June 14, 2019

Tenth Circuit: Overly Optimistic Reporting Not Enough to Prove Scienter

The Tenth Circuit Court of Appeals issued its opinion in Anderson v. Spirit AeroSystems Holdings, Inc. on Tuesday, July 5, 2016.

Spirit AeroSystems Holdings, Inc., agreed to manufacture parts for two Gulfstream aircraft and a Boeing 787. Spirit managed the production of the parts through three projects, each of which encountered production delays and cost overruns. Nevertheless, Spirit executives expressed optimism to investors about the company’s ability to break even. However, in October 2012, Spirit announced the projected loss of hundreds of millions of dollars on the three projects. The investors brought a class action against Spirit and four of its executives—CEO and president Jeffrey Turner, CFO Philip Anderson, Oklahoma Senior Vice President Alexander Kummant, and Vice President Terry George, who was overseeing the Boeing 787 project—for violating § 10(b) of the Securities Exchange Act and SEC Rule 10b-5. Plaintiffs alleged that Spirit and the executives misrepresented and failed to disclose cost overruns and project delays. Defendants moved to dismiss, arguing that the plaintiffs failed to allege facts showing misrepresentations or omissions that were false or misleading and material, and failed to show scienter. The district court granted defendants’ motion, in part agreeing that plaintiffs had failed to show scienter. Plaintiffs appealed.

The Tenth Circuit compared the evidence set forth by plaintiffs to show scienter with the defendants’ explanations, noting that the inference of scienter would only suffice if it were at least as cogent and compelling as any other inference that could be drawn from the facts. Plaintiffs alleged that defendants knew throughout the class period that the projects were experiencing setbacks and generating so much in additional costs that a loss would be inevitable, yet they failed to warn investors of the forward loss until October 2012. Defendants argued that despite the setbacks, they were optimistic that the projects would meet the original cost forecasts, and expected revenues to exceed total costs. When Spirit realized that a loss was likely, it promptly announced a forward loss on the three projects. The Tenth Circuit found Spirit’s explanation that it was overly optimistic more compelling than an inference that the executives intentionally misrepresented or recklessly ignored economic realities. The Tenth Circuit noted that the plaintiffs presented little evidence to presume malevolence over benign optimism.

The Tenth Circuit approved of the district court’s consideration of a lack of a motive to commit securities fraud as a mitigating factor against scienter. Although the plaintiffs did not need to show a motive, the absence of one was relevant. The plaintiffs also proposed testimony by corroborating witnesses, but the Tenth Circuit determined the witnesses were too far removed from the executives to have been able to testify as to the executives’ state of mind. Plaintiffs also alleged that the defendants had a duty to disclose project overruns and delays, but the Tenth Circuit refused to infer scienter from the defendants’ failure to disclose, finding instead that there was no evidence that the defendants knew they needed to disclose more or were reckless in their failure to disclose. The Tenth Circuit disposed of plaintiffs’ remaining claims, characterizing them as “fraud by hindsight” but not securities fraud. Plaintiffs argued that Spirit’s recovery plan for the 787 project supported an inference of scienter, but the Tenth Circuit again accepted the defendants’ explanations of innocent optimism. The plaintiffs also argued that the sheer magnitude of the loss supported an inference of scienter, but the Tenth Circuit noted that the plaintiffs failed to show that the executives knew that their public reports were too encouraging or had recklessly failed to heed red flags from problem reports.

The Tenth Circuit affirmed the district court’s dismissal. Judge McHugh concurred in part and dissented in part; she would have found that Anderson and Turner made materially false statements, therefore satisfying the scienter element.

Tenth Circuit: Dismissal Appropriate Where Plaintiffs Failed to Show Scienter

The Tenth Circuit Court of Appeals issued its opinion in In re ZAGG, Inc. Securities Litigation: Swabb v. ZAGG, Inc. on Tuesday, August 18, 2015.

