The opinion of the court was delivered by: JAMES H. ALESIA
MEMORANDUM OPINION AND ORDER
Plaintiffs Henry T. Endo ("Endo") and John Lesch ("Lesch")
brought this action against defendants Fruit of the Loom, Inc. ("Fruit of the Loom" or "the Company"), various directors and officers of Fruit of the Loom (collectively "Officer and Director defendants") including William F. Farley ("Farley"), John M. Albertine ("Albertine"), William K. Hall ("Hall"), Richard M. Cion ("Cion"), Leon D. Black ("Black"), Douglas M. Kinney ("Kinney"), and Robert J. Meier ("Meier"), accounting firms Arthur Andersen & Co. ("AA&Co.") and Arthur Young & Co. ("AY&Co."), investment banking firms Drexel Burnham Lambert, Inc. ("Drexel Burnham"), Merrill Lynch Capital Markets ("Merrill Lynch"), E.F. Hutton & Co., Inc. ("E.F. Hutton"), Shearson Lehman Hutton, Inc. ("SLH"), and Dean Witter Reynolds, Inc. ("Dean Witter"), alleging nine counts involving securities fraud. Plaintiffs allege that, through a March 3, 1987 Registration Statement and Prospectuses, the various defendants disseminated false ad misleading statements or omitted to disclose material facts in relation to a public offering of securities made by Fruit of the Loom on March 3, 1987. Specifically, the plaintiffs allege that all of the various defendants violated § 10(b) of the Securities ad Exchange Act of 1934 (the "1934 Act") and Rule 10b-5 promulgated thereunder (Count I), § 11 of the Securities Act of 1933 (the "1933 Act") (Count II), committed common law fraud (Count IV), violated the Illinois Consumer Fraud and Deceptive Business Practices Act (the "Illinois Consumer Fraud Act") (Count V), acted negligently (Count VI), violated § 12 of the Illinois Securities law of 1953 (the "Illinois Securities law") and violated § 17(a) of the 1933 Act (Count VIII). Plaintiffs also allege that "certain identified defendants" violated § 12(2) of the 1933 Act (Count III) and that the Fruit of the Loom Officer and Director defendants breached their fiduciary duties of care, of undivided loyalty and of full disclosure of all material and germane facts (Count IX).
All of the defendants filed motions to dismiss the action against them. These motions were referred to Magistrate Judge Rosemond for a Report and Recommendation ("R&R"). Magistrate Judge Rosemond entered his R&R recommending that this court dismiss plaintiffs' Complaint. The plaintiffs subsequently submitted their objections to the R&R and the defendants responded with memoranda in opposition to plaintiffs' objections.
It is these objections and responses which are currently before the court.
For the reasons set forth below, the court sustains some of plaintiffs' objections ad overrules others ad dismisses part of plaintiffs' Complaint.
This case arises from a Registration Statement and Prospectuses issued by Fruit of the Loom on March 3, 1987. On that same date, Fruit of the Loom made a public offering consisting of 31,050,000 shares, including over-allotment options at $ 9.00 per share, of Class A Common Stock, $ 60 million principal amount of 6-3/4% convertible subordinated debentures due in the year 2002, ad $ 280 million principal amount, including over-allotment options, of 10-3/4% senior subordinated notes due in 1995. Also on that date, the plaintiffs bought 2,700 of the available 31,050,000 shares of Fruit of the Loom Class A Common Stock at $ 9.00 per share. Plaintiffs allege that they were induced by the Registration Statement and Prospectuses, which contained false statements or omitted to state material facts, to purchase their shares, and filed this nine-count Complaint against the various defendants.
In the various motions to dismiss, each defendant argued that the plaintiffs' Complaint failed to state a claim upon which relief can be granted pursuant to Federal Rule of Civil Procedure 12(b)(6). The defendants also moved to dismiss Counts I, II, IV, V and VII for failure to plead fraud with particularity as required by Rule 9(b) of the Federal Rules of Civil Procedure. The Magistrate Judge entered his R&R recommending that this court dismiss all counts of the Complaint for failure to state a claim for which relief can be granted and, alternatively, to dismiss Counts I, II, IV, V and VII for failure to comply with the requirements of Federal Rule of Civil Procedure 9(b).
