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Roth v. Officemax

September 26, 2007

DAVID ROTH, ON BEHALF OF HIMSELF AND ALL OTHERS SIMILARLY SITUATED, PLAINTIFF,
v.
OFFICEMAX, INC., ET AL., DEFENDANTS.



The opinion of the court was delivered by: Judge Joan B. Gottschall

MEMORANDUM OPINION AND ORDER

This case is a purported class action*fn1 against OfficeMax, Inc. ("OfficeMax"); Christopher Milliken ("Milliken"), the former President, Chief Executive Officer ("CEO"), and director of OfficeMax; Theodore Crumley ("Crumley"), Chief Financial Officer ("CFO") of OfficeMax; Thomas Carlile ("Carlile"), Vice President and Controller of OfficeMax; Michael Feuer ("Feuer"), former Chairman and CEO of OfficeMax until it was sold to Boise Cascade Corporation ("Boise"); and George Harad ("Harad"), former CEO and Executive Chairman of the Board of OfficeMax.*fn2 Plaintiffs allege that OfficeMax as a company, and Milliken, Crumley, Carlile, Feuer, and Harad as individuals, violated Section 10(b) of the Securities and Exchange Act of 1934, 15 U.S.C. § 78j, and Securities Exchange Commission Rule 10b-5, 17 C.F.R § 240.10b-5. Plaintiffs also allege that the defendants were "control persons" who are liable under Section 20(a) of the Securities Exchange Act, 15 U.S.C. § 78(t), for OfficeMax's fraudulent acts.

On September 12, 2006, this court granted defendants' motion to dismiss plaintiffs' complaint because plaintiffs failed to plead scienter as to any of the defendants with the requisite particularity. Roth v. OfficeMax, Inc., No. 05 C 236, 2006 WL 2661009 (N.D. Ill. Sept. 12, 2006) ("Sept. 12, 2006 Order"). Plaintiffs subsequently filed their First Amended Consolidated Complaint (the "Amended Complaint") and defendants have moved to dismiss that complaint for pleading deficiencies under the Private Securities Litigation Reform Act ("PSLRA") and for failure to state a claim under Rule 12(b)(6) of the Federal Rules of Civil Procedure. The motion to dismiss is granted.

I. BACKGROUND

In July 2003, Boise Cascade Corporation ("Boise") announced its proposed acquisition of OfficeMax ("old OfficeMax"). The acquisition was approved by the shareholders of both companies on December 9, 2003. In October 2004, Boise sold its forest products assets and renamed itself OfficeMax, Inc. ("OfficeMax" or "the Company").*fn3

On December 20, 2004, the Company announced an investigation into "claims by a vendor to its retail business that certain employees acted inappropriately in requesting promotional payments and in falsifying supporting documentation for approximately $3.3 million in claims billed to the vendor by OfficeMax during 2003 and 2004." On January 12, 2005, OfficeMax announced that its fourth quarter 2004 financial results would be delayed pending the outcome of the investigation. Based on the investigation, the Company ultimately restated its financial results for the first three quarters of 2004, finding that net income had been overstated in the first quarter by $7.1 million and understated in the second and third quarters by approximately $1 million in each quarter. The Company has stated that 2003 results were not materially impacted. The Company terminated six employees as a result of the investigation.

This court dismissed plaintiffs' prior complaint because although plaintiffs alleged that all of the defendants except for Feuer made statements that may be actionable, nothing in the complaint supported a strong inference that any of those defendants had the required state of mind when they made their allegedly false and misleading statements. See Sept. 12, 2006 Order at 14. Specifically, plaintiffs did not allege that any of the defendants knew about the improper vendor income reporting or that the improper reporting was obvious. The court granted plaintiffs leave to amend their complaint, which is the complaint at issue. Defendants have moved to dismiss the amended complaint for failure to adequately plead scienter.

II. DISCUSSION

A. Section 10(b) and Rule 10b-5

The Private Securities Litigation Reform Act ("PSLRA") requires fact-pleading that exceeds even the particularity requirement of Rule 9(b) of the Federal Rules of Civil Procedure. Under the PSLRA's heightened pleading requirement, any private securities complaint alleging that the defendant made a false or misleading statement must: (1) "specify each statement alleged to have been misleading [and] the reason or reasons why the statement is misleading," 15 U.S.C. § 78u-4(b)(1); and (2) "state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind," § 78u-4(b)(2). Tellabs, Inc. v. Makor Issues & Rights, Ltd., 127 S.Ct. 2499, 2508 (2007). "That 'required state of mind' is an intent to deceive, demonstrated by knowledge of the statement's falsity or reckless disregard of a substantial risk that the statement is false." Higginbotham et al. v. Baxter Int'l Inc. et al., No. 06-1312, -- F.3d --, 2007 WL 2142298, at *1 (7th Cir. July 27, 2007) (citing Ernst & Ernst v. Hochfelder, 425 U.S. 185, 193 (1976), SEC v. Jakubowski, 150 F.3d 675, 681 (7th Cir. 1998)).

