Thomas v. Shiloh Industries, Inc. et al
OPINION & ORDER re: 31 MOTION to Dismiss Corrected Amended Complaint. filed by Thomas M. Dugan, Ramzi Hermiz, Shiloh Industries, Inc.. For the foregoing reasons, Defendants' Motion to Dismiss is GRANTED. Any pending motions are moot. The Clerk of Court is directed to close this case. (Signed by Judge Kimba M. Wood on 3/23/2017) (kgo)
UNITED STATES DISTRICT COURT
SOUTHERN DISTRICT OF NEW YORK
RAYMOND THOMAS and WILLIAM PORTER,
individually and on behalf of all others similarly
OPINION & ORDER
SHILOH INDUSTRIES, INC., RAMZI HERMIZ,
and THOMAS M. DUGAN,
KIMBA M. WOOD, United States District Judge:
Lead Plaintiff Raymond Thomas and Plaintiff William Porter (“Plaintiffs”) bring this
putative class action against Shiloh Industries (“Shiloh”) and two of its individual directors,
Ramzi Hermiz and Thomas M. Dugan (“Individual Defendants”; collectively, “Defendants”).
Plaintiffs assert claims under Section 10(b) and Rule 10b-5 of the Securities Exchange
Act of 1934 (the “Exchange Act”), and Section 20(a) of the Exchange Act. Corrected Amended
Complaint (“CAC”) ¶¶ 126−36, 137−140. Plaintiffs allege that Defendants perpetrated an
accounting fraud at Shiloh’s manufacturing facility in Wellington, Ohio. Plaintiffs contend that
as a result, this fraudulent accounting artificially inflated Shiloh’s net income. After management
was alerted to potential accounting misconduct, Shiloh launched an internal investigation.
Subsequently, in late 2015, Shiloh issued a restatement of its financial results for the first two
fiscal quarters of 2015, caused by this accounting discrepancy at the Wellington facility.
Plaintiffs allege that when this purported fraud was revealed, Shiloh’s stock price plummeted.
Defendants have moved to dismiss the CAC under Rule 9(b) of the Federal Rules of Civil
Procedure and the Private Securities Litigation Reform Act (“PSLRA”). For the reasons stated
below, because Plaintiffs fail to state with particularity facts giving rise to scienter, Defendants’
motion is GRANTED in its entirety.
The facts stated here, alleged in the Corrected Amended Complaint, are assumed to be
true for the purpose of this motion. See, e.g., Witt v. Vill. of Mamaroneck, N.Y., 639 F. App’x 44,
45 (2d Cir. 2016). Plaintiffs represent a class of all purchasers of Shiloh securities between
January 12, 2015, and September 14, 2015 (the “Class Period”), who are seeking remedies under
the Exchange Act. CAC ¶ 1. Defendant Shiloh, incorporated in Delaware with its principal
offices located in Ohio, is a supplier of lightweighting equipment to various automotive and
commercial vehicle industries. Id. ¶ 35. Lightweighting enables manufacturers to build vehicles
in a more cost and weight efficient manner. Shiloh also provides noise, vibration, and harshness
solutions to manufacturers. Id. Shiloh maintains twenty-one manufacturing facilities, and is
headquartered in Valley City, Ohio. Id. ¶ 15.
Shiloh’s securities are actively traded on the NASDAQ Global Market. Id. ¶ 113.
Defendant Ramzi Hermiz has been President and CEO of Shiloh since 2012. Defendant Thomas
Dugan was Vice President of Finance and Treasurer “at all relevant times.” Id. ¶ 29.
