Doshi v. General Cable Corporation et al

Filing 121

OPINION AND ORDER: 1) Defs' motion to dismiss 98 is GRANTED, and Plfs' claims against Defs are DISMISSED WITH PREJUDICE; and 2) A separate judgment shall enter concurrently herewith. Signed by Judge William O. Bertelsman on 1/27/2015.(ECO)cc: COR

UNITED STATES DISTRICT COURT
EASTERN DISTRICT OF KENTUCKY
NORTHERN DIVISION AT COVINGTON
CONSOLIDATED CIVIL ACTION NO. 2:14-cv-22 (WOB-CJS)
SATISH DOSHI, Individually
And on behalf of all other
Persons similarly situated

PLAINTIFFS

and
CITY OF LIVONIA EMPLOYEES’
RETIREMENT SYSTEM, Individually
And on behalf of all others
Similarly situated
VS.

OPINION AND ORDER

GENERAL CABLE CORP., ET AL.
Lead

Plaintiff

City

DEFENDANTS
of

Livonia

Employees’

Retirement

System

brings this action on behalf of a class of persons and entities that
purchased General Cable Corporation common stock between November 3,
2010,

and

October

14,

2013,

inclusive

(the

“Class

Period”).

Plaintiffs allege that Defendant General Cable Corporation and two of
its

senior

Brian

J.

executives,
Robinson,1

individual

engaged

in

Defendants
a

Gregory

fraudulent

B.

scheme

Kenny
to

and

inflate

artificially General Cable’s stock price in violation of § 10(b) of
the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b), and Rule 10b5, 17 C.F.R. § 240.10b-5.
Robinson

are

liable

as

Plaintiffs further allege that Kenny and
“controlling

persons”

of

General

Cable,

pursuant to § 20(a) of the Securities Exchange Act of 1934, 15 U.S.C.
§78(t)(a).
1

As evidence of fraud, Plaintiffs point to General Cable’s

Kenny has been President and Chief Executive Officer of General Cable since
August 2001, and a Director since 1997.
Robinson has been General Cable’s
Chief Financial Officer and Treasurer since 2007, and Executive Vice
President since January 2008.

need to restate, on two occasions, previously issued financial data to
correct material errors.

These restatements –– announced in 2012 and

20132 –- resulted in significant declines in General Cable’s stock
price.
This putative class action is before the Court on the defendants’
motion to dismiss (Doc. 98).

Defendants argue that Plaintiffs have

failed to state a claim upon which relief may be granted, asserting
that Plaintiffs have not adequately pled scienter.

The Court heard

oral argument on Wednesday, January 7, 2015, and thereafter took the
motion under advisement.

After further study, the Court now issues

the following Memorandum Opinion and Order.
I. FACTUAL AND PROCEDURAL BACKGROUND
A. Parties and Summary of Allegations
General Cable is
cable

and

wire

for

a publicly traded

industrial

uses

company that

around

the

manufactures

world.

Based

in

Highland Heights, Kentucky, the company’s operations, management, and
financial reporting are divided into three geographic segments: North
America; Europe and Mediterranean; and Rest of World (“ROW”).
Plaintiffs’ allegations focus on accounting errors principally
affecting

the

ROW

division

––

specifically,

operations

in

Brazil.

General Cable established the ROW division in October 2007 after it
acquired

Phelps

Dodge

International

privately held subsidiary.

Corp.

(“Phelps

Dodge”)

as

a

Phelps Dodge, which served markets in

2

General Cable released the actual restated financial data in January 2013
and October 2013, respectively.

-2-

developing economies, was acquired to allow General Cable to expand
its international operations.

General Cable placed Phelps Dodge and

the entire ROW division under the supervision of Mathias Sandoval, who
had been Phelps Dodge’s CEO and President.
Plaintiffs assert that the Defendants failed to integrate Phelps
Dodge into General Cable’s internal management and financial reporting
control

systems,

irregularities

allowing

to

“a

occur.”

multitude

Doc.

97,

of

material

Complaint,

accounting

¶ 6.

Further,

Plaintiffs allege that the Defendants affirmatively shielded the ROW
division

from

“meaningful

financial

supervision,”

id.,

instead

instructing corporate finance staffers not to interfere with ROW as it
appeared to be a successful operation.

Id. ¶ 5.

Allegedly as a result of this lax supervision, General Cable
failed to detect not only the accounting errors but also a complex
inventory theft scheme in the ROW division’s Brazilian operation that
resulted in the loss of millions of dollars’ worth of raw materials
and finished goods.

Plaintiffs assert that ROW division executives

learned of the theft and other errors in January 2012 but did not
notify General Cable’s corporate headquarters until September 2012.
B. Restatement of Financial Information – 2012 and 2013
On

October

statements

filed

29,

2012,

between

General
2007

Cable

and

second

announced

that

financial

quarter

2012

contained

material accounting errors and should not be relied upon.
further

announced

that

it

would

be

restating

fourteen

statements covering 2009 through Second Quarter 2012.
-3-

The company
financial

Then, on October 10, 2013, General Cable announced that it needed
to restate the corrected financial statements, as well as three other
publicly filed reports, to correct material errors related to (1)
improperly recognized revenue on Brazilian “bill-and-hold” sales; (2)
Value

Added

inventory;
Brazil.

