On November 7, 2012, the Southern District of New York declined to dismiss securities fraud claims concerning alleged misrepresentations regarding Weatherford International Ltd.’s internal controls, even though the court found that the plaintiffs had failed to state a claim as to the tax understatement that resulted from Weatherford’s internal control failures. Dobina v. Weatherford Int’l Ltd., 2012 WL 5458148 (S.D.N.Y. Nov. 7, 2012) (Kaplan, J.).


“Weatherford is an ‘international provider of equipment and services used in the drilling, completion and production of oil and natural gas wells.’” Id. at *1. Beginning in 2007, Weatherford reported “‘low and rapidly declining effective tax rates’” which were among “‘the lowest, if not the lowest, in the industry.’” Id. However, on March 1, 2011, Weatherford “announced that it would restate its earnings for 2007 through the third quarter of 2010.” Id. at *2. The company disclosed that it had identified a “‘material weakness in internal control over financial reporting for income taxes’” and that its 2007-2010 tax expense was actually $1.2 billion rather than the previously reported $700 million. Id. at *2. The following day, the company’s stock price declined nearly 11 percent. Id.

Plaintiffs subsequently brought suit against Weatherford, certain of its officers, and the company’s auditor under Sections 10(b) and 20(a) of the Exchange Act, as well as Rule 10b-5. The plaintiffs alleged that the Weatherford defendants had “committed securities fraud through false statements and omissions falling into two principal categories: (1) those arising directly from the understatement of tax expense and (2) those pertaining to Weatherford’s maintenance of internal controls over its financial reporting.” Id.

The Court Finds an Interest in Corporate Stock-Funded Acquisitions Insufficient to Allege Motive to Commit Securities Fraud

“A complaint may satisfy the scienter requirement ‘by alleging facts to show either (1) that [the] defendants had the motive and opportunity to commit the fraud, or (2) strong circumstantial evidence of conscious misbehavior or recklessness.’” Id. at *3 (quoting ECA & Local 134 IBEW Joint Pension Trust of Chi. v. JP Morgan Chase Co., 553 F.3d 187, 198 (2d Cir. 2009) (Kelly Jr., J.)).

The plaintiffs’ motive allegations were based on their “theory that the fraud [had] inflated Weatherford’s stock price and thus permitted it to fund its ‘aggressive growth strategy’ while avoiding becoming an acquisition target in its own right.” Id. at *4. The plaintiffs pointed to a series of stock-funded Weatherford acquisitions during the class period as support for this theory.

With respect to the individual defendants, the court found that this theory was “rejected easily” because there was no allegation that the defendants had engaged in stock-funded acquisition transactions “‘to secure personal gain’ as opposed to carrying out their ‘financial responsibilities to the [c]ompany.’” Id. at *5. However, the court found “[m]ore challenging … the question of whether the corporate defendant— Weatherford itself—may be inferred to have had the requisite motive due to its interest in acquiring other companies.” Id.

The court explained that “[w]hether an interest in acquisitions is sufficient [for alleging scienter] is an ‘extremely contextual’ inquiry that demands an allegation of a ‘unique connection between the fraud and the acquisition.’” Id. (quoting ECA, 553 F.3d at 201 n. 6). The Second Circuit “has provided little guidance as to what this ‘unique connection’ must be, but has suggested that it is sufficient when the ‘misstatements directly relat[e] to the acquisition.’” Id. (quoting ECA, 553 F.3d at 201 n. 6). The court concluded that this requirement “demands more than alleging simply that [Weatherford] [had] acquired companies during the class period with the use of stock.” Id.

The court emphasized the need “to apply exacting scrutiny to any claim of motive through company acquisitions.” Id. “[W]hile an acquisition program funded by stock issuances in a certain sense might provide a ‘motive’ to inflate the stock price, it is not sufficient to allege scienter.” Id. at *6. Holding otherwise “would allow a plaintiff to proceed to discovery whenever it can allege that a company that is growing through the issuance of equity made a statement that ultimately proved to have been materially false but helped to raise the company’s share price.” Id. Such a result would be “inconsistent with the [Private Securities Litigation Reform Act (PSLRA)] and [the Second] Circuit’s requirements of a ‘unique connection’ between the fraud and the acquisition.”” Id. The court therefore found that plaintiffs had not adequately alleged motive as to Weatherford based on its interest in stock-funded acquisitions.

The Court Finds the Complaint Adequately Alleges Scienter as to the Statements Concerning Internal Controls

The court next considered whether the complaint adequately alleged that certain defendants had “made statements regarding the effectiveness of Weatherford’s internal controls … either knowing that they were false or with reckless disregard for their truth.” Id. at *6-7.