Allegations in the Complaint
Plaintiffs allege that Defendants intentionally perpetrated the fraud of which Plaintiffs
complain. Id. ¶ 6. They claim that Defendants effected this alleged fraud by allowing
misallocated steel surcharges on the balance sheet to remain uncorrected, which had the effect of
understating the cost of goods sold and inflating inventory. Id. ¶ 7−8. Plaintiffs further allege that
Defendants touted their financial success to investors for the first and second quarters of 2015,
id. ¶ 9, but that on September 9, 2015, Shiloh revealed that it was conducting an internal
investigation into the accounting at its Wellington facility. Id. ¶ 10. Specifically, Shiloh indicated
that there was a potential issue regarding accounting for inventoried costs. Id. ¶ 16. Plaintiffs
claim that this disclosure, as well as the Company’s report to the SEC amending its financial
results for the fiscal year 2014 and the first and second quarters of 2015, caused Shiloh’s stock
price to fall. Id. ¶¶ 11−14. The amended report, called the Restatement, “confirmed that the
Company understated cost of sales, overstated gross margin, and overstated net income for Q1
2015 and Q2 2015.” Id. ¶ 13.
Plaintiffs seek compensatory damages for the injuries sustained as a result of Defendants’
alleged wrongdoing. Id. p. 50.
Rule 9b and PSLRA
To survive a motion to dismiss a complaint alleging securities fraud, the complaint must
satisfy the heightened pleading requirements of Rule 9(b) of the Federal Rules of Civil Procedure
and the PSLRA.
A complaint alleging fraud “must state with particularity the circumstances constituting
fraud,” or otherwise face dismissal. Fed. R. Civ. P. 9(b). See also Ganino v. Citizens Utils. Co.,
228 F.3d 154, 168 (2d Cir. 2000); Chill v. Gen. Elec. Co., 101 F.3d 263, 267 (2d Cir. 1996). Rule
9(b) also allows that “[m]alice, intent, knowledge, and other conditions of a person’s mind may
be alleged generally,” but per the PSLRA, the plaintiff must also allege facts that support a
strong inference of fraudulent intent. 15 U.S.C. § 78u-4(b)(2); Ganino, 228 F.3d at 169; Acito v.
FMCERA Grp., Inc., 47 F.3d 47, 52 (2d Cir. 1995).
Rule 10b-5 and Section 10(b)
To state a claim for securities fraud under section 10(b) and Rule 10b-5, Plaintiffs must
allege (1) a material misrepresentation or omission; (2) scienter; (3) connection with the
purchase or sale of a security; (4) reliance; (5) economic loss; and (6) loss causation. In re China
Mobile Games & Entm’t Grp., Ltd. Sec. Litig., 2016 WL 922711, *3 (Mar. 7, 2016) (Wood, J.).
Plaintiffs’ claims arise from the series of accounting misstatements that took place at
Shiloh’s Wellington facility. Defendants do not dispute that these misstatements occurred.
Defendants informed investors in September of 2015 that an ongoing internal investigation
would prevent Shiloh from timely filing its quarterly financial statements to the SEC, as
required. Defendants admit that the misstatements on the balance sheet reflected an
understatement of the cost of sales by $1.7 million in the first fiscal quarter of 2015 and $1.1
million in the second quarter, which overstated the company’s net income by $1.2 million in the
first quarter and $800,000 in the second quarter. Defs.’ Mot. to Dismiss at 3 (Doc. 31) [“MTD”].
However, the crux of the present dispute is whether Plaintiffs have sufficiently alleged
that Defendants, both Shiloh and Individual Defendants, acted with scienter in perpetrating these
fraudulent misstatements. Because Plaintiffs fail to plead any facts that either show that
Defendants had the motive and opportunity to commit fraud, or that constitute strong
circumstantial evidence of recklessness, Ganino, 228 F.3d at 168–69, this Court GRANTS
Defendants’ Motion to Dismiss.
The PSLRA established a stringent pleading requirement for a Complaint to sufficiently
allege that a defendant acted with scienter. The Supreme Court’s decision in Tellabs requires that
a district court, in evaluating a motion to dismiss a complaint on scienter grounds, “must take
into account plausible opposing inferences,” and not decide “[t]he strength of an inference … in
a vacuum.” Tellabs, Inc. v. Makor Issues & Rights, Ltd., 551 U.S. 308, 323 (2007). “[T]he
requisite strong inference of scienter is present ‘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.’” In re Lehman Bros. Sec. & ERISA Litig., 903 F. Supp. 2d 152, 185 (S.D.N.Y.
