Parnes v. Gateway 2000, Inc.

United States Court of Appeals

FOR THE EIGHTH CIRCUIT

___________

No. 96-1559

___________

Ari Parnes; Deborah Slyne; Corey *

Emert; Faye Martin Anderson; Edward *

R. Pepper, on behalf of themselves and *

all others similarly situated, *

*

Appellants, *

* Appeal from the United States

v. * District Court for the

* District of South Dakota.

Gateway 2000, Inc.; Theodore W. *

Waitt; Richard D. Snyder; James *

Cravens; George H. Krauss; Douglas L. *

Lacey; Norman W. Waitt, Jr., *

*

Appellees. *

------------------------------ *

*

Faye Martin Anderson, on behalf of *

herself and all others similarly situated, *

*

Appellant, *

*

v. *

*

Gateway 2000, Inc.; Theodore W. *

Waitt; Richard D. Snyder; James *

Cravens; George H. Krauss; Douglas L. *

Lacey, *

*

Appellees. *

___________

Submitted: December 12, 1996

Filed: August 8, 1997

___________

Before McMILLIAN and MAGILL,1 Circuit Judges, and WEBBER,2 District Judge.

___________

MAGILL, Circuit Judge.

The Plaintiffs are individual investors3 who purchased

Gateway 2000, Inc. (Gateway) stock soon after the stock

was publicly offered. The stock subsequently decreased

in value after Gateway revealed disappointing earnings,

and the Plaintiffs brought this securities fraud suit

against Gateway and Gateway's corporate officers,

1

The Honorable Frank J. Magill was an active judge at the time this case was

submitted and assumed senior status on April 1, 1997, before the opinion was filed.

2

THE HONORABLE E. RICHARD WEBBER, United States District Judge for

the Eastern District of Missouri, sitting by designation.

3

The Plaintiffs are Ari Parnes, who purchased 50 shares of Gateway common

stock after December 7, 1993, and before June 23, 1994; Deborah Slyne, who

purchased 300 shares of Gateway common stock during the same period; Corey Emert,

who purchased 200 shares of Gateway common stock during the same period; Faye

Martin Anderson, who purchased 500 shares of Gateway common stock during the

same period; Craig Langweiler, who purchased 200 shares of Gateway common stock

during the same period; and Edward R. Pepper, who purchased 7000 shares of

Gateway common stock during the same period. The Plaintiffs sought certification as

a class, but this motion was denied as moot by the district court when it dismissed their

complaint. See Mem. Op. and Order I at 17.

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directors, and principal shareholders (Defendants).4 The

Plaintiffs allege that the

4

The Plaintiffs also brought suit against Goldman Sachs & Co. and Painewebber,

Inc., which underwrote Gateway's offer of stock to the public. The Plaintiffs' claims

against the underwriters were voluntarily dismissed without prejudice on January 17,

1995.

-3-

Defendants violated securities laws by misrepresenting

facts in Gateway's prospectus, registration statement,

and other company communications and by committing fraud

on the market. The district court5 dismissed the

Plaintiffs' complaint for failure to state a claim and

for failure to plead fraud with sufficient particularity.

After dismissal, the Plaintiffs sought leave to file an

amended complaint, which the district court denied. The

Plaintiffs now appeal, and we affirm.

I.

Gateway, founded in 1985 by Theodore Waitt and

Michael Hammond, is a South Dakota-based manufacturer and

direct marketer of personal computers. Gateway was

initially created as a Subchapter S corporation, and the

bulk of Gateway's stock was held by Theodore Waite and his

brother Norman. The company grew dramatically between

1985 and 1993, reaching sales of more than a billion

dollars per year.6 On

5

The Honorable John B. Jones, United States District Judge for the District of

South Dakota.

6

In its prospectus, Gateway describes itself as

the leading direct marketer of personal computers in the United States.

The Company develops, markets, manufactures and supports a product

line of IBM-compatible desktop, notebook and subnotebook PCs for use

by businesses, individuals, government agencies and educational

institutions. On October 1, 1993, the Company entered the European

market with the opening of a facility in Dublin, Ireland. Founded in 1985,

Gateway 2000 has sold over 1.3 million PCs and has increased its net

sales from approximately $11.8 million in 1988 to over $1.5 billion for the

twelve months ended September 30, 1993.

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December 7, 1993, Gateway became a public corporation and,

pursuant to a registration statement and prospectus,

offered stock to the public.

While expressing confidence in its likely continued

growth, see Prospectus (Dec. 7, 1993) at 6, Gateway's

prospectus contains a variety of warnings to prospective

investors. The prospectus explains that,

[a]lthough the Company anticipates significant

growth in the future, it does not expect its

growth to continue at the rates previously

experienced. The Company's operating results for

the fourth quarter of 1993 are expected to

reflect the growth historically experienced by

the Company in its fourth quarters, although not

necessarily at the rates previously experienced.

