In re Fairway Group Holdings Corp. Securities Litigation ...€¦ · Intro.) Defendant Fairway...

Case 1:14-cv-00950-LAK-AJP Document 77 Filed 01/20/15 of 40

UNITED STATES DISTRICT COURT SOUTHERN DISTRICT OF NEW YORK - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - x

In re FAIRWAY GROUP HOLDING CORP. : 14 Civ. 0950 (LAK)(AJP) SECURITIES LITIGATION :

: REPORT AND RECOMMENDATION - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - x

ANDREW J. PECK, United States Magistrate Judge:

To the Honorable Lewis A. Kaplan, United States District Judge:

Plaintiff Jacksonville Police and Fire Pension Fund alleges that defendants made

material misstatements and omissions in order to make the Fairway Group Holdings Corp. IPO more

attractive to investors. (See generally Dkt. No. 59: Am. Compl.) The misstatements and omissions

concern three primary issues: (1) Fairway's expansion to new stores (Am. Compl. ¶¶ 53-58); (2)

Fairway's sales growth at existing store locations (Am. Compl. ¶¶ 59-63); and (3) Fairway's deferred

tax asset and adjusted earnings before interest, taxes, depreciation and amortization (Am. Compl.

¶¶ 64-69). Plaintiff brings claims under Sections 10(b) and 20(a) of the Securities Exchange Act

of 1934, and Sections 11, 12(a)(2) and 15 of the Securities Act of 1933. (Am. Compl. ¶¶ 18, 24-36,

205-13, 283-304.)

Presently before the Court are the defendants' motions to dismiss. (See Dkt. No. 61:

Underwriters Notice of Motion; Dkt. No. 63: Fairway & Sterling Notice of Motion; see also Dkt.

No 62: Underwriters Br.; Dkt. No. 64: Fairway & Sterling Br; Dkt. No. 71: Underwriters Reply Br.;

Dkt. No. 72: Fairway & Sterling Reply Br.) The Underwriter Defendants move to dismiss the

amended complaint pursuant to Rules 8(a), 12(b)(1) and 12(b)(6) of the Federal Rules of Civil

Procedure. (Underwriters Notice of Motion; see also Underwriters Br. at 1.) The Fairway and

Sterling Defendants move to dismiss the amended complaint pursuant to Rules 8, 9(b) and 12(b)(6)


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of the Federal Rules of Civil Procedure, and the Private Securities Litigation Reform Act of 1995.

(Fairway & Sterling Notice of Motion; see also Fairway & Sterling Br. at 1.)

For the reasons set forth below, the defendants' motions to dismiss (Dkt. Nos. 61 &

63) should be GRANTED dismissing plaintiff's Exchange Act Section 20(a) claim and Securities

Act Section 15 claim against defendant Sterling Advisors, and dismissing plaintiff's Securities Act

Section 12(a)(2) claim, and in all other respects should be DENIED.

FACTS

The Parties

Lead plaintiff Jacksonville Police and Fire Pension ("Jacksonville P&F") is a public

pension plan established for police and firefighters in Jacksonville, Florida. (Dkt. No. 59: Am.

Compl. ¶ 23.) Plaintiff purchased shares of Fairway securities between April 17, 2013 and February

7, 2014 (the "Class Period"). (Am. Compl. Intro. & ¶ 23.) Plaintiff brings this claim on behalf of

itself and all others who purchased or acquired Fairway common stock during the Class Period.

(Am. Compl. Intro.)

Defendant Fairway Group Holdings Corp. is a food retailer in the greater New York

City Area. (Am. Compl. ¶ 24.) Fairway became a publicly traded company through an April 2013

IPO. (Id.)

Defendant Charles W. Santoro was Fairway's Executive Chairman of the Board.

(Am. Compl. ¶ 25.) Santoro is a co-founder and managing partner of Sterling Investment Partners

and is a member and general partner of the Sterling Funds discussed below. (Id.) Defendant

Herbert Ruetsch was Fairway's Chief Executive Officer until his resignation on February 6, 2014.

(Am. Compl. ¶ 26.) Defendant Edward C. Arditte was Fairway's Executive Vice President and

Chief Financial Officer, and served as a consultant to Fairway in October and November 2012.


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(Am. Compl. ¶ 27.) According to Fairway's SEC filings, Santoro, Ruetsch and Arditte were "key

personnel" during the Class Period, and were "primarily responsible for determining the strategic

direction of [Fairway's] business and for executing [Fairway's] growth strategy." (Am. Compl. ¶

28.) Fairway, Ruetsch, Arditte, and Santoro are defendants to both the Exchange Act claims and

the Securities Act claims. (Am. Compl. ¶¶ 24-27, 220-25.)

The Sterling Defendants acquired an 80.1 percent stake in Fairway on January 24,

2007 pursuant to an original equity investment of approximately $150 million. (Am. Compl. ¶ 29.)

The Sterling Funds collectively sold 1,898,909 shares of Fairway Class A common stock in the IPO

for approximately $23 million. (Am. Compl. ¶¶ 29-33.)

Defendant Sterling Advisors, a Sterling affiliate, entered into a management

agreement with Fairway in 2010. (Am. Compl. ¶ 34.) Sterling Advisors consulted with Fairway's

Board of Directors and management on business and financial matters, including Fairway's

corporate strategy and the IPO. (Id.) Between 2010 and the April 17, 2013 IPO, Fairway paid

Sterling Advisors approximately $20 million for these services. (Id.) Sterling Advisors also

received $9.2 million in the IPO as a fee to terminate the management agreement. (Id.) Sterling

Advisors and the four Sterling Funds (collectively the "Sterling defendants") are defendants to the

Exchange Act claims and the Securities Act claims. (Am. Compl. ¶¶ 29-34, 242-49.)

Defendant Linda M. Siluk served as Fairway's Vice President-Finance and Chief

Accounting Officer since October 2011. (Am. Compl. ¶ 223.) Defendant Michael Barr is a

principal of Sterling Investment Partners and has served as a Fairway director since 2007. (Am.

Compl. ¶ 226.) Defendant Howard Glickberg has served as a Fairway director since January 2007

and as Fairway's Vice Chairman of Development since January 1, 2012. (Am. Compl. ¶ 227.)

Defendant Stephen L. Key has served as a Fairway director since August 2012 and has served as a


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member of the Senior Executive Advisory Board of Sterling Investment Partners. (Am. Compl. ¶

228.) Defendant William Selden is a co-founder and managing partner of Sterling Investment

Partners, and has served as a Fairway director since January 2007. (Am. Compl. ¶ 229.) Defendant

Farid Suleman has served as a Fairway director since August 2012 and has served as a member of

the Senior Executive Advisory Board of Sterling Investment Partners. (Am. Compl. ¶ 230.) Siluk,

Barr, Glickberg, Key, Selden and Suleman are defendants only to the Securities Act claims. (Am.

Compl. ¶¶ 223, 226-30.)

Defendants Credit Suisse Securities (USA) LLC, Merrill Lynch, Pierce, Fenner &

Smith Inc., Jefferies LLC, William Blair & Company L.L.C., BB&T Capital Markets, Guggenheim

Securities, LLC, Oppenheimer & Co. Inc., Wolfe Trahan Securities, and Morgan Joseph TriArtisan

LLC (collectively, the "Underwriter Defendants") each acted as an underwriter in the Fairway IPO;

they are defendants only to the Securities Act claims. (Am. Compl. ¶¶ 232-41

Factual Allegations in the Amended Complaint

Stated briefly, plaintiff alleges that during the Class Period defendants made material

misstatements and omissions regarding Fairway's growth potential to make Fairway's IPO attractive

to investors. (See generally Dkt. No. 59: Am. Compl.) The misstatements and omissions concern

three primary issues: (1) Fairway's expansion to new stores; (2) Fairway's sales growth at existing

store locations; and (3) Fairway's deferred tax asset ("DTA") and adjusted earnings before interest,

taxes, depreciation and amortization ("EBITDA"). (Am. Compl. ¶¶ 53-69.) Plaintiff's allegations

are based upon SEC and other regulatory filings, press releases, statements made by Fairway's

directors and officers during conference calls and the IPO roadshow, and analysts' reports. (Am.

Compl. ¶¶ 51-79.) Plaintiff's allegations also are based upon the knowledge of seven confidential

witnesses who are former Fairway employees (Am. Compl. ¶¶ 84-93, 123, 127), including: manager


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of financial planning ("CW 1"); assistant controller ("CW 2"); employee in the accounts payable

department ("CW 3"); supervisor of several stores ("CW 4"); store controller ("CW 5"); assistant

general manager ("CW 6"); and director of internal audit ("CW 7). (Am. Compl. ¶¶ 84-93, 123,

127.)

The amended complaint is voluminous and its specific factual allegations will be

discussed in conjunction with the relevant legal analysis.

ANALYSIS

I. LEGAL STANDARDS GOVERNING MOTIONS TO DISMISS

A. The Standard Pursuant to Fed. R. Civ. P. 12(b)(6)

1. The Twombly-Igbal "Plausibility" Standard

In the Twombly and Iqbal decisions in 2007 and 2009, the Supreme Court

significantly clarified the standard for a motion to dismiss, as follows:

Under Federal Rule of Civil Procedure 8(a)(2), a pleading must contain a "short and

plain statement of the claim showing that the pleader is entitled to relief." As the

Court held in Twombly, the pleading standard Rule 8 announces does not require

"detailed factual allegations," but it demands more than an unadorned, the-defendant-unlawfully-harmed-me accusation. A pleading that offers "labels and conclusions"

or "a formulaic recitation of the elements of a cause of action will not do." Nor does

a complaint suffice if it tenders "naked assertion[s]" devoid of "further factual

enhancement."

To survive a motion to dismiss, a complaint must contain sufficient factual

matter, accepted as true, to "state a claim to relief that is plausible on its face." A

claim has facial plausibility when the plaintiff pleads factual content that allows the

court to draw the reasonable inference that the defendant is liable for the misconduct

alleged. The plausibility standard is not akin to a "probability requirement," but it

asks for more than a sheer possibility that a defendant has acted unlawfully. Where

a complaint pleads facts that are "merely consistent with" a defendant's liability, it

"stops short of the line between possibility and plausibility of 'entitlement to relief.'"

Two working principles underlie our decision in Twombly. First, the tenet

that a court must accept as true all of the allegations contained in a complaint is

inapplicable to legal conclusions. Threadbare recitals of the elements of a cause of


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action, supported by mere conclusory statements, do not suffice. Rule 8 marks a

notable and generous departure from the hyper-technical, code-pleading regime of

a prior era, but it does not unlock the doors of discovery for a plaintiff armed with

nothing more than conclusions. Second, only a complaint that states a plausible

claim for relief survives a motion to dismiss. Determining whether a complaint

states a plausible claim for relief will . . . be a context-specific task that requires the

reviewing court to draw on its judicial experience and common sense. But where the

well-pleaded facts do not permit the court to infer more than the mere possibility of

misconduct, the complaint has alleged—but it has not "show[n]"—"that the pleader

is entitled to relief."

In keeping with these principles a court considering a motion to dismiss can

choose to begin by identifying pleadings that, because they are no more than

conclusions, are not entitled to the assumption of truth. While legal conclusions can

provide the framework of a complaint, they must be supported by factual allegations. When there are well-pleaded factual allegations, a court should assume their veracity

and then determine whether they plausibly give rise to an entitlement to relief.

