Franklin v. Centrais Eletricas Brasileiras S.A. - Eletrobras et al

Filing 67

OPINION AND ORDER re: 44 MOTION to Dismiss The Consolidated Second Amended Complaint. filed by Jose Antonio Muniz Lopes, Jose da Costa Carvalho Neto, Centrais Eletricas Brasileiras S.A. - Eletrobras, Armando Casado de Araujo. The Court has considered all of the remaining arguments of the parties. To the extent not specifically addressed above, they are either moot or without merit. For the foregoing reasons, the defendants' motion to dismiss is granted in part and den ied in part. All claims against the defendant Lopes are dismissed. The scheme liability claims under Rule 10b-5(a) and (c) against the defendants Carvalho and Arajo are also dismissed. The motion to dismiss is otherwise denied. The Clerk is directed to close all pending motions. (As further set forth in this Order.) Jose Antonio Muniz Lopes terminated. (Signed by Judge John G. Koeltl on 3/25/2017) (cf)

UNITED STATES DISTRICT COURT
SOUTHERN DISTRICT OF NEW YORK
────────────────────────────────────
IN RE ELETROBRAS SECURITIES
LITIGATION

15-cv-5754 (JGK)

────────────────────────────────────

OPINION AND ORDER

JOHN G. KOELTL, District Judge:
This is a consolidated securities action purportedly
brought on behalf of a class of all purchasers of U.S. exchangetraded securities of Centrais Elétricas Brasileiras S.A.
(“Eletrobras” or the “Company”) between August 17, 2010 and June
24, 2015 (the “class period”). The lead plaintiffs, the City of
Providence and Dominique Lavoie (the “plaintiffs”) filed a
Second Amended Complaint (“SAC”) on February 26, 2016. The
plaintiffs asserted violations of Section 10(b) of the
Securities Exchange Act of 1934, 15 U.S.C. § 78j(b) (the
“Exchange Act”), and Rule 10b-5 promulgated thereunder, 17
C.F.R. § 240.10b-5, against Eletrobras and four senior
executives of the Company, namely, José Antonio Muniz Lopes
(“Lopes”), José da Costa Carvalho Neto (“Carvalho”), Armando
Casado de Araújo (“Araújo”), and Valter Luiz Cardeal de Souza
(“Cardeal”) (collectively, the “individual defendants”). 1 The

1

The plaintiffs claim violations of Rule 10b-5 by Eletrobras,
Lopes, Carvalho, and Araújo, and violations of Rule 10b-5(a) and
(c) by all defendants. See SAC ¶¶ 292-302. The defendant
Cardeal has not yet been served in this litigation; the motion
1

plaintiffs also asserted control person liability under Section
20(a) of the Exchange Act, 15 U.S.C. § 78t(a), against the
individual defendants.
The defendants Eletrobras, Lopes, Carvalho, and Araújo now
move to dismiss the SAC for failure to state a claim under
Federal Rule of Civil Procedure 12(b)(6).
I.
In deciding a motion to dismiss pursuant to Rule 12(b)(6),
the allegations in the complaint are accepted as true, and all
reasonable inferences must be drawn in the plaintiffs’ favor.
McCarthy v. Dun & Bradstreet Corp., 482 F.3d 184, 191 (2d Cir.
2007). The Court’s function on a motion to dismiss is “not to
weigh the evidence that might be presented at a trial but merely
to determine whether the complaint itself is legally
sufficient.” Goldman v. Belden, 754 F.2d 1059, 1067 (2d Cir.
1985). A complaint should not be dismissed if the plaintiffs
have stated “enough facts to state a claim to relief that is
plausible on its face.” Bell Atl. Corp. v. Twombly, 550 U.S.
544, 570 (2007). “A claim has facial plausibility when the
plaintiff[s] plead[] factual content that allows the court to
draw the reasonable inference that the defendant[s] [are] liable
for the misconduct alleged.” Ashcroft v. Iqbal, 556 U.S. 662,

to dismiss is brought only on behalf of the defendants
Eletrobras, Lopes, Carvalho, and Araújo.
2

678 (2009). While factual allegations should be construed in the
light most favorable to the plaintiffs, “the tenet that a court
must accept as true all of the allegations contained in a
complaint is inapplicable to legal conclusions.” Id.
A claim under Section 10(b) of the Securities Exchange Act
sounds in fraud and must meet the pleading requirements of Rule
9(b) of the Federal Rules of Civil Procedure and of the Private
Securities Litigation Reform Act (“PSLRA”), 15 U.S.C. § 78u–
4(b). Rule 9(b) requires that the complaint “(1) specify the
statements that the plaintiff[s] contend[] were fraudulent,
(2) identify the speaker, (3) state where and when the
statements were made, and (4) explain why the statements were
fraudulent.” ATSI Commc’ns, Inc. v. Shaar Fund, Ltd., 493 F.3d
87, 99 (2d Cir. 2007). The PSLRA 2 similarly requires that the
complaint “specify each statement alleged to have been
misleading [and] the reason or reasons why the statement is

2

The plaintiffs assert claims under Rule 10b-5 based on alleged
misrepresentations and omissions and scheme liability claims
under Rule 10b-5(a) and (c) apart from specific
misrepresentations and omissions. “Because scheme liability
‘does not require an allegation that the defendant[s] made a
statement,’ claims brought under Rule 10b-5(a) and (c) ‘need not
comport with Subsection (b)(1) of the PSLRA, which requires that
. . . plaintiff[s] set forth each statement alleged to have been
misleading, and facts giving rise to this belief.’” Menaldi v.
Och-Ziff Capital Mgmt. Grp. LLC, 164 F. Supp. 3d 568, 577
(S.D.N.Y. 2016) (quoting In re Alstom SA Sec. Litig., 406 F.
Supp. 2d 433, 474-75 (S.D.N.Y. 2005)). “Scheme liability claims
are, however, subject to the PSLRA pleading standard with
respect to scienter.” Menaldi, 164 F. Supp. 3d at 577.
3

misleading,” and it adds the requirement that “if an allegation
regarding the statement or omission is made on information and
belief, the complaint shall state with particularity all facts
on which that belief is formed.” 15 U.S.C. § 78u–4(b)(1); ATSI,
493 F.3d at 99.
When presented with a motion to dismiss pursuant to Rule
12(b)(6), the Court may consider documents that are referenced
in the complaint, documents that the plaintiffs relied on in
bringing suit and that are either in the plaintiffs’ possession
or that the plaintiffs knew of when bringing suit, or matters of
which judicial notice may be taken. See Chambers v. Time Warner,
Inc., 282 F.3d 147, 153 (2d Cir. 2002). The Court can take
judicial notice of public disclosure documents that must be
filed with the SEC and documents that both “bear on the
adequacy” of SEC disclosures and are “public disclosure
documents required by law.” Kramer v. Time Warner, Inc., 937
F.2d 767, 773–74 (2d Cir. 1991); see also Plumbers & Pipefitters
Nat’l Pension Fund v. Orthofix Int'l N.V., 89 F. Supp. 3d 602,
607-08 (S.D.N.Y. 2015); Silsby v. Icahn, 17 F. Supp. 3d 348,
353–54 (S.D.N.Y. 2014), aff’d sub nom., Lucas v. Icahn, 616 F.
App’x 448 (2d Cir. 2015).

4

II.
A.
The following facts alleged in the SAC are accepted as true
for purposes of the defendants’ motion to dismiss.
Eletrobras is a state-run energy corporation organized
under the laws of Brazil that generates about 35% of Brazil’s
total electricity.

SAC ¶¶ 27, 41.

The Brazilian government has

generally owned a majority of the Company’s common shares,
giving them the right to appoint seven of the up to ten members
of the board of directors.

Id.

Since at least 2002, Eletrobras

has sponsored American Depository Shares (“ADSs”) representing
Eletrobras’s common and preferred equity and has listed them on
the New York Stock Exchange (“NYSE”).

SAC ¶ 29.

The individual defendants are current and former officers
of Eletrobras.

