T. S. Ellis, III, United States District Judge.
Plaintiffs in this federal securities class action allege claims under (i) § 10(b) and Rule 10b-5; (ii) § 14(a) and Rule 14a-9; and (iii) § 20(a) of the Securities Exchange Act of 1934 ("Exchange Act"). Defendants seek threshold dismissal of claims under all three provisions, and a separate memorandum opinion addresses the § 14(a) and related § 20(a) claims. This memorandum opinion addresses the questions presented under § 10(b) and the related § 20(a) claims, which are as follows:
Before reciting the pertinent facts, it is important to identify the proper source of those facts. First, as the parties agree and as settled precedent requires, the facts recited here are taken chiefly from the Complaint's factual allegations, which must be accepted as true at this stage. Cozzarelli v. Inspire Pharm. Inc., 549 F.3d 618, 625 (4th Cir. 2008) (noting that at the motion to dismiss stage, "we must accept plaintiffs' factual allegations as true"). Defendants have also sought to have additional facts considered by attaching various exhibits to the motion to dismiss.
Settled circuit authority permits courts to consider external documents in a motion to dismiss when they "are integral to and explicitly relied on in the complaint, and when the plaintiffs do not challenge the document's authenticity." Zak v. Chelsea Therapeutics Int'l, Ltd., 780 F.3d 597, 606-07 (4th Cir. 2015) (quotation marks and brackets omitted). The SEC filings attached to defendants' dismissal motion, the transcripts of the August 10, 2016, November 8, 2016, and March 8, 2017 Orbital ATK conference calls, and the Wells Fargo and Barclays analyst reports are integral to or explicitly referenced in the Complaint, and plaintiffs do not challenge their authenticity. Accordingly, these documents are appropriately considered at this stage. Similarly, because the Fourth Circuit permits courts to take "judicial notice of published stock prices without converting a motion to dismiss into a motion for summary judgment," it is also appropriate to consider the chart summarizing Orbital ATK's historical stock prices. Greenhouse v. MCG Capital Corp., 392 F.3d 650, 655 (4th Cir. 2004). By contrast, Alliant's August 1, 2013 conference call is not referenced in the Complaint, nor does the Complaint cite the KeyBank analyst report, so it is inappropriate to consider these documents at the motion to dismiss stage.
Corporate defendant, Orbital ATK, is an aerospace and defense company headquartered
In addition to the corporate defendant, the Complaint names the following four individual defendants:
Defendant Thompson has been the Chief Executive Officer and President of Orbital ATK since the merger; before the merger, he was the Chairman of the Board, CEO, and President of Orbital Sciences. Defendant Pierce is currently Orbital ATK's Chief Financial Officer; before the merger he was Vice Chairman of the Board and CFO of Orbital Sciences. Defendant Larson is the Chief Operating Officer of Orbital ATK; before the merger he was the Senior Vice President of Alliant and President of Alliant's Aerospace Group. Finally, defendant DeYoung was a Director of Orbital ATK from the merger until March 2016; before the merger he served as the CEO and President of Alliant.
Plaintiffs allege that Thompson, Pierce, and Larson made a number of false and misleading statements with respect to the financial success of Orbital ATK after the merger of Orbital ATK's predecessor companies, Orbital Sciences and Alliant. In particular, plaintiffs focus on Thompson, Pierce, DeYoung and Larson's failure to disclose for over a year that a major ammunition contract with the United States Army — the Lake City Contract — was costing Orbital ATK hundreds of millions of dollars. Under Orbital ATK's own accounting policy and Generally Accepted Principles of Accounting ("GAAP"), gross estimated losses on long-term contracts such as the Lake City Contract must be disclosed and recorded as soon as such losses become evident. On August 10, 2016, Thompson, Pierce, and Larson announced that they would be restating several of Orbital ATK's financial statements to reflect nearly $400 million in losses on the Army ammunition contract, and also announced that the losses from this contract should have been recorded earlier pursuant to the accounting policy and GAAP. Defendants' alleged cover-up of the losses on the ammunition contract form the basis of plaintiffs' claims under § 10(b) of the Exchange Act.