Ashcroft v. Iqbal, 556 U.S. 662, 677-79, 129 S. Ct. 1937, 1949-50 (2009) (citations omitted &

emphasis added) (quoting Bell Atl. Corp. v. Twombly, 550 U.S. 544, 556-57, 570, 127 S. Ct. 1955,

1965-66, 1974 (2007) (retiring the Conley v. Gibson, 355 U.S. 41, 45-46, 78 S. Ct. 99, 102 (1957),

pleading standard that required denying a Rule 12(b)(6) motion to dismiss "unless it appears beyond

doubt that the plaintiff can prove no set of facts in support of his claim which would entitle him to

relief")). 1/

1/ Accord, e.g., Affinity LLC v. GfK Mediamark Research & Intelligence, LLC, 547 F. App'x

54, 55-56 (2d Cir. 2013); Massena v. Bronstein, 545 F. App'x 53, 55 (2d Cir. 2013); Cancel

v. Home Depot, 488 F. App'x 520, 520 (2d Cir. 2012); Spataro v. Glenwood Supply, 479 F.

App'x 403, 404 (2d Cir. 2012); Starr v. Sony BMG Music Entm't, 592 F.3d 314, 321 (2d Cir.

2010), cert. denied, 131 S. Ct. 901 (2011); Harris v. Mills, 572 F.3d 66, 71-72 (2d Cir.

2009); Scerba v. Allied Pilots Ass'n, 13 Civ. 3694, 2013 WL 6481583 at *6-7 (S.D.N.Y. Dec. 10, 2013) (Peck, M.J.), aff'd, --F. App'x--, 2014 WL 4851713 (2d Cir. Oct. 1, 2014);

Florio v. Canty, 954 F. Supp. 2d 227, 229-30 (S.D.N.Y. 2013) (Peck, M.J.) (citing cases);

Mahoney v. Sony Music Entm't, 12 Civ. 5045, 2013 WL 491526 at *4-5 (S.D.N.Y. Feb. 11,

2013) (Peck, M.J.); Toto, Inc. v. Sony Music Entm't, 12 Civ. 1434, 2012 WL 6136365 at *5

(S.D.N.Y. Dec. 11, 2012) (Peck, M.J.), report & rec. adopted, 2013 WL 163826 (S.D.N.Y.

Jan. 15, 2013).


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Even after Twombly and Iqbal, the Court's role in deciding a motion to dismiss "is

merely to assess the legal feasibility of the complaint, not to assay the weight of the evidence which

might be offered in support thereof." Bison Capital Corp. v. ATP Oil & Gas Corp., 10 Civ. 0714,

2010 WL 2697121 at *5 (S.D.N.Y. June 24, 2010) (Peck, M.J.) (quotations omitted), report & rec.

adopted, 2010 WL 3733927 (S.D.N.Y. Sept. 16, 2010). 2'

2. Consideration of Documents Attached to the Amended Complaint

A Rule 12(b)(6) motion to dismiss challenges only the face of the pleading. Thus,

in deciding such a motion to dismiss, "the Court must limit its analysis to the four corners of the

complaint." Vassilatos v. Ceram Tech Int'l, Ltd., 92 Civ. 4574, 1993 WL 177780 at *5 (S.D.N.Y.

May 19, 1993) (citing Kopec v. Coughlin, 922 F.2d 152, 154-55 (2d Cir. 1991)). 3' The Court,

however, may consider documents attached to the complaint as an exhibit or incorporated in the

complaint by reference. E.g., ATSI Commc'ns, Inc. v. Shaar Fund, Ltd., 493 F.3d 87, 98 (2d Cir.

2' Accord, e.g., Florio v. Canty, 954 F. Supp. 2d at 230-31; Tasini v. AOL, Inc., 851 F. Supp.

2d 734, 737 (S.D.N.Y.) ("The Court's function on a motion to dismiss is 'not to weigh the

evidence that might be presented at a trial but merely to determine whether the complaint

itself is legally sufficient.'"), aff'd, 505 F. App'x 45 (2d Cir. 2012); Saunders v. Coughlin, 92

Civ. 4289, 1994 WL 88108 at *2 (S.D.N.Y. Mar. 15, 1994) (quoting Geisler v. Petrocelli,

616 F.2d 636, 639 (2d Cir. 1980)).

3' Accord, e.g., Grant v. Cnty. of Erie, 542 F. App'x 21, 23 & n.1 (2d Cir. 2013); Faulkner v.

Beer, 463 F.3d 130, 134 (2d Cir. 2006); Aniero Concrete Co. v. N.Y.C. Constr. Auth., 94

Civ. 3506, 2000 WL 863208 at *31 (S.D.N.Y. June 27, 2000); Six W. Retail Acquisition,

Inc. v. Sony Theatre Mgmt. Corp., 97 Civ. 5499, 2000 WL 264295 at *12 (S.D.N.Y. Mar. 9, 2000) ("When reviewing the pleadings on a motion to dismiss pursuant to Rule 12(b)(6), a court looks only to the four corners of the complaint and evaluates the legal viability of the

allegations contained therein.").

When additional materials are submitted to the Court for consideration with a 12(b)(6)

motion, the Court must either exclude the additional materials and decide the motion based

solely upon the complaint, or convert the motion to one for summary judgment under Fed.

R. Civ. P. 56. See Fed. R. Civ. P. 12(b); Friedl v. City of N.Y., 210 F.3d 79, 83 (2d Cir.

2000); Fonte v. Bd. of Managers of Cont'l Towers Condo., 848 F.2d 24, 25 (2d Cir. 1988).


2007); Chambers v. Time Warner, Inc., 282 F.3d 147, 153 (2d Cir. 2002) ("Because this standard

has been misinterpreted on occasion, we reiterate here that a plaintiff's reliance on the terms and

effect of a document in drafting the complaint is a necessary prerequisite to the court's consideration

of the document on a dismissal motion; mere notice or possession is not enough."); Rothman v.

Gregor, 220 F.3d 81, 88 (2d Cir. 2000) ("For purposes of a motion to dismiss, we have deemed a

complaint to include any written instrument attached to it as an exhibit or any statements or

documents incorporated in it by reference . . . ."). 4/

"However, before materials outside the record may become the basis for a dismissal,

several conditions must be met. For example, even if a document is 'integral' to the complaint, it

must be clear on the record that no dispute exists regarding the authenticity or accuracy of the

document. It must also be clear that there exists no material disputed issue of fact regarding the

relevance of the document." Faulkner v. Beer, 463 F.3d at 134 (citations omitted). In this case, the

documents that plaintiff incorporated by reference in the amended complaint may be considered on

the motions to dismiss, subject to the Faulkner v. Beer proviso.

B. The Standard Pursuant to Fed. R. Civ. P. 12(b)(1)

The "standards for dismissal under [Rule] 12(b)(6) and 12(b)(1) are substantively

identical." Lerner v. Fleet Bank, N.A., 318 F.3d 113, 128 (2d Cir.) (Sotomayor, C. J.), cert. denied,

4/ See also, e.g., Yak v. Bank Brussels Lambert, 252 F.3d 127, 130 (2d Cir. 2001) (citing

Cortec Indus., Inc. v. Sum Holding L.P., 949 F.2d 42, 47 (2d Cir. 1991), cert. denied, 503

U.S. 960, 112 S. Ct. 1561 (1992)); Paulemon v. Tobin, 30 F.3d 307, 308-09 (2d Cir. 1994); Brass v. Am. Film Techs., Inc., 987 F.2d 142, 150 (2d Cir. 1993); Florio v. Canty, 954 F.

Supp. 2d 227, 231-32 (S.D.N.Y. 2013) (Peck, M.J.); In re Lehman Bros. Sec. & ERISA

Litig., 903 F. Supp. 2d 152, 168-69 (S.D.N.Y. 2012) (quoting ATSI Commc'ns, Inc. v. Shaar

Fund, Ltd., 493 F.3d at 98); Drum Major Music Entm't Inc. v. Young Money Entm't, LLC,

11 Civ. 1980, 2012 WL 423350 at *2 (S.D.N.Y. Feb. 7, 2012); Maniolos v. United States,

741 F. Supp. 2d 555, 560 (S.D.N.Y. 2010) (Peck, M.J.), aff'd, 469 F. App'x 56 (2d Cir. 2012).


9

540 U.S. 1012, 124 S. Ct. 532 (2003); see also, e.g., Moore v. PaineWebber, Inc., 189 F.3d 165, 169

n.3 (2d Cir. 1999); Pearl River Union Free Sch. Dist. v. Duncan, 12 Civ. 2938, 2014 WL 4387235

at *10 (S.D.N.Y. Sept. 5, 2014); Bishop v. Porter, 02 Civ. 9542, 2003 WL 21032011 at *3 (S.D.N.Y.

May 8, 2003); Tennant v. U.S. Bureau of Prisons, No. 02 CV 00558, 2003 WL 1740605 at *1 (D.

Conn. Mar. 29, 2003). 5/

C. Pleading Requirements for Securities Fraud

A complaint alleging securities fraud must satisfy the heightened pleadings

requirements of Federal Rule of Civil Procedure 9(b) by stating with "particularity the circumstances

constituting fraud." Fed. R. Civ. P. 9(b); see, e.g., ATSI Commnc'ns, Inc. v. Shaar Fund, Ltd., 493

F.3d 87, 99 (2d Cir. 2007); Ganino v. Citizens Utils. Co., 228 F.3d 154, 168 (2d Cir. 2000) ("It is

well-settled in this Circuit that a complaint alleging securities fraud must satisfy the pleading

requirements of Rule 9(b) of the Federal Rules of Civil Procedure."). Federal Rule of Civil

Procedure 9(b) states:

5/ The only substantive difference is "that the party invoking the jurisdiction of the court has

the burden of proof in a 12(b)(1) motion, in contrast to a 12(b)(6) motion, in which the

defendant has the burden of proof." Lerner v. Fleet Bank, N.A., 318 F.3d at 128 (citing

Thompson v. Cnty. of Franklin, 15 F.3d 245, 249 (2d Cir. 1994)); see also, e.g., Langella v.

Bush, 306 F. Supp. 2d 459, 463 (S.D.N.Y. 2004) ("On a motion to dismiss pursuant to Rule

12(b)(1), plaintiff carries the burden of establishing that subject matter jurisdiction exists

over his complaint."); Bishop v. Porter, 2003 WL 21032011 at *3.

The other difference is that on a motion to dismiss for lack of subject matter

jurisdiction under Rule 12(b)(1), the Court "may refer to evidence outside the pleadings." Makarova v. United States, 201 F.3d 110, 113 (2d Cir. 2000) (citing Kamen v. American

Tel. & Tel. Co., 791 F.2d 1006, 1011 (2d Cir. 1986)); see also, e.g., Land v. Dollar, 330 U.S.

731, 735 n.4, 67 S. Ct. 1009, 1011 n.4 (1947) ("[W]hen a question of the District Court's

jurisdiction is raised . . . the court may inquire, by affidavits or otherwise, into the facts as

they exist."(citations omitted)); Exchange Nat'l Bank v. Touche Ross & Co., 544 F.2d 1126,

1130-31 (2d Cir. 1976); Masters v. Wilhelmina Model Agency, Inc., 02 Civ. 4911, 2003 WL

145556 at *1 (S.D.N.Y. Jan. 17, 2003).


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In alleging fraud or mistake, a party must state with particularity the circumstances

constituting fraud or mistake. Malice, intent, knowledge, and other conditions of a

person's mind may be alleged generally.

