The opinion of the court was delivered by: RUBEN CASTILLO
This lawsuit involves a putative class action claiming securities fraud based on purported violations of Section 10(b) and Section 20(a) of the Securities and Exchange Act of 1934, 15 U.S.C. §§ 78j(b) and 78t, and Securities and Exchange Commission Rule 10(b)(5). Plaintiffs assert a fraud-on-the-market theory. No answer has been filed and no counterclaims are pending. Defendants have filed a Motion to Dismiss all counts of the Consolidated Class Action Complaint ("Consolidated Complaint"), pursuant to Federal Rule 12(b)(6). Plaintiffs seek certification of the class. For the reasons given below, the Court grants the Motion to Dismiss (doc. # 40-1). The Plaintiffs' Motion for Class Certification is also granted (doc. # 46-1).
A motion to dismiss tests the sufficiency of the complaint, not the merits of the suit. Triad Ass'n. Inc. v. Chicago Housing Auth., 892 F.2d 583, 586 (7th Cir. 1989), cert. denied, 498 U.S. 845, 112 L. Ed. 2d 97, 111 S. Ct. 129 (1990). All well-pleaded facts are taken as true, all inferences are drawn in favor of the plaintiff and all ambiguities are resolved in favor of the plaintiff. Dawson v. General Motors Corp., 977 F.2d 369, 372 (7th Cir. 1992). In this case, Rule 9 of the Federal Rules of Civil Procedure requires the underlying facts of the lawsuit to be set out with particularity. Leatherman v. Tarrant County Narcotics Intelligence & Coordination Unit, 122 L. Ed. 2d 517, 113 S. Ct. 1160 (1993). The federal system of notice pleading does not favor dismissal for failure to state a claim. Gray v. County of Dane, 854 F.2d 179, 182 (7th Cir. 1988). In short, the only question is whether relief is possible under any set of facts that could be established consistent with the allegations. Bartholet v. Reishauer A.G., 953 F.2d 1073, 1078 (7th Cir. 1992), citing Conley v. Gibson, 355 U.S. 41, 45-46, 2 L. Ed. 2d 80, 78 S. Ct. 99 (1957).
Plaintiffs' well-pleaded allegations, which the Court takes as true for purposes of this Motion, are as follows. Defendant, Chemical Waste Management Company, Inc. ("CHW"), was formed as a wholly owned subsidiary by defendant WMX in 1978. In late 1986, all of WMX's domestic, hazardous waste management services were consolidated into CHW. On October 16, 1986, 37.8 million new CHW common shares were sold to the public in a registered initial public offering. As a result, CHW is a 77%-owned subsidiary of defendant WMX. Defendant Philip B. Rooney ("Rooney") has served as a director of CHW since 1986 and was, as of December 31, 1992, Chairman of the Executive Committee of the Board of Directors of the Company. Rooney has also served as President and Chief Operating Officer of WMX since November of 1984 and, since November of 1990, has served as Chairman of the Board and Chief Executive Officer of certain other WMX subsidiaries.
Plaintiffs purchased common stock in CHW between February 4, 1993 and September 3, 1993, inclusive (the "Class Period"). Plaintiff, H. Peter Kriendler ("Kriendler"), purchased 2,000 shares of CHW common stock on March 8, 1993, at a price of $ 18-7/8 per share. Kenneth L. Seposs ("Seposs") purchased .3213 shares at $ 15.00 per share. Plaintiff, James C. Tennison ("Tennison"), purchased 300 shares of CHW common stock on March 16, 1993, at a price of $ 17-5/8 per share and an additional 300 shares on May 7, 1993, at a price of $ 12-3/8 per share. Plaintiff, Howard Zuckerman ("Zuckerman"), purchased 2.74 shares of CHW common stock on April 1, 1993, at a price of $ 15.50 per share under a dividend reinvestment plan.
