District Court Properly Dismissed Securities Fraud Class Action because, though Plaintiffs Adequately Alleged Falsity (Contrary to District Court Finding), Class Action Failed to Meet Pleading Requirements of Private Securities Litigation Reform Act (PSLRA) for Scienter Eleventh Circuit Holds
Plaintiffs-shareholders filed a putative class action against Jabil Circuit – “a publicly traded electronics and technology company headquartered in St. Petersburg, Florida” – and certain of its officers and directors alleging violations of securities laws. Edward J. Goodman Life Income Trust v. Jabil Circuit, Inc., ___ F.3d ___, 2010 WL 154519, *1 (11th Cir. January 18, 2010). According to the allegations underlying the class action complaint, Jabil violated its corporate policy of requiring stock options to be exercised at a price “at least equal to fair market value” by backdating options “to a day where the trading price was lower than that on the actual date it is issued, resulting in an instant paper gain to the issuee.” Id. The allegations of backdating in the class action complaint “rely almost exclusively on circumstantial evidence…to show that stock option grants to executives were backdated”; the complaint failed to “identify any particular transaction or scheme of backdating or specific recipients of such a scheme.” Id. The Securities and Exchange Commission had conducted an informal investigation into Jabil’s stock option practices; moreover, Jabil itself reviewed its stock option practices and concluded that an accounting error “resulted in an overstatement of earnings by $54.3 million [from 1996 to 2005], forcing Jabil to restate its earnings for each of those years.” Id., at *2. However, Jabil denied purposely backdating stock options to directors and $49 million of the restated amount was attributable to non-executive employee compensation expenses. Id. Defense attorneys moved to dismiss the class action complaint on the grounds that it failed to meet the heightened pleading requirements established by the Private Securities Litigation Reform Act (PSLRA). Id., at *1. The district court granted the motion and plaintiffs appealed, id. The Eleventh Circuit affirmed.
The Eleventh Circuit began its analysis with the observation that backdating options “is not itself illegal under the securities laws, nor is it improper under accounting principles.” Jabil, at *1. Allegations of improper backdating appeared in the Wall Street Journal, after which Jabil raised its third quarter projections for fiscal year 2006. Id., at *2. The class action complaint alleges that Jabil made this announcement “in order to divert attention from the allegations concerning backdating, and that Jabil knew that the factual bases for its improved forecasts were false even at the time it made the projections.” Id. But these allegations relied on confidential witnesses, and only one confidential source identified anyone as having “specific knowledge” of the allegations asserted therein. Id. The district court dismissed the first amended class action complaint without prejudice, but defense attorneys challenged the second amended class action complaint also for failure to meet the pleading requirements of the PSLRA. Id. “[T]he district court held that the shareholders failed to adequately plead falsity of the allegedly fraudulent statements, failed to raise a sufficient inference of scienter on the part of [plaintiffs], and failed to plead enough facts to show loss causation.” Id., at *3. The Eleventh Circuit began its analysis with the class action’s fraud claim under section 10(b) of the Securities Exchange Act and Rule 10b-5. Id. The Circuit Court did not address loss causation because it concurred with the lower court’s finding that the class action failed to adequately allege scienter. Id.
We do not discuss the Circuit Court’s opinion in detail. We note that the Eleventh Circuit disagreed with the district court’s conclusion that the class action failed to adequately allege falsity. See Jabil, at *4. But as to scienter, and relying on its decision in Rosenberg v. Gould, 554 F.3d 962 (11th Cir.2009), the Court held that the allegations in the complaint failed to raise a strong inference of intent. See id., at *4-*6. Further, the mere fact that there was a $54 million accounting error did not adequately establish a strong inference of scienter “because [plaintiffs] present the restated amounts as a percentage of net income and not total revenue” but “net income can vary so widely period to period, [that] using it as a baseline for comparison provides the court no real standard on which to judge the significance of the accounting error.” Id., at *6. As the Eleventh Circuit held, “This pleading strategy – picking the metric that will yield the highest percentage values – adds nothing to the inference of scienter that the shareholders attempt to create.” Id. Moreover, the class action’s references to insider stock sales were inadequate because plaintiffs failed to provide any information as to the trading history of those insiders. Id., at *7; see also id., at *8 and *12 (rejecting insider trading claims). “Ultimately, [the Circuit Court held] that the allegations contained in the complaint do not create an inference of scienter that is at least as probable as a non-fraudulent explanation-namely that none of the [defendants] knew of the accounting errors until the investigation began in 2006.” Id., at *7.
As usual, the failure of the complaint to adequately allege securities fraud necessitated dismissal of the class action’s claim for control person liability under Section 20(a) of the Securities Exchange Act. Jabil, at *13. Accordingly, the Circuit Court affirmed the dismissal of the class action complaint in its entirety. Id.
NOTE: We do not here summarize the Eleventh Circuit’s discussion of the class action’s Section 10 and Rule 10b-5 claims concerning business condition projections or proxy solicitation. That discussion may be found at pages *9-*11 and *11-*12, respectively.