Home » Securities Law Updates » New Judicial Opinions » Current Summary
Securities Law Summary
Seventh Circuit Dismisses Circulation Fraud Suit Filed Against Tribune Co.
Purgh, et al. v. Tribune Co., et al.
Nos. 06-3898, 06-3909, 2008 WL 867739, Court of Appeals for the Seventh Circuit, 04/02/2008
Companies Mentioned: City of Philadelphia Board of Pensions and Retirement, Tribune Company
Holding
The U.S. Court of Appeals for the Seventh Circuit affirmed a district court’s dismissal of two securities class action law suits filed against the Tribune Co. (“Tribune”), its executive officers, and the employees of its satellite Newsday and Hoy newspapers. Plaintiff shareholders accused defendants of fraudulently overstating the circulation figures of Newsday and Hoy in an effort to boost their advertising revenues. According to the Seventh Circuit, plaintiffs failed to establish the primary liability of any individual defendant, while the alleged misconduct could not be imputed to Tribune by the doctrine of respondeat superior. Specifically, plaintiffs were not able to plead with particularity the required state of mind, or show a strong inference of scienter. Further, misconduct of employees at a corporate subsidiary is not normally attributed to its corporate parent, absent grounds for piercing the corporate veil. Thus, the Seventh Circuit ruled that the securities fraud suit was correctly dismissed.
Detailed Summary
As stated in the Seventh Circuit’s opinion, defendant Tribune was a media and entertainment company engaged in newspaper publishing (e.g., the Chicago Tribune, the Los Angeles Times), television and radio broadcasting (e.g., Superstation WGN), and other entertainment ventures (e.g., the Chicago Cubs-at least for the time being). Tribune’s publishing segment purportedly generated more than 70 percent of its total revenues, which exceeded $5 billion annually during the years immediately prior to these lawsuits. At that time, Newsday was a New York subsidiary of Tribune, while Hoy was a division of Newsday. The rest of the defendants were four of its executive officers, and five employees of Newsday. The Audit Bureau of Circulations (ABC), an independent nonprofit monitoring organization, conducted annual audits of each newspaper’s paid circulation figures. The results of its audits were used to determine how much advertisers pay for their ads to appear in a newspaper.
This action was a consolidated class suit. The first case, a securities action filed by shareholders of Tribune, brought up two claims. The first claim arose under § 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b), and SEC Rule 10b-5, 17 C.F.R. § 240.10b-5. Shareholders brought this action against Tribune, four of its executive officers (the Tribune individual defendants), and certain employees of Newsday and Hoy (the Newsday-Hoy individual defendants). In a § 10(b) private action, a plaintiff must prove (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. Stoneridge Inv. Partners, LLC v. Scientific-Atlanta, Inc., --- U.S. ----, ----, 128 S.Ct. 761, 768, 169 L.Ed.2d 627 (2008).
The second securities claim arose under § 20(a) of the Securities Exchange Act of 1934, 15 U.S.C. § 78t(a). Shareholders of Tribune brought this claim against all of the individual defendants, arguing that the Tribune individual defendants are “controlling persons” of the Newsday-Hoy individual defendants. Section 20(a) states that “(e)very person who, directly or indirectly, controls any person liable under any provision of this title or of any rule or regulation thereunder shall also be liable jointly and severally with and to the same extent as such controlled person[.]” Id. Thus, to state a claim under § 20(a), a plaintiff must first adequately plead a primary violation of securities laws-here, a violation of § 10(b) and Rule 10b-5. See Southland Securities v. INSpire Ins. Solutions, 365 F.3d 353, 383-84 (5th Cir.2004).
The second case involved investments in Tribune stock by two ERISA (Employee Retirement Income Security) benefit plans that were offered to certain Tribune employees. Both were defined contribution plans that assign each participant a personal account, within which the participant may direct his contributions among 10 different funds. The proposed plaintiff class consisted of participants in the two plans whose individual accounts held shares in the Tribune Employee Stock Option Plan (ESOP) at any time from December 2002 up to the date the complaint was filed.
The defendants in the second case were Tribune’s Employee Benefits Committee (the EBC), 11 current or former members of the EBC (the Committee defendants), 13 members of Tribune’s board of directors (the board defendants), and Tribune itself. The EBC was a named fiduciary of each plan and was empowered to administer it. The board was a named fiduciary of one of the two plans; under both plans, however, the board’s only assigned duty was to appoint members of the EBC. Plaintiffs alleged Tribune was a de facto fiduciary based on its sponsorship of the plans. In this case, the plaintiffs did not allege fraud, only breaches of fiduciary duties and ERISA violations.
Plaintiffs alleged that as early as 2001, Newsday and Hoy overstated their circulation figures. Schemes such as phony hawking programs, false affidavits that understated returns and overstated net sales, and directions to subordinates to pay distributors for bogus deliveries of newspapers were employed. In addition, defendants caused many copies of the two papers to be dumped, or delivered to people who had not paid for them. The overstated circulation numbers resulted in Newsday and Hoy charging higher advertising rates than would have been charged otherwise. The true circulation of Newsday and Hoy was roughly 80 percent and 50 percent, respectively, of what was reported.
