegations in the CCAC of the SCI Defendants' motivation is inadequate.
2. PLAINTIFFS' ALLEGATION THAT THE SCI DEFENDANTS MADE
MISSTATEMENTS TO FACILITATE CONSUMMATION OF THE
SCI-ECI MERGER FAILS TO CREATE THE REQUIRED INFERENCE
OF SCIENTER.
Plaintiffs also allege that the SCI Defendants were motivated to commit
fraud to facilitate the consummation of the SCI-ECI merger. See CCAC at
Paragraph 112 ("SCI was motivated to maintain SCI's stock price in an effort to
acquire ECI in a stock-for-stock transaction for less than ECI's true value").
However, it is well-settled that a "desire to consummate [a] corporate
transaction does not constitute a motive for securities fraud." In re Health
Management, Inc. Sec. Litig., 970 F. Supp. 192, 203-04 (E.D.N.Y.1997) (motive
not established by pleading corporate acquisition using supposedly artificially
inflated stock). See also Leventhal v. Tow, 48 F. Supp. 2d 104, 115 (D. Conn.
-34-
42
1999) (finding that allegation that the defendants had a motive to artificially
inflate stock price during the class period in order to get more favorable terms
in the stock-for-stock transactions and in the issuance of the debentures was an
insufficient allegation of scienter); Malin v. Ivax, 17 F. Supp.2d 1345, 1361
(S.D. Fla. 1998) (rejecting motive "maintaining the stock price...to facilitate
mergers and acquisitions"); In re Cirrus Logic Sec. Litig., 946 F. Supp. 1446,
1477 (N.D. Cal. 1996) (allegation that defendants misrepresented reserves to
facilitate stock-for-stock merger is insufficient to establish scienter).
If all a securities fraud plaintiff had to do to sufficiently plead
scienter was to allege that the defendants artificially inflated a stock's price
to obtain more favorable terms in a stock-for-stock transaction "nearly every
stock-for-stock transaction conducted in the United States could be subject to
challenge." In re Cirrus Logic Sec. Litig., 946 F. Supp. at 1477. At that point,
the scienter requirement becomes meaningless.
Additionally, the Plaintiffs do not expressly or even inferentially
explain how the desire to conclude the SCI-ECI merger by using inflated value of
the stock as consideration for the merger, is in the economic self-interest of
the Individual Defendants. Numerous courts have found that stock ownership,
standing alone, is insufficient to plead scienter. See, e.g., Duncan v. Pencer,
1996 WL 19043, at * 11 (S.D. N.Y. 1996) (defendants' motive "to enhance the
value of their personal holdings and options" is insufficient to plead
scienter).
3. THE INDIVIDUAL DEFENDANTS' LACK OF TRADING IN SCI
STOCK NEGATES ANY INFERENCE OF SCIENTER.
Plaintiffs' scienter allegations contain an interesting - although
unsurprising - omission. Plaintiffs fail to inform the Court that none of the
Individual Defendants sold SCI stock during the
-35-
43
Class Period.(29) The collective failure of the three Individual Defendants -
SCI's Chief Executive Officer, Chief Operating Officer and Chief Financial
Officer - to take advantage of "artificially inflated prices" and to sell stock
during the Class Period negates any inference of scienter. See, e.g., In re
Burlington Coat Factory Sec. Litig., 114 F.3d 1410, 1423 (3d Cir. 1997) (finding
that no inference of scienter was established because "two of the more powerful"
defendants did not sell any stock).
The Individual Defendants are, without question, substantial
shareholders in SCI. The chart below summarizes the Individual Defendants stock
ownership as of July 17, 1998:
Total Holdings
Shares of Stock(30) Vested Options(31) Available for Sale
------------------- ------------------ ------------------
Waltrip 889,645 2,235,753 3,125,398
Heiligbrodt 588,944 1,333,452 1,922,396
Champagne 63,150 510 63,660
Despite the fact that the Individual Defendants had a cumulative
5,111,454 shares available for sale, there are no allegations that the
Individual Defendants sold a single share during the Class Period. It defies
belief that the three presumed masterminds of the massive fraud alleged in the
- --------
(29) The Individual Defendants' stock sales are publicly reported on
SEC Form 4 within 10 days of the end of the month in which a transaction occurs.
Form 4 requires the dates and amounts of the security purchased or sold. See SEC
Rules 16a-1 to a-3 and Form 4, codified at 17 C.F.R. Section 240.16a-1 to a-3,
and Official Form (1997). Form 4 is usually the only source of data on insider
trades.
(30) See Forms 4 and Forms 5, attached as Exhibits J, K and L. Form 5
is an Annual Statement of Changes in Beneficial Ownership. These figures include
both indirect and direct holdings.
(31) See 1999 Proxy Statement and 1999 Annual Meeting Notice, attached
as Exhibit M, at p. 14.