Although Rule 9(b) must be read together with Rule 8(a), which requires only a

"'short and plain statement' of the claims," Ouaknine v. MacFarlane, 897 F.2d 75, 79 (2d Cir. 1990),

the fraud allegations in the complaint must be specific enough to allow the defendant "a reasonable

opportunity to answer the complaint," Ross v. A. H. Robins Co., 607 F.2d 545, 557 (2d Cir. 1979),

cert. denied, 446 U.S. 946, 100 S. Ct. 2175 (1980). 6/ Furthermore, the complaint must give the

defendant "adequate information" to allow the defendant "to frame a response." Ross v. A. H.

Robins Co., 607 F.2d at 557-58; Miller v. Holtzbrinck Publishers, LLC, 08 Civ. 3508, 2009 WL

528620 at *2 (S.D.N.Y. Mar. 3, 2009), aff'd, 377 F. App'x 72 (2d Cir. 2010); Kermanshah v.

Kermanshah, 580 F. Supp. 2d 247, 257 (S.D.N.Y. 2008) (Peck, M.J.); Ryan v. Hunton & Williams,

No. 99-CV-5938, 2000 WL 1375265 at *6 (E.D.N.Y. Sept. 20, 2000) ("Allegations of fraud . . .

must be specific enough to provide a defendant with 'a reasonable opportunity to answer the

complaint and . . . adequate information to frame a response.'").

Because the amended complaint asserts a claim for securities fraud, Rule 9(b)'s

requirements are supplemented by the parallel requirements of the Private Securities Litigation

Reform Act ("PSLRA"). See, e.g., ECA, Local 134 IBEW Joint Pension Trust v. JP Morgan Chase

6/ Accord, e.g., Lentell v. Merrill Lynch & Co., 396 F.3d 161, 168 (2d Cir.), cert. denied, 546

U.S. 935, 126 S. Ct. 421 (2005); Rombach v. Chang, 355 F.3d 164, 171 (2d Cir. 2004);

LaSalle Nat'l Bank v. Duff & Phelps Credit Rating Co., 951 F. Supp. 1071, 1081 (S.D.N.Y.

1996) (Knapp, D.J. & Peck, M.J.); In re Towers Fin. Corp. Noteholders Litig., 93 Civ. 0810,

1995 WL 571888 at *12 (S.D.N.Y. 1995) (Peck, M.J.), report & rec. adopted, 936 F. Supp.

126 (S.D.N.Y. 1996); O'Brien v. National Prop. Analysts Partners, 719 F. Supp. 222, 225

(S.D.N.Y. 1989) ("Rule 9(b) is designed to provide a defendant with fair notice of a

plaintiff's claim in order to enable a defendant to prepare a defense, protect defendant's

reputation or goodwill from harm, and reduce the number of strike suits.").


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Co., 553 F.3d 187, 196 (2d Cir. 2009); Lentell v. Merrill Lynch & Co., 396 F.3d at 168; Rombach

v. Chang, 355 F.3d at 172; Novak v. Kasaks, 216 F.3d 300, 306-07 (2d Cir.), cert. denied, 531 U.S.

1012, 121 S. Ct. 567 (2000); Freedman v. Weatherford Int'l Ltd., 12 Civ. 2121, 2013 WL 5299137

at *4 (S.D.N.Y. Sept. 20, 2013) (Kaplan, D.J.); In re AOL, Inc. Repurchase Offer Litig., 966 F.

Supp. 2d 307, 311 (S.D.N.Y. 2013). 7/ The PSLRA provides:

(b) Requirements for securities fraud actions

(1) Misleading statements and omissions

In any private action arising under this chapter in which the plaintiff alleges that the

defendant –

(A) made an untrue statement of a material fact; or

(B) omitted to 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;

the complaint shall specify each statement alleged to have been misleading, the

reason or reasons why the statement is misleading, and, if an allegation regarding the

statement or omission is made on information and belief, the complaint shall state

with particularity all facts on which that belief is formed.

15 U.S.C. § 78u-4(b)(1).

Even before the PSLRA, in order to satisfy the Rule 9(b) pleading requirement for

fraud under § 10(b) and Rule 10b-5, the Second Circuit required that the complaint must:

(1) specify the statements that the plaintiff contends were fraudulent, (2) identify the

speaker, (3) state where and when the statements were made, and (4) explain why the

statements were fraudulent.

7/ See also, e.g., In re Parmalat Sec. Litig., 383 F. Supp. 2d 616, 622 (S.D.N.Y. 2005) (Kaplan,

D.J.); In re Revlon, Inc. Secs. Litig., 99 Civ. 10192, 2001 WL 293820 at *6 (Mar. 27, 2001) ("A complaint alleging a violation of section 10(b) must satisfy the particularity requirement

of Rule 9(b) as well as the pleading requirements of the PSLRA." (citation omitted)); Rich

v. Maidstone Fin., Inc., 98 Civ. 2569, 2001 WL 286757 at *4-7 (S.D.N.Y. Mar. 23, 2001); Vogel v. Sands Bros. & Co., 126 F. Supp. 2d 730, 737 (S.D.N.Y. 2001).


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Acito v. IMCERA Grp, Inc., 47 F.3d 47, 51 (2d Cir. 1995). 8' This requirement continues after

passage of the PSLRA. E.g., ATSI Commc'ns, Inc. v. Shaar Fund, Ltd., 493 F.3d 87, 99 (2d Cir.

2007); Novak v. Kasaks, 216 F.3d at 306; Gordon v. Sonar Capital Mgmt. LLC, 11 Civ. 9665, 2014

WL 3900560 at *2 (S.D.N.Y. Aug. 1, 2014); Fishoff v. Coty Inc., No. 09 Civ. 628, 2009 WL

1585769 at *3 (S.D.N.Y. June 8, 2009); In re Optionable Sec. Litig., 577 F. Supp. 2d 681, 688

(S.D.N.Y. 2008) (Kaplan, D.J.); In re Parmalat Sec. Litig., 383 F. Supp. 2d at 622. 9'

The Second Circuit, both before and after passage of the PSLRA, requires that "a

plaintiff alleging fraud in connection with a securities transaction must specifically allege the acts

or omissions upon which his claim rests. It will not do merely to track the language of Rule 10b-5

and rely on such meaningless phrases as 'scheme and conspiracy' or 'plan and scheme and course

of conduct to deceive.'" Ross v. A.H. Robins Co., 607 F.2d at 557; see, e.g., Slayton v. Am. Exp.

Co., 604 F.3d 758, 773 (2d Cir. 2010) ("plaintiffs must 'state with particularity both the facts

constituting the alleged violation, and the facts evidencing scienter'"); Novak v. Kasaks, 216 F.3d

at 306-11 (discussing particularity and scienter requirements); Rich v. Maidstone Fin., Inc., 2001

WL 286757 at *7. 10'

8' Accord, e.g., Novak v. Kasaks, 216 F.3d at 306; Shields v. Citytrust Bancorp, 25 F.3d 1124,

1127-28 (2d Cir. 1994); LaSalle Nat'l Bank v. Duff & Phelps, 951 F. Supp. at 1081-82, see

also, e.g., In re Towers, 1995 WL 571888 at *13 (& cases cited therein).

9' See also, e.g., In re Complete Mgmt. Inc. Secs. Litig., 153 F. Supp. 2d 314, 329 (S.D.N.Y.

2001); In re Revlon, Inc. Secs. Litig., 2001 WL 293820 at *6; Rich v. Maidstone Fin., Inc, 2001 WL 286757 at *6; Vogel v. Sands Bros. & Co., 126 F. Supp. 2d at 737.

10' See also, e.g., In re Refco Inc. Sec. Litig., 826 F. Supp. 2d 478, 492 (S.D.N.Y. 2011); In re

Austl. & N.Z. Banking Grp. Ltd. Sec. Litig., 08 Civ.11278, 2009 WL 4823923 at *7

(S.D.N.Y. Dec. 14, 2009); Fishoff v. Coty Inc., 2009 WL 1585769 at *3; LaSalle Nat'l Bank v. Duff & Phelps, 951 F. Supp. at 1082; In re Towers, 1995 WL 571888 at *13.


13

Furthermore, a complaint alleging fraud against multiple defendants must state the

allegations specifically attributable to each individual defendant. E.g., In re DDAVP Direct

Purchaser Antitrust Litig., 585 F.3d 677, 695 (2d Cir. 2009), cert. denied, 561 U.S. 1038, 130 S. Ct.

3505 (2010); Mills v. Polar Molecular Corp., 12 F.3d 1170, 1175 (2d Cir. 1993); DiVittorio v.

Equidyne Extractive Indus., 822 F.2d 1242, 1247 (2d Cir. 1987); IKB Int'l S.A. v. Bank of Am., 12

Civ. 4036, 2014 WL 1377801 at *5 (S.D.N.Y. Mar. 31, 2014) (Kaplan, D.J.), aff'd, 584 F. App'x 26

(2d Cir. 2014); In re Parmalat Sec. Litig., 479 F. Supp. 2d 332, 340 (S.D.N.Y. 2007) (Kaplan, D.J.)

("[W]here, as here, 'multiple defendants are asked to respond to allegations of fraud, the complaint

should inform each defendant of the nature of his [or her] alleged participation in the fraud.'"); Rich

v. Maidstone Fin., Inc., 2001 WL 286757 at *6 ("when fraud is alleged against multiple defendants,

a plaintiff must set forth separately the acts complained of by each defendant. A complaint may not

simply clump defendants together in vague allegations to meet the pleading requirements of Rule

9(b)." (quotations, citations, & alterations omitted; collecting cases)).

II. PLAINTIFF ADEQUATELY ALLEGES VIOLATIONS OF EXCHANGE ACT SECTION 10(B) AND SEC RULE 10B-5

A. Elements of § 10(b) and Rule 10b -5 Claims

Exchange Act Section 10(b) and SEC Rule 10b-5 prohibit fraudulent activities in

connection with the purchase or sale of securities, whether or not those securities are registered. 11/

11/ Section 10(b) makes it unlawful:

To use or employ, in connection with the purchase or sale of any security registered on a

national securities exchange or any security not so registered, or any securities-based swap

agreement any manipulative or deceptive device or contrivance in contravention of such

rules and regulations as the Commission may prescribe . . . .

15 U.S.C. § 78j(b). Further, Rule 10b-5 makes it unlawful:

(continued...)


14

In order to state a prima facie case of a violation of § 10(b) and Rule 10b-5, a plaintiff

must allege: "(1) a material misrepresentation or omission by the defendant; (2) scienter; (3) a

connection between the misrepresentation or omission and the purchase or sale of a security; (4)

reliance upon the misrepresentation or omission; (5) economic loss; and (6) loss causation."

Carpenters Pension Trust Fund v. Barclays PLC, 750 F.3d 227, 232 (2d Cir. 2014). 12/ The failure

to establish any element is fatal to a section 10(b)/Rule 10b-5 claim. See, e.g., Central Bank of

Denver, N.A. v. First Interstate Bank of Denver, N.A., 511 U.S. 164, 190-91,114 S. Ct. 1439, 1455

(1994); First N.Y. Sec. LLC v. United Rentals Inc., 391 F. App'x 71, 74 (2d Cir. 2010) (unnecessary

to address materiality where plaintiff failed to establish scienter); Wilson v. Comtech Telecomm.

Corp., 648 F.2d 88, 94 (2d Cir. 1981) ("Because we find that [plaintiff] has failed to demonstrate

11/ (...continued) (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 . . . 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.

17 C.F.R. § 240.10b-5.

12/ See, e.g., Stratte-McClure v. Morgan Stanley, No. 13-0627, 2015 WL 136312 at *5 (2d Cir. Jan. 12, 2015); Acticon AG v. China N.E. Petroleum Holdings Ltd., 692 F. 3d 34, 37 (2d Cir.