Prior to their merger, Orbital Sciences and Alliant were both publicly traded aerospace and defense companies headquartered in Virginia and both sold products such as rockets and satellites to NASA and the United States military. Alliant was also a leading ammunition producer for the United States military; Orbital Sciences did not manufacture or sell ammunition. Both companies relied heavily on government contracts, which were 70% of Alliant's sales and 80% of Orbital Sciences' sales. At the same time, the Complaint alleges that heading into the merger, Alliant was under pressure to renew a major ammunition contract, and Orbital Sciences was dealing with a series of financial missteps. The Complaint alleges that these pressures set the stage for defendants' fraudulent and misleading statements with respect to Orbital ATK's post-merger financial performance.
With respect to Alliant, plaintiffs' claims focus on the Lake City Contract between Alliant and the United States Army, which Alliant originally entered into in 2000. Alliant manufactured billions of rounds of small caliber ammunition under this contract
Plaintiffs allege that making a profit on the new Lake City Contract would be more difficult compared to the old contract owing to the lower production volume, given that overhead costs had to be spread over the total cost of production. Alliant assured investors that it would monitor costs carefully to account for these reductions in volume, but also made clear that Alliant would face some pressure with respect to the profit margins on the Lake City Contract. For instance, on various conference calls, DeYoung acknowledged that Alliant won the Lake City Contract on an "aggressive bid" and that winning that bid would require "price reductions which could impact margins in the early years of winning the recompete." (Compl. ¶ 43). After Alliant won the contract, DeYoung reiterated that it was an "aggressive contract" and that the company would experience an "initial period of margin pressure" and "some reduced revenue" as a result. Id. ¶ 44. DeYoung also informed investors on October 30, 2014 that Alliant was taking a number of steps to reduce costs and boost profitability on the Lake City Contract, including (i) reducing staff and work force; and (ii) offering commercial ammunition out of the Lake City Plant.
As for Orbital Sciences, the Complaint also alleges that this company was facing its own problems in the year before the merger, namely: (i) lower than expected revenues for each quarter of 2014; (ii) two reductions in revenue guidance for 2014; and (iii) a failed rocket launch in October 2014, which jeopardized a multi-year contract with NASA. The Complaint alleges that these failures raised the stakes for a successful proposed merger between Orbital Sciences and Alliant.
On April 29, 2014, Orbital Sciences and Alliant announced that they planned to merge to form Orbital ATK. Orbital Sciences shareholders would receive .449 shares of Orbital ATK stock in exchange for each share of Orbital Sciences stock held, Alliant shareholders would retain their Alliant stock, and Alliant would be renamed Orbital ATK. Thompson would serve as CEO of Orbital ATK, while Pierce would serve as the CFO. DeYoung would become CEO and Chairman of a new company, Vista, which would be a spin-off of Alliant's sporting segment. Even though Vista would manufacture ammunition, Vista and DeYoung did not take the Lake City Contract; that contract remained with Orbital ATK.
After conducting due diligence, Alliant and Orbital Sciences, on December 17, 2014, filed a joint proxy statement ("Joint Proxy Statement") with the SEC concerning
Following the merger, Orbital ATK transitioned from Alliant's fiscal year, which ended March 31, 2015, to a fiscal year ending on December 31. The Class Period begins on May 28, 2015, when Orbital ATK reported its first financial results after the merger. The Complaint alleges that defendants began making a series of statements on May 28, 2015 about Orbital ATK's post-merger financial performance. In particular, the Complaint identifies four categories of false and misleading statements as the basis for the § 10(b) claim:
Because defendants, at this stage, do not contest the materiality or falsity of the statements, a brief summary of the statements suffices.
On May 28, 2015, the beginning of the Class Period, Orbital ATK announced its financial results from the first transition period quarter ending on March 31, 2015. Orbital ATK also filed these results with the SEC on Form 8-K. Between May 28, 2015 and May 11, 2016, Thompson, Larson, and Pierce made a number of public statements in financial releases,
The Complaint alleges all of these statements were false and misleading for the following reasons: (i) the positive statements regarding the benefits, cost reductions, and synergies omitted to disclose that such savings and synergies were outweighed by the $375 million loss on the Lake City Contract; (ii) the various statements regarding the benefits of the merger,
The next category of allegedly false and misleading statements ranges from May 28, 2015 to May 11, 2016 and involves the financial performance of the Lake City Contract. Again, these statements appeared in financial releases
The Complaint alleges that these statements were false and misleading because, in fact, the company was losing money on the Lake City Contract by selling the bullets at a significant loss. In particular, the statements concerning the Lake City Contract's profit margins were false because the contract was in fact operating at negative margins, which resulted in substantial losses. Likewise, statements concerning the profit rate of the Lake City Contract were also false because Orbital ATK was, in fact, losing money on the contract.
