Baron v. Smith

United States Court of Appeals
For the First Circuit

No. 03-2440

JOHN BARON; ALAN LAITES; AND THE
JEWISH FOUNDATION FOR EDUCATION OF WOMEN,

Plaintiffs, Appellants,

v.

RICHARD A. SMITH; PETER C. READ;
FRANCIS E. SUTHERBY; AND G. GAIL EDWARDS,

Defendants, Appellees.

APPEAL FROM THE UNITED STATES DISTRICT COURT
FOR THE DISTRICT OF MASSACHUSETTS
[Hon. George A. O'Toole, Jr., U.S. District Judge]

Before
Torruella, Circuit Judge,
Gibson,* Senior Circuit Judge,
and Lipez, Circuit Judge.

John F. Harnes, with whom Harnes Keller LLP and Joan T. Harnes
were on brief, for appellants.
Gus P. Coldebella, with whom Goodwin Procter LLP and Stuart M.
Glass were on brief, for appellees Peter C. Read, Francis E.
Sutherby, and G. Gail Edwards.
Richard J. Rosensweig, with whom Goulston & Storrs, P.C. and
Thomas J. Sartory were on brief, for appellee Richard A. Smith.

August 18, 2004

*
Hon. John R. Gibson, of the Eighth Circuit, sitting by
designation.
 TORRUELLA, Circuit Judge. Plaintiffs-appellants John

Baron, Alan Laites, and the Jewish Foundation for Education of

Women ("plaintiffs") appeal the district court's grant of a motion

to dismiss their class action complaint for failure to state a

claim under Fed. R. Civ. P. 12(b)(6) and failure to plead fraud

with particularity under Fed. R. Civ. P. 9(b). For the reasons

stated below, we affirm.

I. Facts

Plaintiffs filed a class action complaint on behalf of

purchasers of the stock of GC Companies ("GCX") for violation of

Section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C.

§ 78j(b), as amended by the Private Securities Litigation Reform

Act of 1994 ("PSLRA"), 15 U.S.C. §§ 78u-4-78u-5, and rules

promulgated thereunder.

We review de novo, mindful that "the district court, on

a motion to dismiss, must draw all reasonable inferences from the

particular allegations in the plaintiff's favor, while at the same

time requiring the plaintiff to show a strong inference of

scienter." Aldridge v. A.T. Cross Corp., 284 F.3d 72, 78 (1st Cir.

2002)(citing Greebel v. FTP Software, Inc., 194 F.3d 185, 201 (1st

Cir. 1999)). We first sketch out the relevant facts as pleaded in

plaintiffs' complaint and complemented by the district court's

memorandum and order. Baron v. Smith, 285 F. Supp. 2d 96 (D. Mass.

2003).

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 GCX was a Delaware corporation that publicly traded on

the New York Stock Exchange ("NYSE"). Defendants-appellees

Richard A. Smith, Peter C. Read, Francis E. Sutherby, and G. Gail

Edwards ("defendants") were all former officers and directors of

GCX during the relevant class period.1 GCX was in the movie

theater business in the United States and South America and also

managed an investment capital portfolio. GCX was the parent

company of several wholly-owned subsidiaries, through which it

conducted its business operations.

After several years of disappointing financial results,

and faced with market saturation, GCX filed for Chapter 11

bankruptcy protection on October 11, 2000; some of its subsidiaries

filed for Chapter 7 liquidation. A press release, which will be

outlined in detail below, accompanied the bankruptcy filing. In

the press release GCX described its hopes of emerging from

bankruptcy reorganization revitalized and better structured to

compete. This turn of events was not wholly unexpected as the

company had stated in its September 13, 2000 Quarterly Report ("the

September 2000 10-Q") that "[GCX] is actively considering all of

its strategic alternatives, including additional closing of

unprofitable units, sales of certain of the company's assets, or a

1
The term class period is used, though the class was never
certified.

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potential bankruptcy restructuring, recapitalization, or bankruptcy

reorganization . . . ."