2012); ECA, Local 134 IBEW Joint Pension Trust v. JP Morgan Chase Co., 553 F.3d 187,

197 (2d Cir. 2009); ATSI Commc'ns, Inc. v. Shaar Fund, Ltd., 493 F.3d 87, 105 (2d Cir. 2007); Ganino v. Citizens Utils. Co., 228 F.3d 154, 160 (2d Cir. 2000); Rothman v. Gregor,

220 F.3d 81, 89 (2d Cir. 2000); Grandon v. Merrill Lynch & Co., 147 F.3d 184, 189 (2d Cir.

1998); In re Time Warner Inc. Sec. Litig., 9 F.3d 259, 264 (2d Cir. 1993) (quoting Bloor v. Carro, Spanbock, Londin, Rodman & Fass, 754 F.2d 57, 61 (2d Cir. 1985)), cert. denied, 511

U.S. 1017, 114 S. Ct. 1397 (1994); In re China Valves Tech. Sec. Litig., 979 F. Supp. 2d

395, 406 (S.D.N.Y. 2013) (Kaplan, D.J.); In re Parmalat Sec. Litig., 375 F. Supp. 2d 278, 285 (S.D.N.Y. 2005) (Kaplan, D.J.).


15

his reliance on any actions by appellees, we need not reach the other elements of his 10b-5

claim."). 13/

Defendants argue that plaintiff has failed adequately to allege a material misstatement

or omission, scienter, or loss causation, and instead pleads only "fraud by hindsight." (Dkt. No. 64:

Fairway & Sterling Br. at 15; see id. at 15-33.)

B. Plaintiff Adequately Has Alleged Material Misstatements and Omissions

When a plaintiff alleges "'a statement or omission that a reasonable investor would

have considered significant in making investment decisions,'" such a misstatement or omission is

material. Litwin v. Blackstone Grp. L.P., 634 F.3d 706, 716-17 (2d Cir.), cert. denied, 132 S. Ct.

242 (2011); see also, e.g., Carpenters Pension Trust Fund v. Barclays PLC, 750 F.3d 227, 235 (2d

Cir. 2014); ECA, Local 134 IBEW Joint Pension Trust v. JP Morgan Chase Co., 553 F.3d 187, 197

(2d Cir. 2009); Caiola v. City Bank, N.A., 295 F.3d 312, 329 (2d Cir. 2002) ("[T]o fulfill the

materiality requirement there must be a substantial likelihood that the disclosure of the omitted fact

13/ See also, e.g., ECA, Local 134 IBEW Joint Pension Trust v. JP Morgan Chase Co.,

553 F.3d at 199-203 (failure to plead scienter); ATSI Commc'ns, Inc. v. Shaar Fund,

Ltd., 493 F.3d at 106 (failure to plead loss causation); In re Carter-Wallace, Inc.

Secs. Litig., 220 F.3d 36, 39 (2d Cir. 2000) (affirming dismissal of 10b-5 claim on

basis that plaintiff failed to adequately allege scienter); Rothman v. Gregor, 220 F.3d

at 98 (same); Chill v. General Elec. Co., 101 F.3d 263, 271 (2d Cir. 1997) (same);

In re Parmalat Sec. Litig., 570 F. Supp. 2d 521, 526 (S.D.N.Y. 2008) (Kaplan, D.J.);

In re Glenayre Tech., Inc. Secs. Litig., 96 Civ. 8252, 1998 WL 915907 at *2 n.4 (S.D.N.Y. Dec. 30, 1998) ("Since the plaintiffs fail to adequately plead scienter, I

need not address the other grounds for dismissal articulated by the defendants."),

aff'd mem., 201 F.3d 431 (2d Cir. 1999); The High View Fund, L.P. v. Hall, 27 F. Supp. 2d 420, 426 (S.D.N.Y. 1998); LaSalle Nat'l Bank v. Duff & Phelps, 951 F. Supp. at 1082; In re Towers, 1995 WL 571888 at *13; First Equity Corp. v. Standard

& Poor's Corp., 690 F. Supp. 256, 260 (S.D.N.Y. 1988) ("Because I hold that

plaintiffs have failed to demonstrate the existence of any genuine issue of fact as to

defendant's scienter, I need not address defendant's remaining arguments . . . ."),

aff'd, 869 F.2d 175 (2d Cir. 1999).


16

would have been viewed by the reasonable investor as having significantly altered the total mix of

information made available." (quotations omitted)); Ganino v. Citizens Utils. Co., 228 F.3d 154,

161-62 (2d Cir. 2000); City of Roseville Emps. Ret. Sys. v. Energysolutions, Inc., 814 F. Supp. 2d

395, 410 (S.D.N.Y. 2011).

An omission is actionable "only when the [defendant] is subject to a duty to disclose

the omitted facts." In re Time Warner Inc. Sec. Litig., 9 F.3d 259, 267 (2d Cir. 1993); accord, e.g.,

Kleinman v. Elan Corp., 706 F.3d 145, 153 (2d Cir. 2013); City of Roseville Emps. Ret. Sys. v.

Energy Solutions Inc., 814 F. Supp. 2d at 410. Although Rule 10b-5 imposes no affirmative duty

to disclose all material, non-public information, "once a party chooses to speak, it has a 'duty to be

both accurate and complete.'" Plumbers' Union Local No. 12 Pension Fund v. Swiss Reinsurance

Co., 753 F. Supp. 2d 166, 180 (S.D.N.Y. 2010) (quoting Caiola v. Citibank, N.A., 295 F.3d 312, 331

(2d Cir. 2002)). 14/

Because materiality is a mixed question of law and fact, a complaint may not be

dismissed on the ground that the alleged misstatements or omissions are not material "unless they

are so obviously unimportant to a reasonable investor that reasonable minds could not differ on the

question of their importance." ECA, Local 134 IBEW Joint Pension Trust v. JP Morgan Chase Co.,

553 F.3d at 197 (quotations omitted). 15/

14/ Accord, e.g., Dalberth v. Xerox Corp., 766 F.3d 172, 185 n.2 (2d Cir. 2014); City of

Roseville Emps. Ret. Sys. v. Energy Solutions Inc., 814 F. Supp. 2d at 410.

15/ Accord, e.g., Carpenters Pension Trust Fund v. Barclays PLC, 750 F.3d at 235; Ganino v.

Citizens Utils. Co., 228 F.3d at 162; City of Pontiac Gen. Emps. Ret. Sys. v. Lockheed

Martin Corp., 875 F. Supp. 2d 359, 368 (S.D.N.Y. 2012); In re China Valves Tech. Sec.

Litig., 11 Civ. 0796, 2012 WL 4039852 at *7 (S.D.N.Y. Sept. 12, 2012) (Kaplan, D.J.); In

re Gen. Elec. Co. Sec. Litig., 856 F. Supp. 2d 645, 654 (S.D.N.Y. 2012); In re Sanofi-Aventis Sec. Litig., 774 F. Supp. 2d 549, 561 (S.D.N.Y. 2011).


17

1. Material Misstatements Regarding New Store Growth

Plaintiff alleges that defendants made material misstatements concerning Fairway's

ability to achieve new store growth. (Dkt. No. 59: Am. Compl. ¶¶ 53-58, 82-93.) In support of this

allegation, plaintiff contrasts statements in the IPO Prospectus highlighting Fairway's "'scalable

infrastructure'" and "'proven ability to replicate [its] store model'" with statements from CW 2 and

CW 3 that Fairway's infrastructure, including its IT department and its warehousing and distribution

facilities, could not support Fairway's current stores, let alone a significant expansion. (Am. Compl.

¶¶ 82-85, 138.) Plaintiff contrasts Arditte's statement on a June 6, 2013 conference call that "'it

should be true on an annual basis [that] sales contributions from new store openings grows faster

than our [general and administrative] expense'" with Fairway's balance sheet and income statements,

which, after three years of rapid expansion, reflected over $200 million in debt and $124 million of

net operating losses. (Am. Compl. ¶¶ 158-60.) Plaintiff contrasts Ruetsch's June 6, 2013 statement

that "'the story about Fairway is adding new locations'" and defendant Santoro's remarks of the same

date ("'[w]e have the capacity in the context of our infrastructure to open more stores than this plan

provides for'") with the contemporaneous reality of what CW 1, who had direct access to Fairway's

financials and business strategy prior to the IPO, states was a struggling business model that lost

money each quarter prior to the IPO. (Am. Compl. ¶¶ 90-92, 158.)

Plaintiff alleges that the IPO Prospectus and Registration Statement stated that

Fairway had a "'proven ability to replicate [its] store model'" and "'scalable infrastructure.'" (Am.

Compl. ¶¶ 138, 297.) Similar statements were made in the 2013 10-K, a June 6, 2013 press release

and Form 8-K filed with the SEC, and on a June 6, 2013 quarterly earnings call. (Am. Compl. ¶¶

150-51, 158.).


18

Defendants argue that these statements are "forward-looking statements," and thus

protected by the PSLRA safe harbor and the Second Circuit's "bespeaks caution" doctrine. (Dkt.

No. 64: Fairway & Sterling Br. at 17-19; Dkt. No. 72: Fairway & Sterling Reply Br. at 4-7.) Neither

the PSLRA nor the bespeaks caution doctrine protect misstatements or omissions of present or

historical fact. 15 U.S.C. § 77z-2(c)(1)(B)(ii); see, e.g., Iowa Pub. Emps. Ret. Sys. v. MF Global,

Ltd., 620 F.3d 137, 142, 144 (2d Cir. 2010); Rombach v. Chang, 355 F.3d 164, 173 (2d Cir. 2004)

("'The doctrine of bespeaks caution provides no protection to someone who warns his hiking

companion to walk slowly because there might be a ditch ahead when he knows with near certainty

that the Grand Canyon lies one foot away.'" (quoting In Re Prudential Sec. Inc. P'ship Litig., 930

F. Supp. 68, 72 (S.D.N.Y. 1996)).

Characterizations of Fairway's infrastructure as "scalable" and capacity as greater

than provided for invite the conclusion that the company will expand with ease. Insofar as those

statements communicate present facts about Fairway's business they are not protected by the PSLRA

or the bespeaks caution doctrine. See, e.g., Iowa Pub. Emps. Ret. Sys. v. MF Global, Ltd., 620 F.3d

at 144; In re Bear Stearns Co., Sec., Derivative, & ERISA Litig., 763 F. Supp. 2d 423, 491-92

(S.D.N.Y. 2011); In re Regeneron Pharms., Inc. Sec. Litig., 03 Civ. 3111, 2005 WL 225288 at *13

(S.D.N.Y. Feb. 1, 2005) ("Statements that might arguably have some forward-looking aspect are

unprotected by the PSLRA safe harbor provision to the extent that they are premised on

representations of present fact.").

The statements plaintiff includes in the amended complaint were assurances that

Fairway had the present capacity to support its growth plan, not puffery or forward looking

optimism as defendants contend. (Fairway & Sterling Br. at 21-22; Fairway & Sterling Reply Br.

at 8-9.) The historical fact that Fairway was heavily indebted and operating at a loss posed a serious


19

obstacle to sales contributions from new store openings outpacing expenses. (Am. Compl. ¶¶ 159-

60.) Prefacing such a statement with "it should be true" does not change the assertive nature of the

statement, or the implication that it rests on a factual basis regarding the potential for profitability

at new Fairway stores. See, e.g., In re Bear Stearns Co., Sec., Derivative, & ERISA Litig., 763 F.