Tax
and

(VAT)
(3)

assets

other

related

accounting

to

the

missing

irregularities

Brazilian

unrelated

to

General Cable explained that it discovered these errors while

remedying the errors that necessitated the first restatement.
Plaintiffs allege that the restatements are evidence that General
Cable’s financial statements for the fiscal quarters and years 2008
through

First

Quarter

2013

and

related

earnings

releases

were

materially false and misleading, in violation of Generally Accepted
Accounting Principles (GAAP).

More specifically, Plaintiffs allege

that Defendants violated GAAP by:
(1)

inflating operating income, net income, and earnings per

share by improperly recognizing bill-and-hold sales;
(2)

understating

cost

of

sales

expenses

and

overstating

operating income, net income, earnings per share, and inventory
balances by improperly accounting for inventory and the related
VAT assets in General Cable’s Brazilian subsidiary;
(3)

understating

cost

of

sales

expense

and

overstating

inventory, property, plant & equipment assets, and comprehensive
income by recording erroneous foreign currency adjustments in or
related to its Canadian and Mexican subsidiaries; and

-4-

(4)

improperly

understating

accounting

expense

for

accounts

other

transactions

while

overstating

related

accounts by improperly delaying the reporting of

by
asset

expenses or

other charges.
Following the issuance of the Restatements, General Cable made
significant

changes

in

the

ROW

division,

including

inventory-related processes and security in Brazil.
CEO

and

CFO

resigned

and

terminated from employment.

numerous

other

to

better

communication.

integrate

to

Moreover, the ROW

managers

in

Brazil

were

Kenny and Robinson assumed leadership

responsibilities for the ROW division.
steps

adjustments

ROW

Finally, General Cable took

division

financial

reporting

and

Doc. 97-2, Year 2012 Form 10-K/A, at 7-8.

C. Facts Supporting Scienter
In the Corrected Consolidated Complaint (“Complaint”) (Doc. 97),
Plaintiffs

also

pleaded

facts

related

to

scienter,

as

they

are

required to do.
Plaintiffs assert

that Kenny and

Robinson knew

or recklessly

disregarded that adverse facts had not been disclosed to, and were
being concealed from, the investing public.

Specifically, Plaintiffs

allege that Kenny and Robinson, through their positions as senior
executive officers of General Cable, had direct access to confidential
and proprietary information and an opportunity to commit fraud by way
of their control of the contents of General Cable’s public reports,
filings, and press releases, and their participation in the company’s
management and operations.

Doc. 97, Complaint, ¶¶ 20–22.
-5-

Plaintiffs

also

contend

that

Kenny

and

Robinson

had

motive

to

commit

fraud

because stock options and bonuses tied to stock price and earnings
comprised significant portions of their compensation during the years
covered by the restatements.
Plaintiffs

also

Id. ¶¶ 129–30.

emphasize

the

nature

and

scope

of

the

restatements, noting that General Cable was required to restate its
financial information twice, that the restatements covered a lengthy
period

and

numerous

filings,

that

the

required

adjustments

were

material, and that errors were beneficial to General Cable’s bottom
line.

Id. ¶¶ 35, 39, 47, 49, 53.

Further, Plaintiffs allege that the

time between the initial disclosure of the errors and General Cable’s
issuance of restatements was longer than average for public companies.
Id. ¶ 50.
Plaintiffs also allege that General Cable’s internal controls
were ineffective and insufficient, despite Kenny and Robinson signing
Sarbanes-Oxley

certifications

Id. ¶¶ 51–52, 54–56, 58.

attesting

to

the

controls’

adequacy.

Plaintiffs aver that Kenny and Robinson were

bound by the company’s Code of Ethics, which required them to follow
internal controls to ensure accurate financial reporting.

Id. ¶ 114.

Plaintiffs allege that a proper evaluation of the company’s internal
controls

would

have

alerted

(or

did

deficiencies leading to the restatements.
Next, Plaintiffs

allege that Kenny

alert)

Defendants

to

the

Id. ¶¶ 60–61.
and Robinson

provided lax

oversight of the ROW group, allowing accounting problems to persist.
Specifically, they assert that Kenny and Robinson failed to insist
-6-

upon

open

corporate

communications
controller.

between

Id.

ROW

¶¶ 64-65.

upper

management

Moreover,

they

and

allege

the
that

Defendants failed to require the ROW division to fully explain its
financial data to corporate finance leaders, instead instructing the
controller and other finance staff to “back off” when they sought
clarifying information from the ROW division.

Id. ¶ 126.

Plaintiffs emphasize Defendants’ failure to integrate the Phelps
Dodge

subsidiary

into

the

parent

company’s

internal

control

and

compliance framework, instead allowing Phelps Dodge to continue its
own internal financial control system.

Id. ¶ 121.

A confidential

witness states that Kenny justified the lack of integration by saying,
“Hey, [Phelps Dodge is] a successful organization, leave them alone,
let them do their thing.”