In January 2001, GCX filed its Annual Report for 2000

("2000 Form 10-K") which will be reviewed in detail below. That

filing, like the press release, anticipated that GCX would emerge

from reorganization in a stronger position. Contrary to GCX's

expectations, however, the negotiations between management and

creditors did not go well and, on June 13, 2001, GCX announced that

it had signed a letter of intent with certain buyers who would

purchase all of GCX's stock. Under the terms of the letter of

intent, current shareholders would only receive payment if the

liquidation of the investment portfolio yielded more than $90

million. During the class period, the stock traded at between

$1.60 and $3.25 per share. After the announcement on June 13,

2001, which marks the end of the class period, GCX's stock price

dropped to $0.25 a share.

II. Analysis

The central issue in this appeal is whether the

plaintiffs' complaint states a cause of action for material

omissions under Section 10(b) of the Securities Act. We conclude

that it does not.

To state a claim under Section 10(b) of the Securities

Act, a plaintiff must allege, inter alia, that a defendant "(A)

made an untrue statement of a material fact; or (B) omitted to

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state a material fact necessary in order to make the statements

made, in the light of the circumstances in which they were made,

not misleading." 15 U.S.C. § 78u-4(b)(1)(A)-(B).

SEC Rule 10b-5, 17 C.F.R. § 240.10b-5, makes it unlawful

for any person,

(a) [t]o employ any device, scheme or
artifice to defraud, (b) [t]o 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) [t]o 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.

Id. We evaluate the allegations in the complaint with both

proscriptions in mind.

Plaintiffs concede that defendants have not engaged in

material misstatements; thus, to state a claim for securities

fraud, they rely on the material omissions prong of § 78u-4(b)(1).

Under the PSLRA, a complaint must identify what plaintiffs believe

to be the material omission and why that omission is material. Id.

§ 78u-4(b)(1)(B). The test for materiality, taken from the pre-

PSLRA case of Basic, Inc. v. Levinson, 485 U.S. 224, 231-32 (1988),

was recently summarized as follows:

A fact is material if it is substantially
likely 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.
Information which would have assumed actual

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 significance in the deliberations of a
reasonable shareholder is material. In
general, the materiality of a statement or
omission is a question of fact that should
normally be left to a jury rather than
resolved by the court on a motion to dismiss.
Thus, we review the complaint only to
determine that it pleads the existence of such
statements and presents a plausible jury
question of materiality.

Bielski v. Cabletron Sys., Inc. (In re Cabletron Sys., Inc.), 311

F.3d 11, 34 (1st Cir. 2002)(quoting Basic, 485 U.S. at 231-

32)(internal citations and quotation marks omitted).

The complaint focuses on certain GCX financial

arrangements as well as the press release. Plaintiffs allege that

defendants omitted material facts from GCX financial disclosure

statements. We discuss each in turn.

A. The Press Release

The press release issued by GCX on October 11, 2000

contained the following information:

GC Companies, Inc. (NYSE: GCX), parent
company of General Cinema Theaters, Inc.,
announced today that GC Companies and certain
of its domestic subsidiaries, including
General Cinema Theaters, Inc., are filing
voluntary petitions to reorganize their
business under Chapter 11 of the U.S.
Bankruptcy Code. The Company further stated
that certain of its subsidiaries in Florida,
Georgia, Louisiana, and Tennessee are filing
Chapter 7 liquidation proceedings. The
filings were made in the United States
Bankruptcy Court for the District of Delaware.
In its filings, [GCX] will report total assets
of $328.9 million and total liabilities of
$195.1 million as of August 31, 2000.

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 The Company believes that Chapter 11
reorganization provides the Company with the
most effective means to terminate and
restructure unprofitable leases and position
the Company to succeed in today's highly
competitive market.
. . . .
Through the Chapter 11 process, the
Company expects to be able to terminate
unprofitable leases, reduce the Company's
operating expenses and make necessary
improvements to the business to create a
strong competitive future for [GCX]. While
the Company completes the restructuring, its
operations are expected to continue.
. . . .
The Company is arranging up to $45
million of debtor in possession financing to
provide the Company with resources to fund its
operations during the Chapter 11 proceedings.

