This is a securities case. Plaintiffs F. Kenneth Shockley,M.D., David Shockley, John M. Morrash, Sandra M. Morrash, andPatricia Clement are the lead plaintiffs of an uncertified classconsisting of shareholders who purchased shares of Adams Golf,Inc. common stock in, or traceable to, its July 1998 InitialPublic Offering ("IPO"). Each lead plaintiff purchased at leastpart of his or her Adams Golf stock within twenty-five days ofthe effective date of the of the Registration Statement and theProspectus that were filed prior to the IPO. There are twogroups of defendants. One is composed of parties related toAdams Golf (the "Adams Golf defendants"), and the other composedof the underwriters of the company's IPO (the "Underwriterdefendants").
The Adams Golf defendants include the following parties.Defendant Adams Golf, Inc. is a Delaware corporation with itsprincipal executive offices in Wilmington, Delaware. Adams Golfdesigns, manufactures and markets golf clubs. Defendant B.H.Adams, the founder of Adams Golf, is an officer and director ofthe company. Defendants Darl P. Hatfield and Richard H. Murtlandare officers of the company. Defendants Paul R. Brown, Jr.,Ronald E. Casati, Finis F. Conner, and Stephen R. Patchin aredirectors of the company.
The Underwriter defendants include Lehman Brothers HoldingsInc., Banc of America Securities LLC, and Ferris Baker Watts,Incorporated, the lead underwriters for the IPO.
In their consolidated and amended class action complaint,plaintiffs assert claims pursuant to Sections 11, 12 and 15 ofthe Securities Act of 1933 ("the '33 Act"), 15 U.S.C. § 77k,77l(a)(2) and 77o, which allege that, in connection with theIPO, defendants wrongfully prepared, signed or caused Adams Golfto issue a Registration Statement and an incorporated Prospectusthat were materially false and misleading. Specifically,plaintiffs contend that the defendants failed to disclose thatAdams Golf's profits and revenues were severely threatened byextensive distribution of Adams Golf's products to unauthorizedretailers. That is, the defendants failed todisclose the existence of what the plaintiffs term a "graymarket" for Adams Golf products.
Plaintiffs further contend that defendants failed to disclosethat an industry-wide oversupply of retail inventory hadweakened sales for at least a full quarter prior to theoffering. Plaintiffs argue that certain portions of theRegistration Statement and Prospectus were materially misleadingwith regard to the gray market and oversupply conditions.Plaintiffs allege that as the market learned of theseconditions, the per share price of Adams Golf stock dropped froma high of $18.875 to $3.75.
Plaintiffs seek damages from defendants to compensate for theloss in value of their stock. Defendants have moved to dismissplaintiffs' complaint pursuant to Federal Rules of CivilProcedure 12(b)(6) and 9(b) and the 1995 Private SecuritiesLitigation Reform Act (the "PSLRA") for failure to demonstrateany set of facts that would entitle them to relief.
On January 8, 2001, the court heard oral argument ondefendants' pending motions to dismiss. This is the court'sdecision on the motions to dismiss.
I. FACTUAL BACKGROUND
The court draws the following facts from plaintiffs'consolidated and amended class action complaint and thedocuments referenced therein.
In 1987, Barney H. Adams founded Adams Golf. Adams initiallystarted the company as a general golfing components supplier andcontract manufacturer, but later developed it into a producer ofhigh-end, custom fit golf clubs. In the fall of 1995, Adamsintroduced the "Tight Lies Original," the lead product in a newline of high-end golf clubs. The Tight Lies Original was animmediate success. In December 1996, Adams added three fairwaywoods, the Tight Lies Strong 3, Strong 5, and Strong 7. Adamsadded the Tight Lies Strong 9 to the product line in January1998. Adams Golf enjoyed rapid sales growth with the Tight Liesclubs. According to the July 9, 1998 Prospectus, the company'ssales increased from $1.1 million in 1995 to $36.7 million in1997. In the first quarter of 1998, Adams Golf recorded netsales of $24.5 million and held a 27% market share in the singlefairway woods category.
On July 10, 1998, Adams Golf executed an IPO. According to thecompany's July 13, 1998, Securities and Exchange Commission("SEC") Rule 424(b)(4) filing, the IPO was conducted on a firmcommitment basis through the underwriter defendants andconsisted of six million shares offered at $16.00 per share. OnJuly 10, 1998, the day after the allegedly misleadingRegistration Statement and Prospectus became effective, thestock traded publicly on the NASDAQ exchange and closed at$18.375. At oral argument, counsel for plaintiffs stated thattwo of the lead plaintiffs, F. Kenneth Shockley, M.D. and DavidShockley ("the Shockley plaintiffs"), purchased their sharesdirectly from the Underwriter defendants during the IPO. Theremaining lead plaintiffs ("the non-Shockley plaintiffs")purchased their shares on the public market soon after the IPO.
The amended complaint charges that the defendantsmisrepresented and omitted material facts in the July 10, 1998,Adams Golf Registration Statement. Plaintiffs contend that theomissions relate to two material subjects. First, plaintiffsallege that defendants failed to disclose that Adams Golfsprofits and revenues were artificially inflated by extensive"gray market" distribution of Adams Golfs products to Costco, anunauthorized discount retailer. Second, plaintiffs allegationsinfer thatan industry-wide oversupply of inventory at the retail levelexisted for at least a full quarter prior to the IPO, that thedefendants failed to disclose this allegedly materialinformation, and that this industrywide oversupply has adverselyaffected Adams Golfs' profits.
A. Facts Underlying The Allegation of Gray Market Sales Misrepresentation
At some point before the IPO, personnel at Adams Golf learnedthat certain Tight Lies products were being sold at Costco, anunauthorized discount retailer. According the plaintiffs, thesesales resulted in a "gray market" for the Tight Lies golf clubs.The term "gray market" describes a market condition created bythe unauthorized sale of products to discounters willing toresell the products at prices substantially lower than those setby authorized retailers. These discounters use the lower pricesto draw consumers away from the authorized retailers. When theconsumers purchase the products from the discounters, the profitmargins for the distributor of the product are reduced. Inaddition, according to the complaint, gray markets tend to skewthe distributor's revenues, causing higher sales in the earlierperiods as products filter to discounters through gray marketchannels and lower sales in later periods as the authorizedretailers, losing sales to discounters, order fewer productsfrom the distributor.
On June 9, 1998, one month before the effective date of theRegistration Statement, Adams Golf issued a press releaseexplaining that it had filed a Bill of Discovery against Costco.The press release states, "[t]he bill of discovery was filed inorder to determine whether Costco's claims that they hadproperly acquired Adams' Tight Lies fairway woods for resalewere accurate. . . . Adams Golf became concerned when it learnedthat Costco was selling their Tight Lies fairway woods becauseCostco is not an authorized distributor." At that time, Costcoheld over 5,000 Adams Golf clubs in its inventory.
According to the plaintiffs, these gray market salesartificially inflated Adams Golfs sales prior to the IPO anddamaged the sales after the IPO by reducing the market price forthe clubs. Plaintiffs explain that Costco's gray market salesare only one example of sales by unauthorized discounters andinternational gray market discounters. The RegistrationStatement and Prospectus did not specifically refer to the graymarket. Rather, it stated that "the Company does not sell itsproducts through price sensitive general discount warehouses,department stores or membership clubs."
On January 7, 1999, Adams Golf disclosed in a company pressrelease that sales results would continue to be adverselyaffected as a result of "the gray market distribution of itsproducts to a membership warehouse club." In the company's 1998Form 10-K Report, filed with the SEC in March 1999, the AdamsGolf disclosed that:
Despite the Company's efforts to limit its distribution to selected retailers, Adams Golf products have been found in a certain membership warehouse club, which the Company believes has obtained the products through the use of unauthorized distribution channels. Adams Golf has taken steps to limit this unauthorized distribution through the serialization of all Adams Golf club heads but does not believe the gray marketing of its product can be totally eliminated.