Prospectus at 3. In addition, the front cover of the

prospectus contains, in bold type, a reference to "Risk

Factors." The text of the prospectus includes a

description of sixteen risk factors. These risk factors

include:

Short Product Life Cycles

To maintain its competitive position in the

PC industry, the Company must continue to

introduce new products and features that address

the needs and preferences of its target consumer

markets. The PC industry is characterized by

short product life cycles resulting from rapid

changes in technology and consumer preference and

declining product prices. In 1993, the Company

Prospectus (Dec. 7, 1993) at 3.

-5-

has introduced numerous new products and

features. There can be no assurance that these

products or features will be successful, that the

introduction of new products or features by the

Company or its competitors will not materially

and adversely affect the sale of the Company's

existing products or that the Company will be

able to adapt to future changes in the PC

industry. . . .

-6-

Management of Growth

From its inception, the Company has

experienced a rapid rate of growth. Although the

Company attempts to forecast growth accurately,

the Company has experienced, and may continue to

experience, problems with respect to the size of

its work force and production facilities and the

adequacy of its management information systems

and inventory controls. These problems can

result in a high backlog of product orders and

delays in customer service and support. . . .

Potential for Fluctuating Operating Results

The PC industry generally has been subject to

seasonality and to significant quarterly and

annual fluctuations in operating results. The

Company's operating results are also subject to

such fluctuations. Fluctuations can result from

a wide variety of factors affecting the Company

and its competitors, including new product

developments or introductions, availability of

components, changes in product mix and pricing

and product reviews and other media coverage. . .

.

Potential Liability for Sales, Use or Income Taxes

The Company does not collect or remit sales

and use taxes with respect to its sales in any

state other than the State of South Dakota, where

its physical plant and employees are located. It

does not pay income taxes in any state (South

Dakota currently has no corporate income tax) and

pays franchise taxes only to Delaware and South

Dakota. Taxing authorities in certain other

states have solicited information from the

Company to determine whether the Company has

sufficient contacts with such states as would

require payment of income taxes or collection of

-7-

sales and use taxes from customers in those

states. The Company has not paid any such income

or sales and use taxes for any prior period, nor

has it established any reserves for payment of

such taxes. The Company believes that any amount

it might ultimately be required to pay for prior

periods would not have a material adverse impact

on its results of operations or financial

condition, but there can be no assurance that

there would not be such an effect.

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In the future, the Company may be required to

collect sales and use taxes or to pay state

income and franchise taxes in states other than

South Dakota. Although any requirement to

collect sales or use taxes in the future could

negatively affect the Company's sales, the

Company believes the collection of such taxes

would not have a material adverse effect on the

Company's results of operations or financial

condition. However, there can be no assurance

that there would not be such an effect. . . .

Absence of Public Market and Possible Volatility

of Stock Price

There has been no public market for the

Common Stock prior to the Offerings, and there

can be no assurance that a significant public

market for the Common Stock will develop or will

continue after the Offerings. The market price

for the Company's Common Stock may be highly

volatile. The Company believes factors such as

product announcements by the Company, or its

competitors or suppliers, or quarterly variances

in financial results could cause the market price

of the Common Stock to fluctuate substantially.

. . .

Prospectus at 7-10.

Gateway offered 11.7 million shares of stock at a

price of $15 per share. Roughly half of the income

generated by the stock sales was distributed to the Waite

brothers, in part to satisfy Gateway-related tax

liabilities. In the months that followed, Gateway stock

climbed to a high of $24-3/4 price per share.

-9-

The fourth quarter results of 1993, which were

announced on February 10, 1994, showed $545.9 million in

revenues, an increase of 36% over the third quarter of

1993 and 54% over the fourth quarter of 1992. The first

quarter of 1994 showed $615.9 million in revenues, but a

decline in per share earnings. Following the announcement

of the decline in earnings, price per share of Gateway

stock dropped from $20-7/16 to $15-1/2. The earnings per

share dropped again during the second quarter of 1994, and

the price of Gateway stock plummeted to $9-1/4 per share

on June 23, 1994. The

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announced reasons for Gateway's reduced earnings included

product transitions, unanticipated sales mix, and

technical problems with a new line of portable computers.

To address these problems, the company took cash reserves

and wrote-down against inventory and accounts receivables

of $20 million.