Supp. 2d at 492; In re Oxford Health Plans, Inc., 187 F.R.D. 133, 141 (S.D.N.Y. 1999)

("'Statements regarding projections of future performance may be actionable under section 10(b) or

Rule 10b–5 if they are . . . supported by specific statements of fact . . . or if the speaker does not

genuinely or reasonably believe them.'" (quoting In re IBM Corp. Sec. Litig., 163 F.3d 102, 107 (2d

Cir.1998)).

Defendants argue that plaintiff's confidential witnesses did not directly participate

in developing the growth plans at issue. (Fairway & Sterling Reply Br. at 7.) The amended

complaint identifies the confidential witnesses by their positions and dates of employment. (See

pages 4-5 above.) This information is sufficient to support the probability that someone in their

position would possess the information they each have alleged. Novak v. Kasaks, 216 F.3d 300, 314

(2d Cir.), cert. denied, 531 U.S. 1012, 121 S. Ct. 567 (2000); Freudenberg v. E*Trade Fin. Corp.,

712 F. Supp. 2d 171, 196-97 (S.D.N.Y 2010).

Plaintiff has specified fraudulent statements, identified the speakers, stated when and

where the statements were made, and explained why the statements were fraudulent. Novak v.

Kasaks, 216 F.3d at 306; see also cases cited at pages 11-12 above. Accordingly, plaintiff has

sufficiently pled that defendants made actionable misstatements with regard to new store growth.

2. Material Omission Regarding Same Store Sales Growth

Plaintiff alleges that the IPO prospectus, Registration Statement, June 6, 2013 10-K

and August 8, 2013 10-Q contained a material omission regarding same store sales growth. (Dkt.


20

No. 59: Am. Compl. ¶¶ 59-63, 141-43, 153, 168, 276.) Each document contained a statement that

after Hurricane Sandy, Fairway "'experienced business disruptions due to inventory delays as a

result of transportation issues, loss of electricity at certain of our locations and the inability of some

of our employees to travel to work due to transportation issues.'" (Am. Compl. ¶¶ 141, 153, 168.)

The Prospectus and June 6, 2013 10-K further stated that Fairway "'temporarily closed all [Fairway]

stores'" as a result of the storm. (Am. Compl. ¶¶ 62, 141, 153.) Plaintiff states that it was reasonable

for investors to expect that Fairway's same store sales would increase in subsequent years, absent

the unusual disruptions caused by Sandy, but that in fact Fairway experienced record high sales

before and after Hurricane Sandy. (Am. Compl. ¶¶ 63, 113.) The IPO prospectus stated that

Fairway tracked "sales on a daily basis." (Am. Compl. ¶ 142.) Plaintiff alleges that despite this

practice, defendants did not disclose until November 7, 2013 that Hurricane Sandy had been a boon

to business. (Am. Compl. ¶ 113.)

Rule 10b-5 imposes no affirmative duty to disclose all material, non-public

information; however, once a party chooses to speak, it has a "duty to be both accurate and

complete." Caiola v. Citibank, N.A., 295 F.3d 312, 331 (2d Cir. 2002); see, e.g., Freudenberg v.

E*Trade Fin. Corp., 712 F. Supp. 2d 171, 179 (S.D.N.Y. 2010) ("[O]nce corporate officers

undertake to make statements, they are obligated to speak truthfully and to make such additional

disclosures as are necessary to avoid rendering the statements misleading."); see also cases cited at

page 16 above. "'Even an entirely truthful statement may provide a basis for liability,'" if it misleads

investors. In re Sanofi-Aventis Sec. Litig., 774 F. Supp. 2d 549, 561 (S.D.N.Y. 2011).

Defendants put the topic of Hurricane Sandy's impact on Fairway's business at issue

through their statements. Having done so, they had a duty to disclose additional information if a

reasonable investor might find it "would significantly alter the mix of available information."


21

Freudenberg v. E*Trade Fin. Corp., 712 F. Supp. 2d at 180. Plaintiff alleges that defendants'

statements about the impact of Hurricane Sandy led investors to believe that Fairway's future sales

would improve over sales in 2012. (Am. Compl. ¶ 63.) Plaintiff alleges that this information was

material to investors who were concerned that the New York market could not support expanded

Fairway locations and continued same store sales growth. (Am. Compl. ¶ 59.) The omission is not

"so obviously unimportant to a reasonable investor that reasonable minds could not differ on the

question of [its] importance." ECA, Local 134 IBEW Joint Pension Trust v. JP Morgan Chase Co.,

553 F.3d 187, 197 (2d Cir. 2009); see also cases cited at page 16 above. Accordingly, plaintiff

sufficiently has pled that defendants made an actionable omission concerning sales growth at

existing Fairway stores.

3. Material Misstatement Regarding the Deferred Tax Asset ("DTA")

Plaintiff alleges that defendants reported a $26 million DTA in the IPO prospectus

and June 6, 2013 10-K although they did not subjectively believe future income would justify doing

so. (Dkt. No. 59: Am. Compl. ¶¶ 94-103.) Under Financial Accounting Standards No. 109, a DTA

may be claimed only if it is "more likely than not" that it will be used to offset taxable income in

future years. See, e.g., In re MF Global Holdings Ltd. Sec. Litig., 982 F. Supp. 2d 277, 293, 313-15

(S.D.N.Y. 2013); Kuriakose v. Fed. Home Loan Mortg. Corp., 897 F. Supp. 2d 168, 180-81

(S.D.N.Y. 2012), aff'd sub nom. Cent. States, Se. & Sw. Areas Pension Fund v. Fed. Home Loan

Mortg. Corp., 543 F. App'x 72 (2d Cir. 2013); In re Scottish Re Grp. Sec. Litig., 524 F. Supp. 2d

370, 377, 388-90 (S.D.N.Y. 2007). Plaintiff alleges that defendants' financial forecasts projecting

sufficient income to justify reporting the DTA had no basis in objective figures. (Am. Compl. ¶¶

94-103.) CW 1 stated that defendant Santoro set financial targets as necessary to make Fairway

seem an attractive IPO prospect, and that defendant Arditte manipulated business models to reach


22

those targets. (Am. Compl. ¶¶ 103, 124-26.) According to CW 1, Fairway's internal audit manager

played no role in developing projected earnings. (Am. Compl. ¶ 127.) Rather, at Sterling's direction

Santoro and Arditte, with input from Ruetsch, "came up" with a number of new stores and growth

rate, and modeled around those figures without regard to Fairway's verifiable financial metrics or

continued losses. (Am. Compl. ¶¶ 103, 125-26.)

Defendants argue that statements estimating the fair market value of assets, such as

a DTA, reflect management's judgment and opinion, not matters of objective fact. (Dkt. No. 64:

Fairway & Sterling Br. at 22-24; Dkt. No. 72: Fairway & Sterling Reply Br. at 9-10.) Statements

of opinion that are objectively false or disbelieved at the time they are expressed are actionable

under the securities laws. Fait v. Regions Fin. Corp., 655 F.3d 105, 112 (2d Cir. 2011) ("Requiring

plaintiffs to allege a speaker's disbelief in, and the falsity of, the opinions or beliefs expressed

ensures that their allegations concern the factual components of those statements."); IKB Int'l S.A.

v. Bank of America, 12 Civ. 4036, 2014 WL 1377801 at *1 (S.D.N.Y. Mar. 31, 2014) (Kaplan, D.J.)

(a fraud claim based on an expression of opinion may be actionable "because the speaker either did

not in fact hold the opinion stated or because the speaker subjectively was aware that there was no

reasonable basis for it"), aff'd, 584 F. App'x 26 (2d Cir. 2014); In re Gen. Elec. Co. Sec. Litig., 856

F. Supp 2d. 645, 653 (S.D.N.Y. 2012).

Under the relevant accounting standards, Fairway could not report the $ 26 million

DTA unless defendants believed that Fairway would have taxable income greater than $26 million

within five years. (Am. Compl. ¶¶ 96-99.) The Court has already found it plausible that defendants

knew Fairway did not have the capacity to grow as projected, and thus that Fairway's cumulative

losses would continue. (See pages 17-21 above.) Such finding is consistent with knowledge that

a $26 million profit within five years was unlikely. Although a write down "does not stand for the


23

proposition that values stated before the write-down were inaccurate," coupled with Fairway's

history of losses and plaintiff's allegation that Fairway's financial modeling was not rooted in actual

sales data, it raises the inference that defendants knew they would not have the necessary income.

Yu v. State St. Corp., 686 F. Supp. 2d 369, 380 (S.D.N.Y.), vacated on other grounds, 08 Civ. 8235,

2010 WL 2816259 (S.D.N.Y. July 14, 2010). Accordingly, plaintiff sufficiently has pled that

defendants had no basis to believe, and subjectively did not believe, that they would have income

to justify reporting the DTA.

C. Plaintiff Adequately Has Alleged Scienter

1. Legal Standard

Scienter is "'a mental state embracing intent to deceive, manipulate, or defraud.'"

Tellabs, Inc. v. Makor Issues & Rights, Ltd., 551 U.S. 308, 319, 127 S. Ct. 2499, 2507 (2007).

Under the PSLRA, a complaint must state with particularity facts giving rise to a "strong inference"

that the defendant acted with the required state of mind. 15 U.S.C. § 78u-4(b)(2). In Novak v.

Kasaks, the Second Circuit concluded that the PSLRA "effectively raised the nationwide pleading

standard to that previously existing in this circuit." Novak v. Kasaks, 216 F.3d 300, 310 (2d Cir.),

cert. denied, 531 U.S. 1012, 121 S. Ct. 567 (2000). Previously, the Second Circuit had accepted

allegations of "motive and opportunity" or allegations "constituting strong circumstantial evidence

of conscious misbehavior or recklessness" as means of demonstrating scienter, and both methods

have been used in this Circuit subsequent to the PSLRA's enactment. See, e.g., Stratte McClure v.

Morgan Stanley, No. 13-0627, 2015 WL 136312 at * 10 (2d Cir. Jan. 12, 2015); Kalnit v. Eichler,

264 F.3d 131, 138-39 (2d Cir. 2001); City of Brockton Ret. Sys. v. Avon Prods., Inc., 11 Civ. 4664,

2014 WL 4832321 at *18 (S.D.N.Y. Sept. 28, 2014); In re Pfizer, Inc. Sec. Litig., 538 F. Supp. 2d

621, 635 (S.D.N.Y. 2008) (Kaplan, D.J.).


24

The Second Circuit has further explained that a strong inference of scienter, sufficient

to meet the PSLRA's standards, may arise where the complaint alleges that defendants (1)

"benefitted in a concrete and personal way from the purported fraud"; (2) "engaged in deliberately

illegal behavior"; (3) "knew facts or had access to information suggesting that their public

statements were not accurate"; or (4) "failed to check information they had a duty to monitor."

Novak v. Kasaks, 216 F.3d at 311; see also, e.g., ECA, Local 134 IBEW Joint Pension Trust v. JP

Morgan Chase Co., 553 F.3d 187, 199 (2d Cir. 2009); In re JP Morgan Chase & Co. Sec. Litig., 12

Civ. 3852, 2014 WL 1297446 at *6 (S.D.N.Y. Mar. 31, 2014); U.S. S.E.C. v. Subaye, Inc., 13 Civ.

3114, 2014 WL 448414 at *6 (S.D.N.Y. Feb. 4, 2014).

