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March 30, 1992


The opinion of the court was delivered by: Mihm, Chief Judge.


Before the court is Defendant's Motion to Dismiss for Failure to Adequately Allege Scienter pursuant to Federal Rule of Civil Procedure 9(b) and Defendant's Motion to Dismiss the Second Amended Complaint pursuant to Federal Rules of Civil Procedure 9(b) and 12(b)(6). For the reasons set forth below, the court denies Defendant's Scienter Motion to Dismiss and grants in part and denies in part Defendant's 9(b) and 12(b)(6) Motion to Dismiss.


Plaintiffs have brought this action pursuant to § 10(b) of the Securities Exchange Act of 1934 (15 U.S.C. § 78j(b)), Rule 10b-5 promulgated thereunder (17 C.F.R. § 240.10b-5), § 20 of the Securities Exchange Act (15 U.S.C. § 78t) and state law. This court has jurisdiction of this action pursuant to § 27 of the Securities Exchange Act (15 U.S.C. § 78aa) and pendent jurisdiction over the state law claims.


This is a security holders' class action on behalf of all persons, other than Defendants, who purchased or otherwise acquired the common stock of Caterpillar, purchased call options for Caterpillar common stock, or who sold or otherwise disposed of the put options for Caterpillar common stock between January 19, 1990 and June 26, 1990 (the "Class Period"). On June 25 and 26, 1990, Caterpillar stock dropped a total of $11 (20% of its market value) for an aggregate market loss of over $1 billion upon the disclosure of news that Caterpillar's second quarter net income would be lower than first quarter net income and would only constitute approximately 56% of Caterpillar's net income for the same period a year ago.

Plaintiffs allege in their Second Amended Complaint that the dramatic price drop resulted from the revelation of material facts which Defendants had previously concealed and which rendered their prior statements, via press releases, interviews, filings with the Securities and Exchange Commission, and annual and quarterly reports to shareholders, false and misleading. These alleged omissions and/or misrepresented facts included statements in connection with a plant renovation program called "Plant With a Future" (PWAF), a reorganization plan announced in January of 1990 referred to as the "January Reorganization," and the status of Caterpillar's Brazilian operations in the face of tremendous economic disruption in that country due to the effects of hyper-inflation and economic policies which the new Brazilian administration implemented on March 16, 1990 in an effort to stabilize the Brazilian economy.

I.  Defendant's Dispositive Motion to Dismiss for Failure to
    Adequately Allege Scienter Pursuant to Federal Rule of
    Civil Procedure 9(b).

In their Second Amended Complaint ("complaint"), Plaintiffs allege that Caterpillar violated § 10(b) and Rule 10b-5 by making fraudulent misrepresentations and omissions regarding Caterpillar's financial condition during the relevant class period. The issue before the court is whether Plaintiffs adequately pleaded the essential element of scienter in their § 10(b) action in order to meet the requirements of Federal Rule of Civil Procedure 9(b).

A district court may not grant a motion to dismiss for failure to state a claim "unless it appears beyond doubt that the plaintiff can prove no set of facts in support of his claim which would entitled him to relief." Scola v. Comdisco, Inc., 1991 WL 93268 at *1 (N.D.Ill., May 22, 1991), citing R.E. Davis Chemical Corp. v. Diasonics, Inc., 826 F.2d 678, 684-85 (7th Cir. 1987). "In making this determination, the court must accept as true all well-pleaded facts in the complaint and all inferences which may reasonably be drawn from them." Scola, 1991 WL 93268 at *1, citing Gray v. County of Dane, 854 F.2d 179, 182 (7th Cir. 1988).

Plaintiff alleges that Caterpillar violated § 10(b), which prohibits any person from using or employing "any manipulative or deceptive device or contrivance" in connection with the purchase or sale of a security, 15 U.S.C. § 78j(b), and Rule 10b-5, which makes it unlawful for any person, in connection with the purchase or sale of a security:

  (a) To employ any device, scheme, or artifice to
  defraud, (b) to make any untrue statement of a
  material fact or to omit to state a material fact
  necessary in order to make the statements made, in
  the light of the circumstances under which they
  were made, not misleading, or (c) to engage in any
  act, practice or course of business which operates
  or would operate as a fraud or deceit upon any
  person in connection with the purchase or sale of
  any security.

In Ernst & Ernst v. Hochfelder, 425 U.S. 185, 96 S.Ct. 1375, 47 L.Ed.2d 668 (1976), the United States Supreme Court ruled that the "intent to deceive, manipulate, or defraud," e.g., scienter, was required to establish a violation under § 10(b) and Rule 10b-5. 425 U.S. at 194, n. 12, 96 S.Ct. at 1381, n. 12. In Sundstrand Corp. v. Sun Chemical Corp., 553 F.2d 1033 (7th Cir. 1977), the Seventh Circuit expanded the element of scienter to include a "reckless omission of material facts upon which the plaintiff put justifiable reliance in connection with the sale or purchase of securities . . ." 553 F.2d at 1044. In Sundstrand, the Seventh Circuit applied an objective standard for recklessness articulated by the court in Franke v. Midwestern Oklahoma Development Authority, 428 F. Supp. 719 (W.D.Okla. 1976):

  [r]eckless conduct may be defined as a highly
  unreasonably omission, involving not merely
  simple, or even inexcusable negligence, but an
  extreme departure from the standards of ordinary
  care, and which presents a danger of misleading
  buyers or sellers that is either known to the
  defendant or is so obvious that the actor must
  have been aware of it.

