In Anderson v. Spirit Aerosystems Holdings, Inc., — F.3d —, 2016 WL 3607032 (10th Cir. 2016), the Tenth Circuit provided a blueprint for how to analyze securities class action scienter allegations, looking carefully at allegations made by confidential witnesses, examining the challenged statements in context, evaluating plaintiffs’ motive allegations, and weighing conflicting inferences of innocence and scienter.
In rejecting the scienter allegations as inadequate, the court also analyzed what has come to be known as the “core operations inference,” considering whether the court should attribute knowledge of wrongdoing to top level executives based on their position within the company, and the fact that the plaintiffs claim that their allegations implicate the “core operations” of the company.
Plaintiffs filed a class action against Spirit Aerosystems Holdings, Inc. (“Spirit”), and four executives, alleging violations of Section 10(b) and Rule 10b-5. Spirit supplies parts for Gulfstream aircraft and had periodically reported to the public about its progress on various projects, including cost overruns, production delays, and risks, while also expressing confidence about its ability to meet deadlines and ultimately break even. When Spirit later announced that it expected to lose hundreds of millions of dollars on three projects, its stock price fell and litigation ensued.
Plaintiffs alleged that top executives must have known that problems with the three projects would result in the company failing to meet economic forecasts. They claimed that the executives misrepresented and/or omitted cost overruns and production delays because they knew, or must have known, that the overruns or delays were going to impact materially impact revenue.
But the court rejected these “core operations” allegations because they were based solely on defendants’ positions within the company and their involvement with certain projects. The court cited to the Ninth Circuit’s decision in South Ferry LP, No. 2 v. Killinger, 542 F.3d 776, 784 (9th Cir. 2008), in finding that such allegations will fail to meet the scienter requirement unless there are detailed allegations about an executive’s actual knowledge of information that belied the truth of the public statements. Id. at *10.
The court held: “Based on the plaintiffs’ allegations of the defendants’ involvement in Spirit’s core operations, we can infer only that the four executives were overly optimistic about Spirit’s ability to achieve the forecasted production schedules and cost reductions. The plaintiffs have not provided a good reason to believe that the executives knew that the projects were unlikely to meet forecasts.”
The court also found that plaintiffs failed to demonstrate scienter through (1) allegations that the defendants were “motivated to mislead in order to buy time in the hope that a difficult financial situation ‘would right itself,’” (2) information from confidential witnesses, or (3) implementation of a recovery plan.
The court began its analysis of plaintiffs’ motive allegations by stating the Tenth Circuit’s legal standard: although motive is not required to plead scienter, the absence of a motive allegation is relevant in evaluating scienter. With respect to plaintiffs’ particular alleged motive, the court found, as an initial matter, that the argument had not been properly preserved. But even if it were considered, it would not suffice, because it is nothing more than a generalized corporate motive. In the absence of a particularized motive to obfuscate, the allegations were insufficient to support an inference of scienter.
The court next rejected the confidential-witness allegations, because they did not support the inference that the executives knew of specific contemporaneous facts that were inconsistent with their challenged statements. The court noted that most of the CWs did not work closely with the executives, and the allegations from the one witness who did concerned only claims of general corporate mismanagement, of a kind that was insufficient to establish scienter. Id. at *7.
Finally, the court analyzed plaintiffs’ allegations that the existence of a recovery plan tended to establish scienter. The court started with the assumption that certain statements were false or misleading, and then weighed the dual explanations to determine whether those misrepresentations were made with scienter. The defendants argued the statements were made from an honest belief that the recovery plan would reduce costs and accelerate production. The court, relying on In re Zagg, Inc., Sec. Litig., 797 F.3d 1194, 1198-99 (10th Cir. 2015), determined it was more likely than not that the executives had identified a better way of handling the project and not that the recovery plan suggested scienter. The court concluded that the “innocent inference” was more cogent and compelling than an inference of scienter. Id. at *8.