2012) (Kaplan, J.) (quoting Tellabs, 551 U.S. at 324) (emphasis omitted).
To sufficiently plead scienter, a Rule 10b-5 action requires the complaint to show “an
intent to deceive, manipulate or defraud.” Ernst & Ernst v. Hochfelder, 425 U.S. 185, 193 n. 12
(1976). In the Second Circuit, this can be shown in two ways: first, by alleging facts that show
defendants had both the motive and opportunity to commit fraud, or alternatively, by alleging
facts that constitute strong circumstantial evidence of conscious misbehavior or recklessness.
Ganino, 228 F.3d 154, 168–69 (quoting Shields v. Citytrust Bancorp, Inc., 25 F.3d 1124, 1128
(2d Cir. 1994)); see Acito, 47 F.3d at 52; Rothman v. Gregor, 220 F.3d 81, 90 (2d Cir. 2000); In
re Time Warner Inc. Sec. Litig., 9 F.3d 259, 268–69 (2d Cir. 1993).
1. Motive & Opportunity
For Plaintiffs to successfully plead motive and opportunity, they must allege facts
demonstrating that the defendant “benefitted in some concrete and personal way from the
purported fraud.” Novak v. Kasaks, 216 F.3d 300, 307–08 (2d Cir. 2000). A generalized motive
to maintain corporate profitability, or to keep stock prices high, is not sufficiently concrete for
purposes of inferring scienter. Chill, 101 F.3d at 268. Rather, a misrepresentation in order to
keep the stock prices artificially high, while corporate insiders sold their shares and made a
profit, for example, would amount to a concrete benefit. Id.; Novak, 216 F.3d at 308.
Here, Plaintiffs acknowledge that they do not allege a motive to commit fraud, or a
concrete benefit, and state correctly that they are not required to do so. Pls.’ Opp’n to Defs.’ Mot.
to Dismiss at 11 n.17 (Doc. 36) [“Opp’n”].
Alternatively, a plaintiff unable to show scienter through an allegation of motive and
opportunity can otherwise “raise a strong inference of scienter” by demonstrating persuasive
circumstantial evidence of conscious misbehavior or recklessness, “though the strength of the
circumstantial allegations must be correspondingly greater if there is no motive.” Kalnit v.
Eichler, 264 F.3d 131, 142 (2d Cir. 2001).
In this context, the Second Circuit defines recklessness as conduct so highly unreasonable
that it constitutes “an extreme departure from the standards of ordinary care,” such that “the
danger was either known to the defendant or so obvious that the defendant must have been aware
of it.” Rothman, 220 F.3d at 90; see also Novak, 216 F. 3d at 308; Chill, 101 F.3d at 269 (“An
egregious refusal to see the obvious, or to investigate the doubtful, may in some cases give rise
to an inference of recklessness.”); In re Lululemon Sec. Litig., 14 F. Supp. 3d 553, 581 (S.D.N.Y.
2014) (Forrest, J.), aff’d, 604 F. App’x 62 (2d Cir. 2015).
Plaintiffs’ theory of scienter centers on Defendants’ access to the fraudulent accounting
statements at its Wellington facility; Defendants were allegedly aware of or recklessly
disregarded signals that the facility’s balance sheet was inaccurate due to improper accounting.
E.g., CAC ¶¶ 18, 30, 58−59; Opp’n at 8−9. Plaintiffs contend that the employee who actually
misallocated the steel surcharges was under immense pressure to hit impossible targets, and
Defendants purportedly chose not to ask questions probing into the numbers as long as the
facility was meeting its objectives. CAC ¶¶ 17, 52−56, 69.