B. Facts Underlying The Allegation of Failure to Disclose Oversupply of Inventory at Retail Level
According to the plaintiffs, at some point prior to the IPO,personnel at Adams Golfknew that there was an industry-wide problem of "oversupply ofinventory at the retail level." Plaintiffs contend that theRegistration Statement and the Prospectus failed to disclosethis "debilitating" industry wide oversupply condition, acondition that existed prior to the time of the IPO. Rather, theRegistration Statement and the Prospectus represented that:
In 1997, wholesale sales of golf equipment in the U.S. reached an estimated $2.4 billion. Wholesale sales of golf clubs increased at an estimated compound annual growth rate of approximately 13% over the 5-year period from 1992 to 1997. The Company believes that a number of trends are likely to further increase the demand for Adam's products. . . .
In addition, it is alleged that while the RegistrationStatement and the Prospectus disclosed a number of risksrelating to competition and industry factors, it nowheredisclosed the allegedly material risks flowing from thethen-current oversupply of inventory at the retail level eitherfor Adams Golf itself or throughout the golf equipment industry.Rather, the plaintiffs argue, Adams Golf misled investors intobelieving that Adams Golf retailers would not suffer from excessinventory by stating in the Registration Statement and theProspectus that "[t]he Company believes its prompt delivery ofproducts enables its retail accounts to maintain smallerquantities of inventory than may be required with other golfequipment manufacturers."
Defendants first indicated to the public that retailers werecarrying excess inventory on January 7, 1999, when, inconnection with disappointing financial results, Adams Golfdisclosed in a company press release that it would offer creditsto its retailers, at the cost of millions of dollars, in anattempt to alleviate the problems arising from those retailers'excess inventory.
Then in an April 12, 1999 press release, with reference toresults for the quarter that ended on March 31, 1999, Adams Golfdisclosed for the first time that "Adams Golf believes theoversupply of inventory at the retail level, a condition thathas weakened club sales industry wide over the last 12 months,has resulted in substantial reductions in retailer purchases."According to the amended complaint, one can infer from thatstatement that the undisclosed oversupply condition existed forat least one quarter before Adams Golfs IPO on July 10, 1998.
II. PROCEDURAL BACKGROUND
On April 25, 2000, the court appointed plaintiffs as leadplaintiffs of the as yet uncertified class. The lead plaintiffsfiled their consolidated and amended class action complaint onMay 17, 2000.
On July 6, 2000, the Adams Golf defendants moved to dismissplaintiffs' consolidated and amended complaint on four grounds.On July 11, 2000, the Underwriter defendants moved to dismissthe complaint on essentially the same grounds. First, thedefendants contend that only the particular plaintiffs whopurchased shares of Adams Golf in the IPO have standing toassert claims under sections 11(a) and 12(a)(2) of the '33 Actand, therefore, the claims of all plaintiffs that have notpurchased shares directly from the Underwriter defendants shouldbe dismissed pursuant to Federal Rule of Civil Procedure 12(c).
Second, the defendants contend that the plaintiffs also failedto plead a section 11 or section 12(a)(2) violation with theparticularity required by the PSLRA.
Third, the defendants contend that the plaintiffs failed toplead their claims undersections 11 and 12(a)(2) of the '33 Act with the particularityrequired by Federal Rule of Civil Procedure Rule 9(b) for claimssounding in fraud. Because the plaintiffs, in their amendedcomplaint, specifically state that claims do not allege fraud,this ground for dismissal will require the court to determine ifthe amended complaint nonetheless sounds in fraud.
Last, the defendants contend that the plaintiffs' allegationsthat the Registration Statement contained materialmisrepresentations or omissions fail to state a claim undersections 11 or 12(a)(2) of the '33 Act and, as such, the amendedcomplaint should be dismissed pursuant to Rule 12(b)(6) of theFederal Rules of Civil Procedure. In connection with itsargument that the complaint fails to state a claim, the AdamsGolf defendants further argue that the plaintiffs have failed toallege facts demonstrating that defendants qualify as "statutorysellers," as required for plaintiff's section 12(a)(2) claim andthat the plaintiffs have failed to allege facts demonstratingthat defendants qualify as "control persons," as required forplaintiffs section 15 claim.
The court's discussion is parsed into four main sections below.First, the court sets forth the proper legal standard for amotion to dismiss. After summarizing the legal underpinnings ofplaintiffs' three claims, the court next addresses the thresholdissue of standing. The court then considers the procedural issueof whether plaintiffs' have pleaded their allegations withsufficient particularity. Last, the court addresses thesubstantive issue of whether the complaint states a claim underthe '33 Act.
A. Standard of Decision
Under Rule 12(b)(6), a count of a complaint may be dismissedfor failure to state a claim upon which relief may be grantedonly if, when accepting all of the plaintiffs' factualallegations as true and drawing all reasonable inferences fromthese facts in favor of the plaintiffs, no relief would begranted under any set of facts that could be proved. Conley v.Gibson, 355 U.S. 41, 45-46, 78 S.Ct. 99, 2 L.Ed.2d 80 (1957);Morse v. Lower Merion Sch. Dist., 132 F.3d 902, 906 (3d Cir.1997).
B. Summary of Plaintiffs' Claims
Plaintiffs' consolidated and amended complaint assertsviolations of §§ 11, 12(a)(2), and 15 of the '33 Act. Passed inthe aftermath of the stock market crash of 1929, the '33 Actcreates federal duties, most of which relate to registration anddisclosure obligations, in connection with public offerings.See Gustafson v. Alloyd Co., 513 U.S. 561, 570, 115 S.Ct.1061, 131 L.Ed.2d 1 (1995); Ernst & Ernst v. Hochfelder,425 U.S. 185, 195, 96 S.Ct. 1375, 47 L.Ed.2d 668 (1976) ("TheSecurities Act of 1933 . . . was designed to provide investorswith full disclosure of material information concerning publicofferings of securities in commerce, to protect investorsagainst fraud and, through the imposition of specified civilliabilities, to promote ethical standards of honesty and fairdealing."); Ballay v. Legg Mason Wood Walker, Inc.,925 F.2d 682, 690 (3d Cir. 1991) (citing Hochfelder, 425 U.S. at 195,96 S.Ct. 1375).
1. Section 11 of the '33 Act
Section 11 of the '33 Act creates a private cause of actionfor "any person acquiring [a] security" for which a registrationstatement contained an untrue statement of material fact or anomission of a material fact that is required to be statedtherein or necessary to make the statements therein notmisleading. 15 U.S.C. § 77k(a). A § 11 claim can bebrought against every person who signed the registrationstatement, the issuer of the securities, the issuer's directorsor partners, the underwriters of the offering, and accountantsnamed as having prepared or signed the registration statement.Id. According to the statutory language, a § 11 plaintiff doesnot need to establish a defendant's scienter, or evennegligence. Herman & MacLean v. Huddleston, 459 U.S. 375, 382,103 S.Ct. 683, 74 L.Ed.2d 548 (1983).
2. Section 12(a)(2) of the '33 Act
Section 12(a)(2) of the '33 Act creates a private cause ofaction against persons who offer or sell a security "by means ofa prospectus or oral communication" that includes an untruestatement of material fact or omits to state a material factnecessary in order to make the statements not misleading.15 U.S.C. § 771(a)(2). Liability under this section extends tothose who transfer title to the security and to those whosuccessfully solicit the purchase based on direct and activesolicitation. Id; In re Craftmatic Sec. Litig., 890 F.2d 628,636 (3d Cir. 1989) (citing Pinter v. Dahl, 486 U.S. 622, 108S.Ct. 2063, 100 L.Ed.2d 658 (1988), and adopting itsinterpretation of the scope of "seller" to include one whosolicits the sale as used in section 12(1) for the purposes of12(a)(2)); In re Westinghouse Sec. Litig., 90 F.3d 696, 717 n.19 (3d Cir. 1996) (discussing requirement that solicitation beactive and direct). Like § 11, there is no requirement under §12 that a plaintiff show defendant's scienter or negligence.Gustafson, 513 U.S. at 582, 115 S.Ct. 1061; Westinghouse, 90F.3d at 717 n. 20.
3. Section 15 of the '33 Act
Section 15 of the '33 Act extends liability under §§ 11 and 12to cover "control" persons. Specifically, § 15 provides that anyperson who, "by or through stock ownership, agency, orotherwise, or who, pursuant to or in connection with anagreement or understanding with one or more other persons by orthrough stock ownership, agency, or otherwise," controls anyperson subject to liability under §§ 11 or 12 may also bejointly and severally liable to the same extent as thecontrolled person, unless the controlling person "had noknowledge of or reasonable ground to believe in the existence ofthe facts by reason of which the liability of the controlledperson is alleged to exist." 15 U.S.C. § 77o. Section 15liability, therefore, is predicated on a primary violation of §11 or § 12 by a controlled person. See id.