Per the Franke definition, the Sundstrand court stated that:

  [t]he danger of misleading buyers must be actually
  known or so obvious that any reasonable man would
  be legally bound as knowing, and the omission must
  derive from something more egregious than even
  "white heart/empty head" good faith.

553 F.2d at 1045. In Sanders v. John Nuveen & Co., 554 F.2d 790 (7th Cir. 1977), the Seventh Circuit further defined what constituted reckless:

  [t]he definition of "reckless behavior" should not
  be a liberal one lest any discernible distinction
  between "scienter" and "negligence" be obliterated
  for these purposes. We believe "reckless" in these
  circumstances comes closer to being a lesser form
  of intent than merely a greater degree of ordinary
  negligence. We perceive it to be not just a
  difference in degree, but also in kind.

554 F.2d at 793.

The scienter element in a § 10(b) cause of action is subject to Federal Rule of Civil Procedure 9(b) which states in part that "in all averments of fraud or mistake, the circumstances constituting fraud or mistake shall be stated with particularity." The Second Circuit has described the purpose of this rule to be the following:

  (1) To provide a defendant with fair notice of the
  plaintiff's claim, (2) to protect a defendant from
  harm to his or her reputation or good will, and
  (3) to reduce the number of strike suits.

Cosmas v. Hassett, 886 F.2d 8, 11 (2nd Cir. 1989), citing Stern v. Leucadia National Corp., 844 F.2d 997, 1003 (2nd Cir.), cert. denied, 488 U.S. 852, 109 S.Ct. 137, 102 L.Ed.2d 109 (1988).

The leading Seventh Circuit case regarding the requirement for pleading scienter is DiLeo v. Ernst and Young, 901 F.2d 624 (7th Cir. 1990). In DiLeo, the court refers to the "particularity" requirement of Rule 9(b) by stating:

  [a]lthough states of mind may be pleaded
  generally, the "circumstances" must be pleaded in
  detail. This means the who, what, when, where, and
  how: the first paragraph of any newspaper story.

901 F.2d at 627. The DiLeo court was particularly concerned with the disclosure of circumstances that would separate fraud from the benefit of hindsight. Id. at 628. In that case, the plaintiff claimed that Continental Bank's auditors had violated Rule 10b-5 by certifying fraudulent financial statements and aiding and abetting the primary violator, the Bank. DiLeo, 901 F.2d at 626. The Seventh Circuit affirmed the district court's dismissal of the complaint after plaintiff failed to plead any facts by which the court could infer fraud and distinguish that inference from what appeared to be an accounting firm's failure to recognize that the Bank's loan reserves needed to be increased. Plaintiff failed to allege why this need should have been apparent sooner and why failure to increase the reserves amounted to fraud. Under the aider and abettor theory, plaintiff failed to establish how the accounting firm had a duty to disclose this information or how it had the requisite scienter, given that the complaint contained no direct or circumstantial evidence of scienter. Given the facts of that case, the court found that defendants had nothing to gain from the deceit and therefore no credible motive. 901 F.2d at 629.

Scienter must be pleaded in one of three ways. First, a plaintiff may plead direct evidence of scienter. Renovitch v. Kaufman, 905 F.2d 1040, 1046 (7th Cir. 1990). If the plaintiff fails to produce direct evidence, the court should examine whether there is indirect evidence of scienter by considering whether the fraud was in the interest of the defendants or whether the defendants had a motive to defraud. See Renovitch, 905 F.2d at 1046; DiLeo, 901 F.2d at 629; Barker v. Henderson, Franklin, Starnes & Holt, 797 F.2d 490, 497 (7th Cir. 1986); In re First Chicago Corp. Secur. Litigation, 769 F. Supp. 1444, 1455 (N.D.Ill. 1991). Third, if plaintiff fails to demonstrate the possibility of motive or self-interest, he must demonstrate scienter by alleging circumstances which provide a factual foundation for otherwise conclusory allegations of scienter. Kas v. Chase Manhattan Bank, N.A., CCH Fed.Sec.L.Rep. ¶ 95,381 at 96,864, 1990 WL 113185 (S.D.N.Y. 1990). These factual allegations "must give rise to a `strong inference' that the defendants possessed the requisite fraudulent intent." Id., citing Beck v. Manufacturers Hanover Trust Co., 820 F.2d 46, 50 (2nd Cir. 1987), cert. denied, 484 U.S. 1005, 108 S.Ct. 698, 98 L.Ed.2d 650 (1988). If the fraud alleged does not appear to contain a motive or if the motive appears to be irrational, plaintiffs must make a very strong showing of other circumstances of scienter. DiLeo, 901 F.2d at 629.