The Supreme Court has held that to qualify as strong, an "inference of scienter must

be more than merely plausible or reasonable—it must be cogent and at least as compelling as any

opposing inference of nonfraudulent intent." Tellabs, Inc. v. Makor Issues & Rights, Ltd., 551 U.S.

at 314, 127 S. Ct. at 2504-05. In determining whether an inference of scienter can be drawn, the

Court should consider "all of the facts alleged, taken collectively . . . not whether any individual

allegation, scrutinized in isolation, meets that standard." Id. at 323, 127 S. Ct. at 2509.

2. Motive and Opportunity

a. Facts

Plaintiff advances several allegations to demonstrate the defendants' adequate motive

to commit fraud. Briefly, plaintiff argues that defendants sought to recoup their investment in

Fairway by inflating share prices and selling their own stake through the IPO. (Dkt. No. 59: Am.

Compl. ¶¶ 128-32.) According to plaintiff, 15,697,500 shares were offered in the IPO. (Am.

Compl. ¶ 9.) Plaintiff alleges that Sterling generated $95 million in the IPO: $23 million in stock

sales, $63 million in dividend payments and $9.2 million for the termination of Fairway's


25

management agreement with Sterling Advisors. (Am. Compl. ¶ 9.) Plaintiff argues that from the

time of their initial investment in Fairway, the Sterling defendants' intention was to "cash out" in an

IPO. (Am. Compl. ¶ 41.)

Numerous CWs, from different levels of Fairway's hierarchy, allege that Fairway's

financial projections were baseless, and that income statement line items such as existing stores

payroll were cut to manipulate numbers as a means of "painting over" problems prior to the IPO.

(Am. Compl. ¶¶ 85-90.) Plaintiff contends that in selling a portion of their holdings at inflated

prices (1,898,909 shares), the Sterling defendants were able to limit the risk on their investment and

generate a significant return in the IPO. (Am. Compl. ¶¶ 41, 130-31.)

As to the individual defendants, plaintiff alleges that Santoro, as a cofounder and

managing partner of the Sterling Funds, is deemed the beneficial owner of shares owned by the

Sterling Funds and thereby benefits directly from the Funds' $23 million profit on stock sales. (Am.

Compl. ¶¶ 130-31; Dkt. No. 65-4: Allerhand Aff. Ex. 4 at 23-24.) Plaintiff also alleges that

defendant Ruetsch sold 23,077 shares in the IPO, ten percent of his overall holdings, and received

an IPO related bonus for total IPO proceeds of over $1 million. (Am. Compl. ¶ 132; see Dkt. No.

64: Fairway & Sterling Br. at 28.)

Defendants argue that plaintiff's allegations are not sufficient to satisfy the motive

prong of the scienter inquiry. (Fairway & Sterling Br. 27-29; Dkt. No. 72: Fairway & Sterling Reply

Br. at 11-13.) Defendants state that Sterling sold only eight percent of its interest in Fairway in the

IPO, and a large post-IPO holding negates any showing of a plausible motive. (Fairway & Sterling

Br. at 27; Fairway & Sterling Reply Br. at 12.) Defendants further state that of the Individual

Defendants, only defendant Ruetsch sold stock during the class period. (Fairway & Sterling Br. at

28.)


26

b. Analysis

To raise a strong inference of scienter under the Second Circuit's "motive and

opportunity" standard, plaintiff must allege that defendants "benefitted in some concrete and

personal way from the purported fraud." Novak v. Kasaks, 216 F.3d 300, 307-08 (2d Cir.), cert.

denied, 531 U.S. 1012, 121 S. Ct. 567 (2000). Motives common to all corporate officers, such as

the desire for the corporation to appear profitable, or the desire to keep stock prices high to increase

officer compensation, do not suffice for purposes of this inquiry. Novak v. Kasaks, 216 F.3d at 307;

Kalnit v. Eichler, 264 F.3d 131, 139 (2d Cir. 2001); In re Refco., Inc. Sec. Litig., 503 F. Supp. 2d

611, 645 (S.D.N.Y. 2007) (Lynch, D.J.).

The motive showing is generally met when it is alleged that corporate insiders made

material misrepresentations to the public about the corporation's performance or prospects in order

to keep the stock price artificially high while they sold their own shares at a profit. ECA, Local 134

IBEW Joint Pension Trust v. JP Morgan Chase Co., 553 F.3d 187, 198 (2d Cir. 2009) (“[T]he

‘motive’ showing is generally met when corporate insiders allegedly make a misrepresentation in

order to sell their own shares at a profit.”); In re Refco., Inc. Sec. Litig., 503 F. Supp. 2d at 646;

Duncan v. Pencer, 94 Civ. 321, 1996 WL 19043 at * 14 (S.D.N.Y. Jan. 18, 1996) (misstatements

that inflate stock price in advance of a public offering are sufficient to support an inference of

scienter).

The opportunity showing is met by demonstrating "the means and likely prospect of

achieving concrete benefits by the means alleged." Shields v. Citytrust Bancorp, Inc., 25 F.3d 1124,

1130 (2d Cir. 1994). The opportunity to commit fraud may be assumed when the defendant is a

corporation or corporate officer or director. See, e.g., Kalnit v. Eichler, 264 F.3d 131, 139 (2d Cir.

2001); In re MF Global Holdings Ltd. Sec. Litig., 982 F. Supp. 2d 277, 306 (S.D.N.Y. 2013); Rolin


27

v. Spartan Mullen Et Cie, 10 Civ. 1586, 2011 WL 5920931 at *8 (S.D.N.Y. Nov. 23, 2011); In re

AstraZeneca Sec. Litig., 559 F. Supp. 2d 453, 468 (S.D.N.Y. 2008), aff'd sub nom. State Univ. Ret.

Sys. v. AstraZeneca PLC, 334 F. App'x 404 (2d Cir. 2009); Pension Comm. of Univ. of Montreal

Pension Plan v. Banc of Am. Sec., LLC, 446 F. Supp. 2d 163, 181 (S.D.N.Y. 2006) ("Regarding the

'opportunity' prong, courts often assume that corporations, corporate officers, and corporate directors

would have the opportunity to commit fraud if they so desired.").

The Court finds that the April 2013 IPO provides a motive for fraud. Plaintiff alleges

that in misrepresenting and concealing the state of Fairway's business, defendants were able to raise

millions of dollars in the offering, nearly recouping their entire $150 million investment in Fairway,

"that they otherwise would not have been able to if they presented a more complete and accurate

financial snapshot." Van Dongen v. CNinsure Inc., 951 F. Supp. 2d 457, 474 (S.D.N.Y. 2013).

Fairway and the Sterling Funds, as corporations, and Santoro and Ruetsch, as corporate officers, had

sufficient opportunity to commit fraud. In re AstraZeneca Sec. Litig., 559 F. Supp. 2d at 468. Each

of the individual officers was in a position to approve statements made to the public regarding the

health of Fairway's business, and cannot "seriously dispute that '[s]uch senior executives have the

opportunity to commit fraud.'" In re Refco, Inc. Sec. Litig., 503 F. Supp. 2d at 648.

Plaintiff has pled scienter by demonstrating motive and opportunity to commit fraud

on the part of Santoro, Ruetsch, Fairway, and the Sterling Defendants, all of whom stood to benefit

in a direct, personal and concrete way from the fraud. Plaintiff has not pled facts sufficient to

demonstrate that defendant Arditte had motive to commit fraud, but as discussed below, plaintiff

has alleged scienter as to Arditte by other means.


28

3. Circumstantial Evidence of Conscious Misbehavior or Recklessness

a. Facts

Plaintiff has put forth numerous allegations to support the contention that the

defendants' behavior was reckless. First, plaintiff argues that defendants knew or had access to

information that contradicted their public statements regarding Fairway's growth and growth

prospects. (Dkt. No. 59: Am. Compl. ¶¶ 82-93.) Second, plaintiff alleges that defendants violated

GAAP principles in keeping the DTA on their balance sheet when they knew they would not have

sufficient income to justify doing so. (Am. Compl. ¶¶ 94-102.) Third, plaintiff alleges that

defendant Ruetsch's resignation is suspicious, as it came on the eve of the February 6, 2014

disclosure that Fairway had experienced a reduction in same store sales growth, would write off its

entire DTA and would cut its Fiscal Year 2015 earnings outlook by approximately half. (Am.

Compl. ¶¶ 128-29.)

b. Analysis

To support an inference of recklessness plaintiffs must allege that defendant's conduct

was "'highly unreasonable,'" representing "'an extreme departure from the standards of ordinary

care.'" Novak v. Kasaks, 216 F.3d 300, 308 (2d Cir.), cert. denied, 531 U.S. 1012, 121 S. Ct. 567

(2000). The Second Circuit has defined "recklessness" as an "'egregious refusal to see the obvious,

or to investigate the doubtful.'" Chill v. Gen. Elec. Co., 101 F.3d 263, 269 (2d Cir. 1996).

"[S]ecurities fraud claims typically have sufficed to state a claim based on recklessness when they

have specifically alleged defendants' knowledge of facts or access to information contradicting their

public statements." Novak v. Kasaks, 216 F.3d at 308; Freudenberg v. E*Trade Fin. Corp., 712 F.

Supp. 2d 171, 197 (S.D.N.Y. 2010). Additionally, "[k]nowledge of the falsity of a company's

financial statements can be imputed to key officers who should have known of facts relating to the


29

core operations of their company that would have led them to the realization that the company's

financial statements were false when issued." In re Atlas Air Worldwide Holdings, Inc. Sec. Litig.,

324 F. Supp. 2d 474, 490 (S.D.N.Y. 2004). 16/

The amended complaint recounts numerous statements regarding Fairway's capacity

for growth and sales volume that plaintiff alleges were contradicted by deficient infrastructure and

actual sales data. (Dkt. No. 59: Am. Compl. ¶¶ 53-92.) Plaintiff also alleges that defendants'

misstatements concerned a core operation of their company, as Fairway's ability to support growth

was a key selling point emphasized on the IPO roadshow and in earnings calls with investors. (Am.

Compl. ¶¶ 51-69.) Individual defendants Santoro, Ruetsch and Arditte were high level corporate

executives with responsibility for the financial statements that plaintiff adequately has alleged

contained false or misleading statements. (Am. Compl. ¶¶ 25-28, 135-89.) The alleged access to

facts contradicting defendants' positive public statements supports an inference of scienter.

Plaintiff's additional allegations further support a finding of scienter (at the pleading

stage). Although GAAP violations standing alone are not sufficient, when coupled with allegations

of fraudulent intent they may support an inference of scienter. See, e.g., ECA, Local 134 IBEW

Joint Pension Trust v. JP Morgan Chase Co., 553 F.3d 187, 200-01 (2d Cir. 2009); Freudenberg v.

E*Trade Fin. Corp., 712 F. Supp. 2d at 199; In re Vivendi Universal, S.A., 381 F. Supp. 2d 158, 179

n.8 (S.D.N.Y. 2003); SEC v. DCI Telecomms., 122 F. Supp. 2d 495, 500 (S.D.N.Y. 2000). The

amended complaint alleges that defendants violated Financial Accounting Standards No. 109 by

16/ Courts in this District have taken a range of positions on the "core operations" doctrine

imputing knowledge to high level corporate officials. See In re Wachovia Equity Sec. Litig.,

753 F. Supp. 2d 326, 353 (S.D.N.Y. 2011) (collecting cases). "[T]he court considers 'core

operations' allegations to constitute supplementary but not independently sufficient means

to plead scienter." Id.