The Complaint alleges that between June 1, 2015 and May 9, 2016, defendants
Finally, between May 28, 2015 and May 9, 2016, the Complaint alleges that defendants made a number of false statements in SEC forms
The Complaint alleges that these statements were false and misleading because, in fact, Orbital ATK had not integrated the accounting systems of its predecessor companies, and as such, Orbital ATK could not generate accurate financial reporting. Furthermore, the Complaint alleges that Orbital ATK's financial controls at the time suffered from several material weaknesses, particularly with respect to the failure to maintain an effective financial control environment at the company's Defense Systems Group and Small Caliber Systems Division. These statements were false according to the Complaint because defendants continued to conceal the large losses stemming from the Lake City Contract.
Also on August 10, 2016, Orbital ATK filed a Form 8-K report, which provided further detail about the misstatements relating to the Lake City Contract. Specifically, the Form 8-K explained that:
With respect to the cause of these misstatements, the Form 8-K stated that there were "one or more material weaknesses in [the company's] internal control over financial reporting and disclosure controls and procedures during the Restated Periods." As for the losses caused by the misstatements, Orbital ATK estimated that the forward loss charge would reduce previously reported pre-tax operating income by about $400 million to $450 million and after-tax net income by about $250 million to $280 million. Orbital ATK also estimated that the misstatements resulted in revenues being overstated by $100 million to $150 million, primarily for fiscal year 2015. Finally, the Form 8-K stated that Orbital ATK expected to file an amended Form 10-K for the 2015 transition period, and its quarterly report on Form 10-Q for the quarter ending April 3, 2006 "as soon as reasonably practicable," but that the company had obtained an extension from its lenders to file the reports by November 14, 2016.
Thompson, Pierce, and Larson also held a conference call that day to discuss Orbital ATK's announcement that Orbital ATK's earnings would have to be restated. The transcript from the August 10, 2016 conference call shows that Thompson stated that Orbital ATK's review of its financial processes and controls "ultimately determined that [the Lake City Contract] had in fact[] been in a substantial loss
After these disclosures, Orbital ATK's stock price dropped more than 20%, from a close of $89 per share on August 9, 2016 to a close of $71 per share on August 10, 2016. Analysts from Wells Fargo, Barclays, and Jefferies all lowered their ratings for Orbital ATK, and Wells Fargo analysts noted the surprising magnitude of the revision. In another report issued on August 23, 2016, Wells Fargo reiterated its opinion concerning the substantial size of the earnings restatement.
Three months later, Orbital ATK filed another Form 8-K with the SEC on November 1, 2016. The Form 8-K stated that the company had preliminarily determined, after a multi-month review, that "the majority of the [Lake City Contract] loss provision should be recorded at the inception of the Contract which occurred in fiscal 2013," instead of the August position that the loss should have been recorded in fiscal 2015.
Orbital ATK ultimately filed its Amended Form 10-K for the nine-month transition period ending December 31, 2015 on February 24, 2017. The Amended Form 10-K restated the company's financial statements for the first quarter of 2016, the transition period ending on December 31, 2015, fiscal year 2015, fiscal year 2014, and fiscal year 2013 (except for the first quarter); the Amended Form 10-K also confirmed that the previous financial statements for these fiscal years, as well as the associated quarterly reports, should no longer be relied on due to the misstatements concerning the Lake City Contract. With respect to the Lake City Contract, the Amended Form 10-K confirmed that Alliant had submitted a significantly low bid for the contract on the basis that it would reduce operating costs substantially over the life of the contract. Although the Amended Form 10-K noted that Orbital ATK achieved "significant cost reductions," those reductions "were not sufficient to achieve profitability over the life of the Lake City Contract." As for the misstatements, the Amended Form 10-K confirmed that senior management identified the misstatements in 2016 as part of a company-wide effort to enhance accounting controls and oversight. Once the misstatements were corrected, it became clear that the costs of the Lake City Contract would exceed its revenues over the life of the
The Amended Form 10-K also provided information as to the reasons the misstatements occurred in the first place. The internal investigation revealed that certain personnel in the Small Caliber Systems Division and the Defense Systems Group failed to adhere to company standards with respect to the Lake City Contract. In particular, (i) there was likely a "bias toward maintaining a targeted profit rate;" (ii) there was, in some cases, apparently an "inappropriate use of management reserves to maintain the targeted profit rate;" (iii) "some members of the Small Caliber Systems Division finance staff failed to follow up and inquire further into indications that cost overruns were occurring;" and (iv) "negative information was suppressed, and concerns at the Small Caliber Systems Division about cost overruns were not escalated appropriately" to higher-level company management and finance staff, the Audit Committee, the Board of Directors, or the independent accounting firm.