In their motion to dismiss, Defendants argue that Plaintiffs' allegations of scienter are "boilerplate," conclusory, and insufficient to satisfy the standards set by the Seventh Circuit and Rule 9(b). Defendants allege that in the absence of direct evidence, Plaintiffs have failed to provide evidence of motive to defraud or other circumstantial evidence which raises a strong inference of fraud.

Defendants allege that the Seventh Circuit has affirmed that boilerplate and conclusory allegations of scienter will not suffice. Robin v. Arthur Young & Company, 915 F.2d 1120, 1127 (7th Cir. 1990), cert. denied, ___ U.S. ___, 111 S.Ct. 1317, 113 L.Ed.2d 250 (1991) (court held that assertions that the defendant had knowledge of the misstatements "are nothing more than rote conclusions"); DiLeo v. Ernst and Young, 901 F.2d at 629 (court held that "rote conclusions" and "boilerplate" do not suffice); First Chicago, 769 F. Supp. at 1454 (court held that conclusory allegations "will not satisfy Rule 9(b)").

In response, Plaintiffs argue that Rule 9(b) itself explicitly states that the "condition of mind of a person may be averred generally." See Carter v. Signode Industries, Inc.,

In the instant case, Plaintiffs distinguish DiLeo v. Ernst and Young, 901 F.2d 624 (7th Cir. 1990) by stressing that the plaintiffs in that case failed to plead any allegations from which one could infer that defendants knew or should have known that the bank's loan loss provisions were unreasonable. Plaintiffs also distinguish Robin v. Arthur Young and Co., 915 F.2d 1120 (7th Cir. 1990) on its facts. In that secondary liability case, the court ruled that plaintiff's claim that Arthur Young should have known that the prospectus was false and misleading was a conclusory allegation which failed to plead fraud with sufficient particularity. Noting that Arthur Young would not have discovered this evidence even through routine audit, the court held that plaintiffs failed to allege how Arthur Young was supposed to discover the misleading evidence. 915 F.2d at 1127.

Plaintiffs also distinguish First Chicago by explaining that, in that case, plaintiffs simply quoted documents and alleged that the statements made therein were untrue without actually explaining how or why they were false representations. 769 F. Supp. at 1453-54. In the instant case, Plaintiffs argue that they have provided numerous factual allegations which allege what, why, and how statements and omissions were fraudulent.

Lacking direct evidence, Plaintiffs' complaint concentrates on establishing motive and circumstantial evidence which may infer scienter. Defendants argue that Plaintiffs' attempt to allege motive fails. They deny that status as officers gives rise to an inference of motive to commit fraud. Defendants state that DiLeo and its progeny make clear that Plaintiffs cannot sidestep Rule 9(b) by making conclusory allegations that could be leveled against any officer of any company. Instead, Plaintiffs must plead specific facts that separate ordinary business reverses from fraud in this case. 901 F.2d at 627.

Defendants also argue that Plaintiffs' alleged motive is irrational because the individual Defendants had too much to lose both monetarily and in terms of prestige and reputation to engage in fraud. Defendant contends that this is particularly so in light of the fact that they voluntarily disclosed the alleged withheld information on June 25, 1990. Defendants cite DiLeo, where the court ruled that because defendant accounting firm's greatest asset was its reputation for honesty, it would have been irrational for the firm to have joined cause with the primary violators. 901 F.2d at 629.

Plaintiffs argue that their allegation of motive contained in ¶ 14 of the complaint provides a non-exhaustive list of reasons why senior insiders such as Defendants have a motive to cover up financial problems plaguing the company during their stewardship. See Morse v. Abbott Laboratories, 756 F. Supp. 1108, 1111 (N.D.Ill. 1991), where the court held:

  [u]nlike DiLeo, the individual defendants, all
  directors and/or senior officers, have incentive to
  withhold disclosure of material information which
  would have had an adverse effect on [the company].

In that case, defendants were in possession of adverse information regarding Food and Drug Administration sanctions against the company due to regulatory violations on the part of Abbott Laboratories and failed to disclose this material information during the class period.

In the instant case, Plaintiffs contend that Defendants' voluntary disclosure at the end of the class period does not negate an incentive to delay as long as possible disclosure of the adverse news. Plaintiffs distinguish Defendants' reference to Goldberg v. Freedom Federal Savings Bank, 1989 WL 8503 at *3 (N.D.Ill., Jan. 31, 1989), aff'd sub. nom. Goldberg v. Household Bank FSB, 890 F.2d 965 (7th Cir. 1989) (the court held that "management candor officiates any inference of willful intent.") In the Goldberg case, the court found that defendants promptly disclosed the material information upon reasonable ...

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