C. Do the Non-Shockley Plaintiffs Have Standing to Sue Under Sections 11 or 12(a)(2) of the '33 Act?
Plaintiffs have stated that the Shockley plaintiffs are theonly plaintiffs who purchased their Adams Golf shares in theIPO, at the IPO price, directly from the underwriter defendants.Defendants contend that the remainder of the lead plaintiffs,who did not purchase shares in the IPO but instead purchasedtheir shares in the secondary market, lack standing to bringclaims under §§ 11 and 12(a)(2).
Because the language of the two sections is distinct and thushas been analyzed differently by the majority of courts thathave addressed the issue of standing, the court will address thestanding argument with respect to each of the sectionsseparately. See 15 U.S.C. § 77l(a) (statutory language of §12(a)(2) requires privity by limiting seller's liability "to theperson purchasing such security from him") (emphasis added);15 U.S.C. § 77k (broader statutory language of § 11 contains noprivity requirement and more broadly provides that "any personacquiring such security" may bring suit); See, e.g.,Hertzberg v. Dignity Partners, Inc., 191 F.3d 1076, 1081 (9thCir. 1999) ("while Section 11 and Section 12 are indeed parallelstatutes, their wording is significantly different as to who canbring a suit"); Joseph v. Wiles, 223 F.3d 1155, 1161 (10thCir. 2000) (analyzing Sections 11 and 12 separately).
1. Do the non-Shockley plaintiffs have standing under section 12(a)(2) of the '33 Act?
Defendants argue that according to both the Supreme Court inGustafson v. Alloyd Co., 513 U.S. 561, 115 S.Ct. 1061, 131L.Ed.2d 1 (1995), and the Third Circuit in Ballay v. Legg MasonWood Walker, Inc., 925 F.2d 682 (3d Cir.), cert. denied,502 U.S. 820, 112 S.Ct. 79, 116 L.Ed.2d 52 (1991), claims under §12(a)(2) are limited to initial distributions of securities (inthis case, the IPO) and, therefore, § 12(a)(2) claims that arebrought by plaintiffs who purchased securities on the secondarymarket must be dismissed. Plaintiffs seek to distinguishGustafson and Ballay from the instant case and argue thatthese cases do not divest them of § 12(a)(2) standing. As setforth more fully below, the court finds that the holdings ofGustafson and Ballay mandate that the non-Shockleyplaintiffs lack standing to bring claims under § 12(a)(2).
In Ballay, investors who bought market securities from LeggMason sued the brokerage firm for alleged oralmisrepresentations concerning the book value calculation ofsecurities that they sold. The district court entered judgmenton a jury verdict, awarding investors damages on their claimunder § 12(2) of the '33 Act.1 On appeal, the ThirdCircuit, after reviewing the language and legislative history of§ 12(2), held that § 12(2) does not afford a remedy to a buyerof securities in the secondary market, but was designed toprovide a remedy only to buyers of securities at the initialdistribution. Ballay, 925 F.2d at 684. The Ballay courtdetermined that § 12(2)'s language requiring that the defendantsold a security through a "prospectus or oral communication,"refers only to the transmittal of information concerning thesale of the security in an initial distribution. Id. at 688.To further bolster its statutory interpretation, the ThirdCircuit went on to note that the congressional object of the '33Act was to regulate initial issuances, while the Exchange Act of1934 ("the '34 Act") was intended to regulate the secondarytrading of securities. Id. at 690.
In Gustafson, the Supreme Court considered the standingissue under § 12(2). The plaintiffs, sole shareholders of aprivately held corporation, purchased shares of stock from thesellers, pursuant to a private sale contract. They brought suitunder § 12(2), seeking rescission of the sale agreement on theground that the written sale agreement was a "prospectus" withinthe meaning of § 12(2) and contained material misstatements.Relying on the Third Circuit's decision in Ballay, thedistrict court granted the defendants' summary judgment motion,holding that "§ 12(2) claims can only arise out of initial stockofferings" and not from a private sale agreement. The Court ofAppeals vacated the judgment and remanded the case in light ofits holding that the inclusion of the term "communication" inthe '33 Act's definition of prospectus meantthat prospectus includes all written communications offering asecurity for sale. The Supreme Court reversed the Court ofAppeals, and adopted the Ballay court's interpretation of theword prospectus as "a term of art referring to a document thatdescribes a public offering of securities by an issuer orcontrolling shareholder." Gustafson, 513 U.S. at 584, 115S.Ct. 1061.
Plaintiffs urge this court to adopt a narrow reading of theholding of Gustafson and argue that the language defendantsrely on from the opinion is dicta. Specifically, plaintiffscontend that because of its factual context, Gustafson onlystands for the proposition that the '33 Act covers offerings ofpublic securities and not private placements. They argue thatthe holding of Gustafson does not distinguish between initialpublic offerings and later sales of publicly registeredsecurities because the plaintiffs in Gustafson wereparticipants in a private offering. Therefore, according to theplaintiffs, all of the reasoning and analysis in Gustafsonthat drove the Court to conclude that § 12(2) applies only toinitial public offerings and not to private or secondarysales is dicta that is not controlling upon this court.
While the argument that Gustafson's interpretation of §12(a)(2) does not bar § 12(a)(2) claims brought by aftermarketpurchasers has been adopted by a few courts, see, e.g. Feinerv. SS&C Technologies, Inc., 47 F. Supp.2d 250, 252 (Conn. 1999),it has not been adopted by the majority of courts. See Wardenv. Crown Amer. Realty Trust, No. Civ. A. 96-25J, 1998 WL725946, *2 (W.D.Pa. Oct. 15, 1998); In re Delmarva Sec.Litig., 794 F. Supp. 1293 (Del. 1992) (pre-Gustafson);Giarraputo v. UNUMProvident Corp., No. Civ. 99-301-PC, 2000 WL1701294, *9 (Me. Nov. 8, 2000).
Even if the court were to adopt the plaintiffs' argument thatGustafson does not preclude the non-Shockley plaintiffs' §12(a)(2) claims, Ballay remains the controlling law in theThird Circuit and compels the court to find that thenon-Shockley plaintiffs do not have standing under § 12(a)(2).As the defendants point out, the precise issue framed by theBallay Court was "whether section 12(2) of the Securities Actof 1933 affords a remedy to a buyer of securities in thesecondary market." Ballay, 925 F.2d at 684. The Ballay Courtheld that "Section 12(2) applies only to initial offerings andnot to aftermarket trading." Id. at 693. This holding was notdisturbed by the Supreme Court's opinion in Gustafson; ratherthe Gustafson Court cited Ballay with approval. Gustafson,513 U.S. at 566, 115 S.Ct. 1061.
This court, therefore, finds that the non-Shockley plaintiffsdo not have standing to bring their § 12(a)(2) claims and willdismiss that claim as to those plaintiffs.
2. Do the non-Shockley plaintiffs have standing under section 11 of the '33 Act?
Defendants next contend that the non-Shockley plaintiffs lackstanding under § 11, arguing, as they did with respect to §12(a)(2), that § 11 relief is only available to thoseindividuals who purchase their shares directly through the IPOsubject to the registration statement at issue. They principallybase their contentions on dicta in Gustafson and Ballaystating that, because the two sections share legislative historythat indicates that the entire '33 Act was designed by Congressto regulate initial offerings only, the issue of standing withrespect to § 11 claims should be interpreted in a manner that isconsistent with those courts' interpretation of standing under §12(a)(2); namely, that secondary market purchasers do not havestanding to bring § 11 claims either. See Gustafson,513 U.S. at 572, 115 S.Ct. 1061 ("It is more reasonable tointerpret the liability provision of the 1933 Act as designedfor the primary purpose of providing remedies for the violationsof obligations it had created. Indeed, §§ 11 and 12(1)-thestatutory neighbors of § 12(2)afford remedies for violations ofthose obligations"); Ballay, 925 F.2d at 691 ("All of thesesections [§§ 11, 12, and 13] deal with initial distributions. . . Congress' placement of section 12(2) squarely among the1933 Act provisions concerned solely with initial distributionsof securities indicates that it designed section 12(2) toprotect buyers of initial offers against fraud andmisrepresentation.").