Id.

Plaintiffs also allege that ROW accounting personnel were aware
that several physical inventory counts did not match the Brazilian
subsidiary’s inventory records.

Id. ¶ 34.

Further, personnel in

Brazil knew that the inventory module was “decoupled” from the General
Ledger,

such

that

adjustments

to

inventory

did

not

update the general ledger, making errors more likely.

automatically
Id.

According

to confidential witnesses (an Account Manager and a Cost Analyst in
Brazil),

managers

in

the

ROW

division

were

aware

of

significant

discrepancies between the physical inventory counts and the amounts
shown in the accounting system but did not address them.
Another

confidential

witness

(CW

1)

states

that

Id. ¶ 122.

during

finance

meetings, the Brazilian operations were described as “a bit of a train
-7-

wreck. . . like a bunch of cowboys.”

Id. ¶ 125.

Further, Plaintiffs

assert that the measures General Cable implemented in response to the
inventory control deficiencies were simple and could have prevented
the harm to the company and investors if implemented sooner.

Id.

¶ 127.3
As further evidence of scienter,
Cable’s

recognition

of

revenue

Plaintiffs point

from

to General

bill-and-hold

sales

––

transactions structured to allow earnings to be recorded prematurely,
and known to be “red flags” to the SEC, analysts, and investors.
¶¶ 31, 46.
Cable’s

Id.

According to Confidential Witness 3, who served as General

Senior

Vice

President

for

Latin

America

during

the

Class

Period, Robinson personally approved these transactions via e-mail.
Id. ¶ 30.
II. ANALYSIS
A. Section 10(b) and Rule 10b-5 Claim
Section 10(b) of the Securities Exchange Act of 1934 makes it
unlawful for any person to “use or employ, in connection with the
purchase or sale of any security . . . any manipulative or deceptive
device or contrivance in contravention of such rules as the Commission
may prescribe as necessary or appropriate in the public interest or
for the protection of investors.”

15 U.S.C. § 78j(b).

Implementing

this provision, SEC Rule 10b-5 makes it unlawful to “make any untrue
statement of a material fact or to omit to state a material fact
3

Plaintiffs assert in their Response (Doc. 103, at 39), but not in the
Complaint, that these measures included installing a working security camera
and a truck scale at the Brazil facility to combat inventory loss.

-8-

necessary

in

order

to

make

the

statements

made,

in

light

of

the

circumstances under which they were made, not misleading.”

17 C.F.R.

§ 240.10b-5(b).

To

claim,

plaintiff

prove

must

prevail
the

on

a

§ 10(b)

following

or

Rule

elements:

10b-5
(1)

a

a

material

misrepresentation or omission by the defendant; (2) scienter; (3) a
connection between the misrepresentation or omission and the purchase
or sale of a security; (4) reliance upon the misrepresentation or
omission;

(5)

economic

loss;

and

(6)

loss

causation.

Matrixx

Initiatives, Inc. v. Siracusano, 131 S. Ct. 1309, 1317–18 (2011).
Defendants challenge only the sufficiency of the complaint with regard
to scienter.
1. Standards for Pleading Scienter
The

Supreme

Court

has

defined

scienter

as

a

mental

embracing “intent to deceive, manipulate, or defraud.”
v. Hochfelder, 425 U.S. 185, 193 (1976).

state

Ernst & Ernst

The Sixth Circuit has held

that in addition to knowing or intentional fraud, recklessness may
also constitute scienter in a securities fraud action.
Comshare,

Inc.

Recklessness

is

Sec.

Litig.,

“akin

to

183

F.3d

conscious

542,

550

disregard”

(6th
and

is

See In re
Cir.

1999).

defined

as

“highly unreasonable conduct which is an extreme departure from the
standards of ordinary care.”

Id. (citing Mansbach v. Prescott, Ball &

Turben, 598 F.2d 1017, 1025 (6th Cir. 1979)).

The danger “need not be

known,” but “it must be at least so obvious that any reasonable man
would have known of it.”

Id.

An inference of recklessness typically

requires "multiple, obvious red flags" -- “egregious refusal[s] to see
-9-

the obvious, or to investigate the doubtful.”

PR Diamonds, Inc. v.

Chandler, 364 F.3d 671, 687, 695 (6th Cir. 2004), abrogated on other
grounds by Matrixx Initiatives, 131 S. Ct. 1309.
In

addition

requires

a

to

plaintiff

Federal

Rule

alleging

of

fraud

Civil
to

Procedure

state

the

9(b),

which

circumstances

constituting fraud “with particularity,” Plaintiffs must also satisfy
the heightened pleading standards of the Private Securities Litigation
Reform Act (PSLRA), 15 U.S.C. § 78u-4(b)(2).

The PSLRA requires a

complaint to “state with particularity facts giving rise to a strong
inference that the defendant acted with the required state of mind.”
15 U.S.C. § 78u-4b)(2)(A).4
The inference of scienter “need not be irrefutable, i.e., of the
‘smoking-gun’

genre,

inferences.’”