Between June 27, 1994, and July 1, 1994, the

Plaintiffs filed three identical class-action complaints

against the Defendants. The actions were consolidated in

the district court, and the Plaintiffs were given leave to

file an amended complaint.7 In count I of the amended

complaint, the Plaintiffs allege violations by the

Defendants of Section 11 of the Securities Act of 1933,

codified at 15 U.S.C. § 77k (misrepresentation or omission

of a material fact in a registration statement) (Section

11). In count II of the amended complaint, the Plaintiffs

allege a violation by the Defendants of Section 12(2) of

the Securities Act of 1933, codified at 15 U.S.C. § 77l

(misrepresentation or omission of material fact in a

prospectus or communication) (Section 12(2)). In count

III of the amended complaint, the Plaintiffs allege a

violation by the Defendants of Section 15 of the

Securities Act of 1933, codified at 15 U.S.C. § 77o

(liability for controlling persons) (Section 15). In

count IV of the amended complaint, the Plaintiffs allege

a violation by the Defendants of Section 10(b) of the

Securities Exchange Act of 1934, codified at 15 U.S.C. §

78j, and SEC Rule 10b-5 (fraudulent security transaction)

7

The district court ordered that the record in this case be sealed, and the parties'

briefs were filed under seal. See Clerk's Order (July 19, 1996) at 1. The parties have

agreed that the briefs no longer need to be sealed. Accordingly, we order that the briefs

in this case be unsealed.

-11-

(Section 10(b) and Rule 10b-5). In count V of the amended

complaint, the Plaintiffs allege a violation by the

Defendants of Section 20(a) of the Securities Exchange Act

of 1934, codified at 15 U.S.C. § 78t (liability for

controlling persons) (Section 20(a)).

As the basis for these assertions, the Plaintiffs

allege--based almost exclusively on information and

belief--that the Defendants engaged in a variety of

wrongdoing to

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artificially inflate the price of Gateway stock. The

Plaintiffs contend that in Gateway's prospectus the

Defendants: (1) overstated earnings in 1993 and 1994 by

failing to adequately reserve for uncollectible accounts

receivable, failing to make adequate reserves for product

returns, and failing to write down inventories in a timely

fashion; (2) misrepresented Gateway's prospect for growth;

(3) misrepresented the existence and extent of obsolete

and defective inventories; (4) misrepresented that

Gateway's reserves for doubtful accounts receivable were

adequate, thereby overstating Gateway's assets by at least

$6.8 million; (5) misrepresented the quality of Gateway's

new portable computers, which suffered from malfunctioning

track-balls and malfunctioning power supplies; (6)

misrepresented serious deficiencies of Gateway's

purchasing and inventory control systems, management

information and order systems, and management and

forecasting procedures; and (7) misrepresented Gateway's

obligations to pay sales taxes to states other than South

Dakota.

In addition, the Plaintiffs allege that the Defendants

committed fraud by meeting with and misleading security

analysts and by issuing press releases, broker's reports,

an Annual Report, and a first quarter report which were

misleading. The Plaintiffs also allege that the

individual defendants who controlled Gateway Service

Corporation (GSC) had GSC purchase Gateway products at

inflated prices, thereby artificially inflating Gateway's

profits.

The district court issued two decisions disposing of

this case. The first decision dismissed the Plaintiffs'

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first amended complaint. Following this dismissal, the

Plaintiffs filed Federal Rules of Civil Procedure 59(e)

and 60(b) motions, and sought to file another amended

complaint. The district court's second decision denied

the Plaintiffs' Rules 59(e) and 60(b) motions and denied

the Plaintiffs' motion to amend their first amended

complaint after dismissal.

In dismissing the Plaintiffs' first amended complaint,

the district court held that all of the Plaintiffs'

allegations of fraud failed to state the circumstances of

fraud with

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sufficient particularity to satisfy Federal Rule of Civil

Procedure 9(b). The district court accordingly struck

count IV of the Plaintiffs' complaint, which alleged

Section 10(b) and Rule 10b-5 violations. The district

court further held that, based on the bespeaks caution

doctrine, most of the of the alleged misrepresentations

were immaterial as a matter of law, and that liability

could therefore not attach. The district court also held

that a failure to discount $6.8 million from a company

with assets of $343,769,000 and earnings of $68,645,000

was not material as a matter of law. The district court

therefore dismissed count II of the complaint, which

alleged Section 11 violations, pursuant to Federal Rule of

Civil Procedure 12(b)(6) for failure to state a claim.

The district court originally dismissed count I of the

complaint, which alleged Section 11 violations, because

the Plaintiffs failed to refer to material

misrepresentations or omissions in the registration

statement, but instead referred only to the prospectus.