30

claiming a DTA despite year over year net losses. (Am. Compl. ¶¶ 94-102.) Plaintiff contends that

defendants did not take a valuation allowance to reduce the DTA because doing so would have

alerted investors to Fairway's unsupportable growth plans. (Am. Compl. ¶ 102.) Coupled with the

alleged GAAP violation, the allegation that defendants' intent was to conceal negative financial

prospects supports a finding of scienter.

While not dispositive, Ruetsch's resignation, announced concurrently with the

February 6, 2014 announcement of Fairway's reduced earnings outlook and complete valuation

allowance, also supports an inference of scienter. (Am. Compl. ¶¶ 117-21.) See Van Dongen v.

CNinsure, 951 F. Supp. 2d 457, 474 (S.D.N.Y. 2013) (resignation of insiders alleged to have been

involved in the scheme contributes to an inference of scienter); Ho v. Duoyon Global Water, Inc.,

887 F. Supp. 2d 547, 575 (S.D.N.Y. 2012) (executive's resignation, considered in conjunction with

other allegations, adds to inference of scienter); Hall v. Children's Place Retail Stores, Inc., 850 F.

Supp. 2d 212, 233 (S.D.N.Y. 2008).

Finally, defendants' argument that the CWs allegations fail to support scienter

because (with the exception of one CW) they did not have contact with the defendants is unavailing.

(Dkt. No. 64: Fairway & Sterling Br. at 30; Dkt. No. 72: Fairway & Sterling Reply Br. at 13-14.)

The CWs span a broad swath of Fairway's hierarchy, and corroborate each other's accounts, which

supports a scienter finding. See, e.g., Freudenberg v. E*Trade Fin. Corp., 712 F. Supp. 2d at 197.

In accordance with Tellabs, in finding an inference of scienter, the Court should consider "all of the

facts alleged, taken collectively." Tellabs, Inc. v. Makor Issues & Rights, Ltd., 551 U.S. 308, 323,

127 S. Ct. 2499, 2509 (2007); accord, e.g., Freudenberg v. E*Trade Fin. Corp., 712 F. Supp. 2d at

197 ("[I]n accordance with the Supreme Court's instruction in Tellabs, CWs' information must be

viewed together."). Considered collectively with the other allegations in the complaint, the CWs'


31

allegations that Fairway presented baseless valuations and growth projections, and intentionally

concealed its shortcomings from the investing public, add to the circumstantial evidence of

recklessness on the defendants' part.

The Court finds that plaintiff has alleged a strong inference of scienter based on both

motive and opportunity and circumstantial evidence of the defendants' reckless behavior. This

inference is at least as compelling as defendants' opposing theory that defendants believed Fairway's

growth targets were achievable, and that Fairway merely experienced a challenging retail market

in late fiscal 2013. (Dkt. No. 64: Fairway & Sterling Br. at 27; Fairway & Sterling Reply Br. at 1.)

D. Plaintiff Adequately Has Alleged Loss Causation

Loss causation is an essential element of a Section 10(b) and Rule 10b-5 claim, but

the pleading requirement is not meant to impose a great burden on plaintiffs. See Dura Pharm., Inc.

v. Broudo, 544 U.S. 336, 346-47, 125 S. Ct. 1627, 1633-35 (2005). To establish loss causation in

a case involving allegations of material misrepresentations and omissions, "a plaintiff must

allege . . . that the subject of the fraudulent statement or omission was the cause of the actual loss

suffered." Suez Equity Investors, L.P. v. Toronto-Dominion Bank, 250 F.3d 87, 95 (2d Cir. 2001);

accord, e.g., Lentell v. Merril Lynch & Co., 396 F.3d 161, 173 (2d Cir.), cert denied, 546 U.S. 935,

126 S. Ct. 421 (2005); see also, e.g., Dura Pharm., Inc. v. Broudo, 544 U.S. at 344-45, 125 S. Ct.

at 1633-34; ATSI Commc'ns, Inc. v. Shaar Fund, Ltd., 493 F.3d 87, 107 (2d Cir. 2007); Emergent

Capital Inv. Mgmt., LLC v. Stonepath Grp., Inc., 343 F.3d 189, 197 (2d Cir. 2003). 17/ It is not

17/ See also, e.g.,Prime Mover Capital Partners L.P. v. Elixir Gaming Technologies, Inc., 898

F. Supp. 2d 673, 684-85 (S.D.N.Y. 2012), aff'd, 548 F. App'x 16 (2d Cir. 2013); Freudenberg

v. E*Trade Fin. Corp., 712 F. Supp. 2d 171, 202 (S.D.N.Y. 2010); In re NTL, Inc. Sec. Litig., 02 Civ. 3013, 2006 WL 330113 at *9 (S.D.N.Y. Feb. 14, 2006), report & rec. adopted, 2006 WL 568225 (S.D.N.Y. Mar. 9, 2006) (Kaplan, D.J.).


32

enough for a plaintiff to merely allege that, at the time of plaintiff's purchase of a security, the price

of that security was artificially inflated as a result of a defendant's misrepresentation. Dura Pharm.,

Inc. v. Broudo, 544 U.S. at 344-45, 125 S. Ct. at 1633-34; Lentell v. Merrill Lynch & Co., 396 F.3d

at 174; Emergent Capital Inv. Mgmt., LLC v. Stonepath Group, Inc., 343 F.3d at 198; In re NTL,

Inc. Sec. Litig., 2006 WL 330113 at *9. 18/ Instead, a plaintiff "may do one of two things to

sufficiently allege loss causation. 'Where the alleged misstatement conceals a condition or event

which then occurs and causes the plaintiff's loss,' a plaintiff may plead that it is 'the materialization

of the undisclosed condition or event that causes the loss.' Alternatively, a plaintiff may identify

particular 'disclosing event[s]' that reveal the false information, and tie dissipation of artificial price

inflation to those events." Catton v. Def. Tech. Sys., Inc., 05 Civ. 6954, 2006 WL 27470 at *5

(S.D.N.Y. Jan. 3, 2006) (quoting In re Initial Pub. Offering Sec. Litig., 399 F. Supp. 2d 298, 307

(S.D.N.Y. 2005)). 19/ Allegations of loss causation are evaluated under the notice pleading standard

in Federal Rule of Civil Procedure Rule 8, and a short plain statement that provides defendants with

notice of the loss and its causal connection to the alleged misconduct is sufficient. Dura Pharm., Inc.

18/ "[I]f the loss was caused by an intervening event, like a general fall in the price of Internet

stocks, the chain of causation will not have been established." Emergent Capital Inv. Mgmt.,

LLC v. Stonepath Group, Inc., 343 F.3d at 197; accord, e.g., Lentell v. Merril Lynch & Co.,

396 F.3d at 174; see also, e.g., Dura Pharm., Inc. v. Broudo, 544 U.S. at 342-43, 125 S. Ct.

at 1631-32; In re NTL, Inc. Sec. Litig., 2006 WL 330113 at *9 n.11.

19/ Accord, e.g., Freudenberg v. E*Trade Fin. Corp., 712 F. Supp. 2d at 202 ("A risk allegedly

concealed by defendants which materialized and arguably caused the decline in shareholder

value suffices."); In re AOL Time Warner, Inc. Sec. Litig., 503 F. Supp. 2d 666, 677

(S.D.N.Y. 2007); In re NTL Inc. Sec. Litig., 2006 WL 330113 at *9 & n.12; In re

GeoPharma, Inc. Sec. Litig., 399 F. Supp. 2d 432, 444 (S.D.N.Y. 2005); Teamsters Local 445 Freight Div. Pension Fund v. Bombardier Inc., 05 Civ. 1898, 2005 WL 2148919 at *6

(S.D.N.Y. Sept. 6, 2005); see, e.g., In re Parmalat Sec. Litig., 375 F. Supp. 2d 278, 305-06 (S.D.N.Y. 2005) (Kaplan, D.J.).


33

v. Broudo, 544 U.S. at 346, 125 S. Ct. at 1633; see also, e.g., Van Dongen v. CNinsure Inc., 951 F.

Supp. 2d 457, 469 (S.D.N.Y. 2013); Freudenberg v. E*Trade Fin. Corp., 712 F. Supp. 2d at 202. 20/

Plaintiff alleges that defendants made misstatements and omissions about Fairway's

capacity to (1) meet new store growth targets; (2) increase sales at existing stores; and (3) generate

sufficient income to justify maintaining the $26 million DTA. (See pages 17-23 above.) Plaintiff

alleges that after defendants stated on a November 7, 2013 quarterly earnings call that Fairway

would open fewer stores in 2015 than projected, and that sales at presently existing stores had

experienced record high sales volume around the time of Hurricane Sandy, Fairway's stock price

declined 21.6% in one day. (Dkt. No. 59: Am. Compl. ¶ 196.) Plaintiff further alleges that after

defendants stated on a February 6, 2014 quarterly earnings call that sales had declined at existing

stores, they were cutting growth projections for the upcoming fiscal year, and that Fairway would

take a valuation allowance against the entire DTA, Fairway's share price dropped 29% in one day.

(Am. Compl. ¶¶ 197-98.)

Plaintiff has pled that defendants made material misstatements and omissions,

concealing risks that later materialized, and that "share price fell significantly after the truth became

known." Dura Pharm., Inc. v. Broudo, 544 U.S. at 347, 125 S. Ct. at 1634. Accordingly, plaintiff

adequately has alleged loss causation.

Defendants' motion to dismiss the Exchange Act § 10(b) and Rule 10b-5 claims

should be DENIED.

20/ In Acticon AG v. China N.E. Petroleum Holdings Ltd., 692 F.3d 34, 38 (2d Cir. 2012), the

Second Circuit identified (but did not decide) a circuit split regarding whether Fed. R. Civ.

P. 8(a) or 9(b) applies to pleading loss causation. Decisions in this District subsequent to

Acticon still have applied the "short plain" statement standard to loss causation. See, e.g.,

In re Magnum Hunter Res. Corp. Sec. Litig., 13 Civ. 2668, 2014 WL 2840152 at *10 (S.D.N.Y. June 23, 2014)


34

III. PLAINTIFF ADEQUATELY HAS ALLEGED A VIOLATION OF EXCHANGE ACT SECTION 20(A)

In addition to the Section 10(b) and Rule 10b-5 claims, plaintiff also alleges that

Santoro, Ruetsch, Arditte and the Sterling Defendants are liable as control persons under Section

20(a) of the Exchange Act (Dkt. No. 59: Am. Compl. ¶¶ 210-13), which provides:

Every person who, directly or indirectly, controls any person liable under any

provision of this chapter or of any rule or regulation thereunder shall also be liable

jointly and severally with and to the same extent as such controlled person to any

person to whom such controlled person is liable . . . unless the controlling person

acted in good faith and did not directly or indirectly induce the act or acts

constituting the violation or cause of action.

15 U.S.C. § 78t(a). "To establish a prima facie case of control person liability, a plaintiff must

show (1) a primary violation by the controlled person, (2) control of the primary violator by the

defendant, and (3) that the defendant was, in some meaningful sense, a culpable participant in the

controlled person's fraud." ATSI Commc'ns., Inc. v. Shaar Fund, Ltd., 493 F.3d 87, 108 (2d Cir.

2007).

Defendants' first argument for dismissal of the Section 20(a) claim is that plaintiff

has not alleged a primary Exchange Act violation. (Dkt. No. 64: Fairway & Sterling Br. at 34.)

That argument fails as the Court has found in Part II above that plaintiff adequately alleged a

primary § 10(b) violation. For this reason, defendants' motion to dismiss the Section 20(a) claim

on the part of the Individual Defendants and the Sterling Defendants (except Sterling Advisors)

should be DENIED.