CHW's treatment and resource recovery operations involve processing chemical waste through the use of thermal and other treatment methods at one of the Company's facilities. Thermal treatment refers primarily to processes that use incineration as the principal mechanism for waste destruction. At the close of CHW's fiscal year ended December 31, 1992, the Company owned or leased incinerator facilities on the Southeast side of Chicago, Illinois; at Sauget, Illinois; and at Port Arthur, Texas. Prior to December 31, 1992, CHW had also applied to applicable regulatory authorities for permission to operate incinerators in California and Mexico.
One of the Company's thermal treatment facilities which used incineration is a rotary kiln incinerator located at 11700 Stony Island Avenue in South Chicago, Illinois (the "Stony Island Facility"). CHW received a permit for the destruction of chemical wastes, including polychlorinated biphyenyls ("PCBs") at the Stony Island Facility in late 1983. By December 31, 1992, CHW had experienced enormous continuing operating and regulatory problems at the Stony Island Facility, including the following.
In September of 1992, a Cook County grand jury indicted a CHW supervisor at the Stony Island Facility, Dale Gawlak ("Gawlak"), for allegedly altering waste labels to evade safety rules. In February of 1992, Gawlak publicly stated that CHW officials had told him to change the dates on the labels to avoid a requirement in a court order which limited the amount of hazardous waste that could be held at the Facility for more than ninety days. Gawlak was convicted on September 13, 1993, following a bench trial. Ultimately, CHW agreed to pay fines and penalties totalling an amount well in excess of $ 6,000,000, as a result of its operation of the Stony Island Facility, which is a state record.
Following the explosion in 1991, CHW agreed to keep the Stony Island Facility shut down until it received a Part B operating permit from the State of Illinois. The Company had previously applied to the Illinois Environmental Protection Agency ("IEPA") for a long-term permit for the Facility, but that application was denied in 1989 based upon ninety-six (96) deficiencies noted by the IEPA in the Company's application and proposed procedures for operating the Stony Island Facility. As of December 31, 1992, the Company was representing that it was continuing to seek a long-term permit. The Stony Island Facility has not been in active operation since the explosion in 1991, and as of February 4, 1993, there was no assurance that the Facility would ever again be in operation.
On February 4, 1993, CHW publicly announced and stated the results of its operations for fiscal year ended December 31, 1992, in a news release which was carried over major business and securities news services. In their year-end financial statements,
released on February 4, 1993, CHW reported the value of the Stony Island Facility at historical book value and made hopeful statements that they were holding discussions with regulatory authorities concerning the reopening of the Stony Island Facility. At the close of trading on February 4, 1993, CHW stock traded at $ 21 per share. Property, plant and equipment included CHW's incinerator facilities, which were reported in the financial statements at historical cost.
Several trends began developing in the hazardous waste industry in the 1990's, including a permanent shrinking in the demand for off-site hazardous waste incinerators, increasing efforts at conservation, pretreatment and recycling of hazardous waste, overcapacity for both hazardous waste landfills and incinerators, and the Environmental Protection Agency's strong preference for on-site treatment of hazardous wastes. The shrinking demand for hazardous waste incinerators existed prior to December 31, 1992. For example, CHW was aware that the amount of hazardous waste generated by California had fallen an additional 10% in 1991, and an additional 10% in 1992. CHW was also aware that one of its customers in the chemical and petroleum industries, Amoco Chemical Company of Illinois, had reduced the volume of hazardous waste shipped off-site by it by about 97% from 1983 through 1992. Additionally, during 1992, United States companies engaged in a fundamental change in corporate policy concerning waste management, consciously limiting off-site disposal of hazardous waste and, indeed, sharply reducing their output of hazardous waste, through such methods as pretreatment, enhanced recycling and conservation. This change in policy was primarily due to: (i) increasing costs for landfill and incineration (with landfill costs having risen from $ 15-25 per ton in the 1970's to $ 150-250 per ton currently), (ii) concern over liability exposure on the part of the waste generators (particularly with respect to land disposal, where there is no termination of liability), (iii) negative publicity, caused by the EPA's reporting requirements, (iv) regulatory restrictions on land disposal, and (v) development of products that generate less waste, such as biopesticides, alternatives to cholorfluorocarbons and substitutes for chlorinated solvents. Environmental clean-up projects also were reduced during 1992, in part due to uncertainty over the renewal of Federal Superfund legislation, higher costs of off-site removal, tougher rules on off-site disposal and other regulations which encourage on-site remediation, and the lower volumes at environmental cleanup projects. Prior to December 31, 1992 (and before the change in Federal administrations), the Environmental Protection Agency had expressed a strong preference for on-site treatment of hazardous wastes, including the proposal of new hazardous waste regulations which were projected to shift from 20% to 90% of all hazardous wastes away from landfills and incinerators, thereby reducing the amount of hazardous waste material to be trucked to the off-site facilities owned, operated or leased by CHW.