In its second decision, the district court held that, even

if this was an improper basis for dismissing count I, the

district court would have dismissed count I because all of

the alleged misrepresentations were immaterial.8

8

The Plaintiffs argue, and we agree, that the district court erred in dismissing

count I for the Plaintiffs' failure to refer specifically to Gateway's registration statement

in their complaint. The Defendants have acknowledged that Gateway's prospectus was

filed as part of its registration statement, see Appellees' Br. at 3, and the Plaintiffs'

reference in their complaint to the prospectus necessarily referred to the registration

statement as well. As is discussed below, however, we affirm the district court's

dismissal of count I on the alternative basis provided in the district court's second

memorandum decision.

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Because the Section 10(b), Rule 10b-5, Section 11, and

Section 12(2) counts had been dismissed, the district

court also dismissed counts III and V, which alleged

controlling person liability under Section 15 and Section

20(a), for failure to state a claim.

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In its second decision, the district court examined

the Plaintiffs' proposed complaint and determined that the

Plaintiffs' modifications did not save the complaint.

Relying on much the same reasoning as in its first

decision, the district court held that the Plaintiffs had

failed to plead fraud with sufficient particularity to

satisfy Rule 9(b), that the bespeaks caution doctrine

rendered immaterial most of the Defendants' alleged

misrepresentations, and that the Defendants' alleged

failure to discount $6.8 million was immaterial in light

of Gateway's earnings and assets.

The Plaintiffs now appeal. On appeal, the Plaintiffs

argue that the district court misapplied the bespeaks

caution doctrine when it dismissed the Plaintiffs' Section

11 and Section 12(2) claims for lack of materiality. The

Plaintiffs also argue that materiality is necessarily a

jury question and that the district court erred in ruling

on materiality as a matter of law. In addition, the

Plaintiffs contend that, because their complaint

satisfied Rule 9(b)'s particularity requirement, the

district court erred in dismissing their Section 10(b) and

Rule 10b-5 claims. Finally, the Plaintiffs argue that the

district court abused its discretion in dismissing the

complaint with prejudice and in denying the Plaintiffs

leave to amend.

II.

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In reviewing a dismissal under Federal Rule of Civil

Procedure 12(b)(6),9 this

9

In granting the Defendants' motion to dismiss, the district court considered the

prospectus which accompanied Gateway's December 7, 1993 offer of stock to the

public. See Mem. Op. and Order I at 11. Normally, a district court's decision to

consider matters outside of the pleadings will transform a motion to dismiss for failure

to state a claim into a motion for summary judgment. See Fed. R. Civ. P. 12(b).

However, "[i]n the event that a plaintiff alleges a claim based on a prospectus, as is the

case here, the court may consider the prospectus in ruling on a Rule 12(b)(6) motion

even if the prospectus was not attached to the complaint . . . ." Maywalt v. Parker &

Parsley Petroleum Co., 808 F. Supp. 1037, 1045-46 (S.D.N.Y. 1992) (citing cases); see

also In re Donald J. Trump Casino Sec. Litig., 7 F.3d 357, 368 n.9 (3d Cir. 1993) ("[A]

court may consider an undisputedly authentic document that a defendant attaches as an

exhibit to a motion to dismiss if the plaintiff's claims are based on the document."

(quotations and citation omitted)).

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Court "is constrained by a stringent standard . . . . A

complaint should not be dismissed for failure to state a

claim 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." Fusco v. Xerox Corp., 676

F.2d 332, 334 (8th Cir. 1982) (quotations and citations

omitted). In addition,

[a] complaint must be viewed in the light most

favorable to the plaintiff and should not be

dismissed merely because the court doubts that a

plaintiff will be able to prove all of the

necessary factual allegations. Thus, as a

practical matter, a dismissal under Rule 12(b)(6)

is likely to be granted only in the unusual case

in which a plaintiff includes allegations that

show on the face of the complaint that there is

some insuperable bar to relief.

Id. (quotations and citations omitted).

To present a cognizable claim for securities fraud,

a plaintiff must allege that a defendant made

misrepresentations that were material. See Hillson

Partners Ltd. Partnership v. Adage, Inc., 42 F.3d 204,

208-09 (4th Cir. 1994). Accordingly, a complaint that

alleges only immaterial misrepresentations presents an

"insuperable bar to relief," Fusco, 676 F.2d at 334

(quotations omitted), and dismissal of such a complaint is

proper.

The Plaintiffs argue that the district court erred in

determining the materiality of the Defendants' alleged

misrepresentations as a matter of law, because materiality

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is necessarily a factual question for a jury to decide.

We disagree.

