(1) The number of accounting filings fell from 78 in 2011 to 45 in 2012. Two factors that contributed to this decline were the overall decrease in filings and the specific decrease in Chinese reverse merger cases (which frequently include accounting allegations).
(2) The proportion of accounting filings involving restatements (36%) and internal control weaknesses (67%) remained relatively constant.
(3) Accounting cases are less likely to be dismissed and more likely to settle than non-accounting cases. In 2012, accounting cases were less than 70% of the settled cases, but represented more than 90% of the total value of settlements.
It is not too late to sign up for PLI's Handling a Securities Case 2013: From Investigation to Trial and Everything in Between. The program takes place on Thursday, April 25 in New York and via webcast. The details can be found here.
Lyle Roberts of Cooley LLP (the author of The 10b-5 Daily) is co-chairing the program. The outstanding faculty will cover a wide range of topics, all while following a hypothetical case from the initial investigation through trial. There even will be a panel on ethical issues, for those in need of ethics credits.
Hope to see you there.
Securities class actions alleging that a company issued false or misleading earnings guidance are frequently dismissed. Among other things, to overcome the PLSRA's safe harbor for forward-looking statements a plaintiff must adequately plead (a) the guidance was not accompanied by "meaningful cautionary statements" and (b) the company had "actual knowledge" of its falsity. Given the vagaries of business performance, courts generally find that one or the other pleading burden has not been met.
With that background, the decision in City of Providence v. Aeropostale, Inc., 2013 WL 1197755 (S.D.N.Y. March 25, 2013) is interesting because the court found that the plaintiffs successfully plead an "earnings guidance" claim, albeit with the help of a unique fact pattern and (arguably) a misreading of the law. Aeropostale is a clothing retailer. In the second half of 2010, the company decided to change the design of its women's fashion line and placed orders for the new styles that would provide inventory through the fall of 2011. The new styles sold poorly and, in December 2010, the company fired the officer who led the change.
In response to the poor sales, Aeropostale provided 2011 earnings guidance that was below its 2010 results. According to the complaint, however, this guidance still understated the sales and inventory problems and failed to disclose that the unpopular new styles had been pre-ordered and would continue to be stocked for the next several quarters. The defendants argued that its earnings guidance (and other statements about the company's future performance) were protected by the PSLRA's safe harbor, but the court disagreed.
First, the court found that Aeropostale had failed to provide "meaningful cautionary statements." While the company disclosed risks concerning "consumer spending patterns," "fashion preferences," and "inventory management," its failure to disclose that the new styles would continue to be sold throughout most of 2011 meant that these risks were not hypothetical. Accordingly, the cautionary statements were inadequate because they did not "disclose hard facts critical to appreciating the magnitude of the risks described."
Second, the court found that the "safe harbor does not apply to material omissions" and, as a result, the failure to dislose the pre-ordering of the unpopular new styles was "unprotected by the safe harbor, regardless of whether the statements thereby rendered misleading were forward-looking." Because the court "declined to find that the misleading nature of the statements rests on the forward-looking aspects of the statements," it also declined to find that the safe harbor's "actual knowledge" requirement was applicable.
The court's interpretation of the scope of the safe harbor is questionable (and perhaps unnecessary, given the court's general view of the strength of the complaint's allegations). The PSLRA expressly states that the safe harbor applies "in any private action that is based on an . . . omission of a material fact necessary to make the statement not misleading." While the safe harbor does not apply to statements of current fact (whether they are alleged to be misstatements or rendered misleading by a material omission), that is different than concluding that the safe harbor does not apply to forward-looking statements that are alleged to be misleading because of the omission of a current fact. Indeed, reading the statute in this manner would severely limit its application. Plaintiffs routinely allege that a company's projections were misleading based on its failure to disclose certain current facts.
Holding: Motion to dismiss denied.
Addition: The complaint also contained "opinion evidence from an expert in the retail and wholesale industry," who concluded that the "Defendants had no reasonable basis to believe that Aeropostale could meet the guidance they issued." Although the court summarized this opinion evidence in its decision, it also stated that it "did not consider any of the 'expert testimony' that was included - inappropriately in the Court's view - in the pleading."
The Boeing securities class action related to its development of its 787-8 Dreamliner plane continues to provide some drama. In 2011, as noted on this blog, the district court granted the company's motion to dismiss (on a motion for reconsideration) after it was determined that a key confidential witness denied being the source of the allegations attributed to him in the complaint, denied having worked for Boeing, and claimed to have never met plaintiffs' counsel until his deposition. The plaintiffs appealed this decision to the U.S. Court of Appeals for the Seventh Circuit.
In City of Livonia Employees' Retirement System and Local 295/Local 851, IBT v. Boeing Company, 2013 WL 1197791 (7th Cir. March 26, 2013), the court affirmed the dismissal based on the complaint's failure to establish a strong inference of scienter. The opinion, authored by Judge Posner, contains some interesting commentary.
(1) Motive - The plaintiffs alleged Boeing had failed to disclose in a timely manner that the Dreamliner's first test flight would be cancelled. The court noted that the law does not require the disclosure of the mere risk of failure. Indeed, "[n]o prediction - even a prediction that the sun will rise tomorrow - has a 100 percent probability of being correct . . . If a mistaken prediction is deemed a fraud, there will be few predictions, including ones that are well-grounded, as no one wants to be held hostage to an unknown future." Moreover, it was unclear what motive Boeing would have had to put off the announcement, with the court wryly concluding that the main effect would be to "undermine Boeing's credibility with its customers and expose the company to a multi-hundred million dollar lawsuit for securities fraud."
(2) Confidential Witness - The court found that the recantation of the key confidential witness was fatal to the plaintiffs' claims, because his supposed evidence provided the only basis for concluding that the company knew (at an earlier date) that the first flight test would be cancelled. Moreover, the confidential witness would no longer be useful because "[e]ither he had told the investigator the same thing he said in his deposition, which would be of no help to the plaintiffs and would expose the investigator as a liar, or he had had made the opposite assertions on the two occasions, in which event he was the liar, which wouldn't help the plaintiffs either."
(3) Sanctions - The defendants had cross-appealed for sanctions. The court strongly suggested that sanctions were appropriate in the case, noting that the plaintiffs' lawyers "failure to inquire further [about the supposed evidence from the confidential witness] puts one in mind of ostrich tactics - of failing to inquire for fear that the inquiry might reveal stronger evidence of their scienter regarding the authenticity of the confidential source than the flimsy evidence of scienter they were able to marshal against Boeing." Nevertheless, the court remanded the case to the lower court to determine whether sanctions should be imposed.
Holding: Dismissal affirmed, but case remanded for consideration of whether to impose Rule 11 sanctions.