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PSLRA Class Action Defense Cases–Zerger v. Midway Games: Illinois Federal Court Dismisses Securities Fraud Class Action Holding Class Action Complaint’s Allegations Failed To Meet PSLRA’s Pleading Requirements

Class Action Complaint Alleging Securities Fraud Violations Failed to Allege Facts (as Opposed to Conclusions) or Adequately Plead Scienter under Heightened Pleadings Requirements of Private Securities Litigation Reform Act (PSLRA) Illinois Federal Court Holds

Plaintiffs filed a putative class action against various officers and directors of Midway Games alleging violations of federal securities laws; specifically, the class action complaint “alleg[ed] that the executives artificially inflated the market value of Midway stock by deceiving the public about the company’s financial position.” Zerger v. Midway Games, Inc., ___ F.Supp.2d ___ (N.D. Ill. October 19, 2009) [Slip Opn., at 1]. (Plaintiffs also filed a class action against Midway Games, but voluntarily dismissed it after Midway filed for bankruptcy protection. Id., at 2.) According to plaintiffs, the allegations underlying the class action complaint established violations of §§ 10(b) and 20(a) of the Securities Exchange Act of 1934, and of SEC Rule 10b-5. Id., at 1. Defense attorneys moved to dismiss the class action complaint for failure to meet the heightened pleading requirements established by the PSLRA (Private Securities Litigation Reform Act), id. The district court granted the motion and dismissed the complaint.

Over the course of 20 years, Midway developed more than 400 video games for various platforms, including home-console, handheld, coin-operated and PC. Zerger, at 2. In 2001, the company decided to focus on home-console and handheld devices, such as Xbox, Game Cube, Game Boy and PlayStation. Id. In 2005, the company “announced its first profitable quarter in five years,” id. But in the words of the Circuit Court, “all was not well with Midway’s business model.” Id., at 3. And while the company “repeatedly assured the market that Midway had sufficient working capital to fund day-to-day operations and to continue product development,” in September 2005 it had to borrow money to fund its day-to-day operations. Id. The class action complaint outlined other alleged omissions, see id., at 3-5, concluding that defendants took advantage of the false impression they had given the market to sell 800,000 shares of stock, nearly all of them in a 3-week period, id., at 5. Plaintiffs also blamed Sumner Redstone (chairman of Viacom and controlling shareholder of Midway) for the inflated stock prices because he had announced that he was “evaluating Midway as a potential acquisition target for Viacom” and had purchased millions of shares of stock in the company. Id. Analysts expressed concern that these purchases caused Midway’s stock to be “somewhat overvalued” and warned that if Redstone decided to sell his shares then the stock price would drop. Id. Redstone later announced that Viacom would not acquire Midway, and the stock “immediately began to lose value” ultimately falling more than 50%. Id., at 5-6.

The district court began its analysis by holding that the putative class action representatives lacked standing to challenge statements or acts made after their November 2005 purchase of stock in Midway. See Zerger, at 7-8. The federal court also denied leave to amend because “Plaintiffs have ignored binding and well-settled precedent and have had ample opportunity to proffer putative class representatives with standing to complain of the statements made in 2006.” Id., at 9. Accordingly, the court focused its analysis of the class action’s § 10(b) claim to statements made August 4, November 1 and November 7, 2005. Id. The district court found the allegations in the class action complaint to be “bald assertion[s]” that failed to “satisfy the particularity requirements of the PSLRA,” id., at 12, and that plaintiffs alleged no facts “(as opposed to conclusions)” supporting a finding that statements were known to be false when made, id., at 13. The district court quoted the Seventh Circuit with approval, “‘The story…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.’” Id., at 16 (quoting DiLeo v. Ernst & Young, 901 F.2d 624, 6227-28 (7th Cir. 1990). The federal court further concluded that the class action failed to adequately allege scienter, see id., at 16-20. Accordingly, the court granted defendants’ motion to dismiss the class action complaint. Id., at 20.

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