In a memorandum opinion and order, the U.S. District Court for the Northern District of Illinois dismissed both complaints with prejudice. Hill v. The Tribune Co., Nos. 05 C 2602, 05 C 2927, 06 C 0741, 2006 WL 2861016 (N.D.Ill. Sept.29, 2006). Hence, plaintiffs filed this appeal.
Plaintiffs alleged that the individual defendants, particularly the company executives, “knew or were reckless in not knowing that the sales revenues received from vendors did not support the circulation figures being reported to (ABC).” However, the Seventh Circuit dismissed these allegations as “conclusory.” Higginbotham v. Baxter Int’l, Inc., 495 F.3d 753, 756 (7th Cir.2007). Rather than stating allegations about the existing or missing circulation controls, the plaintiffs argued that the controls must have been weak because a fraud actually occurred. The Seventh Circuit held that this “fraud by hindsight” argument was already rejected in Higginbotham, where it was stated that “by definition, all frauds demonstrate the ‘inadequacy’ of existing controls, just as all bank robberies demonstrate the failure of bank security and all burglaries demonstrate the failure of locks and alarm systems.” Id. at 760.
In regard to the allegation of primary liability against the Newsday-Hoy individual defendants, plaintiffs stated that they knowingly signed false circulation audits for Newsday and Hoy that were submitted to ABC and that these submissions were public statements upon which fraud can be based. The Seventh Circuit found that these allegations failed to satisfy the scienter requirement. Specifically, plaintiff’s failed to comply with the provisions of the PSLRA (Private Securities Litigation Reform Act of 1995). This statute requires that each statement alleged to be misleading be specified in the complaint. 15 U.S.C. § 78u-4(b)(1).
Here, the only misleading statements identified were press releases and SEC filings, not submissions to ABC. The defendants raised this point prior to the district court’s judgment, but the plaintiffs’ second amended complaint failed to make any changes in this regard. According to the Seventh Circuit, without allegations establishing the requisite proximate relation between the Newsday and Hoy advertiser fraud and the Tribune investors’ harm, it can not rule in favor of plaintiffs. Thus, the plaintiffs failed to fulfill the pleading requirements as to any of the Newsday-Hoy individual defendants.
On the allegation of primary liability raised against the Tribune itself, the Seventh Circuit held that the “complaint fail(ed) to plead facts sufficient to support a strong inference of scienter on the part of any of the Tribune individual defendants. So, Tribune’s scienter cannot be based on their state of mind.” The plaintiffs argued that an employee’s (alleged to be a senior officer of the Tribune and the Publisher of the Hoy) scienter can be imputed to Tribune under the principles of respondeat superior. To this the Seventh Circuit wrote that the only fraudulent conduct described in the complaint was not undertaken in this employee’s Tribune capacity. The allegations stated that (1) he was “Publisher” of Hoy, and (2) “Publishers are required to certify their paid circulation figures to ABC every six months.” The Seventh Circuit found these allegations fatal to the plaintiffs’ cause because misconduct of employees at a corporate subsidiary is not normally attributed to its corporate parent, absent grounds for piercing the corporate veil. United States v. Bestfoods, 524 U.S. 51, 63-64, 118 S.Ct. 1876, 141 L.Ed.2d 43 (1998); IDS Life Ins. Co. v. SunAmerica Life Ins. Co., 136 F.3d 537, 540 (7th Cir.1998). Further, the allegations did not show that the alleged Publisher knowingly overstated circulation figures intending to benefit Tribune.
As to the ERISA complaint, plaintiffs stated three “overlapping claims.” The first argued that the defendants violated § 404 of ERISA, 29 U.S.C. § 1104, by failing to prudently and loyally manage assets held by the plans. The second asserted that the defendants violated §§ 404 and 405 of ERISA, 29 U.S.C. §§ 1104, 1105, by failing to provide complete and accurate information to the participants in the plans. The third also contended violations of §§ 404 and 405 of ERISA and stated that Tribune and its board failed to properly appoint, monitor, and inform the EBC.
The Seventh Circuit, after a careful evaluation of the allegations, found them to be insufficient, “as to all three claims.” In particular, the Seventh Circuit upheld the district courts dismissal of the first claim “because the facts alleged did not support that the defendants should have been aware of obvious control deficiencies; thus, no duty to investigate was triggered. The Seventh Circuit similarly affirmed the dismissal of the second claim “because the facts alleged do not support that the defendants should have been aware of the circulation fraud; thus, they were not negligent in the allegedly inaccurate statements they made to plan participants.” Finally, the Seventh Circuit concluded that the third claim “was correctly dismissed because it is premised on the first two rejected claims that the appointed fiduciaries breached their duties.”
On the basis of the foregoing, the Seventh Circuit affirmed the district court’s order of dismissal of the two consolidated actions.
View a PDF of the judicial opinion.Securities Law Commentary
Read the related Securities Law commentary: Seventh Circuit Looks at Corporate Scienter and Scheme Liability Rules in Pugh v. Tribune Co., by Joel B. Ginsberg, Esq.
Service
Link to this article · 
Send via E-mail · 
Printable Version (opens in new window)