Although Ballay, and arguably Gustafson, both decisionsthat considered only § 12(2), control this court'sinterpretation of standing under § 12(a)(2), neither holdingdirectly controls the court's interpretation of the standingrequirements of § 11.
Each of the Circuit Courts that had directly addressed thescope of § 11 prior to Gustafson, had uniformly allowed forrecovery under § 11 by purchasers in the secondary market. SeeVersyss Inc. v. Coopers & Lybrand, 982 F.2d 653, 657 (1st Cir.1992) (section 11 imposes liability "for the benefit even ofpurchasers after the original offering"); Barnes v. Osofsky,373 F.2d 269 (2d Cir. 1967); Columbia Gen. Inv. Corp. v. SEC,265 F.2d 559, 562 (5th Cir. 1959). However, since Gustafson,the issue of whether a plaintiff who purchases on theaftermarket has standing to pursue a § 11 claim has been thesubject of much debate in the district courts. Indeed, bothparties have pointed to district court opinions that supporttheir position on the issue. Compare Gannon v. Continental Ins.Co., 920 F. Supp. 566, 575 (N.J. 1996) (holding aftermarketpurchasers lacked standing under section 11), Gould v. Harris,929 F. Supp. 353, 358-59 (C.D.Cal. 1996) (same) and McKowan Lowe& Co., Ltd. v. Jasmine Ltd., 127 F. Supp.2d 516, 542 (N.J. 2000)(same) with Adair v. Bristol Tech. Sys., Inc., 179 F.R.D. 126,130-33 (S.D.N.Y. 1998) (holding aftermarket purchasers hadstanding under section 11) and In re Livent, Inc. NoteholdersSec. Litig., 151 F. Supp.2d 371, 435-36 (S.D.N.Y. 2001) (same)and Schwartz v. Celestial Seasonings, Inc., 178 F.R.D. 545,555-57 (Colo. 1998) (same).
Since Gustafson, each Circuit Court that has addressed theissue of whether aftermarket purchasers may proceed under § 11has determined that they may, so long as the securities weretraceable to an offering that was covered by the allegedly falseregistration statement. See Joseph v. Wiles, 223 F.3d 1155,1158-61 (10th Cir. 2000) (holding that aftermarket purchaser ofsecurities has standing to pursue § 11 claim so long as he canprove that the securities he bought were traceable to those soldin an offering covered by the false registration statement);Hertzberg v. Dignity Partners, Inc., 191 F.3d 1076, 1079-82(9th Cir. 1999) (same). Recent scholarly criticism supports thisinterpretation of the scope of § 11. See Brian Murray,Aftermarket Purchaser Standing Under 11 of the Securities Act of1933, 73 St. John's L.Rev. 633, 650 ("Following an initialflurry of decision after Gustafson which limited standingunder section 11 to purchasers on an IPO, the more recent andmore well-reasoned decisions allow aftermarket purchasersstanding to sue under section 11"); see also Vincent R.Cappucci, Misreading Gustafson Could Eliminate Liability UnderSection 11, 218 N.Y.J.L. 1 (Sept. 22, 1997).
This court finds the reasoning that supports decisions such asJoseph, Hertzberg, and Adair to be persuasive. Therefore,this court will adopt the view that aftermarket purchasers mayproceed under§ 11 so long as they can trace the purchase of their shares to apublic offering that is covered by the offending registrationstatement.
This reading of the scope of § 11 is supported by the text of§ 11 itself. Section 11(a) provides that where a registrationstatement containing material misstatements or omissionsaccompanies an SEC securities filing, "any person acquiring suchsecurity" may bring an action for losses caused by the defect.15 U.S.C. § 77k(a). Unlike § 12(a)(2), there is no privityrequirement and there is no language limiting the claims tothose investors who purchase their shares in an initial publicoffering. Rather, the natural reading of "any person acquiringsuch security" is that the plaintiff must have purchased, atsome point, a security issued under the registration statementat issue.
As noted by the Ninth Circuit in Hertzberg and the TenthCircuit in Joseph, this reading is also supported by otherportions of § 11. For example, § 11(a), as amended in 1934,requires that a person who acquires the security "after theissuer has made generally available to its security holders anearnings statement covering a period of at least twelve monthsbeginning after the effective date of the registrationstatement," must prove reliance on the registration statement inorder to recover. 15 U.S.C. § 77k(a). In light of thisrequirement, to interpret § 11 as inapplicable to registeredsecurities that were purchased on the secondary market, wouldmake this section applicable only to continuous offerings thatextend beyond twelve months, offerings which were and are quiterare. Joseph, 223 F.3d at 1159. Moreover, § 11(e), thesection's damages provision, also seems to contemplate thataftermarket purchases of registered securities are covered, whenit sets the baseline for damages measurements at "the amountpaid for the security (not exceeding the price at which thesecurity was offered to the public)." 15 U.S.C. § 77k(e).Similarly, § 11(g) caps the maximum recoverable damages at "theprice at which the security was offered to the public." Id. at77k(g). As noted by the Ninth Circuit, such provisions "would beunnecessary if only a person who bought in the actual offeringcould recover, since, by definition, such a person would havepaid `the price at which the security was offered to thepublic.'" Hertzberg, 191 F.3d at 1080.
The court's finding that § 11 claims can be brought byaftermarket purchasers who can demonstrate that they purchasedtheir securities pursuant to the registration statement does notfrustrate the fundamental distinction between the scope of the'33 Act, which was meant to regulate the initial distribution ofsecurities, and the '34 Act, which regulates trading in the openmarket. See, e.g., Gustafson, 513 U.S. at 571-73, 115 S.Ct.1061; Blue Chip Stamps v. Manor Drug Stores, 421 U.S. 723,752, 95 S.Ct. 1917, 44 L.Ed.2d 539 (1975); United States v.Naftalin, 441 U.S. 768, 777-778, 99 S.Ct. 2077, 60 L.Ed.2d 624(1979). Where plaintiffs can trace their shares to the initialoffering, the alleged misrepresentation that violates the '33Act took place in the public offering, even though the shareswere purchased on the open market. See Joseph, 223 F.3d at1159 (citing Columbia Gen. Inv. Corp., 265 F.2d at 562).
Defendants, nonetheless, argue that language from Shapiro v.UJB Fin. Corp., 964 F.2d 272, 286 (3d Cir. 1992), indicatesthat the Third Circuit supports their view that standing under §11 requires that the plaintiffs purchased their shares in theinitial distribution. Specifically, the quoted language inShapiro states that "[i]f plaintiff's shares were purchased inthe secondary market, they would not be linked to a registrationstatement filed during the class period, and the § 11 claimwould fail." Shapiro, 964 F.2d at 286. The court finds thatthe defendants' reliance on this out-of-context statement fromShapiro is misplaced; Shapiro does not support theproposition that the Third Circuit does not recognizeaftermarket purchaser's standing under § 11. Rather, Shapirois an endorsement of the "tracing" theory, and has been sorecognized by other courts. See Joseph, 223 F.3d at 1160(citing Shapiro when discussing how requiring that aftermarketpurchaser to demonstrate that he/she can trace their purchaseback to the offending registration statement satisfies thestanding requirements of § 11).
First, it should be noted that although defendants citeShapiro for the proposition that a § 11 claim requires theplaintiffs to purchase their shares in the initial publicoffering, the court in Shapiro did not dismiss the plaintiffs'§ 11 claim on that ground. Rather, the Shapiro court held thatif the plaintiffs could prove that they could trace their sharesto a false of misleading registration statement, they couldrecover, even when they did not purchase their shares in theinitial offering.
In order to understand the Shapiro court's language, onemust look to the context of the court's statement. The sectionof Shapiro that precedes and follows the above quoted languageis fully set forth below:
Under § 11 of the Securities Act, any person acquiring a security issued pursuant to a false or misleading registration statement may recover damages. Plaintiffs allege that they purchased UJB stock "pursuant to" a DRISP registration statement. The district court dismissed this claim, holding that although the plaintiffs need not prove their shares are traceable to a false or misleading statement at this early stage of the litigation, they must allege it. We agree that traceability must be alleged, but our review of plaintiffs' complaint leads us to conclude that this has been done. . . . At some point, plaintiffs may be able to prove that their DRISP shares came from treasury stock. [Therefore], the § 11 claim cannot be dismissed at this time.