Tellabs Inc. v. Makor Issues & Rights, Ltd., 551 U.S.

308,

324

or

(2007)(citation

even

omitted).

“plausible opposing inferences.”
1324.

the

‘most

plausible

Instead,

courts

of

must

competing

consider

Matrixx Initiatives, 131 S. Ct. at

“A complaint adequately pleads scienter ‘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.’”

Id. (quoting Tellabs, 551 U.S. at 324).

fail to meet this standard “shall” be dismissed.

Pleadings that
15 U.S.C. § 78u–

4(b)(3).

4

Plaintiffs do not allege forward-looking statements, to which the PSLRA
applies different scienter requirements.

-10-

2. Analytical Framework
In evaluating a securities fraud complaint, a court must review
the allegations of scienter “holistically.”
S.

Ct.

at

1324.

plaintiff’s

A

scienter

court’s

analysis

allegations

Tellabs, 551 U.S. at 322-23.

Matrixx Initiatives, 131

of

proceeds

the
in

sufficiency

three

of

steps.

a

See

First, a court must ”accept all factual

allegations in the complaint as true.”

Id. at 322.

Second, the court

must ”consider the complaint in its entirety,” deciding whether the
facts alleged, taken “collectively,” give rise to a strong inference
of scienter.
“cogent”

Id. at 322–23.

inference

inferences.

of

Finally, if the allegations present a

scienter,

a

court

is

to

evaluate

competing

Id. at 323.

3. Evaluating Corporate Scienter
In determining whether a corporation has acted with the requisite
state of mind, the pertinent question becomes, “Whose knowledge and
state of mind matters?”
473 (6th Cir. 2014).

See In re Omnicare Sec. Litig., 769 F.3d 455,
In other words, when can a court impute the

scienter of a corporation’s agent to the corporation?
The Sixth Circuit recently sought to clarify the answer to this
question in In re Omnicare, Inc. Securities Litigation, 769 F.3d 455
(6th

Cir.

2014).

After

reviewing

several

approaches,

the

Sixth

Circuit determined that the states of mind of three categories of
people

are

“probative

misrepresentation

made

requisite scienter.”

for
by

a

purposes
corporation

Id. at 476.

of
was

determining
made

by

These individuals are:
-11-

whether
it

with

a
the

a. The individual
misrepresentation;

agent

who

uttered

or

issued

the

b.
Any
individual
agent
who
authorized,
requested,
commanded, furnished information for, prepared (including
suggesting or contributing language for inclusion therein
or omission therefrom), reviewed, or approved the statement
in which the misrepresentation was made before its
utterance or issuance;
c. Any high managerial agent or member of the board of
directors
who
ratified,
recklessly
disregarded,
or
tolerated the misrepresentation after its utterance or
issuance....
Id. (citing Patricia S. Abril & Ann Morales Olazábal, The Locus of
Corporate Scienter, 2006 Colum. Bus. L. Rev. 81, 135 (2006)).
The Sixth Circuit explained that “a corporation is not insulated
if lower-level employees, contributing to the misstatement, knowingly
provide

false

information

to

their

superiors

with

the

intent

to

defraud the public” and noted that corporations that “willfully permit
or encourage the shielding of bad news from management” may be liable.
Id. at 477 (emphasis added).

But, the Court explained, even if a

corporate agent’s state of mind can be imputed to the corporation
under this standard, the complaint must still plead particular facts
that give rise to a strong inference of fraudulent intent by that
agent.

See id. at 484 (explaining that even though an employee’s

knowledge could be imputed to the corporation, the plaintiff failed to
plead sufficient facts to “give rise to a strong inference that [the
corporation] acted to defraud the public”).
4. Application
Viewed holistically and collectively, the facts pled here fail to
give rise to a strong inference of scienter, much less one that is at
-12-

least as compelling as the opposing inference proffered by Defendants:
that General Cable, Kenny, and Robinson were unaware of the problems
leading to the restated financial results and that they addressed them
when they became aware.
Initially,
support

an

the

complaint

inference

that

contains

General

no

Cable

particularized
knew

of

the

facts

to

intentional

misconduct occurring in Brazil and deliberately concealed it.5

Thus,

the Court focuses on indicia of recklessness -- particular facts that
would suggest that Defendants had reason to know of the accounting
problems and consciously disregarded them.
a. Kenny and Robinson
Plaintiffs

state

a

bevy

of

general

allegations

related

to

scienter, perhaps attempting to make up in quantity what they lack in
substance.

The

bulk

of

these

allegations

would

apply

corporation that has restated financial results and thus

to

any

a strong

inference of scienter does not naturally follow.
For example, Plaintiffs cite Kenny’s and Robinson’s knowledge of
company affairs due to their positions, their access to information,
and

their

responsibility

for

financial

reporting

and

internal

controls, as proof of opportunity and intent to commit fraud.
Plaintiffs

do

not

specify

any

instance

where

But

Defendants

gained

relevant knowledge through these channels and disregarded it.