Finally, Orbital ATK also revealed in the Amended Form 10-K that Orbital ATK was the subject of a non-public SEC investigation, and noted that the restatement could result in government enforcement actions or adverse litigation.
After Orbital ATK filed its Amended Form 10-K, plaintiffs filed the operative Complaint in this matter on April 24, 2017, asserting claims against the defendants. Plaintiffs bring four claims against defendants based on the post-merger statements, as well as defendants' alleged negligence in preparing, reviewing, and disseminating the Joint Proxy Statement issued before the merger: (i) a violation of § 10(b) of the Exchange Act and Rule 10b-5 against all defendants, (ii) a violation of § 20(a) of the Exchange Act against Thompson, Pierce, and Larson, (iii) a violation of § 14(a) of the Exchange Act and Rule 14a-9 against Thompson, Pierce, DeYoung, and Orbital ATK (the "Joint Proxy Defendants"), and (iv) a violation of § 20(a) of the Exchange Act against DeYoung, Thompson, and Pierce.
Defendants then filed a joint motion to dismiss all claims in the Complaint pursuant to Rule 12(b)(6), Fed. R. Civ. P and under the PSLRA. With respect to the § 10(b) and related § 20(a) claims, defendants argue that the Complaint does not allege facts that warrant a strong inference of scienter, and plaintiffs contend that the Complaint satisfies the PSLRA standard. Defendants' dismissal motion has been fully briefed and argued and is ripe for disposition.
Section 10(b) of the Exchange Act prohibits the use of "any manipulative or deceptive device or contrivance" in connection with the sale of securities "in contravention of [the] rules and regulations" prescribed by the SEC. 15 U.S.C. § 78j(b). Pursuant to that prohibition, Rule 10b-5 provides that:
17 C.F.R. § 240.10b-5. The elements of a § 10(b) claim are well-established: "(1) a material misrepresentation or omission by the defendant; (2) scienter; (3) a connection between the misrepresentation or omission and the purchase of a sale or security; (4) reliance upon the misrepresentation or omission; (5) economic loss; and (6) loss causation." Stoneridge Inv. Partners, LLC v. Scientific-Atlanta, 552 U.S. 148, 157, 128 S.Ct. 761, 169 L.Ed.2d 627 (2008).
Defendants' motion to dismiss with respect to plaintiffs' § 10(b) claim focuses solely on the second element — whether plaintiffs have alleged sufficient facts to warrant a strong inference that defendants acted with the requisite scienter of "either intentional or severely reckless conduct." Yates v. Mun. Mortg. & Equity, LLC, 744 F.3d 874, 884 (4th Cir. 2014).
The Complaint alleges numerous facts and indicia in an attempt to establish a strong inference that defendants Thompson, Larson, DeYoung, and Pierce, and by extension Orbital ATK, acted with the requisite scienter in making the misleading statements described above, including:
Defendants argue these allegations are insufficient both individually and as a whole to support a strong inference of scienter. The only proper inference, defendants contend, is that defendants acted in good faith, and thus neither the individual defendants nor the corporate defendant can be liable.
In accordance with Fourth Circuit precedent, each of plaintiffs' individual facts and indicia, and defendants' opposing arguments, will be addressed first to determine whether the allegations give "rise to an inference of scienter and, if so, the strength of that inference." Yates, 744 F.3d at 885. Then, the complaint will be "evaluate[d]... holistically, recognizing that allegations of scienter that would not independently create a strong inference of scienter might [complement] each other to create an inference of sufficient strength to satisfy the PSLRA." Id. at 893 (quotation marks omitted).
The Complaint's first set of allegations focuses on defendants' roles as senior executives at Orbital ATK. These roles, plaintiffs contend, gave defendants the ability to and responsibility for monitoring the Lake City Contract, the merger synergies, and the company's internal controls — the precise topics of the misstatements. Specifically, the Complaint alleges that defendants had access to confidential information about the company's finances and internal controls and were responsible for signing off on the company's public statements, SEC filings, and SOX certifications. These allegations, however, rest on little more than the individual defendants' positions as high-level corporate executives and as such, are not adequate to support a strong inference of scienter.