During 1992 and in March of 1993, CHW and WMX (on CHW's behalf) also made several predictions regarding the long-term financial prospects for the CHW. In its 1992 Annual Report to Shareholders, released during the Class Period, CHW represented that the July 1992 formation of the Company's Thermal Operations Group "allowed the Company to provide customers with needed incineration capacity." In fact, there already existed an excess of capacity which resulted in a permanent impairment in the value of the Company's incinerators. CHW optimistically projected in its 1992 Annual Report that "continued suspension of operations at the Chicago incinerator while the [long-term] permit is being pursued is not expected to materially impact future results of operation."
In its 1992 Annual Report, WMX reported that CHW "aggressively undertook programs" to "streamline its organization across the board" in an effort "to focus further on controlling its costs while enhancing service to customers" and predicted that CHW waste services "should expect to see its revenues grow to more than $ 2 billion in 1993." Additionally, on or about March 15, 1993, CHW advised the market that it expected to report earnings for the first quarter of 1993 comparable to its earnings for the first quarter of 1992. Ultimately, CHW was able to obtain comparable earnings by executing the sale of Wheelabrator Technologies, Inc., a company in which CHW had a stake and in which WMX held majority ownership. The execution of this sale accounted for 40% of its first quarter 1993 earnings.
The market responded to these reports and predictions in the following ways. On February 4, 1993, Prudential Securities issued a public report based upon the just-released earnings, recommending that investors buy CHW common stock and commenting on CHW's apparent "continuing strong based business" and a supposedly strong recent pick-up in CHW's bidding activity on special projects. On February 8, 1993, the Chicago Corporation, another securities firm, commenting on CHW's just released year-end 1992 results, opined that "the Company is positioned for strong 1993 results," and "for the first time in nearly two years, the Company now feels it is seeing a pick-up in volume attributable to an economic recovery," and management appears confident that the special services group will see strong revenue growth in 1993." Based upon the Company's reported results for year-end 1992, the Chicago Corporation estimated CHW's 1993 earnings at $ 0.95 per share and recommended that investors buy CHW common stock "because of the company's outstanding market position and improving earnings outlook."
We expect revenues to sequentially rise as 1993 progresses. Moreover, the recently reported fourth quarter . . . indicated significant underlying operating leverage potential. Importantly, earnings visibility appears to be higher now than at any time over the past ten quarters. Finally, the large earnings gains we expect from Chem-Waste beginning in the first quarter and extending through 1992 should be a significant building block for a re-acceleration of Waste Management's earnings growth as well.
In fact, on March 18, 1993, Prudential was recommending that investors purchase CHW common stock based, in part, on the earnings and other financial data reported for year-end 1992 and based on the Company's estimate of first quarter earnings.
After CHW released its earnings for the first quarter of 1993, it made several statements regarding the reasons for its "flat" or "reduced" earnings. CHW reported that the reasons for a 6% decline in business revenues for the first quarter of 1993, as compared with the first quarter of 1992, were primarily due to temporary conditions, such as bad weather, a weak domestic economy, and the change in the Federal Administration.
On July 19, 1993, CHW, for the first time, hinted that market conditions and other factors might require a downward assessment in the carrying value of its incineration assets. On that day, CHW issued a press release which stated that "the Company . . . will be reviewing whether certain of its assets relating to hazardous waste incineration services are appropriately valued in light of the market conditions referred to above." No write-down was taken at that time. The July 19, 1993, press release suggested that "the possibility exists that the company will record a charge which could be material to its results of operations."