See PR

Diamonds, 364 F.3d at 688 (explaining that fraudulent intent “cannot
5

Plaintiffs admit this indirectly by their emphasis on Defendants’ decision
to allow the Phelps Dodge subsidiary to operate “without meaningful financial
supervision” and on Defendants’ failure to force the ROW group to provide the
kind of financial information that would have given Defendants’ knowledge.

-13-

be

inferred

merely

from

[high-level

executives]

positions

in

the

[c]ompany and alleged access to information” and requiring complaints
to

instead

“allege

[executives’]

specific

knowledge”).

facts

or

Likewise,

circumstances
the

bare

suggestive

allegation

of

that

Defendants were bound by General Cable’s Code of Ethics and legally
obligated to oversee compliance does not support an inference that
Defendants knowingly or recklessly shirked those duties.
Plaintiffs

similarly

emphasize

that

Kenny

and

Robinson’s

incentive-based compensation gave them a motive to commit fraud.
again

Plaintiffs

fail

to

allege

something

more

--

allegations

insider trading, for example –– from which to infer scienter.6

But
of

See In

re Comshare, 183 F.3d at 552 (finding plaintiffs’ allegation that
defendants

stood

to

receive

greater

compensation

if

the

company’s

6

In Helwig v. Vencor, Inc., 251 F.3d 540, 550 (6th Cir. 2001) (en banc),
abrogated on other grounds by Tellabs, 551 U.S. 308, the Sixth Circuit
offered a nonexhaustive list of factors “usually relevant to scienter:”
(1) insider trading at a suspicious time or in an unusual amount;
(2) divergence between internal reports and external statements
on the same subject;
(3) closeness in time of an allegedly fraudulent statement or
omission and the later disclosure of inconsistent information;
(4) evidence of bribery by a top company official;
(5) existence of an ancillary lawsuit charging fraud by a company
and the company's quick settlement of that suit;
(6) disregard of the most current factual information before
making statements;
(7) disclosure of accounting information in such a way that its
negative implications could only be understood by someone with a
high degree of sophistication;
(8) the personal interest of certain directors in not informing
disinterested directors of an impending sale of stock; and
(9) the self-interested motivation of defendants in the form of
saving their salaries or jobs.
The Court notes that Plaintiffs have not pled particular facts related to any
of these factors.

-14-

stock price increased “probative of motive” where defendants actually
did profit by selling their shares at artificially inflated prices
during the class period); cf. PR Diamonds, 364 F.3d at 691 (noting
that the absence of insider trading “dulls allegations of fraudulent
motive” in cases where plaintiffs allege that defendants sought to
personally enrich themselves through the fraud). Without other facts,
these allegations could pin a fraudulent motive on any executive with
stock-related incentive compensation.7
Plaintiffs next point to the “magnitude” of the restatements: the
five-year period covered, the number of financial statements revised,
the amount of time and effort General Cable needed to investigate and
release the restatements, and the amount of money at issue.

The Sixth

Circuit has stated that the “magnitude” of restatements can “serve to
amplify the inference of scienter.”

PR Diamonds, 364 F.3d at 685.

But the PR Diamonds Court also stated that a strong inference of
scienter flows only from “in your face” accounting errors that “cry
out scienter” unless “additional ‘specific, highly suspicious facts
and

circumstances’”

accounting

errors

are

must

also
be

cited.

“drastic,”

See

id.

at

“pervasive,”

686,
and

695.

The

“egregious.”

Id. at 685-86.

7

Although the complaint asserts generally that Kenny and Robinson received
bonuses tied to stock price, it does not make any specific allegation that
the inflated stock price during the Class Period was necessary to earn those
bonuses.
Further, the complaint alleges no facts related to Kenny’s,
Robinson’s, or any other General Cable official’s trading activity before,
during, or after the Class Period.
And, as Defendants correctly note in
their Reply, Doc. 105, Plaintiffs’ motive allegation as it pertains to stock
option compensation does not make sense without allegations that Kenny and
Robinson exercised or sold the options when the stock price was inflated.

-15-

Recalling
complex

that

theft

the

scheme,

majority

the

of

errors

duration

of

were

the

the

errors

result

speaks

of

less

a
to

Defendants’ states of mind and more to the thieves’ sophistication.
Likewise,

the

opposing

inference

that

the

investigation

and

compilation of corrected financial data took longer than “average” due
to the duration of the scheme is most plausible.
Moreover, Defendants have offered a compelling explanation for
why

two

restatements

were

necessary:

the

errors

necessitating

second restatement were discovered while remedying the first.

the
See

Doc. 97-2, General Cable 2011 Form 10 K/A, at 3 (noting that it
discovered additional errors “in remediating the material weaknesses
associated with Restatement No. 1”).
As to the financial “magnitude” of the restatements, although
General Cable erred by millions, the errors’ relative financial impact
was minimal (despite being material according to GAAP standards).
instance,

the

largest

understatement

of

costs

(FY2011)

For

was

$17.9

million, or 0.3% of the company’s $5.2 billion cost of sales.

This

error’s impact on Net Income and basic Earnings per Share was more
significant,

causing

respectively.

But,

a

30%

from

a

overstatement
day-to-day

and

26.7%

management

decrease,

perspective,

deviation of 0.3% in costs would not raise an “obvious red flag.”8
Konkol

v.