Id. at 286.
The confusion about the meaning of Shapiro is due to thatcase's peculiar factual context. In Shapiro, the plaintiffsbrought claims under §§ 11 and 12(2) alleging that UJB'sDividend Reinvestment and Stock Purchase Plan (the "DRISP") andthe accompanying prospectus and registration statement werefalse and misleading. Under the DRISP, shareholders reinvestedtheir UJB dividends by purchasing additional UJB shares. "Someof these new shares were authorized but previously unissuedtreasury stock, but others were purchased by UJB in thesecondary market." Shapiro, 964 F.2d at 285-86. The court inShapiro held that if the DRISP shares could be traced to thetreasury stock, they would properly allege their § 11 claim.However, in the statement quoted by the defendants, the courtnoted that if the plaintiffs were only able to trace theirshares to the secondary market shares, which in this case wereshares already issued on the date of the misleading registrationstatement, they could not satisfy the tracing requirement andtherefore could not bring their § 11 claim.
Accordingly, the court will not dismiss the non-Shockleyplaintiffs' § 11 claims based on lack of standing.
D. Have Plaintiffs Stated Their Claims With Sufficient Particularity Under Federal Rule of Civil Procedure 9(b) and the PSLRA?
Defendants also assert that the plaintiffs have failed toplead their allegations with the particularity required byFederal Ruleof Civil Procedure 9(b) and the PSLRA. The court will addresseach of these contentions in turn.
1. Have plaintiffs stated their claims with sufficient particularity under Rule 9(b)?
Rule 9(b), in relevant part, provides that "[i]n all avermentsof fraud or mistake, the circumstances constituting fraud ormistake shall be stated with particularity." Fed.R.Civ.P. 9(b).Defendants argue that the plaintiffs' allegations of knowingmisstatements trigger the specificity requirements of Rule 9(b).Plaintiffs, while acknowledging that Rule 9(b) applies to claimsthat sound in fraud, argue that their complaint need not anddoes not sound in fraud; they assert rather that it merelyalleges that the Registration Statement and Prospectusnegligently or innocently omitted and misstated material factsin violation of §§ 11, 12(a)(2), and 15 of the '33 Act.
Plaintiffs are correct that allegations under §§ 11 and12(a)(2) need not satisfy any statutory scienter requirement;only a material misstatement or omission need be shown. SeeHuddleston, 459 U.S. at 382, 103 S.Ct. 683; Shapiro, 964 F.2dat 288; see also Shaw v. Digital Equip. Corp., 82 F.3d 1194,1223 (1st Cir. 1996) ("Fraud is not an element of a claim undereither Section 11 or 12(a)(2), and a plaintiff asserting suchclaims may avoid altogether any allegations of scienter orreliance."). Thus, the heightened pleading requirements ofRule 9(b) do not generally apply to § 11 and 12(a)(2) claims.However, the plain language of Rule 9(b), which covers all"averments" of fraud, extends to cover complaints where theplaintiffs' allegations nonetheless allege that the defendants'actions were fraudulent, intentional, or knowing. Shapiro, 964F.2d at 287-88. Therefore, when a plaintiff's § 11 and 12(a)(2)claims are grounded in fraud, the pleading requirements ofRule 9(b) apply. The proper inquiry, therefore, focuses on theallegations in the complaint.
Reviewing the complaint, the court finds that the plaintiffsmerely allege that the IPO offering materials includedmaterially false and misleading statements and omitted todisclose material facts relating to the gray market distributionof Adams Golf products and the oversupply of golf club inventoryat the retail level. Nowhere in the complaint do plaintiffs'allegations focus on or even refer to the defendants' state ofmind.
This case differs factually from Shapiro. There, theplaintiffs' complaint, which alleged violations of both the '33Act and under the anti-fraud statute, section 10(b) of the '34Act, consisted solely of references to intentional and recklessconduct and was therefore "devoid of allegations that defendantsacted negligently in violating Sections 11 and 12(2)." Id. at288. The same set of facts that were alleged to support theplaintiffs' fraud claims were used to support plaintiffs' claimsunder §§ 11 and 12(a)(2). In this case, plaintiffs did notinclude any fraud claims and instead only plead violations ofthe '33 Act, alleging only what is required under §§ 11 and12(a)(2) of the '33 Act — that statements or omissions in theAdams Golf Registration Statement were materially false ormisleading. Furthermore, nothing in the complaint suggests thatit was "artfully pleaded" to avoid the heightened pleadingrequirements. Because plaintiffs claims do not "sound in fraud"the court finds that the heightened pleading standard ofRule 9(b) is not applicable to the plaintiffs' claims in this case.
2. Have plaintiffs stated their claims with sufficient particularity under The PSLRA?
The Underwriter defendants contend that plaintiffs have failedto satisfy theheightened pleading standard of the PSLRA. These defendantspoint out that § 21(D)(b)(1) of the PSLRA requires that, inconnection with any private action arising under the statute inwhich plaintiffs allege to have been misled by defendants'untrue statements or omissions of material fact, "the complaintshall specify each statement alleged to have been misleading[and] . . . the reason or reasons why the statement ismisleading. . . ." 15 U.S.C. § 78u-4(b)(1).
Because §§ 11, 12(a)(2), and 15 do not require proof that thedefendants acted with a particular state of mind, the defendantsrely only on § 21(D)(b)(1) and not § 21(D)(b)(2)2 of thePSLRA in arguing that plaintiffs fail to plead their allegationswith the requisite particularity. The plaintiffs respond thatthe heightened pleading requirements for fraud under the PSLRAdo not apply in this case because the PSLRA applies only toclaims under the '34 Act and not to claims under to the '33 Act.As explained below, the plaintiffs are correct that §21(D)(b)(1) of the PSLRA applies only to '34 Act fraud claimsand does not apply to the claims raised in their complaint,which are wholly premised on the non-fraud provisions of the '33Act.
The PSLRA, passed by Congress in 1995, contains provisionsthat amend the '33 Act (Section 101(a), codified at15 U.S.C. § 77a et seq.) and the '34 Act (Section 101(b), codified at15 U.S.C. § 78a et seq.). While many of the provisions areidentical, the heightened pleading requirement, codified at15 U.S.C. § 78u-4(b)(1), is expressly limited to the '34 Act and isnot applicable to claims brought under the '33 Act. The preambleof § 21(D)(b)(1) of the PSLRA begins, "In any private actionarising under this title" and goes on to state that any materialstatements or omissions must be pleaded with particularity.15 U.S.C. § 78u-4(b)(1). The reference to "this title" is to TitleI of the Exchange Act of 1934 and not to the Securities Act of1933.
Despite this clear statutory language, the Underwriterdefendants rely on dicta from an unreported District ofMassachusetts case. In that case, the court noted thatprovisions of the PSLRA applied to § 11 claims. See Coopermanv. Individual, Inc., No. Civ. A. 96-12272, 1998 WL 953726, *7(Mass. May 27, 1998). In the following paragraph, withoutexplaining why the court determined that the PSLRA applied tothe case at hand, the court stated that despite the fact that"[d]efendants in this case failed to move for dismissal undereither Rule 9(b) or § 78u-4(b) . . . I note that the Complaintdoes satisfy § 78u-4(b). . . ." Id. Given that the text of thePSLRA is clear that it does not apply to §§ 11 or 12(a)(2), thecourt declines to rely on the cited language from Coopermanhere to find that the provisions of the PSLRA apply to claimsunder the '33 Act.
Moreover, even if the heightened pleading requirement didapply, the complaint is sufficiently detailed to meet thoserequirements. The complaint specifically highlights theallegedly false and misleading statements contained in theRegistration Statement and Prospectus in connection with thegray market sales and inventory oversupply, explains whyplaintiffs believe these statements were misleading, andalleges a factual basis for why plaintiffs contend that thedefendants could have known that the statements were false andmisleading at the time of the issuance of the RegistrationStatement and Prospectus.