On or about September 3, 1993, the Company announced that it had abandoned plans, begun in 1987, to build an incinerator in Kettleman Hills, California. CHW also acknowledged that existing incinerator capacity was adequate to meet the disposal needs of the western United States. Following this disclosure, at the close of trading on September 3, 1993, CHW common stock fell to $ 9.25 per share -- a decline of over 50% from the trading price at the commencement of the Class Period only eight months earlier. The September 6, 1993, edition of Crain's Chicago Business thereupon reported:
The company's restructuring options are fairly straightforward, based on public financial records, the company's own statements as to the bleak condition of the hazardous waste disposal market and analysts' views on what the company must do to improve profitability.
The basic elements of Chemical Waste restructuring likely will be to write-down assets -- particularly incineration facilities -- to more closely reflect their current value, and to sharply cut back overhead.
The September 6, 1993, edition of Crain's Chicago Business also quoted Prudential Securities analyst Vishnu Swarup as predicting that CHW will take a write-down of fixed assets in the range of $ 100 million to $ 200 million. The article also states that other analysts believe the overall write-down may be as high as $ 400 million.
On September 30, 1993, CHW finally announced that it would take a $ 363 million after-tax charge (i.e., a "special asset reevaluation and restructuring charge") against third quarter earnings. Seventy percent (70%) of this charge related to CHW's thermal treatment businesses covering incinerators and fuel burning operations, and included a write-down of the value of the Stony Island facility to zero. Defendant Rooney reviewed, commented upon and/or participated in the preparation of drafts of the public reports, documents and statements by the Company referred to herein or had the opportunity to do so. Each of the public reports, documents and statements referred to above resulted from the collective efforts of Company management and others both within and outside of the Company (including Rooney) and constituted group-published information.
This case involves allegations of securities fraud, based on Section 10(b) of the Securities and Exchange Act ("SEA") and Rule 10b-5 promulgated thereunder. In order to state a claim under Rule 10b-5 and § 10b of the SEA, a plaintiff must demonstrate that: (1) the defendant made an untrue statement of a material fact or omitted a fact that rendered a statement made by the defendant misleading; (2) in connection with a securities transaction; (3) with the intent to mislead; and (4) the misrepresentation or omission caused plaintiff's loss. Schlifke v. Seafirst Corp., 866 F.2d 935, 943 (7th Cir. 1989). An omission is material if there is a "substantial likelihood that the disclosure of the omitted fact would have been viewed by the reasonable investor as having significantly altered the "total mix" of information made available." Basic Inc. v. Levinson, 485 U.S. 224, 231-32, 99 L. Ed. 2d 194, 108 S. Ct. 978 (1988).
Because the SEC has adopted the policy of encouraging companies to make predictions about future performance, predictions are not actionable so long as they fall within the "safe harbor" for forward looking statements promulgated under the 1934 Exchange Act. Typically referred to as the SEC's "safe harbor," Rule 3b-6 provides that a company's predictions of future performance shall not be deemed to be fraudulent statements unless they are made or reaffirmed without a reasonable basis in fact or are not made in good faith. 17 C.F.R. § 240.3b-6. A poor prediction does not automatically subject a company to suit under the securities laws. Arazie v. Mullane, 2 F.3d 1456, 1465-66 (7th Cir. 1993). See also Wielgos v. Commonwealth Edison Co., 892 F.2d 509, 513-14 (7th Cir. 1989) (addressing Rule 175, 17 C.F.R. § 230.175, the analog to Rule 3b-6).
Regardless of whether the plaintiff is challenging a misstatement, an omission, or a prediction, the plaintiff also must establish that the defendant acted with scienter.3 Sundstrand Corp. v. Sun Chem. Corp., 553 F.2d 1033, 1045 (7th Cir.), cert. denied, 434 U.S. 875, 98 S. Ct. 224, 98 S. Ct. 225, 54 L. Ed. 2d 155, and cert. denied, Meers v. Sundstrand Corp., 434 U.S. 875, 98 S. Ct. 224, 98 S. Ct. 225, 54 L. Ed. 2d 155 (1977). In this Circuit, that means that the plaintiff must establish that the defendant acted at least recklessly. Renovitch v. Kaufman, 905 F.2d 1040, 1046 (7th Cir. 1990) (citations omitted).