The Fourth Circuit has rejected the contention that individual corporate officers must "have acted intentionally or recklessly" with respect to a company's accounting problem "merely because...they [are] senior executives" of the company. Id. at 890. Accordingly, general allegations based on corporate positions are insufficient to satisfy the PSLRA's particularity requirement. Instead, plaintiffs must allege "additional detailed allegations establishing the defendants' actual exposure to the accounting problem." Id. (emphasis added).
Plaintiffs attempt to provide these more detailed allegations by discussing the importance of the Lake City Contract, defendants' acknowledged monitoring of the contract, and defendants' frequent public statements about the contract. These attempts are unsuccessful.
First, plaintiffs contend that because the Lake City Contract was the company's largest contract, in its largest division, for its largest customer, the contract was one of Orbital ATK's "core operations," all of which, plaintiffs argue, warrant a strong inference of scienter.
Next, plaintiffs focus on defendants' monitoring of the Lake City Contract. Specifically, the Complaint notes that DeYoung admitted that Alliant knew the Lake City Plant very well, that DeYoung monitored the Lake City Contract with monthly meetings, and that the other defendants received regular reports about the contract. Contrary to plaintiffs' position, rather than supporting an inference of scienter, this regular monitoring of the Lake City Contract suggests diligence. Yates, 744 F.3d at 889 ("We view the frequency of accounting meetings as a sign of diligence rather than evidence of a nefarious purpose.").
Finally, plaintiffs point to defendants' frequent public statements about the Lake City Contract and the merger synergies as evidence of scienter. For example, plaintiffs focus on a series of statements on the 2015 Form 10-K concerning the production volumes under the Lake City Contract, the contract's contribution to the company's sales, and a warning that rising costs could have an adverse effect on profit margin. These facts also fall short of warranting a strong inference of scienter because the Complaint does not allege facts that suggest a level of direct involvement by any of the executives and thus establishes at most a very weak inference of scienter. Cf. Kiken, 155 F.Supp.3d at 606 (finding plaintiffs satisfied scienter requirement based on numerous facts indicating direct, personal involvement in the subject of the misstatements). As described above, plaintiffs have failed to allege with particularity that the individual defendants were privy to information concerning cost overruns at the Lake City Plant but concealed this information from the public.
In sum, plaintiffs' arguments that the individual defendants were intimately involved in the Lake City Contract and the merger synergies rest on little more than the nature of the defendants' executive positions with Alliant (for DeYoung) and Orbital ATK (for the other defendants), their review of monthly reports, and their signing of financial statements — facts which, without more detailed allegations, simply fall short of supporting a strong inference of scienter.
Plaintiffs' next set of scienter indicia are various so-called "red flags" that allegedly served to warn the individual defendants that the Lake City Contract was operating at a significant loss and that Orbital ATK was experiencing problems with its internal controls.
The Fourth Circuit has recognized that the "presence of red flags, coupled with the breadth and gravity of a company's problems, may provide substantial weight to an inference that high level corporate agents must have been aware of the problems." Yates, 744 F.3d at 888 (quotation marks omitted).
To begin with, as noted, many of Complaint's alleged red flags were public knowledge, diluting any significant inference of scienter that can be drawn therefrom. For example, Alliant's twelve years of experience with manufacturing ammunition at the Lake City Plant, Alliant's aggressive bid for the Lake City Contract, the fact that the Lake City Contract remained with Orbital ATK instead of going to Vista, and Orbital ATK's statements about lower profit margins all were public knowledge. Those red flags consequently do not support a strong inference of scienter. The remaining red flags fail to establish a strong inference of scienter because plaintiffs have not demonstrated that those red flags would have necessarily alerted the defendants' to the Lake City Contract accounting errors or Orbital's internal control issues.