E. Have Plaintiffs Stated a Claim Under Sections 11, 12(a)(2), and 15 of the '33 Act?
The defendants have three remaining arguments in support oftheir motions to dismiss. First, the Adams Golf defendants claimthat they do not qualify as "statutory sellers" as required by §12(a)(2) of the '33 Act. In connection with this defense, theyargue that the complaint did not allege that the Adams Golfdefendants were either in privity with the plaintiffs or hadimmediately, directly, and actively solicited their purchases.See Pinter v. Dahl, 486 U.S. 622, 623, 108 S.Ct. 2063, 100L.Ed.2d 658 (1988); In re Craftmatic Sec. Litig.,890 F.2d 628, 636 (3d Cir. 1989). Second, the Adams Golf defendants claimthat the plaintiffs failed to plead specific facts of "control"as required by § 15 of the '33 Act, arguing that plaintiffs'allegations of the defendant's status as director or seniorofficer of Adams Golf are insufficient to establish that thedefendant is a "control person." See Paracor Fin., Inc. v.General Elec. Capital Corp., 96 F.3d 1151, 1163 (9th Cir. 1996)(stating that mere status as an officer or director does notestablish "control"). Last, both sets of defendants argue thatplaintiffs have failed to state a substantive claim under §§ 11,12(a)(2), and 15 of the '33 Act because none of the statementsin the Registration Statement and Prospectus were untrue ormisleading when they were made. Because this last argument couldbe dispositive of all claims, the court will address it first.
As noted above, the plaintiffs' claims rest on two generaltheories. First, the plaintiffs allege that the defendantsfailed to disclose the existence of a gray market in Adams GolfTight Lies Clubs, whereby unauthorized discount retailers likeCostco acquired the Tight Lies Clubs and sold them at discountedprices. Plaintiffs claim that this gray market ultimately causedprice margins for Adams Golf to erode. While the RegistrationStatement and Prospectus did not specifically refer to the graymarket risk, it stated that "the Company does not sell itsproducts through price sensitive general discount warehouses,department stores, or membership clubs." Second, the plaintiffsallege that the defendants failed to disclose the fact thatthere was an industry-wide oversupply of inventory at the retaillevel at the time of the IPO. Adams Golf confirmed in an April12, 1999 press release that this oversupply condition weakenedclub sales industry wide. The Registration Statement andProspectus did not disclose this condition; it stated that"[t]he Company believes its prompt delivery of products enablesits retail accounts to maintain smaller quantities of inventorythan may be required with other golf equipment manufacturers."Plaintiffs assert that the failure to disclose this "excessretail inventory" was a material misrepresentation of AdamsGolfs present business condition and future business prospectsthat adversely affected the company's operating results.
1. Do the plaintiffs' gray market allegations state a claim under the '33 Act?
Plaintiffs allege that at the time of the IPO, theunauthorized, "gray market" distribution of Adams Golfs productsto retail discounters posed "a material risk to the company'sfuture results" that should have been disclosed in theRegistration Statement. Plaintiffs also claim that the existenceof gray market sales rendered thefollowing statements from the Registration Statement false ormisleading:
• "the Company limits its distribution to retailers that market premium quality golf equipment and provide a high level of customer service and technical expertise;"
• "The Company currently sells its products to on-and-off course golf shops and selected sporting goods retailers;"
• "the Company does not sell its products through price sensitive general discount warehouses, department stores or membership clubs;"
• "The Company believes its selective retail distribution helps its retailers to maintain profitable margins;"
In order to state a claim under the '33 Act, the plaintiffs mustallege that the registration statement contains a false ormisleading statement or omits a material fact.
Defendants contend that the plaintiffs have alleged nothingmore than that an unauthorized discount retailer obtained someAdams Golf clubs prior to the IPO and argue that the plaintiffs'gray market theory fails for two reasons. First, defendantsclaim, the challenged statements in the Registration Statementand Prospectus were true, were not misleading, and omittednothing that was required to be stated when the RegistrationStatement became effective on July 9, 1998. Second, defendantsassert that nothing alleged in the complaint raises an inferencethat Adams Golf should have or could have predicted that a graymarket in its products posed any material threat to Adams Golfsbusiness when the Registration Statement became effective.Defendants claim that the plaintiffs' claims are classic "fraudby hindsight" and that plaintiffs have simply worked back fromstatements made months after the IPO was completed to allegethat the state of affairs as they were perceived at that timemust have been the state of affairs on the effective date of theRegistration Statement. Adams Golf stated in its RegistrationStatement that it limits its distribution to retailers thatmarket premium quality golf equipment and that the Company doesnot sell its products through price sensitive general discountwarehouses. The court finds nothing in plaintiffs' allegationsindicating that each of the these representations made in theRegistration Statement were not true. Nowhere does the complaintallege that Adams Golf sold its products to Costco or authorizedits retailers to do so; rather, the plaintiffs complaint allegesthat authorized dealers and not Adams Golf, were "responsiblefor unauthorized distribution to discount retailers." P1. Compl¶ 28. It is noteworthy that the complaint itself defines "graymarket distribution" as "the unauthorized distribution of theCompany's products to discount retailers." Id. at ¶ 32(emphasis added). The very existence of this alleged gray marketis predicated on the selective distribution policy that AdamsGolf discussed in its Registration Statement; the alleged graymarket in Adams Golf products could not exist unless theCompany's distribution were selective and discounters wereunable to obtain Adams Golf products directly from Adams Golf.Therefore, the court finds that the facts alleged by theplaintiffs fail to demonstrate that any of the foregoingstatements made in the Registration statement were false.
Having found that the plaintiffs have failed to allege thatany of the statements made in the Registration Statement werefalse, the court next turns to the plaintiffs' claim that theRegistration Statement contained misleading misrepresentationsand material omissions that are actionable under the '33 Act.Plaintiffs attribute a great deal of significance to the factthat on June9, 1998, one month before the Effective Date of the RegistrationStatement, Adams Golf issued a press release stating that "AdamsGolf became concerned when it learned that Costco was sellingtheir Tight Lies fairway woods because Costco is not anauthorized distributor." According to the press release, AdamsGolf filed a Bill of Discovery against Costco on that same day"to determine whether Costco's claims that they had properlyacquired Adam's Tight Lies fairway woods for resale wereaccurate." The plaintiffs assert in their complaint that theRegistration Statement and Prospectus was materially false andmisleading because it stated that "`the Company does not sellits products through price sensitive general discountwarehouses, department stores, or membership clubs,' [when] infact, at the time of the IPO, Costco was obtaining and sellingto the golfing public significant numbers of Tight Lies clubs."Pl. Consol. and Am. Class Action Comp. ¶ 36.
As stated above, the court finds that the above statement isnot false; just because Costco was obtaining the clubs doesnot mean Adams Golf was selling the clubs to them. Moreover, thefiling of the Bill of Discovery and the issuing of the pressrelease are consistent with the defendants contentions that itwas in fact Adams Golfs policy not to authorize "distribution ofthe Company's products to discount retailers." Adams Golf fileda Bill of Discovery against Costco precisely because itmaintained a selective distribution strategy. In addition,although the '33 Act does not require proof of fraudulentintent, Adams Golfs disclosure of their investigation into thisincident in its press release undermines the allegations thatthe defendants sought to conceal or did conceal the existence ofan gray market for its products.
Adams Golf issued the allegedly false on misleadingRegistration Statement and Prospectus on July 9, 1998, andstated within that selective distribution was one of Adams Golfskey marketing policies. Six months later, on January 7, 1999, ina statement accompanying its projections of disappointing fourthquarter 1998 results, Adams Golf disclosed that "results hadbeen, were currently, and would continue to be materially,adversely affected by gray market distribution to discountretailers . . . [such as] membership warehouse club[s]." Id.at ¶ 40. Later that year, in the Company's' 1998 Form 10-KReport, filed with the SEC in March, Adams Golf stated that:
Despite the Company's efforts to limit its distribution to selected retailers, Adams Golf products have been found in a certain membership warehouse club, which the Company believes has obtained the products through the use of unauthorized distribution channels. Adams Golf has taken steps to limit this unauthorized distribution through the serialization of all Adams Golf club heads but does not believe the gray marketing of its products can be totally eliminated.