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A misrepresentation or omission is material if there

is "a substantial likelihood that the disclosure of the

omitted fact would have been viewed by the reasonable

investor as having significantly altered the total mix of

information made available." Basic Inc. v. Levinson, 485

U.S. 224, 231-32 (1988) (quotations and citations

omitted). In many circumstances, of course, this presents

a factual question for a jury to decide. See, e.g., In re

Control Data Corp. Sec. Litig., 933 F.2d 616, 621 (8th

Cir. 1991) ("Determination of whether a misrepresentation

would have the effect of defrauding the market and

inflating the stock price is a jury question. The trier

of fact is uniquely competent to determine materiality, as

that inquiry requires delicate assessments of inferences

a reasonable investor would draw from a given set of

facts." (citations and quotations omitted)). Where a

reasonable investor could not have been swayed by an

alleged misrepresentation, however, a court may determine,

as a matter of law, that the alleged misrepresentation is

immaterial. See, e.g., Hillson, 42 F.3d at 211.

There are a variety of reasons why an alleged

misrepresentation or omission may, as a matter of law, be

immaterial. Some matters are such common knowledge that

a reasonable investor can be presumed to understand them.

Id. at 213-14 ("It is not a violation of any securities

law to fail to disclose a result that is obvious even to

a person with only an elementary understanding of the

stock market." (quotations and citations omitted)). For

example, "[a]s a general matter, investors know of the

risk of obsolescence posed by older products forced to

compete with more advanced rivals. '[T]echnical

obsolescence of computer equipment in a field marked by

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rapid technological advances is information within the

public domain.'" In re Convergent Technologies Sec.

Litig., 948 F.2d 507, 513 (9th Cir. 1991) (quoting In re

Seagate Tech. II Sec. Litig., Fed. Sec. L. Rep. (CCH) ¶

94,502 at 93,202 (N.D. Cal. 1989) (parentheses omitted)).

Alleged misrepresentations may also present or conceal

such insignificant data that, in the total mix of

information, it simply would not matter to a reasonable

investor.

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In this case, the district court concluded, and we agree,

that the Defendants' alleged overstatement of assets by

$6.8 million was immaterial as a matter of law. Taken in

context, this amount represented only 2% of Gateway's

total assets. It seems clear that a reasonable investor,

faced with a high-risk/high-yield investment opportunity

in a company with a history of very rapid growth, would

not have been put off by an asset column that was 2%

smaller. While there may certainly be many cases where

this amount of money would be material and would

dramatically affect the total mix of information relied on

by a reasonable investor, this simply is not the situation

in this case.

Furthermore, some statements are so vague and such

obvious hyperbole that no reasonable investor would rely

upon them. "The role of the materiality requirement is

not to attribute to investors a childlike simplicity but

rather to determine whether a reasonable investor would

have considered the omitted information significant at the

time." Hillson, 42 F.3d at 213 (quotations and citation

omitted). The Hillson court explained that "soft, puffing

statements generally lack materiality because the market

price of a share is not inflated by vague statements

predicting growth. No reasonable investor would rely on

these statements, and they are certainly not specific

enough to perpetrate a fraud on the market." Id. at 211

(citations and quotations omitted); see also Lasker v. New

York State Elec. & Gas Corp., 85 F.3d 55, 59 (2d Cir.

1996) (per curiam) (statements that a company would not

"compromise its financial integrity," had a "commitment to

create earnings opportunities," and that these "business

strategies would lead to continued prosperity" were

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"precisely the type of puffery that this and other

circuits have consistently held to be inactionable."

(quotations omitted)); Searls v. Glasser, 64 F.3d 1061,

1066 (7th Cir. 1995) (Use of phrase "recession-resistant"

"is simply too vague to constitute a material statement of

fact. . . . It is a promotional phrase used to champion

the company but is devoid of any substantive information.

Just as indefinite predictions of 'growth' are better

describe as puffery rather than as material statements of

fact, describing a company as 'recession-resistant' lacks

the requisite specificity to be considered anything but

optimistic rhetoric. Its lack of

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specificity precludes it from being deemed material; it

contains no useful information upon which a reasonable

investor would base a decision to invest." (citation

omitted)).

The Plaintiffs' complaint is filled with allegations

that precisely these types of "puffing" statements made by

the Defendants in Gateway's prospectus and other

communications were misrepresentations. For example, the

Plaintiffs allege that the Defendants' projection in

Gateway's prospectus of "significant growth" was

misleading. See Am. Compl. at 38, 44-45. As the Fourth

Circuit has explained,

Predictions on future growth . . . will almost

always prove to be wrong in hindsight. If a

company predicts twenty-five percent growth, that

is simply the company's best guess as to how the

future will play out. As a statistical matter,

twenty percent and thirty percent growth are both

nearly as likely as twenty-five. If growth

proves less than predicted, buyers will sue; if

growth proves greater, sellers will sue.