Despite their efforts to urge this Court to view scienter “holistically,” as a sum of several
insufficient allegations, see Opp’n at 6, Plaintiffs fail to proffer a single adequate claim
establishing a compelling inference of scienter. Tellabs, 551 U.S. at 314. Plaintiffs submit that
the contrary, contending that their allegations of scienter are at least as compelling as any
opposing inference. Opp’n at 6. Not one of Plaintiffs’ theories represents evidence showing
Defendants’ actual knowledge of the accounting statements; an “extreme departure from the
standards of ordinary care;” or a danger so obvious that Defendants must have been aware. See
Rothman, 220 F.3d at 90. This Court will evaluate each of Plaintiffs’ theories of scienter in
a. Magnitude of Fraud
Plaintiffs allege that the magnitude of the accounting error was so significant, that
Defendants were reckless in not deeming the exceptional performance at the Wellington facility
to be suspicious. CAC ¶ 15.
Plaintiffs allege that significant violations occurred under the Generally Accepted
Accounting Principles (“GAAP”), as steel surcharges were misallocated in a way that inflated
Shiloh’s reported gross margin and net income. Id. ¶ 7. The improper accounting had the
following effects: as the Company disclosed in its Restatement, after investigating the fraud, net
income was cumulatively overstated by approximately $1.2 million in Q1 2015 (50%) and
$800,000 in Q2 2015 (13%). Defendants note that accounting discrepancies often have an
exaggerated effect on net income, and therefore net income is an inappropriate gauge of the
magnitude of an accounting error. Defs.’ Reply in Supp. of Mot. to Dismiss at 4 (Doc. 37)
[“Reply”]. Instead, the appropriate measure of a failure to “allocate appropriate amounts to the
cost of sales account,” CAC ¶ 7, is the error’s overall impact on the cost of sales. Reply at 5.
Accordingly, the cost of sales was understated by 0.7% in the first quarter of 2015 and 0.4% in
the second quarter. Id.; CAC ¶ 85.
Although “[a]llegations of failure to comply with GAAP do not suffice to allege
scienter,” Plaintiffs argue that significant GAAP violations can provide “powerful indirect
evidence of scienter.” Plumbers & Pipefitters Local Union No. 719 Pension Trust Fund v.
Conseco Inc., 2011 WL 1198712, at *22 (S.D.N.Y. Mar. 30, 2011) (Koeltl, J.) [hereinafter
“Conseco”]; Opp’n at 16 (quoting In re McKesson HBOC, Inc. Sec. Litig., 126 F. Supp. 2d 1248,
1273 (N.D. Cal. 2000)). But the significance of the GAAP violations was minor here.
The decision Plaintiffs cite for the proposition that GAAP violations can suggest scienter
guides courts to distinguish between minor and significant violations. In re McKesson, 126 F.
Supp. 2d at 1273. Here, where the overall effect of the improper accounting on the company’s
financial results was modest, an attribution of scienter is less plausible. In re Magnum Hunter
Res. Corp. Sec. Litig., 26 F. Supp. 3d 278, 295 (S.D.N.Y. 2014) (Forrest, J.), aff’d, 616 F. App’x
442 (2d Cir. 2015).
The CAC also states that the Wellington facility was Shiloh’s supposed “crown jewel,”
making the overstatement of the gross margin and net income so obvious that it was reckless to
not catch the accounting fraud. Plaintiffs argue that a fraud involving a company’s core
operations may support an inference of scienter. Opp’n at 14.
Courts applying the core operations doctrine generally “require that the operation in
question constitute nearly all of a company’s business before finding scienter.” Hensley v. IEC
Elecs. Corp., 2014 WL 4473373, at *5 (S.D.N.Y. Sept. 11, 2014) (Furman, J.) (quoting Tyler v.
Liz Claiborne, Inc., 814 F. Supp. 2d 323, 343 (S.D.N.Y. 2011) (Holwell, J.)). Given that the
Wellington facility is only one of Shiloh’s 21 facilities, and the accounting issues were not all-
encompassing, the core operations argument is unavailable here.