After announcing a management restructuring which

included the named defendants in this action, the press release

ended with the following:

Forward-Looking Statements in this
press release are made pursuant to the safe
harbor provisions of the [PSLRA] of 1995. The
words 'expect,' 'anticipate,' 'intend,'
'plan,' 'believe,' 'seek,' 'estimate' and
similar expressions are intended to identify
such forward-looking statements; however this
press release also contains other forward-
looking statements. [GCX] cautions that there
are various important factors that could cause
actual results to differ materially from those
indicated in the forward-looking statements .
. . . Among [them] . . . are: the overall
viability of the Company's long-term
operational reorganization and financial
restructuring plan; . . . .

To the extent that plaintiffs seek to state a claim under

the securities laws for a deceptive press release or as an

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indication that the company omitted material information from its

filings, we agree with the district court that the press release

contained forward-looking statements, as so stated therein, and

therefore comes under the protection of the statutory safe harbor.

See 15 U.S.C. § 78u-5(c)(1);2 see also Greebel 194 F.3d at 201

(discussing the safe harbor for forward-looking statements); Suna

v. Bailey Corp., 107 F.3d 64, 70 (1st Cir. 1997)(stating, in a pre-

PSLRA case, that "no reasonable investor would have read these

statements, especially as they are accompanied by cautionary

language, as promises or guarantees of future performance.").

Thus, none of the statements made by GCX in the press release,

which plaintiffs seek to attribute to the defendants, are

actionable under Section 10(b) or Rule 10b-5. We therefore affirm

2
This section states:

Except as provided in subsection (b), in any private
action arising under this title that is based on an . . .
omission of a material fact necessary to make the
statement not misleading, a person . . . shall not be
liable with respect to any forward-looking statement,
whether written or oral, if and to the extent that --
(A) the forward-looking statement is --
(i) identified as a forward-looking statement,
and is accompanied by meaningful cautionary
statements identifying important factors that
could cause actual results to differ
materially from those in the forward-looking
statement; or
(ii) immaterial; . . . .

15 U.S.C. § 78u-5(c)(1).

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the district court's dismissal of the claims based on the press

release.

B. The Synthetic Leases

Plaintiffs devote a considerable portion of their efforts

in constructing a claim under Section 10(b) and Rule 10b-5 to GCX's

use of synthetic leases as a corporate finance tool and GCX's

description of the leases in its financial disclosure filings. GCX

entered into two synthetic leases before filing for bankruptcy.

Plaintiffs argue that GCX omitted material information from its

public filings regarding these synthetic leases which was necessary

for the disclosed information not to mislead investors.

A synthetic lease is an arrangement that allows a

corporation to finance real estate ownership while shifting the

risk away from itself should the deal prove unprofitable. "A

primary factor motivating many synthetic leases is the off-balance

sheet treatment that such transactions receive." H. Peter Nesvold,

What Are You Trying to Hide? Synthetic Leases, Financial Disclosure

and the Information Mosaic, Stan. J. L., Bus. & Fin. 83, 93 (1999).

Overall, the off-balance treatment gives the corporation the

opportunity to show a stronger bottom line in its financial

disclosure statements. Id. Other financing advantages, such as

tax savings, can also make synthetic leases a good vehicle for

corporate financing.

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 The first synthetic lease at issue here was with General

Electric Credit Company ("the GECC lease") and the second was with

Heller ("the Heller lease"). The district court held that GCX

disclosed the existence and the amount of the leases in its 2000

Form 10-K, and that "a reasonable investor [would have been] on

notice of the nature of GCX's lease arrangement." Baron, 285 F.

Supp. 2d at 105.

The 2000 Form 10-K contained the following information

regarding the leases:

[GCX] has entered into $118.8 million of
operating leases with a major financial
institution under a lease financing
arrangement. The receivable due from the
financing institution at October 31, 1999
[sic] of $15.5 million was reclassified to
capital expenditures in 2000. [GCX] has
Bankruptcy Court approval to make monthly
adequate protection payments of approximately
$1.1 million, in respect [sic] of the lease
financing arrangement.

Plaintiffs argue that this information is not sufficient to meet

defendants' disclosure requirements.3 They allege, inter alia,

that more information was necessary to inform investors of the

3
To the extent that plaintiffs relied on the language in the
press release to bolster its claim that GCX violated Section 10(b)
and Rule 10b-5, that information is not considered probative of
alleged omissions, as they are protected by the statutory safe
harbor unless the person making the forward-looking statements, in
this case GCX, had actual knowledge they were false or misleading.
See 15 U.S.C. § 78u-15(c)(1)(B); see also Greebel, 194 F.3d at 201.
Plaintiffs have made no allegation that defendants had actual
knowledge the statements regarding GCX freeing itself from the
operating leases in bankruptcy were actually false or misleading.