Lopes was a government-appointed member of

Eletrobras’s board of directors from the start of the class
period through February 25, 2011, and the board-selected Chief
Executive Officer (“CEO”) during that period.

SAC ¶ 30.

Carvalho replaced Lopes in both roles on February 25, 2011.
SAC ¶ 31.

Araújo served as the Chief Financial Officer (“CFO”)

and the Head of Investor Relations throughout the class period.
SAC ¶ 32.

Cardeal served as Eletrobras’s Chief Generation

Officer throughout the class period.

5

SAC ¶ 33.

In June 2010, Eletrobras updated and amended its “Code of
Ethics: Ethical Principles and Conduct Commitments” (“Code of
Ethics”) and declared that it would be adhered to by all
Eletrobras companies and all Eletrobras employees.
80.

SAC ¶¶ 79-

The Code of Ethics was signed by the President of every

Eletrobras affiliate company, and emphasized that Eletrobras
would “repudiat[e] any manner of fraud and corruption,” as well
as “comply[] with Brazilian laws and with the legislation of
countries in which Eletrobras Companies operate.”

SAC ¶ 82.

The Code of Ethics further pledged “[t]o make corporate
decisions based on the principles of ethics, transparency,
integrity, loyalty, impersonality, legality and efficiency” and
“[t]o refuse and denounce any form or attempt of corruption,
bribery, kickback and ‘backscratching’.”

SAC ¶ 84.

The

Company’s 2010 annual report asserted that the Code of Ethics
was binding on all Eletrobras employees, and, according to the
plaintiffs, the Code of Ethics was effective throughout the
class period.

SAC ¶ 80-81.

Both Carvalho and Araújo signed Eletrobras’s annual reports
on Form 20-F for fiscal years 2009 through 2013, and also signed
Sarbanes Oxley (“SOX”) certifications included in each of the
annual reports.

SAC ¶¶ 31-32.

In each annual report from 2010

through 2013, the Company admitted that there were material
weaknesses in the design of its internal controls related to
6

financial reporting.

SAC ¶¶ 111-19.

The 2010 annual report

also included certifications from Carvalho and Araújo stating
that they were responsible for establishing, maintaining, and
designing disclosure controls.

SAC ¶ 114. In its 2011 annual

report, the Company disclosed that eight previously disclosed
material weaknesses in internal controls were recurrent, and
added that it did not adequately design and maintain controls
“with respect to accounting for property, plant and equipment,
specifically, to ensure the completeness, accuracy and
validation of these acquisitions.”

SAC ¶ 120. The 2012 annual

report further disclosed that the Company “did not adequately
design and maintain effective controls with respect to the
impairment calculation of assets.”

SAC ¶ 125.

Each annual

report from 2010 through 2013 also acknowledged that, despite
the issues with internal controls, the financial statements were
fairly presented in all material respects.

See SAC ¶¶ 113, 122,

127, 132.
The plaintiffs allege that Eletrobras significantly
increased the use of Special Purpose Entities (“SPEs”) to
conduct its business throughout the class period. See SAC ¶ 4648.

In 2013, the Company’s internal audit unit conducted a

special audit that showed an overall need to improve control
processes over SPEs, specifically identifying that Eletrobras
needed to develop, formalize and adopt a code of ethics with
7

respect to SPEs, that shareholder agreements with SPEs did not
contain provisions giving Eletrobras unrestricted access to
technical and operational information in its SPEs, and that
Eletrobras failed to require SPE partners to provide
anticorruption statements attesting to no knowledge of unlawful
business activities.

SAC ¶ 248-49.

These concerns were

reiterated in a December 12, 2014 internal audit report that was
allegedly circulated to Eletrobras’s board of directors,
including Carvalho; the report concluded that with respect to
SPEs, “corporate management is a black hole and that the company
lacks controls to approve their accounts.”

SAC ¶ 249.

In March 2014, a Brazilian criminal money laundering
investigation known as “Operation Car Wash” uncovered evidence
of a bribery scheme related to the state-run oil company,
Petróleo Brasileiro S.A. (“Petrobras”).

SAC ¶ 7.

On October

24, 2014, a Brazilian newspaper reported that the investigation
had expanded to include Eletrobras.

SAC ¶ 271.

On October 27,

2014, the value of Eletrobras ADSs fell 11.95%, and the
following day, Eletrobras filed a Form 6-K with the SEC and
issued a press release stating that all Eletrobras companies
“respect the principles set out in its [sic] Code of Ethics,”
and that Eletrobras’s corporate governance rules follow the laws
of Brazil and the United States and “are observed by Eletrobras

8

companies in its [sic] operations, including through the Special
Purpose Entities. . . .”

SAC ¶¶ 103, 271.

On November 20, 2014, after media reports indicated that
documents relating to an Eletrobras project were discovered in
the office of a money-launderer at the center of the Petrobras
bribery scandal, then-CEO Carvalho stated that “[w]e have a
governance system, management, and internal control[s] that are
very strong, and we are always looking to improve them.”

SAC

¶ 104.
On February 10, 2015, Eletrobras issued a 6-K, signed by
Araújo, denying news reports claiming that the Company’s auditor
was requiring that Eletrobras include certain provisions related
to corruption measures in the Company’s financial statements,
and stating that “the Company, through its internal controls and
compliance program, did not identify the existence of any
episode of fraud and corruption in its projects.”
That day, Eletrobras ADSs declined nearly 7%.

SAC ¶ 106.

SAC ¶ 275.

Beginning on February 28, 2015 and during the first two
weeks in March 2015, reports surfaced that construction
contracts for Angra 3 -- a thermonuclear reactor operated by
wholly owned Eletrobras subsidiary Eletrobras Thermonuclear S.A.
(“Eletronuclear”) -- may have been tainted by bribery and
corruption as part of a scheme allegedly organized and executed

9

in part by Chief Generation Officer Cardeal.

SAC ¶¶ 12, 44B 3.

Between February 28, 2015 and March 12, 2015, the value of
Eletrobras ADSs declined by over 19%.

SAC ¶ 278.

On April 29, 2015, in response to more news reports about
potential bribery and corruption with the Angra 3 project,
Eletrobras also filed a Form 6-K, signed by Araújo, “reiterating
to its investors the Company’s commitment to transparency and
ethic[al] conduct in its business.”

SAC ¶ 108.

The Company delayed the filing of its 2014 Form 20-F annual
report, missing the initial April 30, 2015 prescription date,
the extended deadline of May 15, 2015, and a third deadline of
November 18, 2015.

SAC ¶ 19.

On June 10, 2015, Eletrobras

disclosed in an SEC filing that it had hired an international
law firm to conduct an internal investigation related to the
allegations stemming from Operation Car Wash.

SAC ¶ 284.

The

investigation focused primarily on nine different projects that
Eletrobras was involved in either directly through its
subsidiaries or indirectly through investments in SPEs: (1) the
“Angra 3” thermonuclear reactor; (2) the “Belo Monte”
hydroelectric dam; (3) the “Jirau” hydroelectric plant; (4) the
“Santo Antonio” hydroelectric plant; (5) the “Teles Pires”
hydroelectric plant

(6) the “São Manoel” hydroelectric plant;

3

The SAC contains two sets of paragraphs numbered 44–54. The
Court will cite to paragraphs in the first set with the suffix
“A,” and those in the second set with the suffix “B.”
10

(7) the “Mauá 3” thermoelectric plant; (8) the “Tumarín”
hydroelectric plant ; and (9) the “Simplício” hydroelectric
plant.

SAC ¶ 8, 9, 15, 17.

On October 11, 2016, Eletrobras eventually filed its Form
20-F 2014 and 2015 annual reports.

See Campbell Decl., ECF. No

61, Ex. K, (2014 Annual Report); Ex. L (2015 Annual Report).
The reports begin with an “explanatory note” describing the
results of the Company’s “independent internal investigation”
that assessed “violations of the U.S. Foreign Corruption
Practice Act (FCPA), the Brazilian Anticorruption Law and the
Eletrobras’ code of ethics.”
at 1.