Imposing liability would put companies in a

whipsaw, with a lawsuit almost a certainty. Such

liability would deter companies from discussing

their prospects, and the securities markets would

be deprived of the information those predictions

offer. We believe that this is contrary to the

goal of full disclosure underlying the securities

laws, and we decline to endorse it.

Raab v. General Physics Corp., 4 F.3d 286, 290 (4th Cir.

1993). Accordingly, any misrepresentation regarding the

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Defendants' prediction of "significant growth" is

immaterial.

Finally, a defendant's alleged misrepresentations or

omissions may be immaterial as a matter of law if

accompanied by sufficient cautionary statements. The

"bespeaks caution doctrine," created by this Court in

Polin v. Conductron Corp., 552 F.2d 797, 806 n.28 (8th

Cir. 1977), and recently reaffirmed in Moorhead v. Merrill

Lynch, 949 F.2d 243, 245-46 (8th Cir. 1991), provides that

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when an offering document's forecasts, opinions

or projections are accompanied by meaningful

cautionary statements, the forward-looking

statements will not form the basis for a

securities fraud claim if those statements did

not affect the "total mix" of information the

document provided investors. In other words,

cautionary language, if sufficient, renders the

alleged omissions or misrepresentations

immaterial as a matter of law.

In re Donald J. Trump Casino Sec. Litig., 7 F.3d 357, 371

(3d Cir. 1993). The cautionary language must "relate

directly to that by which plaintiffs claim to have been

misled." Kline v. First Western Gov't Sec., Inc., 24 F.3d

480, 489 (3d Cir. 1994); see also Virginia Bankshares,

Inc. v. Sandberg, 501 U.S. 1083, 1097 (1991) (noting that

"not every mixture with the true will neutralize the

deceptive. If it would take a financial analyst to spot

the tension between the one and the other, whatever is

misleading will remain materially so, and liability should

follow.").

A dismissal of a securities fraud complaint under Rule

12(b)(6) should be granted under the bespeaks caution

doctrine only where "the documents containing defendants'

challenged statements include enough cautionary language

or risk disclosure that reasonable minds could not

disagree that the challenged statements were not

misleading." Fecht v. Price Co., 70 F.3d 1078, 1082 (9th

Cir. 1995) (citations and quotations omitted) (emphasis in

original), cert. denied, 116 S. Ct. 1422 (1996).

In this case, the district court properly dismissed

the Plaintiffs' Section 11 and Section 12(2) claims,

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contained in counts I and II of the Plaintiffs' complaint,

because the Defendants' cautionary statements rendered

immaterial all of their alleged misrepresentations. "We

can say that the prospectus here truly bespeaks caution

because, not only does the prospectus generally convey the

riskiness of the investment, but its warnings and

cautionary language directly address the substance of the

statement[s] the plaintiffs challenge." In re Trump, 7

F.3d at 372.

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For example, in their complaint, the Plaintiffs argue

that the Defendants misrepresented Gateway's obligations

to pay sales taxes to states other than South Dakota.

While never asserting that Gateway was liable for, or

actually paid, non-South Dakota sales taxes prior to the

December 7, 1993 public offering of stock, the Plaintiffs

allege that the Defendants had entered into negotiations

with various states regarding Gateway's obligations to pay

non-South Dakota sales taxes. See Am. Compl. at 43.10 In

Gateway's prospectus, the Defendants specifically warned

that "[t]axing authorities in certain other states have

solicited information from the Company to determine

whether the Company has sufficient contacts with such

states as would require payment of income taxes or

collection of sales and use taxes from customers in those

states. The Company has not . . . established any

reserves for payment of such taxes. . . . In the future,

the Company may be required to collect sales and use taxes

or to pay state income and franchise taxes in states other

than South Dakota." Prospectus at 9. Clearly, any

reasonable investor would be on notice that Gateway faced

potential state tax liability for states other than South

Dakota, and could not have been misled by the prospectus

to believe that Gateway did not face such potential

liability.

Similarly, the Plaintiffs' allegation that the quality

and desirability of Gateway's portable computer products

was misrepresented does not constitute a material

10

At oral argument, the Defendants represented that, during the first quarter of

1994, well after the December 7, 1993 public offering of stock, Gateway entered into

an agreement with various states to pay non-South Dakota sales taxes.

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misrepresentation in light of the Defendants' cautionary

statements. The Defendants went to great lengths to warn

potential investors that, due to the nature of a volatile

industry, new product lines of computers represent a risky

venture. See id. at 7. Specifically referencing the

"numerous new products and features" that Gateway

introduced in 1993, the prospectus warned that "[t]here

can be no assurance that these products or features will

be successful . . . ." Id. In light of this explicit

cautionary statement, no reasonable investor could have

been misled that Gateway's new portable

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products, which represented a small fraction of Gateway's

total sales, were anything but a risky venture.