Diebold,

Inc.,

590

F.

3d

390,

400

(6th

Cir.

a

See
2009)

(explaining that in a multi-billion dollar company, the amount of
8

The comparison is similar for overstatement of inventory.
In 2011, for
example, General Cable overstated inventory by $43.2 million, which
represented 3.6% of total inventory and 0.9% of total assets.

-16-

improperly recognized revenue “would have to be significant to support
a finding of scienter” and distinguishing improper revenue recognition
from errors leading a company to report profits when it should have
reported

losses);

PR

Diamonds,

364

F.3d

at

694

(“To

support

an

inference of fraudulent scienter, allegations of GAAP . . . violations
must extend in nature and magnitude beyond merely the materiality
threshold.”).
Plaintiffs also argue that it is highly suspicious that so many
“errors” were in General Cable’s favor.9

While scienter could be

inferred from this circumstance, the argument ignores the origin of
most of the errors: theft.

To operate without detection, a theft

scheme must disguise the losses, as unexplained losses might elicit
investigation
theft

would

and

discovery.

report

Thus,

inventories

that

figures until discovering the theft.

any

corporation

were

greater

victimized

than

the

by

actual

Likewise, any error related to

understatement of costs will lead to a “favorable” adjustment for the
corporation.
Plaintiffs’
restate

financial

allegations
information,

that
that

General

Cable

restatements

was
are

that the required adjustments were material add little.

required
uncommon,

to
and

As Plaintiffs

admit, all restatements correct material errors in prior financial
statements because that is all GAAP permits.
¶ 44.

See Doc. 97, Complaint,

And the law is clear that fraudulent intent cannot be inferred

9

Defendants remind the Court that not all errors in the original financial
statements were in General Cable’s favor.
See Doc. 98, at 12 (highlighting
that restated figures for 2012 increased rather than decreased net income).

-17-

from the mere fact that a company makes a restatement.

See In re

Comshare, 183 F.3d at 553 (rejecting the argument that a “subsequent
revelation of the falsehood of previous statements implies scienter”
and noting that “mere allegations that statements in one report should
have

been

made

securities

in

earlier

fraud”);

inference

of

violations

PR

Diamonds,

fraudulent

must

reports

extend

364

scienter,
in

do

not

F.3d

make

at

694

allegations

nature

and

out

claim

GAAP

beyond

of

support

(“To

of

magnitude

a

an

and

GAAS

merely

the

materiality threshold.”).
Plaintiffs
restatement
problems,

also
2005

in

its

argue
that

restatements

that

because

involved
eight

General

Cable

issued

inventory-related

years

later

stemming

inventory-related problems suggest fraudulent intent.

a

accounting
from

other

Although one

could infer that a prior inventory problem would put Defendants on
notice

to

scrutinize

inventory

controls,

the

Sixth

Circuit

has

rejected the argument that such circumstances can form the basis of a
strong inference of scienter.

See Ricker v. Zoo Entm’t, Inc., 534 F.

App’x

2013)

495,

500-01

(6th

Cir.

(praising

the

district

court’s

holding that even if a defendant company knew or should have known of
a potentially problematic account, it does not reasonably follow that
the

company

knew

or

should

have

known

that

the

related

financial

statements were false).
Moreover, Plaintiffs describe the 2005 problems generally, see
Doc. 97, Complaint, ¶ 117 (“controls over the recording of inventory
shipments”; “controls over [] financial reporting”), and allege no
-18-

specific facts showing how the prior problems would cause Defendants
to

know

of

the

later

problems.

Furthermore,

that

the

inventory

control problems occurred in a subsidiary that Plaintiffs admit was
allowed

to

operate

weakens

with

Plaintiffs’

separate

position.

internal

That

control

General

Cable

systems
had

further

encountered

problems in its own system does not support the inference that General
Cable was on notice of problems in another company’s system.
As

to

Kenny

and

Robinson’s

signing

of

Sarbanes-Oxley

certifications, the Sixth Circuit has concluded that such acts are
probative of scienter only “if the person signing the certification
was severely reckless in certifying the accuracy of the financial
statements.”

Konkol, 590 F.3d at 402.

Plaintiffs have alleged no

facts to support an inference that Kenny and Robinson were severely
reckless

in

conclusory

signing
statement

evaluation

been

discovered.

the

forms.

that,

carried

out

had

Plaintiffs
the

properly,

instead

required
the

rely

internal

errors

would

on

the

controls
have

been

They argue, thus, that Defendants must have either known

their certifications were false when made or Defendants must not have
evaluated the company’s internal controls at all.
support neither conclusion.

The facts alleged

See id. at 403 (explaining that finding

scienter under such facts would be equivalent to the ‘classic fraud by
hindsight case’”).
The
available”
similarly

argument
control

that

Defendants’

measures

unavailing.

failure

supports

Plaintiffs
-19-

do

an

to

implement

inference
not

allege

of

“readily

scienter

specific

is

facts

suggesting that Defendants had reason to believe these controls were
necessary or that Defendants considered them and recklessly rejected
them.