Weatherford’s CEO, Bernard Duroc-Danner, and the company’s CFO, Andrew Becnel, individually certified that they were “‘responsible for establishing and maintaining [the company’s] disclosure controls and procedures … and internal controls for financial reporting’” and represented that they had “‘[d]esigned such internal control over financial reporting … to provide reasonable assurance regarding the reliability of [Weatherford’s] financial reporting.’” Id. at *6. Duroc-Danner and Becnel continued to make attestations regarding the effectiveness of the company’s internal controls as late as November 1, 2010.

In contrast to these representations, Weatherford’s “March 2011 restatement … detailed significant gaps in [the company’s] internal controls.” Id. “Although the March 2011 restatement specifically stated only that Weatherford’s internal control over financial reporting … was not effective ‘as of December 31, 2010,’” the court found it reasonable to infer that “Weatherford’s internal controls in fact were inadequate throughout the class period” in view of “the [c]ompany’s attestations through the class period that its internal controls had not changed and the fact that the $500 million tax expense understatement persisted from 2007 through 2010.” Id. at *7.

Turning to the question of scienter, the court acknowledged that the certifications at issue “involve[d] a certain amount of subjectivity, e.g., regarding whether Weatherford’s internal controls provide[d] reasonable assurance about the reliability of financial reporting.” Id. (internal quotations omitted). However, the court explained that “subjectivity will not completely immunize a statement from review under Section 10(b).” Id. “Indeed, a plaintiff can plead a claim adequately based even on a statement of opinion if it alleges facts sufficient to ‘permit a conclusion that [the defendant] either did not in fact hold that opinion or knew that it had no reasonable basis for it.’” Id. (quoting In re Lehman Bros. Sec. and ERISA Litig., 799 F. Supp. 2d 258, 302 (S.D.N.Y. 2011) (Kaplan, J.)).

The court concluded that the plaintiffs had “alleged scienter adequately with regard to Becnel’s statements about internal controls” based, among other factors, on “the personal participation of Becnel in designing and evaluating [Weatherford’s] internal controls” and “the stark realities about the inadequacies of the internal controls that were revealed in the March 2011 restatement.” Id. at *7, *9. The restatement “admitted inadequate staffing and technical expertise, ineffective review and approval practices, inadequate processes to effectively reconcile income tax accounts and inadequate controls over the preparation of quarterly tax provisions.” Id. at *7 (internal quotations omitted). “Given Becnel’s personal participation in designing and evaluating the internal controls,” the court found that “he presumably had extensive knowledge about precisely these matters.” Id. Thus, the court held that “[t]he inference that his certifications were made with reckless disregard for the truth is at least as compelling as any opposing, nonculpable inference.” Id. at *7, *9.

The court also found the complaint “adequately alleges scienter with regard to Weatherford.” Id. at *9. However, the court determined that the complaint “does not sufficiently allege scienter with respect to any of the other individual defendants.” Id. Specifically, the court found the complaint’s scienter allegations “insufficient … with respect to Duroc-Danner because it fails to allege that he was aware of any issues with internal controls at all during the class period.” Id.

The Court Finds No Basis for Inferring Scienter as to Weatherford’s Tax Understatement

The court next considered the plaintiffs’ allegations of an “‘international scheme whereby defendants ‘crudely manipulated the [c]ompany’s effective tax rate expense by a few percentage points each quarter and fiscal year to generate enough earnings to meet or beat the [c]ompany’s targets in key periods.’” Id. The court found the complaint “entirely devoid of factual allegations that could make plausible, let alone compelling, the inference that [the] defendants actively manipulated the tax receivable asset in order to beat Wall Street estimates or otherwise inflate earnings by a desired amount.” Id.

Notably, the court held that the defendants’ alleged misstatements concerning internal controls did not support an inference of scienter as to Weatherford’s tax understatement. “While Weatherford’s poor internal controls may give rise to liability with respect to the defendants’ statements about internal controls, the weak internal controls provide little if any circumstantial support that the statements [regarding the] understated tax expense were made with scienter.” Id. at *10. “Simply put, ‘[w]eak accounting controls may pave the way for fraud. They do not themselves constitute fraud.’” Id. (quoting In re BISYS Sec. Litig., 397 F. Supp. 2d 430, 450 (S.D.N.Y. 2005) (Kaplan, J.)).

This left the plaintiffs’ “central points—that the magnitude of the understatement and the defendants’ and investors’ considerable focus on Weatherford’s tax rates demonstrate[d] that the defendants were at least reckless with regard to the truth of their statements.” Id. The court quickly disposed of both arguments, explaining that “’the size of the fraud alone does not create an inference of scienter’” and noting the absence of any allegation that “the Weatherford defendants had any contemporaneous basis to believe that the information they related was incorrect.” Id. at *11.

Here, the court found it plausible that “management’s statements about the [c]ompany’s tax expense were the result of merely careless mistakes at the management level based on false information fed it from below.” Id. (internal quotations omitted). Thus, the court held that the complaint “fails adequately to allege scienter with regard to the understatement of tax expense.” Id.