Campbell Decl. Ex. K at 1, Ex. L

It disclosed that a former officer of Eletronuclear was

sentenced to 43 years in prison for passive bribery, money
laundering, obstruction of justice, tax evasion, and
participation in a criminal organization, and that other former
officers had been formally charged with corruption, money
laundering, and obstruction of justice.

See id.

Eletrobras

also disclosed that “[s]ince the start of the investigation, the
Company replaced its entire Board of Directors, hired a new CEO
and a Compliance Officer, and created an independent Compliance
Department to help coordinate compliance across subsidiaries.”
Id.
The explanatory note also disclosed the results of the
internal investigation, stating that for some of Eletrobras’s
11

power generation projects, there was “overpricing related to
bribery and bid-rigging (a form of fraud in which a commercial
contract is promised to one party even though for the sake of
appearance several other parties also present a bid. This
practice is illegal in most countries) activities deemed to be
of an illicit nature in some contracts, since 2008.”
Decl. Ex. K at 2, Ex. L at 2.

Campbell

It went on to note that “[t]he

Independent Investigation discovered bribes used to fund
improper payments to political parties, elected officials or
other public officials, individual contractor personnel, former
personnel of subsidiaries or SPEs of Eletrobras and other
individuals involved in bid-rigging.”

Id.

Because the Company could not identify the exact timing of
these improper payments, Eletrobras determined that the amount
of Property Plant and Equipment (“PP&E”) improperly capitalized
because of overpricing due to illicit bribes or bid-rigging
prior to December 31, 2014 would be written off and expensed in
the 2014 annual report, while any improperly capitalized amounts
for contracts entered into between December 31, 2014 and
December 31, 2015 would be written off and expensed in the 2015
annual report.

Campbell Decl. Ex. K at 2-3, Ex. L at 2-3.

12

As a result, the Company recognized a loss totaling R$ 4
195.1 million in 2014 and R$ 16.0 million in 2015.
Decl. Ex. K at 3, Ex. L at 3.

Campbell

The R$ 195.1 million expensed in

2014 represented illicit payments of R$ 129.8 million for the
Angra 3 thermonuclear reactor project, R$ 62.7 million for the
Mauá 3 thermoelectric plant project, and R$ 2.6 million in
illicit payments made for the Simplício hydroelectric plant.
Campbell Decl. Ex. L at F-78; SAC ¶¶ 70, 74.

The R$ 16.0

million expensed in 2015 represented illicit payments of R$ 11.5
million made for the Angra 3 project, and R$ 4.5 million for the
Mauá 3 project.

Campbell Decl. Ex. L at F-78.

Eletrobras also

recognized a R$ 91.5 million loss in 2014 due to illicit
payments for its equity method investments in certain SPEs not
controlled by the Company, but did not specify which SPE
projects were impacted by payments related to bribery or bidrigging.

Id.
B.

The plaintiffs assert three claims.

In Count One, the

plaintiffs allege violations of Section 10(b) of the Exchange
Act and Rule 10b-5 against Eletrobras, Lopes, Carvalho, and
Araújo based on alleged misrepresentations and omissions.

In

Count Two, the plaintiffs allege violations of Section 10(b) of

4

“R$” denotes the Brazilian Real, the official currency of
Brazil.
13

the Exchange Act and Rule 10b-5(a) and (c) against all
defendants based on alleged “scheme liability.”

In Count Three,

the plaintiffs allege control person liability in violation of
Section 20(a) of the Exchange Act against Lopes, Carvalho,
Araújo, and Cardeal.
Eletrobras, Lopes, Carvalho, and Araújo now move to dismiss
the plaintiffs’ claims.
III.
The defendants argue that the named plaintiffs, purchasers
of Eletrobras ADSs during the class period, lack standing to
bring claims on behalf of purchasers of Eletrobras bonds.

“[I]n

a putative class action, a plaintiff has class standing if he
plausibly alleges (1) that he personally has suffered some
actual . . . injury as a result of the putatively illegal
conduct of the defendant, and (2) that such conduct implicates
the same set of concerns as the conduct alleged to have caused
injury to other members of the putative class by the same
defendants.”

NECA-IBEW Health & Welfare Fund v. Goldman Sachs &

Co., 693 F.3d 145, 162 (2d Cir. 2012) (citation and quotation
marks omitted); see also In re Winstar Commc’ns Sec. Litig., 290
F.R.D. 437, 452 (S.D.N.Y. 2013) (concluding that an alleged
misstatement in a Form 10-K’s unqualified audit letter
“implicate[d] the same set of concerns for all investors in [the

14

defendant’s] securities, including stocks and bonds, because of
their common concern for the company’s financial health”).
As purchasers of Eletrobras’s ADSs during the class period,
the named plaintiffs have plausibly pleaded that they suffered
some actual injury as a result of the allegedly material
misrepresentations in Eletrobras’s annual reports, press
releases, and public statements in a way that “was broadcast at
the same time to all members of the public, prospective
shareholders and prospective bondholders alike.”

Winstar, 290

F.R.D. at 452.
The defendants argue that class standing on behalf of
bondholders should be denied because there are fundamental
differences between the characteristics of ADSs and bonds.
While the accompanying levels of risk between ADSs and bonds do
differ, the Second Circuit Court of Appeals has made clear that
“varying levels of payment priority [do not] raise such a
fundamentally different set of concerns as to defeat class
standing.” NECA, 693 F.3d at 164 (citation and quotation marks
omitted). 5

Accordingly, the named plaintiffs have class standing

5

The defendants’ reliance on In re Salomon Analyst Level 3
Litigation, 350 F. Supp. 2d 477 (S.D.N.Y. 2004) is misplaced.
First, In re Salomon was decided before the Second Circuit Court
of Appeals clarified the class standing standard. See NECA, 693
F.3d at 162. Second, the court in In re Salomon concluded that
the named plaintiffs did not have standing to assert claims on
behalf of bondholders because the case involved allegations of
“fraud perpetrated by means of false statements made by an
15

to assert claims on behalf of those who purchased Eletrobras
bonds during the class period.
IV.
The defendants move to dismiss the claims asserted in Count
One for a violation of Section 10(b) and Rule 10b–5 based on
alleged misrepresentations and omissions on the grounds that the
plaintiffs have failed to allege adequately (1) any material
misstatements or omissions with respect to the defendants’
statements about Eletrobras’s ethics and integrity; (2) any
material misstatements or omissions regarding Eletrobras’s
financial condition; and (3) scienter.
Section 10(b), as effectuated by Rule 10b–5, makes it
“unlawful for any person . . . [t]o make any untrue statement of
a material fact or to omit to state a material fact necessary in
order to make the statements made, in the light of the
circumstances under which they were made, not misleading.”
C.F.R. § 240.10b–5(b).

17

To state a claim under Section 10(b) and

Rule 10b–5, the plaintiffs must allege that the defendants, in
connection with the purchase or sale of securities, made a
materially false statement or omitted a material fact, with

equity analyst about the investment quality of a company’s
equity securities” such that “the injury claimed to bondholders,
if cognizable at all, seems fundamentally different than the
injury claimed to equity security holders.” 350 F. Supp. 2d at
497 (emphasis added). The defendants fail to point to any such
equity-specific considerations in this case.
16

scienter, and that the plaintiffs’ reliance on the defendants’
action caused injury to the plaintiffs.

Ganino v. Citizens

Utils. Co., 228 F.3d 154, 161 (2d Cir. 2000); see also City of
Roseville Employees’ Ret. Sys. v. EnergySolutions, Inc., 814 F.
Supp. 2d 395, 409 (S.D.N.Y. 2011).

An alleged omission of fact

is material if there is “a substantial likelihood that the
disclosure of the omitted fact would have been viewed by the
reasonable investor as having significantly altered the ‘total
mix’ of information made available.” Basic, Inc. v. Levinson,
485 U.S. 224, 231–32 (1988) (internal citation omitted). “Put
another way, a fact is to be considered material if there is a
substantial likelihood that a reasonable person would consider
it important in deciding whether to buy or sell shares of
stock.”