Their failure to implement the measures thus suggests little

about their state of mind.
Statements by confidential witnesses that individuals in Brazil
knew about the inventory-related accounting problems suffer from the
same flaw.

See Doc. 97, Complaint, ¶ 34, ¶ 122.

Plaintiffs allege no

facts showing that Kenny or Robinson were aware of the discrepancies
or

Phelps

Dodge

managers’

failure

to

address

them.

Moreover,

Plaintiffs do not allege that Kenny or Robinson, when confronted by a
subordinate with bad news, had a policy of putting their heads in the
sand.
Plaintiffs speculate that had the company implemented remedial
measures earlier, the accounting errors and false statements could
have been avoided.

Given that a complex theft scheme was at work --

one that employed efforts to actively conceal the inventory loss -there is no guarantee that better internal control measures could have
prevented the losses.

The thieves might simply have adjusted their

strategy to continue avoiding detection.

See In re Comshare, 183 F.3d

at 554 (“Claims of securities fraud cannot rest on speculation and
conclusory allegations.”)(internal quotations omitted).
Plaintiffs rely heavily on allegations that Defendants allowed
Phelps

Dodge

to

continue

its

own

financial

and

internal

control

systems and shielded the ROW group from meaningful financial scrutiny.

-20-

If scienter were to be found in this complaint, these facts seem most
likely to harbor it.
Sixth

But, again, the allegations are insufficient.

Circuit

recklessness

or

law

is

intentional

clear

that

misconduct

courts
from

should
parent

a

reliance on its subsidiary’s internal controls.”
F.3d at 554.

not

“presume

corporation’s

In re Comshare, 183

Moreover, Defendants’ decision not to integrate Phelps

Dodge into the company’s general compliance framework, while perhaps
imprudent in hindsight, is not evidence of scienter.

It is not an

“extreme departure from the standards of ordinary care” for a parent
corporation executive to insist that his subordinates not micromanage
a subsidiary.

That, in hindsight, micromanagement might have been the

wiser course is not relevant to a scienter analysis.

See Ernst &

Ernst v. Hochfelder, 425 U.S. 185, 214 (1976) (“Negligent conduct
cannot

give

rise

to

liability

under

§ 10(b)

or

Rule

10b-5.”).

Plaintiffs allege no specific facts suggesting that Defendants made
these business decisions for the purpose of concealing fraud or that
Defendants ignored “red flags” in deciding not to integrate certain
Phelps Dodge systems.
Plaintiffs’ argument that confidential witness statements provide
these “red flags” is unconvincing.

Confidential Witness 1’s statement

that

finance

he

or

operations

she
were

participated
discussed

and

in

described

meetings
as

“a

where
bit

of

Brazilian
a

train

wreck . . . like a bunch of cowboys,” Doc. 97, Complaint ¶ 125, is
properly discounted because it lacks context.
facts

linking

Kenny

or

Robinson
-21-

to

these

Plaintiffs provide no
meetings.

Moreover,

Plaintiffs do not specify the timing of these statements or identify
which aspects of the Brazilian operations were like a “train wreck.”
These statements are irrelevant if not linked to the specific problems
that led to the restatements.
Plaintiffs also emphasize Confidential Witness 1’s assertion that
Kenny justified the lack of integration by saying, “Hey, they are a
successful organization, leave them alone, let them do their thing.”
Id.

¶ 121.

This

statement

suggests

not

that

Defendants

ignored

obvious “red flags” but instead that they held a genuine belief that
Phelps Dodge did not need closer scrutiny.
Most importantly, the inquiry is not whether management decisions
related to ROW were prudent; the question is whether Defendants knew
or

should

have

reported.
Cir.

known

the

financial

statements

were

false

when

See Ricker v. Zoo Entm’t, Inc., 534 F. App’x 495, 501 (6th

2013)

corporation

(declining
knew

problematic”).

to

that
The

find
a

facts

scienter

particular
alleged

even

where

account

simply

do

the

was
not

defendant

“potentially
lead

to

this

inference.
Finally, Robinson’s approval of bill-and-hold sales via email
does not naturally lead to an inference of scienter because Plaintiffs
allege no facts suggesting that Robinson knew or had reason to believe
that the transactions were improper.
hold

sales

stricter
Defendants

are

not

revenue
for

per

se

improper;

recognition

failing

to

As Plaintiffs admit, bill-andthey

criteria.

disclose
-22-

that

simply

are

Plaintiffs
General

subject
also

Cable

to

vilify

recognized

revenue from bill-and-hold sales, allegedly because those transactions
are “red flags” to the SEC and investors.

Yet Plaintiffs describe no

GAAP or other regulation that requires such a disclosure.

Nor do

Plaintiffs assert that General Cable’s bill-and-hold practices were
hidden from its auditors to avoid that heightened scrutiny.
Analyzing these allegations collectively, the complaint fails to
support a strong inference of scienter as to either Kenny or Robinson.
b. Corporate Scienter
Having found no facts from which to draw a strong inference of
scienter as to Kenny or Robinson, the Court now looks to other actors
whose states of mind might be imputed to the corporation.
At oral argument, Plaintiffs pointed to Sandoval, chief executive
of the ROW group.