Furthermore, the Defendants provided explicit warnings

which render immaterial the alleged misrepresentations

regarding Gateway's obsolete and defective inventories,

deficiencies in Gateway's purchasing and inventory control

systems, management information and order systems, and

management and forecasting procedures. Gateway's

prospectus advised that, "[a]lthough the Company attempts

to forecast growth accurately, the Company has

experienced, and may continue to experience, problems with

respect to the size of its work force and production

facilities and the adequacy of its management information

systems and inventory controls. These problems can result

in a high backlog of product orders and delays in customer

service and support. . . ." Id. Any reasonable investor

apprised of these warnings would not be misled to believe

that Gateway did not face potential problems in these

areas.

Only by discarding common sense and ignoring the

multitude of explicit and on-point warnings contained in

Gateway's prospectus could investors have been misled by

the misrepresentations allegedly made by the Defendants in

Gateway's prospectus. Because a reasonable investor would

not have ignored such warnings, these alleged

misrepresentations are immaterial as a matter of law.11

11

Relying on Gustafson v. Alloyd Co., 115 S. Ct. 1061 (1995), the Defendants

argue, for the first time on appeal, that relief under Section 11 and Section 12(2) is

unavailable to those who purchase stock from the open market rather than directly from

a company at a public offering. Because the Plaintiffs did not allege that they

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III.

The Plaintiffs argue that the district court erred in

dismissing their Section 10(b) and Rule 10b-5 claims,

contained in count IV of their complaint, for the

Plaintiffs' failure to plead fraud with sufficient

particularity. We disagree.

Federal Rule of Civil Procedure 9(b) provides that

"[i]n all averments of fraud or mistake, the circumstances

constituting fraud or mistake shall be stated with

particularity. Malice, intent, knowledge, and other

conditions of mind of a person may be averred generally."

In the context of securities litigation, this

particularity requirement serves three purposes:

First, it deters the use of complaints as a

pretext for fishing expeditions of unknown wrongs

designed to compel in terrorem settlements.

Second, it protects against damage to

professional reputations resulting from

allegations of moral turpitude. Third, it

ensures that a defendant is given sufficient

notice of the allegations against him to permit

the preparation of an effective defense.

Weisburgh v. St. Jude Med., Inc., 158 F.R.D. 638, 642 (D.

Minn. 1994), aff'd, 62 F.3d 1422 (8th Cir. 1995)

(unpublished) (per curiam).

purchased the stock from Gateway during the public offering, the Defendants argue that

the Plaintiffs have failed to state a cognizable claim. Because we affirm the district

court's dismissal of the Plaintiffs' complaint on other grounds, we decline to consider

this argument.

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This Court has explained that, for Rule 9(b),

"'[c]ircumstances' include such matters as the time, place

and contents of false representations, as well as the

identity of the person making the misrepresentation and

what was obtained or given up thereby. . . . [C]onclusory

allegations that a defendant's conduct was fraudulent and

deceptive are not sufficient to satisfy the rule."

Commercial Property Invs., Inc. v. Quality Inns Int'l,

Inc., 61 F.3d 639, 644 (8th Cir. 1995) (quotations and

citations omitted); see also DiLeo v. Ernst & Young, 901

F.2d 624, 627 (7th Cir. 1990) ("[T]he circumstances

[constituting fraud] must be pleaded in detail. This

means the who, what, when, where, and how: the first

paragraph of any newspaper story. None of this appears in

the complaint, although the flood of information released

about Continental

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Bank since 1984 offers ample fodder if there is indeed a

tale to tell." (quotations omitted)); Bennett v. Berg, 685

F.2d 1053, 1062 (8th Cir. 1982) ("The location of other

allegedly false statements is said to be a 'pamphlet,'

'promotional material,' or a 'typical life-care contract.'

These allegations are not sufficiently particular to

satisfy Rule 9(b)." (footnote omitted)), superseded and

reinstated in relevant part on rehearing en banc, 710 F.2d

1361 (8th Cir. 1983); In re Lifecore Biomedical, Inc.

Sec. Litig., 159 F.R.D. 513, 516 (D. Minn. 1993) (Rule

9(b) requires that "the complaint must allege the time,

place, speaker and sometimes even the content of the

alleged misrepresentation."). Where "allegations of fraud

are explicitly or, as in this case, implicitly, based only

on information and belief, the complaint must set forth

the source of the information and the reasons for the

belief." Romani v. Shearson Lehman Hutton, 929 F.2d 875,

878 (1st Cir. 1991).