To start with, the fact that SEC rules generally acknowledge the materiality of even small amounts of money when those amounts shift gains to losses is simply too generic to qualify as a significant red flag, as there is nothing in the SEC's requirement that should have alerted the individual defendants to the particular accounting problems with the Lake City Contract. Further, plaintiffs make much of the fact that Orbital ATK issued two restatements — one in March 2016 to correct errors in long-term contracts and the other in February 2017 (the Amended Form 10-K) to correct the errors concerning the Lake City Contract. According to plaintiffs, the first restatement should have alerted the individual defendants to potential weaknesses in their cost estimates for the Lake City Contract. This argument fails because the two restatements addressed different problems, and the need for a restatement related to one problem would not automatically signal the existence of other problems to directors. The first restatement addressed the proper application of the percentage-of-completion accounting method to long-term contracts, whereas the problem with the Lake City Contract concerned the inability to cut costs sufficiently. This difference negates any inference of scienter because the existence of one problem does not necessarily alert managers to the existence of another, different problem. See In re Stonepath Grp., Inc. Sec. Litig., 397 F.Supp.2d 575, 588 (E.D. Pa. 2005) (concluding that the "mere fact that there were three restatements [did not] show[] defendants acted recklessly" where the restatements addressed different problems).
Similarly, plaintiffs use another group of red flags — (i) the high volume and low margin nature of manufacturing ammunition; (ii) the fixed nature of production costs; (iii) the fact that pricing would decline over the life of the Lake City Contract;
These red flags also fail to support a strong inference of scienter for the same reason noted above, namely that the Complaint contains no particularized factual allegations that connect the red flags with a specific problem with the Lake City Contract accounting. Specifically, the Complaint fails to provide any particularized facts showing that defendants had contemporaneous information indicating that their cost-cutting estimates were unrealistic. See Anderson, 827 F.3d at 1251 (concluding that plaintiffs failed to establish scienter partly because they did "not identify particularized facts showing that the [] executives had known, before [the company] publicly announced the forward loss, that the three projects would fall behind forecasts on cost or production).
Finally, neither Pierce's statements on the August 10, 2016 conference call nor the statements in the Amended Form 10-K establish that defendants knew about the Lake City Contract problems. Viewed in
In sum, each of the red flags alleged in the Complaint was either public knowledge or insufficient to alert defendants to the problems with the Lake City Contract estimates and Orbital ATK's internal controls, and thus, none of those red flags can be the basis for the requisite strong inference of scienter.
Plaintiffs next concentrate on the sheer magnitude of the loss on the Lake City Contract, asserting that the large amount alone establishes scienter. Although the Fourth Circuit has stated that "[i]nferential weight may be attributed to the magnitude of [accounting] errors," courts should do so "only in the context of [the company's] financial position." Matrix, 576 F.3d at 184. When placed in the context of Orbital ATK's overall financial position, the magnitude of the losses here are diminished and accordingly, do not support a strong inference of scienter.
In absolute terms, it is clear the $375 million loss on the Lake City Contract is significant and probative of scienter,
For these reasons too, plaintiffs' reliance on the Microstrategy decision is unpersuasive. That case involved a company which reported a net income of $18.9 million over three years, when, in fact, the company lost $36 million during that time and also overstated its revenue by $66 million. As the Microstrategy Court stated, the GAAP
In short, $375 million may be a significant amount of money in absolute terms but placed in the context of Orbital ATK's overall sales and other contracts, that amount of loss alone cannot establish a strong inference of scienter.
Plaintiffs also contend that the simplicity of the percentage-of-completion accounting method establishes a strong inference of scienter. This argument is unpersuasive because plaintiffs do not actually show the simplicity of the method at issue, and courts have not explicitly recognized the percentage-of-completion method as giving rise to § 10(b) liability.
In some cases, the simplicity of an accounting method can serve as a basis for finding that individual defendants acted with the requisite level of scienter. See In re Microstrategy, 115 F.Supp.2d at 638 (noting that an inference of scienter "takes on added significance if...the violated GAAP rules and Company accounting policies are, in fact, relatively simple."). For instance, the Fourth Circuit has noted that premature recognition of revenue, in some circumstances, can give rise to liability under § 10(b). See Malone v. Microdyne Corp., 26 F.3d 471, 478 (4th Cir. 1994).
In this case, plaintiffs' argument concerning the simplicity of the percentage-of-completion method is flawed in two respects. First, plaintiffs cite no authority indicating that the percentage-of-completion method — which requires companies to "first estimate the total costs of performing the contract and then compare or reconcile that estimate with accrued actual costs at regular intervals...over the life of the contract"
Plaintiffs' fifth set of scienter allegations focuses on (i) DeYoung's departure from the Orbital ATK Board as well as firings in the company; (ii) an SEC investigation against Orbital ATK; and (iii) Thompson and Pierce's signing of false SOX certifications. As explained below, none of these allegations support a strong inference of scienter.