Robert Pedersen, former CEO and Chair of ZAGG, Inc., pledged nearly half of his shares in ZAGG, Inc., as collateral in a margin account. Pedersen’s pledged shares equaled nearly 9 percent of the company. ZAGG was required by SEC Rule S-K to disclose the amount of shares pledged as security “in a footnote or otherwise” in ZAGG’s Form 10-K, but Pedersen failed to make the required disclosure. In December 2011, ZAGG share prices fell, creating a deficiency in Pedersen’s account, and he was forced to sell 345,200 of his shares to meet the margin call. He mailed a Form 144 to the SEC disclosing the margin call on December 22, 2011, and electronically filed a Form 4 the next day. Pedersen’s account experienced a second margin deficiency in August 2012, and he was forced to sell an additional 515,000 shares. Pedersen filed a Form 4, stating the sale occurred “to meet margin calls.”

On August 17, 2012, ZAGG issued a press release announcing Pedersen was stepping down as Chair and CEO. ZAGG also filed a Form 8-K with the SEC, stating the company had implemented a policy prohibiting officers, directors, and 10 percent shareholders from pledging ZAGG securities on margin. A week later, after Pedersen’s resignation was final, a third margin call resulted in the forced sale of his remaining ZAGG shares. ZAGG held a conference call to reassure investors, and stated that Pedersen’s departure was entirely related to the margin call situation. Pedersen also spoke at the call, telling investors he had taken a step toward building investor confidence by completely deleveraging his ZAGG stock.

Plaintiffs filed a complaint against ZAGG and six individual officers and directors on behalf of a putative class of all people who purchased ZAGG stock during the relevant time period, alleging the company’s filings omitted material information regarding Pedersen’s pledged shares and also that ZAGG failed to disclose a secret succession plan that had been implemented after Pedersen’s first margin call in December 2011. Defendants filed two motions to dismiss, the first by Pedersen and the second by ZAGG and several individual officers and directors. After a hearing on the motions, the court dismissed the complaint with prejudice, finding the § 10(b) and § 14(a) claims failed because they did not allege with particularity facts giving rise to a strong inference Pedersen intended to violate securities laws. Plaintiffs appealed only the dismissal of their §10(b) and Rule 10b-5 claims and only as to Pedersen and ZAGG, and only as to Pedersen’s material omission of his margin account.

The Tenth Circuit agreed with the district court that plaintiffs failed to meet the heightened pleading requirements applicable to the scienter element in § 10(b) claims. The district court held that plaintiffs proved only one element of scienter—that Pedersen knew of the pledged securities in the margin account. The district court held, and the Tenth Circuit agreed, that the complaint failed to allege any facts showing that Pedersen knew failure to reveal the account would likely mislead investors. Plaintiffs listed five facts they claimed proved scienter: (1) Pedersen made inconsistent statements following the first margin call, (2) Pedersen selectively complied with the Item 403(b) disclosure requirement, (3) Pedersen knew that disclosing his margin account would jeopardize his position at ZAGG, (4) Pedersen was forced to resign because of his margin account, and (5) following Pedersen’s resignation, ZAGG adopted a policy prohibiting holding stock in margin accounts. The Tenth Circuit analyzed each claim.

First, the Tenth Circuit evaluated plaintiffs’ claim that Pedersen’s statements on the Forms 144 and 4 in December 2011 were inconsistent. Pedersen stated on the Form 4 that the sale was made “to meet an immediate financial obligation” and on the Form 144 that the sale was made “to meet margin calls.” The Tenth Circuit found no inconsistency in these two statements, as margin calls could certainly be characterized as immediate financial obligations. Plaintiffs also argued that it was deceptive of Pedersen to mail the Form 144 when he e-filed the Form 4, but the Tenth Circuit noted Pedersen was under no obligation to deliver the forms via the same method.