We agree with the district court that the Plaintiffs'

complaint is entirely lacking in the particularity

required by Rule 9(b). For example, the Plaintiffs allege

that:

In an effort to boost Gateway's earnings and

thereby increase the marketability of Gateway

stock, the Controlling Shareholders caused

[Gateway Service Corporation] to purchase $6

million of product from Gateway at prices far in

excess of their fair market value, which had a

material favorable effect on Gateway's razor-thin

net margins. Likewise, [Gateway Service

Corporation] sold Gateway $4 million of products

and services at lower than fair market value in

a similar attempt to improve Gateway's financial

performance in advance of the Offering. A

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significant amount of these fraudulent

transactions took place in the third quarter of

1993, artificially boosting Gateway's unaudited

financials just prior to the Offering.

Am. Compl. at 41.

This allegation of fraud is simply not particularized.

Plaintiffs fail to identity the goods and services

allegedly purchased and sold by Gateway at deflated and

inflated

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prices. The Plaintiffs fail to allege the amount of

fraudulent profit allegedly obtained by Gateway. Although

the Plaintiffs declare that a total of $10,000,000 in

goods and services were bought and sold, the Plaintiffs

fail to provide the source for the gross amounts they

allege. The Plaintiffs provide the barest clue as to when

the alleged fraud took place, and the Defendants are left

to guess which controlling shareholders were responsible

for this alleged fraud. Neither this nor the Plaintiffs'

other allegations of fraud meet Rule 9(b)'s particularity

requirements, and the district court properly struck

them.12

IV.

Finally, the Plaintiffs argue that the district court

erred in dismissing their complaint with prejudice and

denying them leave to amend their complaint after its

dismissal. We disagree.

Although a motion to amend a complaint should be

freely given under Federal Rule of Civil Procedure 15(a),

"different considerations apply to motions filed after

dismissal." Humphreys v. Roche Biomedical Lab., Inc., 990

F.2d 1078, 1082 (8th Cir. 1993). The Humphreys court

explained that:

12

Because the Plaintiffs presented no actionable claim for violation of Section 11,

Section 12(2), Section 10(b), or Rule 10b-5, the claims for controlling person liability

were also properly dismissed. See Van Dyke v. Coburn Enter. Inc., 873 F.2d 1094,

1100 (8th Cir. 1989) (Section 15); Deviries v. Prudential-Bache Sec., Inc., 805 F.2d

326, 329 (8th Cir. 1986) (Section 20(a)).

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After a complaint is dismissed, the right to

amend under Fed.R.Civ.P. 15(a) terminates. Leave

to amend may still be granted, but a district

court does not abuse its discretion in refusing

to allow amendment of pleadings to change the

theory of a case if the amendment is offered

after summary judgment has been granted against

the party, and no valid reason is shown for the

failure to present the new theory at an earlier

time.

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Id. (quotations and citations omitted).

The Plaintiffs in this case have failed to provide any

valid reason for failing to amend their complaint prior to

the grant of summary judgment against them. Accordingly,

we conclude that the district court did not abuse its

discretion in denying them leave to amend their complaint

after it had been dismissed under Rule 12(b)(6).

V.

While it is unfortunate that the Plaintiffs in this

case lost money in their investments, their misfortune

alone does not create a viable cause of action. "The

federal securities laws should not be mistaken for

insurance against risky investments; the federal reporters

are replete with failed attempts to do just that.

Securities laws protect investors against fraud; they do

not provide investors with a recourse against unsuccessful

management strategies." Searls v. Glasser, 64 F.3d 1061,

1069 (7th Cir. 1995). As the district court noted, Judge

Frank Easterbrook's description of the litigation in

another case succinctly and accurately describes the

instant case as well:

The story in this complaint is familiar in

securities litigation. At one time the firm

bathes itself in a favorable light. Later the

firm discloses that things are less rosy. The

plaintiff contends that the difference must be

attributable to fraud. "Must be" is the critical

phrase, for the complaint offers no information

other than the differences between the two

statements of the firm's condition. Because only

a fraction of financial deteriorations reflects

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fraud, Plaintiffs may not proffer the different

financial statements and rest. Investors must

point to some facts suggesting that the

difference is attributable to fraud.

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DiLeo, 901 F.2d at 627 (quoted in part at Mem. Op. and

Order II at 14). The Plaintiffs in this case have simply

failed to produce an actionable complaint. Accordingly, we

affirm the district court's dismissal of their claims

against the Defendants.

A true copy.

Attest:

CLERK, U.S. COURT OF APPEALS, EIGHTH CIRCUIT.

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