Operating Local 649 Annuity Tr. Fund v. Smith Barney

Fund Mgmt. LLC, 595 F.3d 86, 92–93 (2d Cir. 2010) (internal
citation and quotation marks omitted); see also Silsby, 17 F.
Supp. 3d at 358.
“A[n] omission is actionable under federal securities laws
only when the [defendant] is subject to a duty to disclose the
omitted facts.” In re Time Warner Inc. Sec. Litig., 9 F.3d 259,
267 (2d Cir. 1993).

Even though Rule 10b–5 imposes no duty to

disclose all material, nonpublic information, once a party
chooses to speak, it has a “duty to be both accurate and
complete.” Caiola v. Citibank, N.A., 295 F.3d 312, 331 (2d Cir.
17

2002).

“[A]n entirely truthful statement may provide a basis

for liability if material omissions related to the content of
the statement make it . . . materially misleading.” In re
Bristol Myers Squibb Co. Sec. Litig., 586 F. Supp. 2d 148, 160
(S.D.N.Y. 2008); see also City of Roseville, 814 F. Supp. 2d at
410.

However, corporations are “not required to disclose a fact

merely because a reasonable investor would very much like to
know that fact.”

In re Optionable Sec. Litig., 577 F. Supp. 2d

681, 692 (S.D.N.Y. 2008) (quoting In re Time Warner, 9 F.3d at
267); see also In re Vivendi, S.A. Sec. Litig., 838 F.3d 223,
239-40 (2d Cir. 2016); In re Bank of Am. AIG Disclosure Sec.
Litig., 980 F. Supp. 2d 564, 575 (S.D.N.Y. 2013), aff’d, 566 F.
App’x 93 (2d Cir. 2014).
A.
The defendants argue that the plaintiffs have failed to
plead any actionable misstatements related to Eletrobras’s
references to its Code of Ethics.

“[G]eneral statements about

reputation, integrity, and compliance with ethical norms are
inactionable ‘puffery,’ meaning that they are ‘too general to
cause a reasonable investor to rely upon them.’” City of Pontiac
Policemen’s & Firemen’s Ret. Sys. v. UBS AG, 752 F.3d 173, 183
(2d Cir. 2014) (quoting ECA, Local 134 IBEW Joint Pension Tr. of
Chi. v. JP Morgan Chase Co., 553 F.3d 187, 206 (2d Cir. 2009)).
But “[t]his is not to say that statements about a company's
18

reputation for integrity or ethical conduct can never give rise
to a securities violation.”

Ind. Pub. Ret. Sys. v. SAIC, Inc.,

818 F.3d 85, 98 (2d Cir. 2016).

“[F]or example, a company’s

specific statements that emphasize its reputation for integrity
or ethical conduct as central to its financial condition or that
are clearly designed to distinguish the company from other
specified companies in the same industry” could “in some
circumstances violate the securities laws.”

Id.

Here, Eletrobras initially emphasized its adherence to its
Code of Ethics and corporate governance rules in response to
specific press reports indicating that the Operation Car Wash
money laundering investigation –- initially focused on energy
company Petrobras -- had widened to include Eletrobras projects.
See SAC ¶ 103.

And as news continued to trickle out about

further evidence implicating Eletrobras in the bribery and bidrigging investigation, Eletrobras repeatedly emphasized and
reasserted the strength of its internal controls and its
commitment to transparency and ethical conduct. 6

6

See SAC ¶¶ 104-

The statements responding to damaging reports also purported to
reflect the Company’s current state of affairs, stating that
corporate governance rules “are observed by Eletrobras companies
. . . including through [SPEs],” and that Eletrobras had “a
governance system, management, and internal control[s] that are
very strong.” SAC ¶¶ 103, 133 (emphasis added). They are
therefore distinguishable from the references to ethical
standards in City of Pontiac, which appeared in offering
materials and were “explicitly aspirational, with qualifiers
such as ‘aims to,’ ‘wants to,’ and ‘should.’” 752 F.3d at 183.
19

08.

The repeated references made specifically in response to

damaging media reports about bribery and bid-rigging at
Eletrobras were made to “emphasize its reputation for integrity
or ethical conduct as central to its financial condition” and
“clearly designed to distinguish [Eletrobras] from [Petrobras]”
as news spread that the Operation Car Wash investigation had
expanded to Eletrobras.

See SAIC Inc., 818 F.3d at 98.

Moreover, Eletrobras’s repeated assertions about its strong
ethical standards stand in stark contrast with the explanatory
notes in its 2014 and 2015 annual reports, which confirm
overpayments related to bribery and bid-rigging, a lack of
effective internal controls over its corruption prevention
program and monitoring of SPEs, criminal convictions and charges
filed against former officers, and the implementation by the
newly appointed board of directors and CEO of a new compliance
program that seeks to “[d]evelop a new compliance-focused
company culture.” 7

Campbell Decl. Ex. K at 1-5, Ex. L at 1-5.

“[W]hen (as here alleged) the statements were made
repeatedly in an effort to reassure the investing public about
7

Eletrobras’s attempt to distance itself from Petrobras, coupled
with the clear differences between Eletrobras’s original
statements on ethical conduct and its subsequent disclosures
admitting to bribery, bid-rigging, and criminal proceedings
against former officers, make this case distinguishable from the
general statements on ethical conduct deemed not actionable in
Boca Raton Firefighters & Police Pension Fund v. Bahash, 506 F.
App’x 32, 37 (2d Cir. 2012) (summary order) and In re Sanofi
Sec. Litig., 155 F. Supp. 3d 386, 401-02 (S.D.N.Y. 2016).
20

the Company's integrity, a reasonable investor could rely on
them as reflective of the true state of affairs at the Company.”
In re Petrobras Sec. Litig., 116 F. Supp. 3d 368, 381 (S.D.N.Y.
2015).

Accordingly, there was a substantial likelihood that

these statements, made to reassure investors, would be important
to a reasonable person in considering whether to buy or sell
shares of Eletrobras securities.
F.3d 86 at 92–93.

See Operating Local 649, 595

The plaintiffs have thus plausibly alleged

material misstatements or omissions with respect to Eletrobras’s
repeated references to its ethics and integrity.
B.
The defendants argue that the plaintiffs have failed to
plead any material misstatements regarding the Company’s
financial condition 8 as reflected in annual reports filed
throughout the class period.

The defendants focus primarily on

the fact that the amount of illicit payments made since 2008 -ultimately expensed in the 2014 and 2015 annual reports -- were
not quantitatively material because the amounts represented only
0.20% of Eletrobras’s 2014 total assets and .01% of 2015 total
assets.

However, the Second Circuit Court of Appeals has

explained that courts must fully analyze “all relevant
8

The plaintiffs allege that the Company materially overstated
PP&E, misstated earnings, understated and improperly accounted
for certain expenses, failed timely to recognize losses from
SPEs, and misrepresented or failed properly to disclose relatedparty transactions throughout the class period. See SAC ¶ 137.
21

considerations” when assessing materiality.

Litwin v.

Blackstone Grp., L.P., 634 F.3d 706, 717 (2d Cir. 2011);
Hutchison v. Deutsche Bank Sec. Inc., 647 F.3d 479, 485 (2d Cir.
2011).

Under the holistic analysis endorsed by the Court of

Appeals, sufficiently strong qualitative evidence of materiality
can establish materiality as a matter of law.
at 717-18.

Litwin, 634 F.3d

The qualitative inquiry is guided by SEC Staff

Accounting Bulletin No. 99 (“SAB 99”), 64 Fed. Reg. 45,150
(1999).

Id. at 717; see also In re New Oriental Educ. & Tech.

Grp. Sec. Litig., 988 F. Supp. 2d 406, 422-23 (S.D.N.Y. 2013).
SAB 99 provides a non-exhaustive list of the relevant
qualitative factors that could render material a quantitatively
small misstatement of a financial statement item. See SAB 99, 64
Fed. Reg. at 45,152.