The Tenth Circuit next addressed plaintiffs’ argument that Pedersen’s failure to disclose his margin account amounted to scienter. Defendants argued that the violation of a rule is not enough to show scienter, and the Tenth Circuit agreed. Without some other facts evidencing Pedersen knowingly omitted the disclosure, the violation alone was not enough. Plaintiffs argued Pedersen failed to disclose the account because he knew it would jeopardize his position at ZAGG, but the Tenth Circuit again found that at most Pedersen’s execution of the certifications supported an inference of negligence.

The Tenth Circuit similarly found that neither Pedersen’s forced resignation nor ZAGG’s implementation of a new policy barring investors from pledging ZAGG shares on margin accounts established an intent to defraud. Rather, the Tenth Circuit found that both the resignation and new policy acknowledged that the company had found a better way to run its business moving forward. The district court found, and the Tenth Circuit agreed, that the complaint failed to allege any facts giving rise to an inference of scienter. Plaintiffs argued that even if the knowing element was not met, the facts showed that Pedersen acted with reckless disregard of a substantial likelihood of misleading investors. The Tenth Circuit disagreed, finding that plaintiffs failed to overcome the high standard necessary to show recklessness.

The Tenth Circuit affirmed the district court.

Tenth Circuit: Statements as to Reason for Deal Failure Could Have Materially Misled Investors

The Tenth Circuit Court of Appeals issued its opinion in Nakkhumpun v. Taylor on Tuesday, April 7, 2015.

Patipan Nakkhumpun, lead plaintiff in a securities class action against executives of Delta Petroleum Corp., filed suit in district court after a deal between Delta and Opon International, LLC fell through. Plaintiffs alleged the Delta executives violated § 10(b) of the Securities Act and SEC Rule 1ob-5 by misleading investors through statements about the proposed transaction with Opon and about Delta’s financial condition. The district court granted Defendants’ motion to dismiss, holding Plaintiffs failed to allege loss causation regarding the Opon deal and falsity regarding the statements about Delta’s financial condition. Plaintiffs moved for leave to amend, which the district court denied.

Plaintiffs appealed, and the parties dispute whether Plaintiffs adequately pled falsity, scienter, and loss causation as to the Opon transaction and falsity and scienter as to the financial statements. The Tenth Circuit first addressed the Opon transaction.

Delta issued a press release in March 2010 announcing a preliminary agreement with Opon, in which Opon would purchase a 37.5% non-operating interest in Delta’s Vega Area assets for $400 million. Defendants issued more press releases between March and June 2010 indicating that Opon was trying to obtain financing for the transaction, and in a July 2010 press release, Delta board chair Taylor announced termination of the deal, stating that Opon failed to receive financing. However, confidential informants related that the Opon deal fell through because Opon determined the assets were not worth $400 million and refused to pay that price, and further negotiations between Opon and Delta were unsuccessful.

The district court agreed with Plaintiffs that the statements were false or misleading but concluded Plaintiffs failed to show loss causation. On appeal, Plaintiffs argue they alleged all requirements for securities fraud under § 10(b), and the Tenth Circuit agreed. The Tenth Circuit found a reasonable investor would have been lead to believe that the Vega Area assets were worth $400 million, satisfying the falsity prong. The Tenth Circuit also found Plaintiffs established scienter, finding potential for Taylor’s statements to mislead buyers and sellers and noting the danger was so obvious Taylor must have been aware of it. The Tenth Circuit reversed the district court’s dismissal of Plaintiffs’ § 10(b) claim on this issue.

Turning next to the loss causation issue, the Tenth Circuit affirmed the district court’s finding that Plaintiffs’ proposed amended complaint contained adequate allegations of loss causation under a theory of materialization of a concealed risk. Plaintiffs pleaded particular facts tying financial loss to Taylor’s misleading explanation about the reason the Opon deal fell through.