Plaintiffs then timely filed their Objections to the R&R. Plaintiffs subsequently filed their Amended Objections to the R&R. The defendants then, collectively, filed their Memorandum in Opposition to plaintiffs' Amended Objections. Finally, plaintiffs filed their Reply Memorandum in Opposition to Magistrate Judge Rosemond's R&R. These objections and the opposition to these objections are currently before the court. The court will discuss each count in turn.
Before discussing each specific count, however, a brief synopsis of the legal standard applicable to this case is in order. A motion to dismiss will only be granted where it appears beyond doubt that plaintiffs can prove no set of facts in support of their clan that would entitle them to relief. Cruz v. Beto, 405 U.S. 319, 322, 31 L. Ed. 2d 263, 92 S. Ct. 1079 (1972); Rothner v. City of Chicago, 929 F.2d 297, 302 (7th Cir. 1991). An analysis of the facts is limited to the language of the complaint. The court may not consider opposing briefs which would alter the facts as alleged in the complaint. See Gomez v. Illinois State Bd. of Educ., 811 F.2d 1030, 1039 (7th Cir. 1987). The facts alleged in the complaint must be taken as true for purposes of the motion to dismiss. In addition, all such allegations must be viewed in a light most favorable to the plaintiffs. Gomez, 811 F.2d at 1039.
Furthermore, in this case, the court must also be cognizant of the standard to apply to the recommendation made by the Magistrate Judge in the R&R. Pursuant to 28 U.S.C. § 636(b)(1), this court must make a "de novo determination of those portions of the report . . . or recommendations to which objection is made." Therefore, this court will review plaintiffs' objections and make de novo determinations as to each. Each count and relevant objections will be discussed in turn.
A. Count One - Section 10(b) and Rule 10b-5
In this count, the plaintiffs allege that the defendants "acted in violation of § 10(b) . . . and Rule 10b-5 . . . by (a) employing devices, schemes and artifices to defraud; (b) making untrue statements of material fact and/or omitting to state material facts . . .; and (c) engaging in transactions, practices, or courses of business which operated as fraud or deceit upon plaintiffs." Complaint, at p. 22-23, P 42. In his R&R, the Magistrate Judge compared the wording of the Registration Statement and Prospectus regarding each specific instance of an alleged violation to the relevant paragraph in the Complaint. We will do the same as to each objection of the plaintiffs.
In paragraph 32 of their Complaint, plaintiffs stated that defendants violated § 10(b) by not stating the full tax obligation of Fruit of the Loom, as follows:
32. (a) Although at the time Fruit of the Loom filed and issued the Registration Statement, Prospectuses and Form 10-K defendants knew that Fruit of the Loom would be required to pay the Internal Revenue Service ("IRS") well over $ 100 million in tax deficiencies and that the Company would have to borrow funds to meet this tax obligation, defendants omitted to disclose adequately to the public this obligation, or the material impact of the payment of this obligation on the Company's financial condition.
(b) In the notes, accompanying Fruit of the Loom's financial statements, defendants stated that the Company had adequately provided for any additional tax deficiencies and interest. Defendants omitted to disclose that:
(i) the Company expected to pay more than $ 100 million to the IRS and would be required to borrow funds to pay this tax obligation; and
(ii) payment of this tax obligation and the debt obligation that would be incurred to pay these taxes would have a materially adverse effect on the Company's financial condition and statements.
Complaint, at p. 15-16, P 32.