The emphasis on Sandoval stemmed from an admission

by General Cable in its 2012 Form 10-K/A (Doc. 97-2, at 7, attached to
the

Complaint),

that

“ROW

executive

management”

became

aware

of

allegations of theft and inventory accounting issues in January 2012
but

failed

to

notify

General

Cable’s

executive

management

of

the

issues until September 2012.

General Cable further admitted that “ROW

executive

excessive

management

placed

emphasis

on

meeting

business

plan goals rather than on the integrity of the financial reporting
process.”

Id.

In their Response (Doc. 103, at 16-18), Plaintiffs argue that
Sandoval was one of these ROW executives and asks the Court to infer
that

he

contained

engaged
in

in

General

intentional
Cable’s

misconduct

March
-23-

28,

by

2013

referring
Schedule

to

facts

14A

Proxy

Statement, Doc. 105-1, detailing General Cable’s recoupment, pursuant
to

the

corporation’s

Sandoval.10
based

“Clawback

Policy,”

of

a

bonus

award

paid

to

This policy allows the corporation to recover incentive-

compensation

from

an

executive

in

circumstances

where

the

corporation is required to restate accounting data due to material
noncompliance and the executive is found to have materially violated
the corporation’s Code of Ethics.

Id. Plaintiffs argue that scienter

on the part of Sandoval can be inferred from these circumstances and
then imputed to the corporation.
Although Sandoval –– as an individual who furnished information
for

financial

described

in

reports
Omnicare

––

falls

whose

within

knowledge

the
may

categories
be

of

imputed

persons
to

the

corporation, the allegations against him are nonetheless insufficient
to

support

an

inference

of

corporate

scienter.

As

discussed

previously, to impute an agent’s state of mind to the corporation, a
complaint must allege particular facts to support a strong inference
that the agent acted with the requisite state of mind.
have failed to do so here.

Plaintiffs

Although Sandoval may have been aware of

problems and failed to disclose them, there are no facts to support
that he did so with intent to defraud.

Instead, the allegations

support an inference that his intent was one shared by most corporate

10

The Court notes that this proxy statement —— the first to mention Sandoval
by name —— was not referenced in or attached to the Complaint and
acknowledges Plaintiffs’ Corrected Request for Judicial Notice (Doc. 106) of
General Cable’s Schedule 14A. The Court need not decide whether these facts
are properly before the Court because even assuming they are, Plaintiffs’
scienter allegations pertaining to Sandoval fail for other reasons.

-24-

executives:

to

be

profitable

and

achieve

business

goals.

Not

surprisingly, when the Court asked Plaintiffs’ counsel during oral
argument

to

identify

specific

facts

showing

Sandoval’s

intent, Plaintiffs’ counsel struggled to answer.

fraudulent

As such, the Court

concludes that scienter cannot be imputed to General Cable based on
allegations related to Sandoval.
Analyzing the allegations collectively, the complaint fails to
support a strong inference of scienter.

Plaintiffs simply lack the

type of particularized facts that would lead a reasonable person to
find a powerful or cogent inference of fraudulent intent as to any of
the defendants.

The Court thus finds that Plaintiffs have failed to

state a claim for securities fraud under Section 10(b) or Rule 10b-5.
B. Section 20(a) “Controlling Person” Claim
Section 20(a) of the Securities Exchange Act provides for joint
and

several

“directly

or

liability

against

indirectly”

“controlling

control

any

persons”

person

liable

–for

those

who

securities

violations “unless the controlling person acted in good faith and did
not directly or indirectly induce the act or acts constituting the
violation

or

cause

of

action.”

15

U.S.C.

§ 78t(a)(2012).

Thus,

Section 20(a) claims “are predicated upon at least one underlying
violation committed by a controlled party.”
F.3d 954, 962 (6th Cir. 2011).

Frank v. Dana Corp., 646

Therefore, “[w]here plaintiffs do not

state a claim for a primary securities law violation under Rule 10b–5,
dismissal

of

a

“control

§ 78t(a) is also proper.”

person”

liability

claim

under

15

U.S.C.

Dailey v. Medlock, 551 F. App’x 841, 849
-25-

(6th Cir. 2014) (citing Ind. St. Dist. Council of Laborers & Hod
Carriers Pension & Welfare Fund v. Omnicare, Inc., 583 F.3d 935, 947
(6th Cir. 2009)).

Because Plaintiffs fail to state a claim for a

securities fraud, the Court concludes that their § 20(a) claims also
fail.
III. CONCLUSION
Therefore,

having

reviewed

this

matter,

and

the

Court

being

otherwise sufficiently advised,
IT IS ORDERED that
(1)

Defendants’ motion to dismiss (Doc. 98) be, and hereby is,
GRANTED, and Plaintiffs’ claims against Defendants be, and
hereby are, DISMISSED WITH PREJUDICE; and

(2)

A separate judgment shall enter concurrently herewith.

This 27th day of January, 2015.

-26-