When pressed to point out any incident, statement, or event which would have alerted
Defendants to the unusually positive performance, Plaintiffs highlight quarterly PowerPoint
presentations that laid out financial data for each facility. CAC ¶ 85; Opp’n at 8. Plaintiffs claim
that the PowerPoint presentations made the accounting errors at Wellington “so obvious that the
defendant must have been aware of it.” Novak, 216 F.3d at 308. Various confidential witnesses
also attest that Individual Defendants were aware of “atypically high gross margins and allaround exceptional performance relative to the rest of the Company’s plants.” Opp’n at 9.
Plaintiffs argue that Defendants “roundly rejected” reviewing the data in question. Id. at 11.
These allegations, however, are conclusory, and fail to demonstrate that Defendants “made
misleading public statements despite knowledge” of the true accounting levels at Wellington.
Hensley, 2014 WL 4473373, at *6.
b. Sarbanes-Oxley Certifications
Plaintiffs maintain that Defendants offered false certifications as part of their required
submissions under the Sarbanes-Oxley Act. Individual Defendants signed the certifications,
which attest that the company had adequate internal controls over financial reporting. CAC ¶ 80.
Plaintiffs imply that this was a lie, based on contrary allegations from the confidential witnesses.
Id. ¶ 82. Plaintiffs argue that these false certifications demonstrate scienter.
This argument fails for the same reasons as stated supra. Conclusory statements that
Defendants “consciously turned a blind eye” to problems with the company’s internal controls
for financial reporting, absent any concrete, compelling evidence to support the allegation, do not
suffice to show scienter. “A failure ‘to identify problems with the defendant-company’s internal
controls and accounting practices does not constitute reckless conduct sufficient for § 10(b)
liability.’” Conseco, 2011 WL 1198712, at *22 (quoting Novak, 216 F.3d at 309).
Plaintiffs further assert that Defendants commenced an internal investigation as a sham
procedure to cover up the fraudulent accounting. They claim that Defendants crafted the story
that a rogue employee was responsible for the mistaken accounting at the Wellington facility in
order to cover up their complicity with the fraud, and that the investigation commenced only
after the fraud could no longer be concealed.
The evidence to support this theory comes from a confidential witness, who claims to
have alerted the Group Controller to the accounting issue. CAC ¶ 95. The Group Controller is
not one of the Individual Defendants. In their Opposition to the Motion to Dismiss, Plaintiffs
also submit that the Group Controller’s subsequent resignation, and Defendants’ failure to
publicly disclose the resignation, was a deliberate attempt to conceal Individual Defendants’ role
in the fraud. Opp’n at 12.
Defendants admitted in their Restatement that there was “a material weakness in the
Company’s internal control over financial reporting,” and once that was discovered, the
Company commenced an internal investigation into the matter. CAC ¶ 81 (Form 8-K, filed Sept.
14, 2015 (Doc. No. 33-3)). Similar to the facts in Higginbotham v. Baxter Int’l, Inc., Shiloh
“learned enough to lead a reasonable person to conduct an investigation.” 495 F.3d 753, 758 (7th
Cir. 2007). Defendants’ conduct “demonstrat[es] a pursuit of truth rather than reckless
indifference to the truth,” as discovering facts that instigate an investigation “is a very great
distance from convincing proof of intent to deceive.” Id.
Accounting for “plausible opposing inferences” of scienter, as the Supreme Court guides
in Tellabs, this Court finds that Plaintiffs fail to allege facts that tell a cogent and compelling
story as to why the internal investigation was a cover-up, rather than a responsible effort to
identify and eliminate issues with the company’s internal controls. 551 U.S. at 323. There is no
“fraud by hindsight,” and such an allegation will not hold, here. Id. at 320.
d. Individual Defendants
Plaintiffs wage a host of allegations against Individual Defendants; none provides a
compelling inference of recklessness. Because Hermiz and Dugan assumed roles of influence
within the company, Plaintiffs theorize, they had the authority to control Shiloh’s SEC
disclosures. CAC ¶ 30. With access to private information about the Company’s finances,
Plaintiffs allege that the Individual Defendants “knew that the adverse facts … were being
concealed from the public.” ¶ 30.