The Tenth Circuit found adequate support for Plaintiff’s § 10(b) arguments as to defendant Taylor, but not regarding the other named defendants. The Tenth Circuit therefore affirmed the dismissal of Plaintiffs’ complaint as to the other named defendants.

Finally, the Tenth Circuit turned to Plaintiffs’ claims that Defendants made false or misleading statements regarding its financial situation. In the district court and on appeal, Defendants challenged these statements as failing to allege scienter or falsity. The district court granted Defendants’ motion to dismiss on the ground that the statements were not false. The Tenth Circuit affirmed the dismissal but on the ground that the statements were missing allegations of either scienter or falsity.

The Tenth Circuit reversed the dismissal of Plaintiffs’ Opon-related claims as to defendant Taylor but affirmed as to all other defendants. On the claims of misleading financial statements, the Tenth Circuit affirmed the district court’s dismissal and denial of leave to amend.

Tenth Circuit: PSLRA Requires Showing of Intent to Deceive, Defraud, or Manipulate In Order to Prove Scienter

The Tenth Circuit Court of Appeals issued its opinion in In re Gold Resource Corp. Securities Litigation: Banker v. Gold Resource Corp. on Friday, January 16, 2015.

Gold Resource Corporation (GRC) is a publicly traded Colorado corporation engaged in mining for gold, silver, and other minerals in Mexico. At one of its mines, the El Aguila property, GRC began stockpiling ore and developed an aggressive business plan calling for increased mining activities. GRC had a single buyer for its mining products from the El Aguila property. GRC issued a press release in January 2012, announcing “record” production at the El Aguila facility and predicting continued growth and success. GRC issued several other press releases and filings with the SEC documenting “record” production and growth.

GRC first announced production problems at the El Aguila facility on July 19, 2012, admitting its second quarter production was lower than expected due to several factors. It lowered its production outlook by 15 percent, causing stock values to plummet. GRC announced its third quarter results in an October 2012 press release, notifying investors that production was lower still than expected. In November 2012, GRC issued a press release announcing that settlement of its billing dispute with its single buyer required restatement of the already-reported financial results. It submitted a Form 8-K to the SEC explaining that executive management became aware of significant variances between GRC’s assays and those of the buyer in the third quarter of 2012, but that GRC believed those discrepancies were remedied as of September 30, 2012.

Nitesh Banker and others, investors, brought suit against GRC, alleging violation of § 10(b) of the Securities Exchange Act. Investors asserted that by September 30 at the latest, GRC was aware of serious problems with its accounting control, and therefore misled investors with its first and second quarter financial reportings. Investors also alleged that two statements in the January 30, 2012, press release were materially misleading, because GRC was aware of significant production problems but failed to report them, and because the statement about continuing on the trajectory of projected growth did not prove to be accurate. The district court dismissed the complaint with prejudice, finding plaintiff investors failed to meet the heightened scienter requirement required by the Private Securities Litigation Reform Act (PSLRA). Plaintiffs appealed.

The Tenth Circuit first examined the requirements for properly stating a claim for securities fraud, and the heightened pleading requirements for the untrue statement and scienter requirements under the PSLRA. The PSLRA requires that plaintiffs must show with particularity a mental state involving intent to deceive, manipulate, or defraud, in order to prove the scienter requirement.

First addressing plaintiffs’ allegations of scienter because of the misstatement of first and second quarter profits, the Tenth Circuit found no wrongdoing by GRC. The Tenth Circuit found other plausible inferences in GRC’s accounting misstatements and SOX miscertifications, including that employees in Oaxaca did not immediately tell executive management in Denver about the variances because they thought buyer’s figures were wrong, and it was prudent of the management to investigate the variances before confirming the discrepancy publicly. Addressing the accounting practices, the Tenth Circuit found no recklessness where GRC recognized as income the amount buyer agreed to pay, rather than the amount buyer eventually did pay, since that was the contractual agreement between GRC and the buyer. The Tenth Circuit similarly dismissed plaintiffs’ remaining assertions of scienter, finding instead that at most the conduct constituted negligence, and defendants’ explanation offered a plausible alternative. The defendants had every right not to disclose the variances before the matter was investigated and resolved.