Defendants further argue that plaintiff fails to adequately plead that Sterling Advisors

was a control person. (Fairway & Sterling Br. at 35). Control may be established by showing that

a defendant, directly or indirectly, possessed "the power to direct or cause the direction of the

management and policies of a person, whether through the ownership of voting securities, by


35

contract, or otherwise." 17 C.F.R. § 240.12b–2; see also, e.g., In re China Valves Tech. Sec. Litig.,

979 F. Supp 2d 395, 413-14 (S.D.N.Y. 2013) (Kaplan, D.J.). Also required for liability under

Section 20(a) is "actual involvement in the making of the fraudulent statements by the putatively

controlled entity." In re Refco, Inc. Sec. Litig., 503 F. Supp. 2d 611, 663 (S.D.N.Y. 2007) (Lynch,

D.J.).

The Second Circuit has held that the provision of advice and guidance does not raise

a reasonable inference of the power to direct, rather than merely inform, an entity's ultimate

decision. In re Lehman Bros. Mortg.-Backed Sec. Litig., 650 F.3d 167, 187 (2d Cir. 2011)

("Providing advice that the banks chose to follow does not suggest control."). Plaintiff has not

alleged that Sterling Advisors did anything more than consult with and advise Fairway's board on

business and financial matters. (Am. Compl. ¶ 34.) Accordingly, defendants' motion to dismiss the

Section 20(a) claim as to Sterling Advisors should be GRANTED.

IV. PLAINTIFF'S SECURITIES ACT CLAIMS

Plaintiff brings Securities Act claims under 15 U.S.C.§ 77k ("Section 11") against

Fairway, the Individual Defendants (all of whom are Fairway directors or officers), and the

Underwriter Defendants alleging that the Registration Statement contained omissions and

misstatements of material fact. (Dkt. No. 59: Am. Comp. ¶¶ 284-86.) Plaintiff brings claims under

15 U.S.C. § 77l(a)(2) ("Section 12(a)(2)") against Fairway and the Underwriter Defendants alleging

that the Prospectus contained omissions and misstatements of material fact. (Am. Compl. ¶¶ 294-

300.) Plaintiff also brings a claim against the Sterling Defendants and the Individual Defendants

under 15 U.S.C. § 77o ("Section 15" ) alleging control person violations. (Am. Compl. ¶¶ 301-04.)


36

A. Legal Standards

Securities Act Section 11 establishes liability on the part of issuers of registration

statements if "any part of the registration statement, when such part became effective, contained an

untrue statement of a material fact or omitted to state a material fact required to be stated therein or

necessary to make the statements therein not misleading." 15 U.S.C. § 77k(a); see also, e.g., In re

UBS AG Sec. Litig., 07 Civ. 11225, 2012 WL 4471265 at *24 (S.D.N.Y. Sept. 28, 2012), aff'd sub

nom. City of Pontiac Policemen's & Firemen's Ret. Sys. v. UBS AG, 752 F.3d 173 (2d Cir. 2014);

In re Morgan Stanley Info. Fund. Sec. Litig., 592 F.3d 347, 358 (2d Cir. 2010).

Section 12(a)(2) imposes liability upon "any person" who "offers or sells a security

. . . by means of a prospectus or oral communication, which includes an untrue statement of a

material fact or omits to state a material fact necessary in order to make the statements, in light of

the circumstances under which they were made, not misleading. . . ." 15 U.S.C. § 77l(a)(2); see,

e.g., NECA–IBEW Health & Welfare Fund v. Goldman Sachs & Co., 693 F.3d 145, 156 (2d Cir.

2012), cert denied, 133 S. Ct. 1624 (2013).

Section 15 imposes liability on "[e]very person who, by or through stock ownership,

agency, or otherwise, or who, pursuant to or in connection with an agreement or understanding with

one or more other persons by or through stock ownership, agency, or otherwise, controls any person

liable under" sections 11 or 12. 15 U.S.C. § 77o(a). To establish a claim for control-person liability

under Section 15, plaintiff must allege "(a) a primary violation by a controlled person, and (b)

control by the defendant of the primary violator." In re Refco, Inc. Sec. Litig., 503 F. Supp 2d. 611,

637 (S.D.N.Y. 2007) (Lynch, D.J.); accord, e.g., Ho v. Duoyuan Global Water, Inc., 887 F. Supp.

2d 547, 578 (S.D.N.Y. 2012); Fait v. Regions Fin. Corp., 712 F. Supp. 2d 117, 125 (S.D.N.Y. 2010)

(Kaplan, D.J.), aff'd, 655 F.3d 105 (2d Cir. 2011); In re CIT Grp., Inc. Sec. Litig., 349 F. Supp. 2d


37

685, 688 (S.D.N.Y. 2004) ("Section 15 simply imposes derivative liability against those who control

section 11 or 12 violators."); In re Vivendi Universal, S.A., 381 F. Supp. 2d 158, 187-88 (S.D.N.Y.

2003).

B. Analysis

1. Plaintiff Adequately Has Alleged a Violation of Section 11

Defendants argue that plaintiff has not alleged an actionable misstatement or

omission in the Registration Statement. (Dkt. No. 64: Fairway & Sterling Br. at 34; Dkt. No. 62:

Underwriters Br. at 3-12; Dkt. No. 71: Underwriters Reply Br. at 1-5.) Because the Court has found

that plaintiff adequately alleged misleading statements and omissions in the Registration Statement

and Prospectus (see pages 17-23 above), defendants' motions to dismiss the Section 11 claim should

be DENIED.

2. Plaintiff Fails to Allege a Violation of Section 12(a)(2)

Defendants argue that plaintiff does not have standing under Section 12(a)(2). (Dkt.

No. 62: Underwriters Br. at 12-14; Dkt. No. 64: Fairway & Sterling Br. at 34 n.23; Dkt. No. 71:

Underwriters Reply Br. at 5; Dkt. No. 72: Fairway & Sterling Reply Br. at 15.) The Supreme Court

has defined a prospectus as "a document that describes a public offering of securities." Gustafson

v. Alloyd Co., 513 U.S. 561, 584, 115 S. Ct. 1061, 1073 (1995). Following that decision, the Second

Circuit has determined that "a Section 12(a)(2) action cannot be maintained by a plaintiff who

acquires securities through a private transaction, whether primary or secondary," because a "private

offering is not effected 'by means of a prospectus.'" Yung v. Lee, 432 F.3d 142, 149 (2d Cir.

2005).21/ The amended complaint merely alleges that plaintiff "purchased shares of Fairway

21/ See also Caiafa v. Sea Containers Ltd., 331 F. App'x 14, 16 (2d Cir. 2009) (plaintiffs did not

(continued...)


38

securities during the Class Period." (Dkt. No. 59: Am. Compl. ¶23.) As defendants correctly point

out (Underwriters Br. at 13), plaintiff purchased Fairway stock on December 20, 2013 and January

4, 2014. (Dkt. No. 28: Silk Aff. Ex. A at 4.) Plaintiff does not allege that it purchased stock in the

April 2013 initial public offering. Accordingly, defendants' motion to dismiss plaintiff's Section

12(a)(2) claim should be GRANTED.

3. Plaintiff Adequately Has Alleged a Violation of Section 15

Control under Section 15 entails "the power to direct or cause the direction of the

management and policies of a person, whether through the ownership of voting securities, by

contract, or otherwise.'" 17 C.F.R. § 240.12b–2; see also, e.g., In re China Valves Tech. Sec. Litig.,

979 F. Supp. 2d 395, 413-14 (S.D.N.Y. 2013) (Kaplan, D.J.). "Allegations of control under Section

15 are subject only to notice-pleading requirements, and accordingly survive motions to dismiss 'as

long as it is at least plausible that the plaintiff could develop some set of facts that would pass

muster.'" In re Refco, Inc. Sec. Litig., 503 F. Supp. 2d 611, 637 (S.D.N.Y. 2007) (Lynch, D.J.); see

also, e.g., Ho v. Duoyon Global Water, Inc., 887 F. Supp. 2d 457, 562 (S.D.N.Y. 2012).

Defendants argue that plaintiff's Section 15 control person claims fail because the

amended complaint does not allege an underlying violation of the Securities Act. (Fairway &

Sterling Br. at 34.) Because the Court has found that plaintiff adequately has alleged a violation of

21/ (...continued) have standing under Section 12(a)(2) as they "failed to alleged that they purchased the

securities at issue in an initial public offering"); Johnson v. Sequans Commc'ns S.A., 11 Civ.

6341, 2013 WL 214297 at *16 (S.D.N.Y. Jan. 17, 2013) (the Second Circuit "generally

requires plaintiffs to plead that the securities at issue were purchased in the initial public

offering"); In re Refco, Inc. Sec. Litig., 503 F. Supp. 2d 611, 625 (S.D.N.Y. 2007) (Lynch,

D.J.) ("Even where the defendants' marketing efforts in connection with the private

transaction relied heavily upon the same prospectus used in a public offering, there was no

liability because defendants were not obligated to distribute the prospectus in connection

with that transaction.").


39

Section 11, the motion to dismiss on this ground fails as to all defendants except for Sterling

Advisors, for the reasons set forth above. (See pages 34-35 above.)

CONCLUSION

For the reasons set forth above, the defendants' motions to dismiss (Dkt. Nos. 61 &

63) should be GRANTED dismissing plaintiff's Exchange Act Section 20(a) claim and Securities

Act Section 15 claim as to defendant Sterling Advisors, and dismissing plaintiff's Securities Act

Section 12(a)(2) claim, and DENIED in all other respects.

FILING OF OBJECTIONS TO THIS REPORT AND RECOMMENDATION

Pursuant to 28 U.S.C. § 636(b)(1) and Rule 72(b) of the Federal Rules of Civil

Procedure, the parties shall have fourteen (14) days from service of this Report to file written

objections. See also Fed. R. Civ. P. 6. Such objections (and any responses to objections) shall be

filed with the Clerk of the Court, with courtesy copies delivered to the chambers of the Honorable

Lewis A. Kaplan, 500 Pearl Street, Room 2240, and to my chambers, 500 Pearl Street, Room 1370.

Any requests for an extension of time for filing objections must be directed to Judge Kaplan (with

a courtesy copy to my chambers). Failure to file objections will result in a waiver of those

objections for purposes of appeal. Thomas v. Arn, 474 U.S. 140, 106 S. Ct. 466 (1985); Ingram v.

Herrick, 475 F. App'x 793, 793 (2d Cir. 2012); IUE AFL-CIO Pension Fund v. Herrmann, 9 F.3d

1049, 1054 (2d Cir. 1993), cert. denied, 513 U.S. 822, 115 S. Ct. 86 (1994); Frank v. Johnson, 968

F.2d 298, 300 (2d Cir.), cert. denied, 506 U.S. 1038, 113 S. Ct. 825 (1992); Small v. Sec'y of Health


40

& Human Servs., 892 F.2d 15, 16 (2d Cir. 1989); Wesolek v. Canadair Ltd., 838 F.2d 55, 57-59 (2d

Cir. 1988); McCarthy v. Manson, 714 F.2d 234, 237-38 (2d Cir. 1983).

Dated: New York, New York January 20, 2015

Respectfully submitted,

Andrew J. Pe& United States Magistrate Judge

Copies ECF to: All Counsel Judge Lewis A. Kaplan

In re Fairway Group Holdings Corp. Securities Litigation ...€¦ · Intro.) Defendant Fairway...

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