The furthest the CAC goes in showing that Individual Defendants either actually knew of
the accounting mishaps at Wellington, or that there were red flags that Defendants recklessly
ignored, is the assertion from a confidential witness that senior managers were given PowerPoint
presentations with data from inventory accounts. As discussed, supra, a PowerPoint presentation
alone does not make the incorrect accounting data “so obvious that [Defendants] must have been
aware of it.” In re PXRE Grp., Ltd., Sec. Litig., 600 F. Supp. 2d 510, 547 (S.D.N.Y. 2009)
The CAC contains several allegations from confidential witnesses, including an
encounter between the third confidential witness (“CW3”) and Defendants Hermiz and Dugan.
In this instance, Individual Defendants allegedly chastised CW3 for not reporting a fixed assets
accounting error in a particular chain of command—to Hermiz and Dugan, first.
The CAC and Motion to Dismiss tell different stories about that encounter. E.g., MTD at
18; CAC ¶ 19. In the CAC, CW3 never claims that he reported accounting errors to the
Individual Defendants, who then deliberately ignored those reports. He never claims he was
prevented from reporting similar issues after this encounter. The allegation of an alleged
confrontation over a reporting hierarchy fails to raise a compelling inference of scienter.
The first confidential witness (“CW1”) states that he noticed abnormalities in the balance
sheet at the Wellington facility, and he notes that Individual Defendants had access to this
material, yet chose not to ask questions about the Wellington facility’s numbers. CAC ¶¶ 57−58,
87. According to the CAC, CW1 was the employee who brought the accounting issues to the
Group Controller’s attention; this prompted an internal investigation. Id. ¶ 31. Similar to CW3,
CW1’s claim falters for the same reason: none of the confidential witnesses asserts that the
Individual Defendants had personal knowledge of the accounting discrepancies at issue. MTD at
20 (quoting In re Magnum Hunter Res., 26 F. Supp. 3d at 285). And, as discussed supra, mere
access to data is not a stand-in for recklessness.
Several insufficient allegations of recklessness can never add up to a compelling
inference of scienter. The Court notes that “the strength of the circumstantial allegations must be
correspondingly greater if there is no motive.” Kalnit, 264 F.3d at 142. The innocent explanation
for the series of events at Wellington is far more compelling than the version of events tendered
by Plaintiffs: someone raised an unfortunate accounting problem at one of Shiloh’s 21 facilities,
upon which management promptly conducted an investigation, identified culpable employees
and corrected the errors, and issued a Restatement to the SEC amending their financial
The contention that Defendants insisted on turning a blind eye to irregular accounting
data at Wellington is not “cogent and at least as compelling” as the opposing inference of
responsible conduct by Defendants. All of the facts alleged, taken together and evaluated
holistically, do not give rise to a strong inference of scienter.
Because Plaintiffs fail to adequately plead scienter, the Court need not address the
remaining requirements to plead a cause of action for securities fraud. See In re China Mobile
Games, 2016 WL 922711, at *3.
Section 20(a) Claim
As Plaintiffs failed to sufficiently plead an underlying violation under Section 10(b) and
Rule 10b-5, this Court dismisses the Plaintiffs’ claim for liability under Section 20(a). See In re
Alstom SA Sec. Litig., 406 F. Supp. 2d 433, 486 (S.D.N.Y. 2005) (Marrero, J.).
For the foregoing reasons, Defendants’ Motion to Dismiss is GRANTED. Any pending
motions are moot. The Clerk of Court is directed to close this case.
DATED: New York, New York
March 23, 2017
THE HON. KIMBA M. WOOD
United States District Judge
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