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consequences of the leases and that GCX's failure to disclose the

subsequent claims that came into being once they filed for

bankruptcy constituted a violation of Section 10(b) and Rule 10b-5.

Plaintiffs' claim fails because GCX disclosed the

material facts that would lead a reasonable investor to make an

informed decision regarding the purchase of stock in GCX. We

review allegations of securities fraud under the particular facts

of each case. See Greebel, 194 F.3d at 196. First, during the

relevant class period, the company was in reorganization

proceedings. Thus, any reasonable investor was aware that the

business operations of GCX were strained and the company was

undergoing substantial changes in its operations. Upon evaluating

the particular language of the 2000 Form 10-K regarding the leases,

it is clear that the amount of the liability is disclosed as is the

nature of the transaction and the accounting change over to capital

expenditure. Second, and most important, GCX specified its

continuing obligation, as well as the amount of the obligations, as

a debtor-in-possession vis-à-vis the leases, during the relevant

class period.4 Cf. In re Cabletron, 311 F.3d at 35 (where

company's revenues were materially inflated by tens of millions and

4
Moreover, plaintiffs' claims that the leases were vulnerable to
acceleration are unavailing. Most financial instruments are
subject to some type of default or penalty if a party stops
payment; in this case, however, the 2000 Form 10-K disclosed that
GCX would continue to meet its obligations under the supervision of
the bankruptcy court.

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the inaccuracy in earnings was derived from actual fraud, filings

were considered materially misleading).

Plaintiffs also allege, on a slightly different track,

that one of the reasons the district court dismissed their claims

regarding the synthetic leases was "because compliance with GAAP

immunized defendants from liability." We do not believe the

district court's holding is susceptible to such an interpretation.

In fact, the district court stated that "[t]here is no allegation

of any violation of generally accepted accounting principles in

respect [to] the synthetic leases." Baron, 285 F. Supp. 2d at 105

n.3. We have previously observed that a violation of GAAP in SEC

filings raises an inference that the disclosure is misleading or

inaccurate under SEC regulations. See In re Cabletron, 311 F.3d at

34 (citing to 17 C.F.R. § 210.4-01(a)(1)). In the same vein we

have held that even when a company's disclosure is in violation of

GAAP, "some techniques . . . might prove to be entirely legitimate,

depending on the specific facts." Id. In this case, plaintiffs

concede that the SEC filings are in compliance with GAAP.

Nevertheless, they argue that GAAP rules should not immunize the

defendants from liability.5 We think this misses the central

5
Synthetic leases are treated as operating leases under GAAP.
See generally Donald J. Weidner, Synthetic Leases: Structured
Finance, Financial Accounting and Tax Ownership, 25 J. Corp. L.
445, 454-465 (providing an expanded overview of the relationship
between financial accounting principles and synthetic leases).
While there is some controversy over this treatment, there is no
question that, under GAAP, the leases were properly reported.

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question in this matter which is whether the leases were disclosed

in compliance with Section 10(b). All the material information

necessary for a reasonable investor to make an informed decision

was provided.

C. The Mexican Note

According to plaintiffs, GCX represented in its filings

that a $6.8 million note ("the Mexican note"), payable in

connection with GCX's sale of its Mexican theater investment, was

a GCX asset.

The existence of the Mexican note was disclosed in the

2000 Form 10-K. It stated that "[i]n May 2000, [GCX] sold its

Mexican theater investment for approximately $14.3 million of which

$7.5 million of the sales price was received in cash, and the

remaining balance will be paid in three installments over two

years." Plaintiffs argue that defendants were obligated to state

that the Mexican note was owned by a subsidiary, not by GCX, and

was therefore outside GCX's bankruptcy estate during Chapter 11

proceedings.

The district court characterized this claim as "fatuous."

