D&O issuers and policyholders concerned about their exposure to Exchange Act claims for overly optimistic wind-energy deals may be breathing easier in the wake of a Massachusetts federal district court's holding that a pension fund could not state a viable cause of action against American Superconductor. In Lenartz v. American Superconductor Corporation, et al., No. 11-cv-10582 (D.Mass. Jul. 26, 2012), Judge William Young dismissed claims under the Exchange Act’s Section 10(b), Section 20(a), and Rule 10b-5, holding that the plaintiffs' allegations did not create the strong inference of scienter required under controlling law. A copy of the court's decision is available here.
American Superconductor is a publicly-traded company that derives the majority of its revenue from the sale of wind turbine electrical control systems. In June 2008, the company entered into a contract with a Chinese company called Sinovel Wind Group. The contract provided that American Superconductor would ship electrical control system components to Sinovel over a 28-month period, for a contract price of $470 million. The contract required that Sinovel guarantee payment on each shipment by securing a letter of credit in favor of American Superconductor at least two weeks prior to each shipment date. According to its publicly-available filings, American Superconductor would recognize revenue for each shipment “upon customer acceptance,” provided that the collectability of each payment was “reasonably assured.” During the life of the contract, shipments to Sinovel accounted for approximately 75% of American Superconductor’s recognized revenue.
Shortly after completing a secondary offering of stock in November 2010 and announcing the acquisition of a Finnish competitor in March 2011, American Superconductor issued a press release stating that Sinovel had refused delivery of certain contracted shipments, and had failed to pay for others, in fiscal 2010. After investigating the circumstances, in July 2011, American Superconductor announced that it would be restating its 2010 financials, and expected to report full-year revenues of only $307 million, as against original projections of $430 million. Market reaction was swift. Shortly after the July 2011 restatement announcement, an analyst report advised that American Superconductor’s stock was “uninvestable given the lack of reliable financial statements.” American Superconductor’s stock crashed to a low of $8.12 per share, a 78% decline from its high of $38.09 per share in October 2010.
Predictably, various investors immediately brought suit. The court’s decision in Lenartz disposed of all claims under the Exchange Act, holding that their claims of scienter were nothing more than a “house of cards.” Noting that Exchange Act claims are subject to heightened pleading standards and that the detailed allegations in the complaint must give rise to a “strong” inference of scienter, the court proceeded to dismantle the plaintiffs’ case.
The court held that the core of the plaintiffs’ case rested on an allegation that, “on information and belief,” Sinovel never furnished American Superconductor with letters of credit to guarantee payment, as required under the contract. The court pointed out that the complaint never set forth the basis for that allegation, or why the letter-of-credit requirement was the only relevant payment provision that could have given rise to American Superconductor’s inability to collect payment on certain shipments during the class period. The court went on to hold that the plaintiffs had failed to plead any facts giving rise to a “strong inference” of scienter, and accordingly dismissed the Exchange Act claims.
The court did, however, allow certain Securities Act claims to proceed, holding that they did not sound in fraud and, instead, alleged only negligence that would give rise to strict liability under the statute. The court rested its decision, in part, on a close analysis of the pleadings, and ultimately concluded that a theory of liability that did not sound in fraud was provided to support each allegation of negligence. The case continues.
Lenartz is a welcome example of a court closely analyzing the pleadings in a securities suit, and dismissing Exchange Act claims because they (i) were not pled with the requisite particularity, and (ii) simply do not give rise to the requisite “strong inference” of scienter. D&O issuers and policyholders alike should take steps to encourage any court reviewing a securities claim to undertake the same rigorous analysis.