Cady v. Key Energy Services, Inc. et al
Filing
58
OPINION AND ORDER granting 50 MOTION to Dismiss 37 Amended Complaint/Counterclaim/Crossclaim etc., 49 MOTION to Dismiss 37 Amended Complaint/Counterclaim/Crossclaim etc. The Court further grants leave to Lead Plaintiff to file with in 20 days a Second Consolidated Amended Complaint that satisfies the heightened pleading requirements of Rule 9(b) and the PSLRA or to inform the Court that it no longer wishes to proceed with this suit. (Signed by Judge Melinda Harmon) Parties notified.(rhawkins)
United States District Court
IN THE UNITED STATES DISTRICT COURT
FOR THE SOUTHERN DISTRICT OF TEXAS
HOUSTON DIVISION
Southern District of Texas
ENTERED
April 01, 2016
§
IN RE KEY ENERGY SERVICES, INC.§
SECURITIES LITIGATION
§
§
David J. Bradley, Clerk
CIV. A. NO. 4:14-CV-2368
OPINION AND ORDER
The above referenced securities-fraud, putative class
action
alleges
Defendants
material
regarding
Key
misrepresentations
Energy
Services,
and
omissions
Inc.’s
by
(“Key’s”)
financial condition and the future of its business, leading to
inflated stock prices in violation of §§ 10(b), control person
liability under 20(a) of the Securities Exchange Act of 1934 (the
“Exchange Act”), 15 U.S.C. §§ 78j(b) and 78t(a), as amended by the
Private Securities Litigation Reform Act of 1995 (the “PSLRA”), 15
U.S.C. § 78u-4(b)(2), et seq., Securities and Exchange Commission
(“SEC”) Rule 10b-5, 17 C.F.R. § 240.10b-5, and by the Foreign
Corrupt Practices Act of 1977 (the “FCPA”), 15 U.S.C. § 78dd-1, et
al., by overstatement of lucrative business opportunities in
foreign countries despite significant, highly publicized risks,
particularly in Mexico and Russia, and by failure to disclose
serious deficiencies in Key’s internal control systems to protect
Key from the threat of FCPA violations and to attract and maintain
investor interest in Key’s business operations in areas known for
corruption.
Pending before the Court are two motions to dismiss the
Consolidated Amended Complaint (instrument #37) of Lead Plaintiff
Inter-Local Pension Fund of the Graphic Communications of the
International Brotherhood of Teamsters, pursuant to the PSLRA and
Federal Rules of Civil Procedure 9(b) and 12(b)(6), filed by (1)
-1-
Defendants Key Energy Services, Inc. (“Key”),1 Richard J. Alario
(“Alario”),2 J. Marshall Dodson (“Dodson”),3 and Newton W. “Trey”
Wilson III (“Wilson”)4(#49); and (2) Defendant Taylor M. Whichard,
III
(#50),5 who also joins in #49.
This action is brought on behalf of a putative class
composed of all persons and entities, excluding Defendants and
their affiliates, who or which purchased or acquired Key’s common
stock
from
September
4,
2012
to
July
17,
2014
(the
“Class
Period”).
I.
A.
Standards of Review
Rule 12(b)(6)
When a district court reviews a motion to dismiss
pursuant to Fed. R. Civ. P. 12(b)(6), it must construe the
complaint in favor of the plaintiff and take all well-pleaded
1
Key, based in Houston, Texas, is an on-shore, rigbased, well-servicing contractor which provides the full range of
well intervention services (including the completion of newly
drilled wells, workover of existing oil and natural gas wells,
well maintenance, and specialty drilling services) in all major
onshore oil- and gas-producing regions of the United States, as
well as in Mexico, Colombia, Ecuador, the Middle East, and Russia.
2
Alario at all relevant times was Key’s Chairman,
President, and Chief Executive Officer.
3
Dodson served as Vice President and Treasurer of Key
from 2009 until March 25, 2013, when he succeeded as Key’s Senior
Vice President and Chief Financial Officer.
4
Wilson at all relevant times served as Key’s Executive
Vice President and Chief Operating Officer. As of May 20, 2014
Wilson served as Key’s Executive Vice President responsible for
international operations, technology development, and corporate
strategy.
5
Whichard was Key’s Senior Vice President and Chief
Financial Officer.
-2-
facts as true. Randall D. Wolcott, MD, PA v. Sebelius, 635 F.3d
757, 763 (5th Cir. 2011), citing Gonzalez v. Kay, 577 F.3d 600, 603
(5th Cir. 2009).
The plaintiff’s legal conclusions are not
entitled to the same assumption. Ashcroft v. Iqbal, 556 U.S. 662,
678 (2009)(“The tenet that a court must accept as true all of the
allegations contained in a complaint is inapplicable to legal
conclusions.”), citing Bell Atlantic Corp. v. Twombly, 556 U.S.
662, 678 (2007); Hinojosa v. U.S. Bureau of Prisons, 506 Fed.
Appx. 280, 283 (5th Cir. Jan. 7, 2012).
“While a complaint attacked by a Rule 12(b)(6) motion to
dismiss does not need detailed factual allegations, . . . a
plaintiff’s
obligation
‘entitle[ment]
to
to
relief’
provide
the
requires
more
‘grounds’
than
of
his
labels
and
conclusions, and a formulaic recitation of the elements of a cause
of action will not do . . . .”