Baron, 285 F. Supp. 2d at 104. We agree that plaintiffs' claim

that the disclosure of the Mexican note in 2000 Form 10-K was in

violation of Section 10(b) is a non-starter. The 2000 Form 10-K

for GCX was, by its terms, a consolidated return and included

financial data for both the parent company and its subsidiaries, in

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compliance with § 13 and § 15(d) of the Securities Exchange Act of

1934. See 15 U.S.C. § 78m, § 78o(d); see also 17 C.F.R. § 210.3-01

(detailing the SEC regulations for consolidated balance sheets).

Plaintiffs allege that the possibility that the Mexican

note would not be part of the bankruptcy estate is a material

omission that should have been disclosed under the securities laws.

As stated above, claims for securities fraud during the relevant

class period should be evaluated in the context of GCX's bankruptcy

filing.

Moreover, GCX's proceeds from the Mexican note were

included in the bankruptcy estate, as is evident from GCX's

bankruptcy filings and the quarterly report (Form 10-Q) for the

quarter ending on April 30, 2001, which stated that "[GCX] received

$6.4 million as payment in full on its Mexican note receivable."

We find that no material information that was necessary

for a reasonable investor to determine GCX's financial condition

was omitted with respect to the Mexican note.

D. The South American Joint Venture

Plaintiffs allege that defendants omitted the fact that

the filing of a bankruptcy petition was an event of default under

a loan guarantee made for a South American joint venture. The loan

guarantee by its terms involved a two-step process required to

trigger GCX's obligations: first, an event of default had to occur

and second, the loan guarantee had to be called. Plaintiffs argue

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that GCX's failure to disclose that the Chapter 11 petition was an

event of default in the 2000 Form 10-K constitutes a material

omission.

We agree with the district court that "there is no

question that [GCX] disclosed the fact that it had guaranteed 50%

of the debt of the South American joint venture." Baron, 285 F.

Supp. 2d at 103. The 2000 Form 10-K also disclosed the current

status of the joint venture as well as the amount of GCX's

guarantee obligations.

Plaintiffs admit that the default as to the South

American joint venture was not a current default during the

relevant class period. They argue, however, that the failure to

disclose the effect of the bankruptcy filing on the joint venture

was a material omission. We disagree. It is not a material

omission to fail to point out information of which the market is

already aware. See In re Donald Trump Casino Sec. Litig., 7 F.3d

357, 377 (3d Cir. 1993)(no violation where investors were not

informed of the weakened economic conditions in particular

geographic areas). Plaintiffs admit that the filing of a voluntary

petition for reorganization under Chapter 11 is considered a

standard event of default for most guarantee obligations in the

financial markets. In addition, as plaintiffs acknowledge, a

default and an event of default are different things under the

bankruptcy code. See generally U.S. Fid. & Guar. Co. v. Braspetro

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Oil Servcs. Co., 369 F.3d 34, 51 (2d Cir. 2004)(explaining that

where failure to comply with contract clauses was event of default

as specified in contract, the court must still examine whether

there was actual default on performance).

Moreover, given the structure of the financial

transaction, the event of default did not materially alter GCX's

financial obligations. The loan still had to be called; the record

makes clear that the company's obligations under the guarantee were

not triggered until it was called in January 2002, more than six

months after the end of the class period at issue in this case, and

as disclosed in GCX's Quarterly Report (Form 10-Q) for the quarter

ending January 31, 2002.6

E. Pleading Fraud

The district court dismissed the complaint on the

alterative grounds that plaintiffs had failed to plead fraud with

particularity as required by Fed. R. Civ. P. 9(b). See, e.g.,

Aldridge v. A.T. Cross Corp., 284 F.3d 72, 78-79 (1st Cir.

2002)(stating that a complaint must meet the PSLRA standard for

pleading fraud). Because we find that the complaint failed to

6
Plaintiffs make somewhat oblique references to defendants'
alleged violations of SEC Regulations S-K and S-X because of a
failure to supplement certain information which appeared in prior
financial documents. We find, as did the district court, see
Baron, 285 F. Supp. 2d at 104 n.2, that plaintiffs' allegations as
to the event of default were not actionable under the facts of this
case.

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plead any material omissions, we need not reach the issue of

whether fraud was adequately pleaded.

III. Conclusion

We therefore affirm the district court's dismissal of

plaintiffs' complaint for failure to state a claim under Section

10(b) and Rule 10b-5 of the Securities Exchange Act.

Affirmed.

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