Such qualitative factors include whether

the misstatement involves concealment of an unlawful
transaction.

Id.; ECA, 553 F.3d at 198.

Although not cited by the plaintiffs, SAIC, Inc., is
particularly instructive in assessing materiality in this case.
There, two SAIC employees in charge of a contract with New York
City for timekeeping services became involved in an “elaborate
kickback scheme” with an outside contractor, in which the
contractor illegally paid the SAIC employees to hire the
contractor on behalf of SAIC, incur unnecessary costs from the
contractor’s artificially inflated bills, and offload cost
22

overruns to the City.

See SAIC, Inc., 818 F.3d at 89.

As the

scheme unraveled, SAIC removed one of the employees and hired an
outside law firm to conduct an internal investigation of
possible fraud.

See id.

Meanwhile, SAIC “touted its commitment

to high standards of ethical performance and integrity,” and it
was only after federal criminal charges were filed against the
SAIC employees and the outside contractor that SAIC disclosed to
investors the details of the kickback scheme.

See id. at 89-90

(internal quotation marks omitted).
The Second Circuit Court of Appeals rejected the
defendants’ argument that the City project at issue was
immaterial due to a lack of quantitative materiality, because
such an approach would require the court to “consider
quantitative factors only in the narrowest light in determining
the financial impact of losing the [City project] due to the
fraud, and to otherwise ignore qualitative factors.”
(citing Litwin, 634 F.3d at 717-18).

Id. at 96

Due to the “possible

exposure to significant civil and even criminal liability” and
the potential risks to future revenues, the court was “reluctant
to conclude . . . that the alleged misstatements were ‘so
obviously unimportant’ either quantitatively or qualitatively
that they could not be material.”
(quoting ECA, 553 F.3d at 197).

23

SAIC, Inc., 818 F.3d at 96

Here, the 2014 and 2015 annual reports reveal that
Eletrobras has been involved in illegal bribery and bid-rigging
since at least 2008, and that the Company has been concealing
these unlawful transactions by improperly capitalizing illicit
payments as PP&E and failing to write off illicit payments paid
by SPEs.

See Campbell Decl. Ex. K at 2, Ex. L at 2.

And beyond

just the “possible exposure to significant civil and even
criminal liability,” SAIC, Inc., 818 F.3d at 96, the Company has
now disclosed that a former officer of a wholly owned Eletrobras
subsidiary was sentenced to more than four decades in prison for
passive bribery, money laundering, obstruction of justice, tax
evasion, and participation in a criminal organization, with
other former officers being charged on similar grounds.
Campbell Decl. Ex. K at 2, Ex. L at 2.

See

The 2014 and 2015 annual

reports further disclose that the entire board of directors and
CEO have been replaced, and that a new compliance program has
been launched.

See id.

Plainly, the fact that some of Eletrobras’s officers have
been engaged in conduct since 2008 that resulted in serious
criminal consequences, an overhaul of Eletrobras’s corporate
governance system, and the replacement of board of directors and
management is not “so obviously unimportant to a reasonable
investor” to be immaterial.

ECA, 553 F.3d at 197; see also

Petrobras, 116 F. Supp. 3d at 380 (“The errors in [the
24

Company’s] financial statements were directly related to its
concealment of the unlawful bribery scheme, revelation of which
would ‘call into question the integrity of the company as a
whole.’” (quoting Strougo v. Barclays PLC, 105 F. Supp. 3d 330,
349 (S.D.N.Y. 2015))).
Aside from Eletrobras’s concealment of unlawful
transactions, other SAB 99 factors weigh against concluding at
this stage that Eletrobras’s alleged misstatements and omissions
regarding illicit payments were not material as a matter of law.
For example, the 2014 annual report reveals that all amounts of
illicit payments made for the acquisition of PP&E from 2008
through 2014 were expensed in the 2014 annual report.
Campbell Decl. Ex. K at 3.

See

In other words, prior annual reports

understated expenses and overstated earnings, thereby
implicating whether such misstatements in the previous annual
reports “mask[ed] a change in earnings or other trends” or
“change[d] a loss into income or vice versa.”

SAB 99, 64 Fed.

Reg. at 45,152.
SAB 99 also states that in assessing materiality, whether
management expects that a “known misstatement may result in a
significant positive or negative market reaction, that expected
reaction should be taken into account when considering whether a
misstatement is material.”

Id.

Here, the plaintiffs describe

in detail Eletrobras management’s responses to allegations of
25

bribery and bid-rigging that arose after the Operation Car Wash
investigation unfolded, as well as corresponding market
reactions in the value of Eletrobras ADSs.
271-88.

See SAC ¶¶ 267, 268,

While “market volatility alone is ‘too blunt an

instrument to be depended on in considering whether a fact is
material,’” ECA, 553 F.3d at 205 (quoting SAB 99, 64 Fed. Reg.
at 45,152), the significant volatility of Eletrobras ADSs,
considered in aggregate with other SAB 99 factors 9, preclude the
conclusion that the alleged misstatements and omissions related
9

Other SAB 99 factors further indicate that the plaintiffs at
this stage have adequately pleaded material misstatements or
omissions in Eletrobras’s financial condition.
One relevant factor is “[w]hether the misstatement arises
from an item capable of precise measurement or whether it arises
from an estimate and if so, the degree of imprecision inherent
in the estimate,” SAB 99, 64 Fed. Reg. at 45,152, and the 2014
and 2015 annual reports emphasize the uncertain nature of the
amounts of illicit payments because “[t]he information to
determine the amount by which the Company was potentially
overcharged by . . . contractors and suppliers is not contained
within the Company’s accounting records or internal control
systems.” Campbell Decl. Ex. K at 3, Ex. L at 3.
Another relevant factor is the “significance of the
misstatement in relation to the company’s operations.” ECA, 553
F.3d at 198; Hutchison, 647 F.3d at 488 (“If a particular
product or productline, or division or segment of a company's
business, has independent significance for investors, then even
a matter material to less than all of the company’s business may
be material for purposes of the securities laws.”); SAB 99, 64
Fed. Reg. at 45,152 (“Whether the misstatement concerns a
segment or other portion of the registrant’s business that has
been identified as playing a significant role in the
registrant’s operations or profitability.”). Here, the alleged
misstatements related to the value of Eletrobras’s electricityproducing infrastructure, which is at the heart of Eletrobras’s
business. See Petrobras, 116 F. Supp. 3d at 380 (“[T]he
misstatements related to the value of Petrobras’ oil-producing
infrastructure, which is the core of its business.”)
26

to the bribery scheme in previous annual reports were “so
obviously unimportant to a reasonable investor” to be
immaterial.

ECA, 553 F.3d at 197; see also Petrobras, 116 F.

Supp. 3d at 380 (“[P]laintiffs allege that [the Company’s] share
price dropped dramatically when news of the corruption emerged,
indicating that investors did, in fact, consider that
information to be material.”).

Accordingly, the plaintiffs have

plausibly alleged that the annual reports disclosing the
financial condition of the Company during the class period
contained material misstatements or omissions. 10
C.
The defendants argue that the plaintiffs have not alleged
facts sufficient to support a strong inference of scienter.

The

scienter required to support a securities fraud claim can be
“intent to deceive, manipulate, or defraud, or at least knowing
10

The plaintiffs also allege that the Company materially
misrepresented or failed to disclose the true extent of its
internal control problems throughout the class period. However,
the allegations within the SAC indicate that Eletrobras
recognized numerous material weaknesses with respect to its
internal controls throughout the class period. SAC ¶¶ 112, 113,
117-134. While these allegations provide further support to
infer scienter, they are not sufficiently particularized to form
a basis for material misrepresentations.
In re Magnum Hunter
Res. Corp. Sec. Litig., 26 F. Supp. 3d 278, 295 (S.D.N.Y. 2014),
aff'd, 616 F. App'x 442 (2d Cir. 2015) (“The fact that
defendants recognized problems, announced that they were
implementing effective controls and procedures, and then
recognized more problems does not indicate that their statements
were false at the time that they were made.”).