PROSPECTUS - Income Taxes:
The Company has filed two petitions with the United States Tax Court contesting statutory notices of deficiencies. The first involves approximately $ 60,000,000 of alleged deficiencies covering the years 1970 through 1975, and the second approximately $ 45,000,000 for the years 1976 and 1977. In addition, the IRS has recently assessed the Company approximately $ 93,000,000 for alleged deficiencies covering the years 1978 through 1980. The IRS is currently examining the Company's tax returns for the years 1981 through 1983. The Company believes that its ultimate deficiency, before interest, will be substantially less than the amounts asserted and that it has adequately provided for any additional taxes and interest.
Income Taxes, Notes To Consolidated Financial Statements (Prospectus), at F-17, Exhibit A to the Complaint.
As to this allegation, the R&R states that the claim is "either contradicted or unsupported by the Prospectus, and, thus, . . . immaterial as a matter of law." R&R, at p. 10. In response, the plaintiffs state that the "Magistrate misconstrued plaintiff's allegations." Plaintiff's Amended Objections, at p. 10 (hereinafter "Objections"). Basically, the plaintiffs argue that the Magistrate Judge erred by merely adding the amounts of potential tax liability disclosed in the Prospectus (to wit, $ 60, $ 45, and $ 93 million). Plaintiffs argue this was incorrect because "the $ 93 million was totally unrelated to plaintiffs' allegations . . . . [Rather], the Prospectus was misleading because it expressly stated that the $ 105 million claimed for 1970 through 1977 was not expected to be assessed against the Company." Objections, at p. 6. The court has disregarded this argument. The relevant allegations of the Complaint, reproduced above, make no distinction as to the different years of tax liability. The Magistrate Judge correctly read the allegations exactly as stated in the Complaint. Plaintiffs' attempt to reconfigure their allegation in their memoranda accompanying this motion is improper, as stated above. See Gomez, 811 F.2d at 1039. However, our discussion of this claim cannot end there. Plaintiffs further alleged "that defendants knew that their [tax] liability would be of this magnitude, and knew their interest [liability] would be of this magnitude, and deliberately misled the public as to its size." Objections, at p. 10; Complaint, at p. 15-16, P 32. As to this claim, the court is persuaded, at this point, by the plaintiffs.
In his R&R, the Magistrate Judge found that the Prospectus contradicted this allegation because it disclosed potential tax liability of "more than $ 100 million." This is true. However, the Prospectus also states that "the Company believes that its ultimate deficiency, before interest, will be substantially less than the amounts asserted . . .". In fact, this turned out to be true, too, but the interest assessed turned out to be approximately $ 81 million -- nearly double the tax ultimately due. A close reading of the Complaint alleges that the defendants knew that their liability, including interest, would be over $ 100 million. So, while the relevant statements in the Prospectus in this regard are technically true, the plaintiffs may be able to prove facts in support of their claim which would entitle them to relief. If the plaintiffs can show that the defendants knew that the interest due the IRS would be such a significant amount, and intentionally failed to disclose this information, the court believes that plaintiffs may be able to succeed on a § 10(b) claim. Whether or not they are ultimately able to prove this is not a matter for the court to decide on a motion to dismiss. What matters is that it is possible, based only on the pleadings thus far. Therefore, the plaintiffs' objection to this portion of Count One is sustained.
Plaintiffs argue, next, in regards to the same section of the Prospectus, that that section also violates § 10(b) and Rule 10b-5 because it states that "the Company . . . has adequately provided for any additional taxes and interest," when in fact the Company knew that it would have to borrow substantial sums of money to pay any tax liabilities. The Magistrate Judge held that this statement could not be a violation of § 10(b) because "to the reasonable investor one obvious and adequate means of providing for payment of such a large sum of money is to borrow. Moreover, the Prospectus specifically states that a source of funds will be obtained from bank loans." R&R, at p. 9. This is not dispositive. The question, now, is not what a reasonable investor might think, but whether, taking all allegations as true and in a light most favorable to the plaintiffs, the plaintiffs can prove any set of facts showing a § 10(b) violation. To succeed on a motion to dismiss, the defendants must show, as a matter of law, that no reasonable investor would consider the statement or omission misleading. The defendants have not met that burden here. On the contrary, the court believes that based on these pleadings, the plaintiffs may he able to prove such a claim.