Plaintiffs first argue that the timing of DeYoung's departure and the firing of other employees raise a strong inference of scienter. Plaintiffs focus on DeYoung's announcement that he would not seek re-election to Orbital ATK's Board of Directors on March 8, 2016 — a week after Orbital ATK issued the first restatement relating to long-term contracts. Beyond the timing of his departure, however, plaintiffs provide no other allegations showing that his decision not to seek re-election had anything to do with the Lake City Contract. See Zucco Partners, 552 F.3d at 1002 (concluding that plaintiffs' allegation about timing of CFO's retirement did not support scienter allegations because the complaint did "not indicate whether [the CFO] was nearing retirement age, whether he left to pursue other opportunities, or even the length of his tenure"). Without more, this allegation cannot support an inference of scienter.
Plaintiffs' allegations that Orbital ATK fired employees in the Small Caliber Systems Division and the Defense Subgroup for improper accounting practices, and replaced the company's principal accounting officer since the merger, also fail to establish a strong inference of scienter. Orbital ATK disclosed in its Amended Form 10-K that an internal investigation determined that lower level individuals engaged in improper accounting behavior. Firing those individuals and the person responsible for the company's accounting suggests only that Orbital ATK sensibly sought to fix the problem that prevented full disclosure of the accounting problem with the Lake City Contract in the first place. It does not show that defendants knew about or recklessly disregarded the problem at the time the statements were made.
With respect to the SEC investigation and the SOX certifications, plaintiffs' arguments fare no better. The Fourth Circuit has stated that the allegation that the SEC is conducting an investigation "is too speculative to add much, if anything, to an inference of scienter." Cozzarelli, 549 F.3d at 628 n.2.
In sum, the firings and departures from Orbital ATK, the SEC investigation and the false SOX certifications suggest, at most, innocent inferences — not the nefarious ones required for a showing of scienter.
Plaintiffs conclude with a series of arguments related to defendants' motives — namely, (i) that Thompson, Pierce and Larson profited from their alleged fraud through incentive compensation; (ii) that Thompson and DeYoung profited through insider trading; and (iii) that Thompson and Pierce, in particular, faced pressure to make the merger successful. None of these financial motives, which are shared by most corporate executives, establish a strong inference of scienter.
With respect to the incentive compensation argument, the Fourth Circuit has made clear, "financial motivations common to every" officer are not a basis for inferring fraud. Yates, 744 F.3d at 891. In this regard, because "motivations to...increase one's own compensation are common to every company," these motivations "add little to an inference of fraud." Cozzarelli, 549 F.3d at 627.
Beyond mere incentive compensation, plaintiffs contend that DeYoung and Thompson profited from their fraud through insider trading. In particular, plaintiffs allege that from March to June 2015, DeYoung sold nearly $14 million of Orbital ATK stock, which was nearly fourteen times his annual salary. These sales allegedly involved options that were not set to expire for several years, and DeYoung had not reported a sale of Alliant or Orbital ATK stock since December 2009. As for Thompson, plaintiffs allege that he sold 5,000 shares of Orbital ATK stock for $435,000 on May 17, 2016, several months before the disclosure of the Lake City Contract losses when the stock was trading for nearly $90 per share. Plaintiffs argue that DeYoung and Thompson's sales establish an inference of scienter, but neither argument is persuasive.
To be sure, the Fourth Circuit has stated that "[a]llegations of personal financial gain may weigh heavily in favor of a
These factors applied to Thompson and DeYoung's sales suggest the sales can carry only minimal weight in a scienter calculus. To begin with, the number of insiders involved was small — only Thompson and DeYoung made allegedly suspicious sales while the plaintiffs allege nothing with respect to Pierce and Larson, the other two defendant insiders. With respect to Thompson, the amount of his sales is not suspicious; he sold 5,000 shares out of over 100,000 outstanding shares, amounting to less than 5% of his holdings. See Cozzarelli, 549 F.3d at 628 (concluding that sales of 13%, 12%, and 5% were "modest to de minimis").
In sum, although Thompson and DeYoung's sales are relevant to the scienter analysis, the fact that other insiders did not also sell stock, combined with the flaws in plaintiffs' allegations with respect to DeYoung and Thompson, suggests these facts warrant at most a weak, and certainly not a strong, inference of scienter.
To summarize, none of the motives plaintiffs allege — incentive compensation, insider trading or merger success — establish the requisite strong inference of scienter.