27

misconduct.”

SEC v. First Jersey Sec., Inc., 101 F.3d 1450,

1467 (2d Cir. 1996) (internal citations omitted).

The PSLRA

requires that a complaint alleging securities fraud “state with
particularity facts giving rise to a strong inference that the
defendant[s] acted with the required state of mind.”
§ 78u-4(b)(2).

15 U.S.C.

Scienter may be inferred from (i) facts showing

that a defendant had “both motive and opportunity to commit the
fraud,” or (ii) facts that constitute “strong circumstantial
evidence of conscious misbehavior or recklessness.”

ATSI, 493

F.3d at 99; see also City of Roseville, 814 F. Supp. 2d at 41819.
In order to plead scienter adequately, the plaintiffs must
allege facts supporting a strong inference with respect to each
defendant.

See Plumbers & Pipefitters Local Union No. 630

Pension–Annuity Tr. Fund v. Arbitron Inc., 741 F. Supp. 2d 474,
488 (S.D.N.Y. 2010).

“[I]n determining whether the pleaded

facts give rise to a ‘strong’ inference of scienter, the court
must take into account plausible opposing inferences.”

Tellabs,

Inc. v. Makor Issues & Rights, Ltd., 551 U.S. 308, 323 (2007).
A complaint sufficiently alleges scienter when “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. at 324; see also Slayton v. Am. Express

Co., 604 F.3d 758, 766 (2d Cir. 2010).
28

In this case, the plaintiffs do not attempt to allege
scienter by showing that the defendants had a “motive and
opportunity” to commit fraud, relying instead on the defendants’
alleged “conscious misbehavior or recklessness.”

Where the

defendants’ motive to commit fraud is not apparent, “the
strength of the circumstantial allegations [that a defendant
consciously or recklessly misbehaved] must be correspondingly
greater.”

Kalnit v. Eichler, 264 F.3d 131, 142 (2d Cir. 2001).

Plaintiffs typically allege conscious or reckless misbehavior by
pleading with specificity that the defendants had “knowledge of
facts or access to information contradicting their public
statements.”

Novak v. Kasaks, 216 F.3d 300, 308 (2d Cir. 2000).

As the Second Circuit Court of Appeals has explained,
“[r]eckless conduct is, at the least, conduct which is highly
unreasonable and which represents an extreme departure from the
standards of ordinary care . . . to the extent that the danger
was either known to the defendant or so obvious that the
defendant must have been aware of it.”

Chill v. Gen. Elec. Co.,

101 F.3d 263, 269 (2d Cir. 1996) (alterations in original);
Teamsters Local 445 Freight Div. Pension Fund v. Dynex Capital
Inc., 531 F.3d 190, 194 (2d Cir. 2008) (noting a strong
inference of scienter through recklessness may arise where the
complaint sufficiently alleges that the defendants “knew facts
or had access to information suggesting that their public
29

statements were not accurate; or . . . failed to check
information they had a duty to monitor” (quoting Novak, 216 F.3d
at 311)); see also Orthofix, 89 F. Supp. 3d at 614.
1.
The plaintiffs have failed to raise a strong inference of
scienter with respect to Lopes.

The only facts specifically

alleged against Lopes were that he was Eletrobras’s Chairman and
CEO for six months from the start of the class period on August
17, 2010, until his transition to Chief Transmission Officer in
February 2011, that he signed the Code of Ethics, and that from
at least 2013 through 2015, he was the Chairman of the board of
an Eletrobras subsidiary that owned a minority stake in the SPE
responsible for the Belo Monte hydroelectric dam, one of the
projects subject to Eletrobras’s internal investigation.
¶¶ 17, 30, 237.

SAC

These are merely “general allegations regarding

. . . the organizational role of a defendant” that “by
themselves . . . are insufficient to raise a strong inference of
a defendant’s scienter.”

In re Marsh & Mclennan Cos., Inc. Sec.

Litig., 501 F. Supp. 2d 452, 483 (S.D.N.Y. 2006) (collecting
cases).

Moreover, the only public statement that plaintiffs

allege Lopes made was that he signed the Code of Ethics, and
they fail to plead with particularity any allegations indicating
that Lopes had “knowledge of facts or access to information
contradicting [his] public statements.”
30

Novak, 216 F.3d at 308.

Accordingly, the motion by Lopes to dismiss the plaintiffs’
claim against him in Count One for violations of Section 10(b)
and Rule 10b-5 is granted.
2.
The allegations against Carvalho and Araújo are
significantly more particularized than the allegations against
Lopes.

Both Carvalho, who replaced Lopes as CEO and as a member

of Eletrobras’s board of directors in February 2011, and Araújo,
Eletrobras’s CFO and Head of Investor Relations throughout the
class period, signed the annual reports released throughout the
class period, as well as the corresponding SOX certifications
indicating that both had designed, established, and maintained
internal controls related to disclosure.

SAC ¶¶ 31-32; 114.

Each annual report indicated numerous material weaknesses in
internal controls, SAC ¶¶ 111-19, including some that disclosed
deficient controls “with respect to accounting for property,
plant and equipment, specifically, to ensure the completeness,
accuracy and validation of these acquisitions,” as well as
deficient controls related to the impairment calculation of
assets.

SAC ¶¶ 120; 125.

The plaintiffs further allege that Eletrobras’s internal
audit unit conducted two audits during the class period that
indicated significant problems with a lack of controls at
Eletrobras SPEs -- including the lack of any requirement that
31

SPE partners execute anticorruption declarations attesting to no
knowledge of unlawful business activities statements.
SAC ¶¶ 248-49.

These audits culminated in an internal report,

circulated to the board of directors including Carvalho,
concluding that with respect to SPEs, “corporate management is a
black hole and that the company lacks controls to approve their
accounts.”

Id.

Despite these problems, Carvalho and Araújo signed the
relevant annual reports, which stated that the financial
statements were fairly presented in all material respects. See
SAC ¶¶ 113, 122, 127, 132.

And as news reports implicating

Eletrobras emerged, Carvalho stated that Eletrobras had a
“governance system, management, and internal control[s] that are
very strong,” SAC ¶ 133, while Araújo signed a 6-K stating that
“the Company, through its internal controls and compliance
program, did not identify the existence of any episode of fraud
and corruption in its projects.”

SAC ¶ 106.

These red flags highlighted significant problems with
Eletrobras’s internal controls -- including those in PP&E and
investments in SPEs that were ultimately subject to write-offs
due to illicit payments -- and therefore support a strong
inference that Carvalho and Araújo acted with scienter.

See

Dobina v. Weatherford Int’l Ltd., 909 F. Supp. 2d 228, 247-48
(S.D.N.Y. 2012) (noting that control deficiencies can support a
32

strong inference of individual scienter); Varghese v. China
Shenghuo Pharm. Holdings, Inc., 672 F. Supp. 2d 596, 608
(S.D.N.Y. 2009); In re Veeco Instruments, Inc. Sec. Litig., 235
F.R.D. 220, 232 (S.D.N.Y. 2006) (“[A] failure to maintain
sufficient internal controls to avoid fraud is sufficiently
indicative of scienter.”); see also In re Marsh & Mclennan Cos.,
501 F. Supp. 2d at 486 (determining that, after the announcement
of a government investigation of misconduct at subsidiary, an
executive’s personal comments aggressively supporting company’s
business practices, combined with the rapid discovery of
misconduct at subsidiary thereafter, constituted strong
circumstantial evidence of the executive’s scienter).
Carvalho and Araújo’s positions within the Company and its
subsidiaries further bolster the circumstantial evidence
supporting an inference of scienter.

Eletrobras CEO and

director Carvalho was also the chairman of the board of the
Eletrobras subsidiary since February of 2011 through the end of
the class period that owned 100% of the Simplício hydroelectric
plant that was subject to write offs due to illicit payments and
also had minority interests either directly or through SPEs in
three other projects subject to Eletrobras’s internal
investigation. 11

SAC ¶ 237.