-36-
44
CCAC would not take advantage of that scheme and sell even a small portion of
their stock holdings during the Class Period.
In evaluating whether the allegations of a complaint sufficiently
allege scienter, courts routinely place great importance on the complaint's lack
of any allegations of stock trading by the company's high-ranking executives. In
In re Gleaner Technologies, Inc. Sec. Litig., 1998 WL 915907 (S.D.N.Y. 1998),
for example, the Court stated:
[P]erhaps most importantly, the inference of scienter is
undermined by the fact that [the company's] Chief Executive
Officer ("CEO") and Chairman, Vice Chairman, Chief Financial
Officer ("CFO") and Comptroller did not sell any stock before
the Company publicly disclosed the [negative] impact of the
FCC freeze [on the company]. Certainly one can assume that
these high-ranking corporate officers, arguably the most
knowledgeable of all Board members, would be part of any
fraudulent scheme to benefit from insider information through
pre-emptive stock sales. The absence of sales from these
individuals, then, suggests that the February trading by the
seven defendants does not give rise to a strong inference of
scienter.
Id. at *4. See also Head v. NetManage, Inc., 1998 WL 917794, at *4 (N.D. Cal.
1998) (dismissing complaint; holding that chief financial officer did not sell
negated scienter and stating that it makes no sense that "the alleged
masterminds of the fraudulent scheme" would not take advantage of the scheme);
In re Health Mgmt. Sys. Sec. Litig., 1998 WL 283286, at * 6 (finding that no
inference of scienter is created because the CFO did not sell any stock); In re
Comshare Sec. Litig., 1997 WL 1091468, at * 10 (E.D. Mich. 1997), aff'd, 183
F.3d 542 (6th Cir. 1999) ("the CEO and CFO would have been essential
participants in any scheme, thus, their having sold no stock, undermines any
suggestion of knowledge on the part of defendants due to the other sales"); In
re Credit Acceptance Corporation Securities Litigation, 50 F. Supp.2d 662, 677
(E.D. Mich. 1999) ("It seems as though the CFO would have been an essential
participant in any fraudulent scheme to defraud the company.
-37-
45
The fact that he did not sell any shares during the class period undermines the
suggestion that the Defendants engaged in securities fraud in order to profit
from their own stock sales") .
The fact that the three Individual Defendants retained substantial
holdings affirmatively demonstrates no scienter. See In re Worlds of Wonder Sec.
Litig., 35 F.3d at 1425 (holding that there was no inference of scienter where
defendants retained the bulk of their shares). Waltrip's SCI total holdings
declined in value approximately $46.6 million on January 26, 1999, the day SCI
announced that it expected earnings per share for the fourth quarter 1998 to be
lower than analysts' expectations. That same day, Heiligbrodt's SCI total
holdings declined in value approximately $28.7 million and Champagne's SCI total
holdings declined in value approximately $950,000. Far from supporting a "strong
inference" that the Individual Defendants had a motive to capitalize on
artificially inflated stock prices, these facts suggest they had every incentive
to ensure the long term growth and stability of SCI.(32)
CONCLUSION
Plaintiffs' allegations against the SCI Defendants epitomize the
abusive claims the Reform Act was designed to prevent. For the reasons stated
above, the SCI Defendants respectfully request that the Court dismiss the
Consolidated Class Action Complaint in its entirety with prejudice.
- --------
(32) Further refuting an inference of scienter is the fact that
Heiligbrodt sold all of his holdings of SCI stock after the end of the Class
Period, at $17 per share. See Exhibit M at p. 17. This is approximately 50
percent less than SCI's stock price at the beginning of the Class Period. If, as
Plaintiffs assert, Heiligbrodt was responsible for committing a fraud, one would
expect him to sell his stock when it was "inflated," not when it was at a
52-week low.
-38-
46
Respectfully submitted,
Bracewell & Patterson, L.L.P.
By:
----------------------------------
J. Clifford Gunter III
State Bar No. 08627000
South Tower Pennzoil Place
711 Louisiana, Suite 2900
Houston, Texas 77002-2781
Telephone: (713) 223-2900
Facsimile: (713) 221-1212
ATTORNEY-IN-CHARGE
Andrew M. Edison
Bracewell & Patterson, L.L.P.
South Tower Pennzoil Place
711 Louisiana, Suite 2900
Houston, Texas 77002-2781
Telephone: (713) 223-2900
Facsimile: (713) 221-1212
COUNSEL FOR DEFENDANTS
-39-
47
CERTIFICATE OF SERVICE
I hereby certify that a true and correct copy of the foregoing document
was forwarded by messenger on the 8th day of October, 1999 to Plaintiffs' Lead
Counsel:
Mr. Roger E. Greenberg
Greenberg, Peden, Siegmyer & Oshman, P.C.
12 Greenway Plaza
10th Floor
Houston, Texas 77046
----------------------------------------
Andrew M. Edison
-40-