Plaintiffs assert that the foregoing chronology demonstratesthat the Adams Golf Prospectus failed to disclose and thusmisrepresented the following two facts: "(1) that gray marketingrepresented a material risk to the Company in that it posed athreat to the Company's earnings; (2) that gray marketingrepresented a material problem that could not be `totallyeliminated' by the Company's corporate controls." Id. at 1 42.
While the plaintiffs build their case around Adams Golfstatements appearing after the IPO date, in order to state aclaim for a material omission, the plaintiffs allegations mustidentify that this allegedundisclosed material risk was known and material at the time ofthe IPO. Zucker v. Quasha, 891 F. Supp. 1010, 1014 (N.J. 1995)(quoting Sinay v. Lamson & Sessions Co., 948 F.2d 1037, 1040(6th Cir. 1991)) ("A court evaluates whether the statement oromission was misleading at the time it was made . . . `Fraud byhindsight' . . . is not actionable."); see also CastlerockManagement Ltd. v. Ultralife Batteries, Inc., 68 F. Supp.2d 480,488 (N.J. 1999) ("omissions that create a misleading impression— particularly one that is misleading in hindsight — are notsufficient to constitute the basis of a securities action underSection 11 or Section 12(2)").
The plaintiffs' complaint does not plead facts that, ifproved, would demonstrate that at the time of the filing of theIPO, the Adams Golf defendants or the Underwriter defendants hadany reason to assume that the presence of a limited number ofgolf clubs at one discount retailer was anything more than anisolated incident or that the incident would have any materialsignificance. Drawing all favorable inferences from thewell-pleaded facts, the complaint pleads only that at the timeof the IPO, Costco had about 5,000 Tight Lies clubs and thatAdams Golf was investigating Costco's apparent acquisition ofTight Lies product. The complaint does not allege facts thatdemonstrate that, at the time of the IPO, Adams Golf should haveor did consider the presence of its clubs at Costco to beanything more than an isolated event. In sum, plaintiffs havenot alleged support for their proposition that the fact that anunauthorized discount retailer had illegally obtained a numberof Adams Golf clubs constituted a material risk at the time ofthe IPO, or a "known trend" threatening the Company's futuresales, that should have been disclosed. The securities lawsrequire that companies disclose known material facts; they donot require companies to disclose speculative facts that mighthave some material albeit unknown impact on future earnings.Craftmatic, 890 F.2d at 644. Accordingly, the court finds thatthe plaintiffs' allegations regarding the alleged "gray market"claim are insufficient to survive the defendants' Rule 12(b)(6)motions and will dismiss the complaint with respect to the thoseallegations.
2. Do the plaintiffs' industry oversupply allegations state a claim under the '33 Act?
Plaintiffs' second theory for relief under the securities lawsis that the Registration Statement and Prospectus containedfalse or misleading statements or omissions regarding theexistence of a retail level oversupply condition in the golfclub industry prior to the IPO offering. This theory focuses ontwo alleged wrongs by the defendants. First, Adams Golf failedto disclose material information regarding the levels of retailinventory in the golf equipment industry, generally. Second,this failure to disclose this general industry problem renderedfalse or misleading Adams Golfs firm-specific statements aboutits ability to deliver its products promptly to its retailersand about its prospects for future growth.
In support of their oversupply theory, plaintiffs allege thaton January 7, 1999, approximately six months after the IPO,Adams Golf disclosed that it would "offer extraordinary creditsto its own retailers, at the cost of millions of dollars, in anattempt to alleviate problems arising from those retailers'excess inventory." Pl. Consol. and Am. Class Action Comp. ¶ 49."Then, on April 12, 1999, in reporting disappointing results forthe first quarter of 1999, ending March 31, 1999, defendantsdisclosed that for at least 12 months . . . there had been an`oversupply of inventoryat the retail level' on an industry-wide basis." Id. at ¶¶ 43,49.
Inferring that since the April 12, 1999 disclosure stated thatthe oversupply had existed for at least 12 months, and thattherefore the defendants must have known about the conditionprior to the July 9, 1998, Effective Date of the RegistrationStatement and Prospectus, the plaintiffs allege that thefollowing statements from the Registration Statement areactionable under the '33 Act as being false or misleading:
• "The Company believes its prompt delivery of products enables its retail accounts to maintain smaller quantities of inventory than may be required with other golf equipment manufacturers;"
• "In 1997, wholesale sales of golf equipment in the U.S. reached an estimated $2.4 billion. Wholesale sales of golf clubs increased at an estimated compound annual growth rate of approximately 13% over the 5-year period from 1992-1997. The Company believes that a number of trends are likely to further increase the demand for Adams' products. These trends include: (i) significant growth in the number of golf courses; (ii) increasing interest in golf from women, junior, and minority golfers; (iii) the large numbers of golfers entering their 40s and 50s, the age when most golfers begin to play more often and increase their spending on the sport; (iv) the correspondingly large population of `Echo Boomers,' who are beginning to enter their 20s, the age of when golfers generally take up the sport; and (v) the rapid evolution of golf club designs and materials;"
Plaintiffs assert that not only did the Registration Statementand Prospectus fail to indicate that Adams Golf retailers werecarrying excess inventory, the first of the above statementsfrom the Registration Statement materially misled the marketthat the opposite was the case. Id. at ¶ 49. Plaintiffsfurther contend that the defendants should have disclosed theindustrywide retail oversupply problem in the RegistrationStatement and that their failure to do so, especially in lightof all the other risks relating to competition and industryfactors that were disclosed, was an omission of material fact inviolation of the '33 Act. See id. at ¶¶ 45-48.
In support of the plaintiffs' claim that this fact was bothmaterial and that it was known or knowable by Adams Golf priorto the IPO, the complaint (i) notes that "various sources haveinformed plaintiffs that, prior to the IPO, competitors of AdamsGolf had begun to take corrective action to address theindustry-wide oversupply of equipment," id. at ¶ 50, and (ii)references an April 13, 2000 article from the Wall StreetJournal, which analyzes golf industry trends for the pastdecades and concludes that "industry revenue growth in the 1990swas achieved by `milking money out of its cash cows — avidgolfers who play at least 25 times a year — withever-more-costly equipment and playing fees.'" Id. at ¶¶ 51-54.
In their briefs the defendants counter that they had no dutyto disclose industry-level trends, but only had a duty todisclose material risks regarding Adams Golf itself. Therefore,with respect to the alleged omissions, defendants contend thattheir failure to disclose industry trends is not actionable.See Whirlpool Fin. Corp. v. GN Holdings, 67 F.3d 605 (7th Cir.1995) (finding that nondisclosure of industrywide trends is nota basis for a securities claim); Wielgos v. Commonwealth EdisonCo., 892 F.2d 509, 515 (7th Cir. 1989) (noting that"[s]ecurities laws require issuers to disclose firm-specificinformation;investors and analysts combine that information with knowledgeabout the competition, regulatory conditions, and the economy asa whole to produce a value for stock."). The defendants alsorespond that even if there were a duty to disclose industrytrends, there are no facts alleged that demonstrate that theinformation that plaintiffs contend should have been disclosedwas known or even knowable on July 9, 1998. Instead, theplaintiffs assume that the pattern of macro-economic factorsperceived in April 1999 were just as visible and obvious on July9, 1998 and should have at that time been seen to have certainmaterial effects on the company's future performance. SeeCraftmatic, 890 F.2d at 644 (holding that where there was noallegation that management had any reliable forecasts regardingmatters plaintiffs urged should have been disclosed, failure todisclose not actionable because it would have been so"speculative and unreliable" as to be immaterial).
The defendants go on to specifically address the allegedmisrepresentations. First, defendants note that the allegedlyfalse or misleading statement that "[Adams Golfs] promptdelivery of products enables its retail accounts to maintainsmaller quantities of inventory" than retailers of Adams Golfcompetitors is both relative and qualified. Such a statement,defendants argue, cannot be false or misleading as to AdamsGolfs retailers' inventory levels, because it does not make anyrepresentation about this fact. It merely states that AdamsGolfs business practice of prompt delivery enables its retailersto maintain a relatively smaller inventory.
The complaint alleges no facts indicating that Adams Golf didnot deliver its products to its retailers in a prompt fashion orthat this policy did not enable Adams Golf retailers to carryrelatively less inventory as compared to its competitors'retailers. Therefore, the court presumes that plaintiffs do notchallenge the truth of the statement, but rather allege that itis misleading. Moreover, the court agrees with the defendantsthat the plaintiffs have alleged no facts that could demonstratethat this statement of an Adams Golf business strength thatgives it an advantage over its competitors is misleading.