CFO Araújo was also chairman of the

11

Whether illicit payments were made in relation to these
projects is still unclear; the 2014 and 2015 annual reports
33

board of another Eletrobras subsidiary that owned minority
interests in the SPEs responsible for two projects subject to
Eletrobras’s internal investigation.

SAC ¶ 237.

And both

Carvalho and Araújo were senior executives at a company in which
one former officer has been sentenced to 43 years in prison for
passive bribery, money laundering, obstruction of justice, tax
evasion and participation in a criminal organization, with other
former officers formally charged with corruption, money
laundering and obstruction of justice.
In sum, Carvalho and Araújo held senior executive positions
at Eletrobras, governance positions in subsidiaries with
affiliations with projects subject to write-offs or
investigations, and were allegedly aware of material weaknesses
in internal controls at Eletrobras.

As such, there is a strong

inference that both Carvalho and Araújo “knew facts or had
access to information suggesting that their public statements
were not accurate” or ”failed to check information they had a
duty to monitor.” Dynex Capital, 531 F.3d at 194.
Finally, the 2014 and 2015 annual reports disclose that
since the start of Eletrobras’s internal investigation, Carvalho

reveal that the Company recognized a loss in its equity method
investments related to SPEs not controlled by the Company, but
they do not provide a list of specific SPE-owned projects that
were subject to write-offs due to illicit payments. See
Campbell Decl. Ex. K at 1-5, Ex. L at 1-5.
34

has been replaced as Eletrobras’s CEO, 12

and “the timing and

circumstances of individual defendants’ resignations may add
some further weight to an overall inference of scienter.”
Orthofix, 89 F. Supp. 3d at 619.
In light of the foregoing, a reasonable person would deem
an inference of scienter for defendants Carvalho and Araújo “at
least as compelling as any opposing inference one could draw
from the facts alleged.”

Tellabs, 551 U.S. at 324.

Accordingly, the motion by Carvalho and Araújo to dismiss
the plaintiffs’ claims against them in Count One for violations
of Section 10(b) and Rule 10b-5 is denied.
3.
Eletrobras moves to dismiss the plaintiffs’ Section 10(b)
and Rule 10b-5(b) claim as against it, arguing that the
plaintiffs have failed to plead scienter by the Company.

But

because the SAC properly alleges scienter against two key
officers of Eletrobras, it necessarily alleges scienter against
12

The defendants attempt to argue that the replacement of
Carvalho as CEO, and indeed the replacement of its entire board
of directors, was an ordinary part of the political cycle in
Brazil and does not raise an inference that the changes were
related to Operation Car Wash or the results of the internal
investigation. But Eletrobras’s disclosure regarding executive
turnover appears in the explanatory note, which focuses
exclusively on issues related to Operation Car Wash and the
internal investigation. See Campbell Decl. Ex. K at 1-5, Ex. L
at 1-5.
The clear implication of the disclosure and its
placement in this explanatory note is that the CEO and board
were replaced, at least in part, because of the findings of
Operation Car Wash and the internal investigation.
35

Eletrobras itself. 13 See Dynex Capital, 531 F.3d at 195 (“In most
cases, the most straightforward way to raise [an inference of
scienter] for a corporate defendant will be to plead it for an
individual defendant.”); Arbitron, 741 F. Supp. 2d at 491
(“Because the plaintiffs have successfully pleaded scienter as
to . . . Arbitron’s then-president, CEO, and chairman, they have
also pleaded corporate scienter as to Arbitron.”); see also In
re Marsh & Mclennan Cos., 501 F. Supp. 2d at 483 (“There are
sufficient allegations regarding the pervasiveness of the fraud,
the conscious misbehavior of particular corporate employees, and
the complicity of the corporate entities to find that [the
parent company] was aware of or recklessly disregarded the
intentional misconduct at [subsidiary].”); Orthofix, 89 F. Supp.
3d at 619-20.

Accordingly, Eletrobras’s motion to dismiss the

plaintiffs’ claim against it in Count One for violations of
Section 10(b) and Rule 10b-5 is denied.
V.
In Count Two, the plaintiffs allege that all defendants are
liable under a “scheme liability” theory pursuant to subsections
(a) and (c) of Rule 10b-5, which states:

13

Because the
scienter with
be imputed to
intent of the
Eletrobras.

plaintiffs have adequately raised an inference of
respect to Carvalho and Araújo that can therefore
Eletrobras, the Court need not address whether the
Company’s other officers may be imputed to

36

It
shall
be
unlawful
for
any
person,
directly or indirectly, by the use of any
means
or
instrumentality
of
interstate
commerce, or of the mails or of any facility
of any national securities exchange, (a) To
employ any device, scheme, or artifice to
defraud, [or] ... (c) To engage in any act,
practice,
or
course
of
business
which
operates or would operate as a fraud or
deceit upon any person, in connection with
the purchase or sale of any security.
17 C.F.R. § 240.10b–5(a), (c).
“To state a claim for scheme liability, a plaintiff must
present facts showing ‘(1) that the defendant committed a
deceptive or manipulative act, (2) in furtherance of the alleged
scheme to defraud, (3) with scienter, and (4) reliance.’”
Menaldi v. Och-Ziff Capital Mgmt. Grp. LLC, 164 F. Supp. 3d 568,
577 (S.D.N.Y. 2016) (quoting In re Alstom SA Sec. Litig., 406 F.
Supp. 2d 433, 474 (S.D.N.Y. 2005).

“Scheme liability under

subsections (a) and (c) of Rule 10b–5 hinges on the performance
of an inherently deceptive act that is distinct from an alleged
misstatement.”

S.E.C. v. Kelly, 817 F. Supp. 2d 340, 344

(S.D.N.Y. 2011); see also Lentell v. Merrill Lynch & Co. Inc.,
396 F.3d 161, 177 (2d Cir. 2005) (denying a market manipulation
claim under 10b-5(a) and (c) because the plaintiffs’ “sole basis
for such claims is alleged misrepresentations or omissions”).
“[T]he three subsections of Rule 10b–5 are distinct, and courts
must scrutinize pleadings to ensure that misrepresentation or
omission claims do not proceed under the scheme liability
37

rubric.” In re Smith Barney Transfer Agent Litig., 884 F. Supp.
2d 152, 161 (S.D.N.Y. 2012); see S.E.C. v. China Ne. Petroleum
Holdings Ltd., 27 F. Supp. 3d 379, 391–92 (S.D.N.Y. 2014)
(“[T]he SEC has competently pled the existence of a larger
scheme, one that went beyond mere misrepresentations to
investors, whereby defendants enriched themselves and their
families at shareholders’ expense.”).
Generally, plaintiffs may raise a strong inference of a
corporate entity defendant’s scienter by pleading the necessary
facts against an individual corporate officer whose intent can
be imputed to the corporate entity.
at 195.

See Dynex Capital, 531 F.3d

However, under the “adverse interest” exception, an

individual corporate officer’s scienter may not be imputed to
the corporate entity defendant “if the officer acted entirely in
his own interests and adversely to the interests of the
corporation.”

In re CBI Holding Co., 529 F.3d 432, 448 (2d Cir.

2008) (emphasis added); see Petrobras, 116 F. Supp. 3d at 382;
see also Kirschner v. KPMG LLP, 938 N.E.2d 941, 952 (N.Y. 2010)
(emphasizing the “narrow scope” of the adverse interest
exception, which requires that the individual agent “must have
totally abandoned his principal's interests and be acting
entirely for his own or another’s purposes,” and noting that the
exception is inapplicable if “there is a benefit to both the

38

insider and the corporation” (quotations mark and citation
omitted)).
“Reliance by the plaintiff upon the defendant’s deceptive
acts is an essential element” of a private cause of action
alleging scheme liability under subsections (a) and (c) of Rule
10b-5. Stoneridge Inv. Partners, LLC v. Sci.-Atlanta, 552 U.S.
148, 152-53, 159, 160-61 (2008) (denying a scheme liability
claim against “entities who, acting both as customers and
suppliers, agreed to arrangements that allowed the investors’
company to mislead its auditor and issue a misleading financial
statement” because the entities’ “deceptive acts . . . [were]
too remote to satisfy the requirement of reliance” and “nothing
[the entities] did made it necessary or inevitable for [the
Company] to record the transactions as it did”).
Here, the plaintiffs allege that all defendants are liable
for scheme liability claims under Rule 10b-5(a) and (c). But
the plaintiffs do not adequately allege that Lopes, Carvalho,
and Araújo actively participated in any bribery or bid-rigging
scheme.