The defendants respond to plaintiffs' objections stating that the Magistrate Judge's conclusion was correct because "the Prospectus disclosed that the Company was highly leveraged, that the Company has historically borrowed money and had substantial debt, and the Prospectus nowhere suggested that the Company would not continue, as it had in the past, to borrow funds if necessary . . . ." Def. Memo. in Opp., at p. 8. This misses the point. In essence, the alleged misstatement is the claim in the Prospectus that the Company had "adequately provided for" its tax liabilities. The fact that the Company "had historically borrowed" does not complete the purported "half truth" of the claim in the Prospectus. It may be important to the reasonable investor to know whether or not Fruit of the Loom intended to borrow over $ 100 million to pay its tax liabilities. As it currently stands, there is nothing in the Prospectus to indicate that Fruit of the Loom would need to borrow funds to cover this liability. One reasonable assumption that can be made after reading that the Company "adequately provided for any additional taxes and interest" is that existing funds had already been allocated. When dealing with a debt in excess of $ 100 million, it is material whether or not additional borrowing is necessary to pay it off. In any case, at this point in the litigation, the court cannot say that no reasonable investor would consider this information important. As such, the court will not dismiss this portion of plaintiffs' Complaint.
Finally, regarding this element of Count One, the defendants rely on the fact that the Prospectus emphasized that any potential liability was pre-interest and that, thus, there was nothing misleading about it. This is not dispositive. The Prospectus stated that the Company believed that its ultimate tax liability, before interest, would he substantially less than the $ 105 million sought by the IRS. It follows, then, that if the Company knew that its tax liability would be substantially less than that assessed, it may have had some idea that interest still could be substantial. In the instant case, the interest alone turned out to exceed $ 80 million dollars -- a significant amount. This statement, then, could be construed to be a half-truth which could be shown to be a § 10(b) violation. Therefore, the court will not dismiss this portion of the claim.
2. Environmental Liabilities
PROSPECTUS - Contingent Liabilities:
The Company and its subsidiaries are involved in certain legal actions and claims on a variety of matters, including environmental matters relating to discontinued operations. The Company also remains contingently liable for $ 118,200,000 of certain obligations of former subsidiaries of the Company. The obligations of the former subsidiaries relate primarily to future minimum lease payments under operating leases and do not consider the value of the underlying leased property. It is the opinion of management that such actions and claims will not have a material effect on the business or financial condition of the Company.
Contingent Liabilities, Notes To Consolidated Financial Statements Prospectus), at F-12 and F-13, Exhibit A to Complaint.
During 1986, the Company sold Velsicol in a series of transactions for approximately $ 240,000,000 in cash, net of expenses. . . . No significant gain or loss resulted, or is contemplated to result, to either Northwest [Northwest Industries, Inc.] or the Company from these sales.
Because . . . of the sale of . . . Velsicol [and other companies] the financial information for these operations is presented as discontinued operations in these financial statements.
Discontinued Operations, Notes To Consolidated Financial Statements Prospectus), at F-18, Exhibit A to Complaint.
Litigation ad Contingencies. The Company and its subsidiaries are parties to certain legal proceedings and have retained certain liabilities with respect to the sale of certain discontinued operations, including "Superfund" and other environmental liabilities. The Company believes that these matters will not have a material effect on its business or financial condition.
Prospectus, at 19, Exhibit A to the Complaint. Magistrate Judge Rosemond found, based on these disclosures in the Prospectus and three newspaper accounts, that the "news-informed public knew exactly what the Prospectuses were referring to." R&R, at p. 13. Plaintiffs objected, saying the Magistrate Judge made incorrect factual findings. In essence, plaintiffs argue that the Magistrate Judge incorrectly assumed that an ordinary investor would know, after reading the Prospectus, that Fruit of the Loom retained Velsicol's enormous environmental liabilities. In response, defendants argue that the ...