After this court's prior opinion was issued, the Supreme Court issued its opinion in Tellabs, which was meant to "prescribe a workable construction of the 'strong inference' standard." Tellabs, Inc., 127 S.Ct. at 2509. First, as with any Rule 12(b)(6) motion to dismiss, the court must accept all factual allegations in the complaint as true. Id. Second, the court must consider the complaint in its entirety; the inquiry "is whether all of the facts alleged, taken collectively, give rise to a strong inference of scienter, not whether any individual allegation, scrutinized in isolation, meets that standard." Id. Third, the court must take into account plausible competing inferences. Id. Specifically, plaintiffs cannot "merely . . . allege facts from which an inference of scienter rationally could be drawn." Id. at 2510 (internal citations omitted). Rather, plaintiffs must "plead with particularity facts that give rise to a 'strong'-i.e., a powerful or cogent- inference." Id. The court's inquiry in this regard is "inherently comparative"; a "complaint will survive . . . only if a reasonable person would deem the inference of scienter cogent and at least as compelling as any opposing inference one could draw from the facts alleged." Id.

The Supreme Court did not, however, disturb the Seventh Circuit's requirement that plaintiffs must create the strong inference of scienter "with respect to each individual defendant in multiple defendant cases." Id. at 2511, n.6 (citing Makor Issues & Rights, Ltd. v. Tellabs, Inc., 437 F.3d 588, 603 (7th Cir. 2006)). Nor did the Supreme Court address the question whether and when recklessness satisfies the scienter requirement. See Tellabs, Inc., 127 S.Ct. at 2507 n.3. The Seventh Circuit has stated that reckless conduct involves "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." Sundstrand Corp. v. Sun Chemical Corp., 553 F.2d 1033, 1044-45 (7th Cir. 1977)

Although plaintiffs have alleged that statements issued by the Company regarding its financial results for the first three quarters of 2004 and statements that the Company had no internal control problems may have been false or misleading,*fn4 it is now well established that a securities complaint will not survive a motion to dismiss if plaintiffs simply point to statements that are later revealed to be misleading or untrue. Importantly, mere allegations of GAAP violations, the restatement of income, or statements regarding the internal controls of a company that are later proven to be false, are not sufficient to demonstrate that those who made the statements committed securities fraud. See Higginbotham, 2007 WL 2142298, at *5 (dismissing claim that defendants "'knew' the financial controls in Brazil to be inadequate yet failed to disclose this to investors until July 22" when hindsight was the only basis of the proposed inference); c.f. Ezra Charitable Trust v. Tyco Intern., Ltd., 466 F.3d 1, 10 (1st Cir. 2006) ("The simple fact of a correction is also not particularly probative; plaintiffs may not simply seize upon disclosures made later and allege that they should have been made earlier."); Abrams v. Baker Hughes Inc., 292 F.3d 424, 432 (5th Cir. 2002) ("The mere publication of inaccurate accounting figures or failure to follow GAAP, without more, does not establish scienter. The party must know that it is publishing materially false information, or must be severely reckless in publishing such information."); Higginbotham v. Baxter Intern., Inc., Nos. 04 C 4909, 04 C 7096, 2005 WL 1272271, at *7 (N.D. Ill. May 25, 2005) ("Overstatements of income or revenues are not by themselves sufficient to draw an inference of scienter." (collecting cases)). There must also be other allegations, direct or circumstantial, that together will support a strong inference of scienter. Otherwise such allegations amount to pleading fraud by hindsight.

With these considerations in mind, the court turns to plaintiffs' allegations of scienter.

B. Group Allegations of Scienter

Plaintiffs have not alleged in the Amended Complaint that any of the individual defendants knew about the problems that caused the restatement of the Company's financials-i.e., the improper vendor income reporting, the alleged GAAP violations or the deficiencies in the internal controls-at the time the allegedly false and misleading statements were made. Plaintiffs have instead attempted to bolster their allegations of scienter by leveling a number of generalized allegations at all the individual defendants together. Specifically, plaintiffs allege: 1) the defendants ignored certain "red flags" that should have notified them of the improper vendor income reporting, the GAAP violations and the deficiencies in the internal controls; 2) defendants knew about an internal investigation into the vendor income reporting sometime in the summer or fall of 2004; and 3) based on an accounting expert's declaration, defendants could not have certified that OfficeMax's internal accounting controls were sufficient without departing from the standards of ordinary care. The court addresses each allegation in turn below and then applies them to the individual defendants to evaluate whether all the allegations together support a strong inference of scienter. See ...


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