Instead, the plaintiffs focus only on these defendants’

alleged misstatements or omissions, and therefore fail to state
that they committed an “inherently deceptive act that is
distinct from an alleged misstatement.”

Kelly, 817 F. Supp. 2d

at 344; see also In re Smith Barney Transfer Agent Litig., 884
F. Supp. 2d at 161.

Accordingly, the plaintiffs have failed
39

adequately to plead scheme liability claims against Lopes,
Carvalho, and Araújo.
As to the defendant Eletrobras, the plaintiffs claim that
the Company should be liable under Rule 10b-5(a) and (c) because
of the actions of Chief Generation Officer Cardeal, who,
according to the plaintiffs, undertook a deceptive scheme and
course of conduct beyond mere misrepresentations by actively
participating in the bribery and bid-rigging scheme.
The defendants do not appear to dispute that Cardeal
allegedly committed a deceptive or manipulative act in
furtherance of an alleged scheme to defraud.

Instead, they

argue that Cardeal’s scienter cannot be imputed to Eletrobras
under the adverse interest exception.
The defendants’ argument is without merit.

According to

the plaintiffs, Chief Generation Officer Cardeal helped award
the Angra 3 project to certain contractors and subsequently
ordered those contractors to re-direct Eletrobras payments to
political officials as kickbacks.

See SAC ¶ 241.

The

plaintiffs further allege that one of the political officials
who received illicit payments was the head of the Brazilian
government’s primary regulator of the power industry.
¶ 13.

See SAC

Thus, Eletrobras likely benefitted at least in part from

the alleged deceptive scheme by receiving the political
advantages derived from such illicit payments.
40

See Petrobras,

116 F. Supp. 3d at 382 (“[I]t is reasonable to infer that the
Company benefited from remaining in favor with its political
patrons.”).

And Eletrobras further benefitted from the scheme

by including such payments as part of the Company’s PP&E,
despite the fact that such amounts “should not have been
capitalized” according to the Company’s own 2014 and 2015 annual
reports.

Campbell Decl. Ex. K at 2, Ex. L at 2; see Petrobras,

116 F. Supp. 3d at 382 (“[T]he value of Petrobras’ PP&E appeared
to be higher than it actually was, which in turn inflated the
value of Petrobras’ securities. Thus, the inflation of the
Company’s PP&E operated as a fraud on the investing public, not
on Petrobras itself.”).

Cardeal’s alleged acts were not

“entirely in his own interests and adverse[] to the interests of
the corporation.”

In re CBI Holding Co., 529 F.3d at 448.

Accordingly, as it relates to the plaintiffs’ scheme liability
claims, Cardeal’s scienter may be imputed to Eletrobras.
The defendants further argue that the scheme liability
claim against Eletrobras should be dismissed because the
plaintiffs cannot establish that they relied on Cardeal’s
deceptive acts.

However, the plaintiffs allege that Chief

Generation Officer Cardeal organized an illegal kickback scheme
with contractors that resulted in misleadingly overstated PP&E,
attempted to collude with Eletronuclear’s former CEO to cover up
and deny allegations of bribery, and met personally on two
41

occasions with contractors who have admitted to paying bribes in
connection with another Eletrobras project. See SAC ¶¶ 12, 14,
20, 33, 46B, 54B, 241-42, 250, 254, 287.

The plaintiffs have

therefore adequately pleaded scheme liability reliance because
Cardeal’s alleged participation in this deceptive scheme made it
“necessary or inevitable” that falsehoods on the part of
Eletrobras would result.

See Stoneridge, 552 U.S. at 161; In re

Bristol Myers Squibb Co., 586 F. Supp. 2d at 170. 14
Based on the foregoing, the defendants’ motion to dismiss
the plaintiffs’ scheme liability claims in Count Two pursuant to
Rule 10b-5(a) and (c) against Lopes, Carvalho, and Araújo is
granted.

However, the plaintiffs have pleaded factual

allegations sufficient to support a scheme liability claim under
Rule 10b-5(a) and (c) against Eletrobras based on the alleged
conduct of Cardeal.

The motion to dismiss the plaintiffs’

14

The defendants attempt to rely on Pacific Investment
Management Company LLC v. Mayer Brown LLP (“PIMCO”), 603 F.3d
144, 159 (2d Cir. 2010) to claim that the plaintiffs cannot
establish reliance here. But PIMCO addressed scheme liability
for “secondary actors,” in other words “lawyers[,] accountants,
or other parties who are not employed by the issuing firm whose
securities are the subject of allegations of fraud.” 603 F.3d
at 148 n.1 (emphasis added). Because Cardeal’s alleged
participation in the deceptive scheme was in his role as an
officer of Eletrobras and not as a secondary actor, PIMCO is
inapposite here. Moreover, pursuant to the bribery scheme and
its cover-up, the financial statements of Eletrobras were
allegedly misstated and the plaintiffs allegedly relied on that
deceptive conduct by Eletrobras.
42

scheme liability claim in Count Two against Eletrobras is
therefore denied. 15
VI.
In Count Three, the plaintiffs allege that the individual
defendants are liable under Section 20(a) of the Exchange Act
because they controlled Eletrobras, which in turn violated
Section 10(b) and Rule 10b-5.

Section 20(a) provides:

Every person who, directly or indirectly,
controls
any
person
liable
under
any
provision of this chapter or of any rule or
regulation thereunder shall also be liable
jointly and severally with and to the same
extent as such controlled person to any
person to whom such controlled person is
liable . . . 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).

“To establish a prima facie case of control

person liability, a plaintiff must show (1) a primary violation
by the controlled person, (2) control of the primary violator by
the defendant, and (3) that the defendant was, in some
meaningful sense, a culpable participant in the controlled
person’s fraud.”

ATSI, 493 F.3d at 108; see also Orthofix, 89

F. Supp. 3d at 621.

The individual defendants argue that they

are not liable under Section 20(a), first, because Eletrobras

15

There is no motion to dismiss the scheme liability claims
against Cardeal because the summons and SAC have not yet been
served on him.
43

did not violate Section 10(b) and Rule 10b-5, and second,
because none of the individual defendants were culpable
participants in Eletrobras’s alleged fraud.

The first argument

fails because, as discussed above, there are sufficient
allegations of Eletrobras’s liability.

Similarly, with respect

to the second argument, there are sufficient allegations as to
the culpable participation of Carvalho and Araújo.

However,

there are insufficient allegations concerning the culpable
participation of defendant Lopes.

Therefore, while the motion

to dismiss the Section 20(a) claims is granted with respect to
Lopes, it is denied with respect to Carvalho and Araújo. 16

CONCLUSION
The Court has considered all of the remaining arguments of
the parties. To the extent not specifically addressed above,
they are either moot or without merit. For the foregoing
reasons, the defendants’ motion to dismiss is granted in part
and denied in part.
dismissed.

All claims against the defendant Lopes are

The scheme liability claims under Rule 10b-5(a) and

(c) against the defendants Carvalho and Araújo are also
dismissed. The motion to dismiss is otherwise denied.

16

The Clerk

The Section 20(a) claim against Cardeal survives because this
motion to dismiss was brought only on behalf of Eletrobras,
Lopes, Carvalho, and Araújo.
44

is directed to close all pending motions.

SO ORDERED.
Dated:

New York, New York
March 25, 2017

______________/s/______________
John G. Koeltl
United States District Judge

45