In the case of an alleged omission, the plaintiff must show that the defendant omitted facts with the intent to deceive, defraud, or manipulate. Ernst & Ernst v. Hochfelder, 425 U.S. 185, 193, 47 L. Ed. 2d 668, 96 S. Ct. 1375 (1976); Schlifke, 866 F.2d at 946. Allegations of recklessness are sufficient if the alleged omission is a:
highly unreasonable omission involving not merely simply, 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 so obvious that the actor must have been aware of it.
Sundstrand, 553 F.2d at 1045. As the Seventh Circuit emphasizes, however, the question is not whether the defendant knew of the undisclosed facts, but whether the defendant knew or should have known of the danger of misleading buyers by failing to disclose those facts. Schlifke, 866 F.2d at 946 (citing Sundstrand, 553 F.2d at 1045).
A plaintiff alleging fraud must satisfy heightened pleading standards.
Fed. R. Civ. P. 9(b). Rule 9(b) requires that the "circumstances constituting fraud or mistake shall be stated with particularity." The reference to "circumstances" in the rule requires "the plaintiff to state 'the identity of the person who made the misrepresentation, the time, place and content of the misrepresentation, and the method by which the misrepresentation was communicated to the plaintiff.'" Uni* Quality, Inc. v. Infotronx, Inc., 974 F.2d 918, 924 (7th Cir. 1992) (quoting Bankers Trust Co. v. Old World Republic Ins. Co., 959 F.2d 677, 683 (7th Cir. 1992)); Midwest Grinding Co. v. Spitz, 976 F.2d 1016, 1020 (7th Cir. 1992); 5 Wright & Miller, Federal Practice and Procedure § 1281, at 364 (1969). In other words, the plaintiff must plead the circumstances constituting fraud in detail, the "who, what, when, where, and how . . . of the alleged fraud." Arazie, 2 F.3d at 1465 (quoting DiLeo v. Ernst & Young, 901 F.2d 624, 626 (7th Cir.), cert. denied, 498 U.S. 941, 112 L. Ed. 2d 312, 111 S. Ct. 347 (1990)). This stringent pleading burden is intensified when, as in this case, all of the substantive allegations have been made solely on "information and belief." In these circumstances, the Plaintiffs "must set forth the facts on which that information and belief rests." In re Abbott Laboratories Securities Litigation, 813 F. Supp. 1315, 1318 (N.D.Ill. 1992); Bankers Trust Co. v. Old Republic Ins. Co., 959 F.2d 677, 683-84 (7th Cir. 1992).
Because Rule 9(b) serves the purpose of providing notice of the claim to the adverse party, Rule 9(b) precludes a plaintiff from "simply point[ing] to a bad result and alleging fraud." In re Westinghouse Securities Litigation, 832 F. Supp. 948, 965 (W.D. Pa. 1993). Instead, a plaintiff must provide "enough detail about the underlying facts which illustrate that a firm's public statements were fraudulent to allow a court to evaluate the claim in a meaningful way." Arazie, 2 F.3d at 1465. "Courts generally are satisfied that allegations of fraud are adequate if the pleadings allege the time, place and particular contents of the false representations as well as the identity of the parties involved and the injury incurred thereby." In re Olympia Brewing Co. Securities Litigation, 674 F. Supp. 597 (N.D. Ill. 1987).
Thus, the Plaintiffs in this case may not simply proffer the fact that CHW's financial results in July of 1993 differed from the earlier-offered projections. Arazie, 2 F.3d at 1465. "Because only a fraction of financial deterioration reflects fraud, . . . investors must point to some facts suggesting that the difference is attributable to fraud." Id. The degree of specificity required in a case like the one before us -- a case challenging defendants' performance projections and subsequent failure to ...