On March 23, 2017, Judge Kimba Wood of the United States District Court for the Southern District of New York dismissed a putative securities fraud class action against Shiloh Industries, Inc. (“Shiloh” or the “Company”), and certain of its officers and directors. Thomas v. Shiloh Indus. Inc., 15-cv-7449 (KMW) (S.D.N.Y. Mar. 23, 2017). Plaintiffs, purported shareholders of Shiloh, alleged that defendants violated Section 10(b) of the Securities Exchange Act of 1934 (the “Exchange Act”) when they allowed misallocated surcharges on the Company’s balance sheet to remain uncorrected, which thereby understated the cost of goods sold and inflated inventory. The Court granted defendants’ motion to dismiss, holding that plaintiffs had failed to plead with particularity facts supporting their claim that defendants were aware of or recklessly disregarded indications of accounting issues that ultimately resulted in a restatement of Shiloh’s financial results for the first two fiscal quarters of 2015.
Shiloh supplies equipment to automotive manufacturers. Plaintiffs alleged that the Company touted its financial success to investors for the first and second quarters in 2015, but later in the year revealed it was conducting an internal investigation into the accounting at Shiloh’s manufacturing facility in Wellington, Ohio. That investigation resulted in a restatement that reduced the Company’s net income by approximately 50 percent and 13 percent in the first and second quarters of 2015, respectively, and increased its cost of sales by 0.7 percent and 0.4 percent for those same time periods. The Company’s stock price dropped significantly following the announcement in September 2015 of the restatement and related internal investigation.
The Court held that plaintiffs failed to adequately allege scienter. Plaintiffs claimed that the employee responsible for the misallocated surcharges was under immense pressure to hit sales targets, and defendants chose not to ask questions about these figures because the facility was meeting its financial goals. According to plaintiffs, defendants acted recklessly by disregarding clear signals that the Wellington facility’s balance sheet was inaccurate. These alleged warnings included quarterly PowerPoint presentations given to the individual defendants that contained financial data for each of the Company’s facilities, the exceptional performance of the Wellington facility compared to the Company’s other plants, and statements by confidential witnesses describing the discussion of accounting issues within the Company. Plaintiffs further alleged that the accounting discrepancies should have been obvious because the Wellington facility, which was one of Shiloh’s largest plants and was located in close proximity to the Company’s headquarters, was the Company’s “crown jewel.”
Noting that the Wellington plant was just one of the Company’s 21 facilities and the accounting issues here “were not all-encompassing,” the Court held that plaintiffs could not argue that scienter should be inferred because the fraud involved the Company’s “core operations.” In addition, although confidential witnesses had allegedly asserted that defendants received the PowerPoint presentations described above, none of these witnesses asserted that the individual defendants had personal knowledge of the accounting discrepancies. The Court pointed out that “mere access to data is not a stand-in for recklessness.” Stating that multiple allegations of recklessness that are each insufficient on their own could not collectively create a compelling inference of scienter, the Court held that an alternative nonculpable explanation for the series of events at issue here was “far more compelling” than plaintiffs’ version.
The Court’s decision highlights the level of pleading specificity necessary to establish a strong inference of scienter and underscores that even a restatement accompanied by a basis for management to have been previously aware of the issues does not necessarily meet that standard.
Click here to view the judgement.