Given none of these scienter indicia individually supports a strong inference of scienter, the next step is to consider the indications as a whole to ascertain whether together they warrant the requisite strong inference. As the Fourth Circuit has noted, this step requires courts to "evaluate plaintiffs' allegations of scienter holistically," giving the allegations only "the inferential weight warranted by context and common sense." Yates, 744 F.3d at 885 (quotation marks omitted). Importantly, "allegations of scienter that would not independently create a strong inference of scienter might [complement] each other to create an inference of sufficient strength to satisfy the PSLRA." Id. at 893.
Before conducting the holistic analysis, it is important to summarize the indicia established thus far. Plaintiffs' allegations that the individual defendants are high-level corporate officers who monitored the Lake City Contract through meetings and reports must be accepted.
The innocent inferences from these allegations taken as a whole are ultimately more compelling than the malicious ones. In Svezzese v. Duratek, the Fourth Circuit considered a complaint arising out of a similar factual background
The Complaint here is missing that same essential ingredient — some indication that defendants intentionally concealed the losses on the Lake City Contract or recklessly failed to recognize the losses. Instead, the allegations point more compellingly in the opposite direction; Thompson, Pierce, Larson, and DeYoung were simply too optimistic with respect to their cost reduction estimates for the Lake City Contract, and the loss was obscured because lower-level employees concealed the accurate figures and full production on the contract did not begin until fiscal year 2014. Indeed, the Fourth Circuit has recognized that simply because corporate executives are "in over [their] head[s]" with respect to an accounting problem does not mean that they commit fraud. Yates, 744 F.3d at 893.
These facts fall short both individually and holistically of establishing a strong inference of scienter. As the Supreme Court has made clear, a § 10(b) claim survives a motion to dismiss "only if a reasonable person would deem the inference of scienter cogent and at least as compelling as any opposing inference one could draw from the facts alleged." Tellabs, Inc., 551 U.S. at 324, 127 S.Ct. 2499. The facts alleged here may very well reflect an absence of care on the part of the defendants, but the facts do not warrant an inference that the defendants knew about or recklessly disregarded the errors in the Lake City Contract cost-reduction estimates. Put simply, the negligent or innocent inference is more compelling than the inference of scienter. Accordingly, plaintiffs' § 10(b) claims against Thompson, Pierce, Larson, and DeYoung must be dismissed, but plaintiffs should be given leave to amend if plaintiffs can state additional particularized facts that warrant a strong inference of scienter.
The final issue with respect to plaintiffs' § 10(b) claims is whether Orbital ATK itself can be liable despite the dismissal of plaintiffs' claims against the individual defendants. As the Fourth Circuit stated in Yates, where a plaintiff "alleges corporate fraud, the plaintiff must allege facts that support a strong inference of scienter with respect to at least one authorized agent of the corporation." Yates, 744 F.3d at 885. Under this rule, plaintiffs fail to state a claim against Orbital ATK because plaintiffs' claims against the authorized agents — Thompson, Larson, and Pierce — must all be dismissed.
The fact that some lower-level employees may have acted with the requisite scienter in failing to disclose problems with the Lake City Contract does not alter this conclusion because plaintiffs do not allege that any of these employees made false or misleading statements. See Mizzaro v. Home Depot, 544 F.3d 1230, 1254-55 (11th Cir. 2008) (concluding that complaint failed to establish a strong inference of scienter with respect to a corporate defendant because there were no allegations that unnamed officials "were both responsible for issuing the allegedly false public statements and were aware of the alleged fraud").
Plaintiffs also bring claims under § 20(a) of the Exchange Act against Thompson, Pierce, and Larson based on their positions as controlling persons of Orbital ATK. Section 20(a) provides that "[e]very person who, directly or indirectly, controls any person liable under any provision of this chapter or of any rule or regulation thereunder shall also be liable." 15 U.S.C. § 78t(a). Accordingly, § 20(a) "liability is derivative of § 10(b)." Yates, 744 F.3d at 894 n.8. Because plaintiff's § 10(b) claims against Thompson, Pierce, and Larson fail, their § 20(a) claims against these defendants also fail. Id.
In sum, plaintiffs' § 10(b) claims against Orbital ATK and the individual defendants, as well as their § 20(a) claims against Thompson, Pierce, and Larson, must be dismissed for failure to state a claim for relief. Plaintiffs must be given an opportunity to file an amended complaint, however, as they may yet able to allege facts establishing a strong inference of scienter with respect to the company or to an individual officer.