With respect to plaintiffs' contention that the secondstatement, a forward-looking expression of belief that certainfactors and positive trends in the golf industry bode well forthe company's future growth prospect, is "misleading withrespect to the prospects for growth in the golf industry," P1.Am. and Consol. Comp. at ¶¶ 44, 51, the defendants raise threearguments. First, in order to be actionable, the challengedstatements must mislead a reasonable investor as to theprospects of Adams Golf — not the golf industry, generally.Whirlpool, 67 F.3d at 609. Second, the statement Adams Golfmade about itself is merely an expression of vaguely optimisticbelief that these factors would positively influence demand forits products, and is therefore too vague to be actionable. SeeIn re Burlington Coat Factory Sec. Litig., 114 F.3d 1410, 1427(3d Cir. 1997) (stating that generally optimistic statementsregarding growth prospects constitute nothing more than pufferyand are not actionable under federal securities laws). Third,this statement cannot be actionable because, under the "bespeakscaution" doctrine, which holds that if "an offering document'sforecasts, opinions or projections are accompanied by meaningfulcautionary statements," those forecasts cannot be the basis of asecurities claim unless it is reasonable to assume that thestatements affected the total mix of information the documentprovided investors. In re Donald J. Trump Casino Sec. Litig.,7 F.3d 357, 364 (3d Cir. 1993). It is undisputed that AdamsGolfs statements concerningthe golf equipment industry were accompanied by the disclosureof certain cautionary statements concerning the investment risksassociated with investing in a golf equipment maker based onsuch factors as decline in demand, pressure on sales marginsfrom reduced consumer spending, and market competition. Thedefendants argue that in light of its contemporaneous disclosureof these risks, Adams Golfs forward-looking statements of beliefas to general industry trends cannot be considered misleading.
Plaintiffs do not allege that Adam's Golf retailers had anexisting oversupply of golf clubs at the time of the IPO. Theyonly allege that there was a problem in "the industry." Thecourt's analysis begins with the proposition that Adams Golfdoes not have the absolute duty to disclose industry-widetrends. Rather, it is Adams Golfs duty under the securities lawsto disclose in its Registration Statement and Prospectus allmaterial facts with respect to Adams Golf that were known orknowable at the time of the IPO. Failure to do so is an omissionthat is actionable under the '33 Act.
The plaintiffs argue that three "facts" alleged in thecomplaint support their allegation that Adams Golf had knowledgeat the time of the IPO that an industry-wide trend of oversupplywas a material risk to its performance. Those facts are that:(i) plaintiffs' "sources" indicate that other competitors wereaddressing the oversupply issue prior to July 9, 1998; (ii) anApril 2000 Wall Street Journal article analyzing trends in golfconcludes that the growth potential of the market in the 1990swas vastly exaggerated by companies within the industry; and(iii) Adams Golfs April 1999 disclosure states that "for atleast 12 months . . . there had been an `oversupply of inventoryat the retail level' on an industry-wide basis." Id. at ¶¶ 43,49.
The court finds that even when the truth of those facts areassumed, as they must be for the purposes of this motion, theydo not demonstrate that Adams Golf had any knowledge at thetime of its IPO that there was an existing industry-wide trendof oversupply that was or would be materially affecting AdamsGolf. The fact that competitors assessed a problem at that timewith their retailers, says nothing about the existence of anyproblems discoverable at that time by Adams Golf. Nor can theplaintiffs rely on the Wall Street Journal article from nearlytwo years after the Effective Date or Adams Golfs April 1999statement. With respect to those two supporting facts, the courtagrees with defendants that, even under the deferential standardof Rule 12(b)(6), one cannot reasonably infer from ex-postanalyses of macro-economic trends that factors which weredetermined as material based on a backward-looking analysis wereequally apparent and material at some earlier point in time.Accord Scibelli v. Roth, 98 Civ. 7228, 2000 WL 122193, *3,2000 U.S. Dist. LEXIS at *10 (S.D.N.Y. January 31, 2000)(dismissing Section 11 action and noting that plaintiffs'complaint failed to allege a securities violation because "[t]oinfer that Nortel possessed such information on July 24 becauseNortel announced such information on September 29 is not areasonable inference"); see also Zucker, 891 F. Supp. at 1016("Even Section 11, which provides strict liability against theissuer of stock for misstatements in the prospectus, does notimpose liability for the omission of material information whichwas unknown to, and not reasonably discoverable by, thedefendants.") (internal quotations omitted); In re Number NineVisual Tech. Corp. Sec. Litig., 51 F. Supp.2d 1, 17 (Mass. 1999)(plaintiffs "insufficiently alleged material misstatements basedsolely on the subsequentannouncement of inventory markdowns by [defendant]" eight monthsafter the initial public offering). Defendants cannot be subjectto liability under the securities laws for their failure topredict in the IPO documents facts that occurred or patternsthat were discerned after the IPO. See Castlerock,68 F. Supp.2d at 488 ("omissions that create a misleading impression— particularly one that is misleading only in hindsight — arenot sufficient to constitute the basis of a securities actionunder section 11 or section 12(2)") (citing Zucker,891 F. Supp. at 1017).
Having found that the defendants did not omit a material factin the Registration Statement, the court next turns to whetherany of the statements that were included were false ormisleading. The court agrees with the defendants that theforward-looking statements cited in the plaintiffs' complaintthat identify trends, which "the Company believes . . . arelikely to further increase the demand for Adams' products," arenot actionable as false or misleading under the "bespeakscaution" doctrine. While the plaintiffs argue that the riskfactors failed to include the specific risk of retailerinventory oversupply, the court has already found that theplaintiffs failed to allege sufficient facts indicating thatthis risk was known or knowable at the time of the offering.Therefore, the court finds here that Adams Golfs optimisticstatements were adequately tempered by the host of risk factorsthat accompanied it, such that they cannot be considered falseor misleading.
Accordingly, the court finds that the plaintiffs' allegationsregarding the alleged "inventory oversupply" claim areinsufficient to survive the defendants' Rule 12(b)(6) motionsand will dismiss the complaint with respect to the thoseallegations. Having now found that the plaintiffs have notstated a claim under either §§ 11 or 12(a)(2), the court iscompelled to find that the plaintiffs have not stated a claimunder § 15, because a § 15 violation requires, as aprerequisite, a violation of § 11 or § 12(a)(2).
The court first determined that plaintiffs' complaint ispleaded with sufficient particularity, that certain of theplaintiffs do not have standing under § 12(a)(2), and that allof the plaintiffs have standing under § 11 to the extent theycan prove that their shares are traceable to the IPO.
However, after reviewing the substance of the plaintiffsallegations, the court finds that the plaintiffs' allegationsare insufficient to withstand the defendants' motions todismiss. Even drawing all reasonable inferences in favor of theplaintiffs in assessing the defendants' motions to dismiss, thecourt is unable to find that the factual allegations in supportof either of plaintiffs' two theories state a claim forviolation of § 11, § 12(a)(2), or § 15 of the '33 Act. Thereforethe court will grant the defendants' motions to dismiss.Accordingly the court need not assess the other aspects of theAdams Golf defendants' motion challenging the adequacy of theallegations as to whether they qualify as "statutory sellers"for purposes of § 12(a)(2) and whether they qualify as "controlpersons" for purposes of § 15.
The court will enter an order in accordance with this opinion.
1. There is no substantive difference between a § 12(2) claimand a § 12(a)(2) claim; both refer to the same statute that wasrenumbered in 1995 when Congress added another subsection to §12. See Private Securities Litigation Reform Act of 1995,Pub.L. No. 104-67, § 105, 109 Stat. 737, 757 (codified at15 U.S.C. § 771). Therefore, § 12(2) claims now are numbered as §12(a)(2) claims.
2. Section 21(D)(b)(2) of the PSLRA mandates that in actionsarising under the statute "in which the plaintiff may recovermoney damages only on proof that the defendant acted with aparticular state of mind, the complaint shall . . . state withparticularity the facts giving rise to a strong inference thatthe defendant acted with the required state of mind."15 U.S.C. § 78u-4(b)(2).