As for the production problems, the Tenth Circuit accepted defendants’ explanations for encountering difficulties as a plausible reason to produce less ore than originally expected. The risks of the mining business were set forth in the cautionary statements issued to investors, and encountering the risks did not rise to the level of scienter.

The Tenth Circuit affirmed the district court’s dismissal of plaintiffs’ claims with prejudice. The Tenth Circuit also concluded the district court did not abuse its discretion by failing to allow plaintiff to amend its complaint and in denying its motion to strike.

Tenth Circuit: Opinions Not Enough to Trigger Liability Under Section 11 of the Securities Act

The Tenth Circuit Court of Appeals issued its opinion in MHC Mutual Conversion Fund, L.P. v. Sandler O’Neill & Partners, L.P. on Friday, August 1, 2014.

In 2009, in the immediate aftermath of the financial crisis, Bancorp sought to conduct a secondary stock offering to raise money. In its securities filings, the company informed investors that it had significant assets in mortgage backed securities and those investments had suffered badly, but advisors had predicted that the market would begin to rebound. Those predictions did not, however, pan out, and MHC, one of the investors, suffered losses as a result of Bancorp’s predictions. MHC sued under Section 11 of the Securities Act, but the district court denied its petition with prejudice, ruling that failed market predictions, without more, were not enough to trigger liability. MHC appealed to the Tenth Circuit.

The Tenth Circuit reviewed the district court’s decision for error and found none. Upon detailed review of Section 11 of the Securities Act, the Tenth Circuit determined that mere opinions are not enough to trigger liability. The offerer of the opinion must know it to be false and harm must come to the entity relying on the opinion in order to trigger liability. Because nothing in the record supported an inference that Bancorp did not believe its opinion to be true, this test was not met.

MHC also argued that by offering the erroneous opinion, Bancorp did not fulfill its requirement of due diligence. The Tenth Circuit first expressed dissatisfaction with this argument because securities offerers are not fiduciaries and should not be held to a fiduciary standard. Next, the Tenth Circuit determined that Bancorp made the necessary warnings and disclaimers to its potential investors that if its opinion turned out to be false, the company would face significant additional losses.

Finally, MHC argued that Bancorp’s assertions violated section 10(b) of the Securities Act. To show a violation of section 10(b), though, the plaintiff must prove that defendant made an untrue statement of material fact with intent to defraud or with reckless disregard for the truth. However, plaintiffs did not allege facts sufficient to make a strong showing of scienter in the Bancorp opinion.

The district court’s opinion was affirmed.

Tenth Circuit: Strong Showing of Scienter Required in Securities Class Action Fraud Case

The Tenth Circuit Court of Appeals issued its opinion in Weinstein v. McClendon on Tuesday, July 8, 2014.

Plaintiffs filed a complaint in federal district court on behalf of a class of purchasers of Chesapeake Energy Corporation common stock, alleging that various corporate officers of Chesapeake, including CEO Aubrey McClendon, materially misled the public through false statements and omissions regarding two products, Volumetric Product Payment (VPP) transactions and the Founder Well Participation Program (FWPP). The district court did not decide whether defendants had made false material statements or omissions of fact, holding simply that the allegations in the complaint did not give rise to a strong inference that defendants acted with the intent to defraud as required by the Private Securities Litigation Reform Act. The district court granted defendants’ motion to dismiss.

In its analysis, the Tenth Circuit examined the burden faced by plaintiffs in securities class actions, and determined that there must be a strong showing of scienter on the part of defendants in order for plaintiffs’ claim to proceed. The Tenth Circuit noted that there was no cogent or compelling inference that defendants materially misrepresented or withheld facts for the purpose of misleading investors. The district court’s dismissal was affirmed.