Bell Atlantic Corp. v. Twombly,
127 S. Ct. 1955, 1964-65 (2007)(citations omitted).
“Factual
allegations must be enough to raise a right to relief above the
speculative level.”
Id. at 1965, citing 5 C. Wright & A. Miller,
Federal Practice and Procedure
§ 1216, pp. 235-236 (3d ed.
2004)(“[T]he pleading must contain something more . . . than . .
.
a statement of facts that merely creates a suspicion [of] a
legally cognizable right of action”). “Twombly jettisoned the
minimum notice pleading requirement of Conley v. Gibson, 355 U.S.
41 . . . (1957)[“a complaint should not be dismissed for failure
to state a claim unless it appears beyond doubt that the plaintiff
can prove no set of facts in support of his claim which would
entitle him to relief”], and instead required that a complaint
-3-
allege enough facts to state a claim that is plausible on its
face.”
St. Germain v. Howard,556 F.3d 261, 263 n.2 (5th Cir.
2009), citing In re Katrina Canal Breaches Litig., 495 F.3d 191,
205 (5th Cir. 2007)(“To survive a Rule 12(b)(6) motion to dismiss,
the plaintiff must plead ‘enough facts to state a claim to relief
that is plausible on its face.’”), citing Twombly, 127 S. Ct. at
1974). “‘A claim has facial plausibility when the pleaded factual
content allows the court to draw the reasonable inference that the
defendant is liable for the misconduct alleged.’”
Montoya v.
FedEx Ground Package System, Inc., 614 F.3d 145, 148 (5th Cir.
2010), quoting Ashcroft v. Iqbal, 556 U.S. 662, 678 (2009).
The
plausibility standard is not akin to a “probability requirement,”
but asks for more than a “possibility that a defendant has acted
unlawfully.”
Twombly, 550 U.S. at 556.
Dismissal is appropriate
when the plaintiff fails to allege “‘enough facts to state a claim
to relief that is plausible on its face’” and therefore fails to
“‘raise a right to relief above the speculative level.’” Montoya,
614 F.3d at 148, quoting Twombly, 550 U.S. at 555, 570.
In Ashcroft v. Iqbal, 556 U.S. at 679, the Supreme Court
stated that “only a complaint that states a plausible claim for
relief survives a motion to dismiss,” a determination involving “a
context-specific task that requires the reviewing court to draw on
its judicial experience and common sense.” “[T]hreadbare recitals
of the elements of a cause of action, supported by mere conclusory
statements do not suffice” under Rule 12(b).
1949.
Iqbal, 129 S. Ct. at
The plaintiff must plead specific facts, not merely
conclusory allegations, to avoid dismissal.
-4-
Collins v. Morgan
Stanley Dean Witter, 224 F.3d 496, 498 (5th Cir. 2000). “Dismissal
is proper if the complaint lacks an allegation regarding a
required element necessary to obtain relief . . . .“
Rios v. City
of Del Rio, Texas, 444 F.3d 417, 421 (5th Cir. 2006), cert. denied,
549 U.S. 825 (2006).
Dismissal under Rule 12(b)(6) is proper not only where
the plaintiff fails to plead sufficient facts to support a
cognizable legal theory, but also where the plaintiff fails to
allege a cognizable legal theory.
Kjellvander v. Citicorp, 156
F.R.D. 138, 140 (S.D. Tex. 1994), citing Garrett v. Commonwealth
Mortgage Corp., 938 F.2d 591, 594 (5th Cir. 1991); ASARCO LLC v.
Americas Min. Corp., 832 B.R. 49, 57 (S.D. Tex. 2007).
“A
complaint lacks an ‘arguable basis in law’ if it is based on an
indisputedly meritless legal theory’ or a violation of a legal
interest that does not exist.”
Ross v. State of Texas, Civ. A.
No. H-10-2008, 2011 WL 5978029, at *8 (S.D. Tex. Nov. 29, 2011).
When a plaintiff’s complaint fails to state a claim, the
court should generally give the plaintiff at least one chance to
amend the complaint under Rule 15(a) before dismissing the action
with prejudice.
Great Plains Trust Co v. Morgan Stanley Dean
Witter & Co., 313 F.3d 305, 329 (5th Cir. 2002)(“District courts
often afford plaintiffs at least one opportunity to cure pleading
deficiencies before dismissing a case, unless it is clear that the
defects are incurable or the plaintiffs advise the court that they
are unwilling or unable to amend in a manner that will avoid
dismissal.”); United States ex rel. Adrian v. Regents of the Univ.
of Cal., 363 F.3d 398, 403 (5th Cir. 2004)(“Leave to amend should
-5-
be freely given, and outright refusal to grant leave to amend
without
a
justification
.
.
.
is
considered
an
abuse
of
discretion. [citations omitted]”). The court should deny leave to
amend if it determines that “the proposed change clearly is
frivolous
or
advances
a
claim
insufficient on its face . . . .”
or
defense
that
is
legally
6 Charles A. Wright, Arthur R.
Miller & Mary Kay Kane, Federal Practice and Proc. § 1487 (2d ed.
1990).
“Rule 12(b) is not a procedure for resolving contests
about the facts or the merits of a case.”
Gallentine v. Housing
Authority of City of Port Arthur, Tex.,
F. Supp. 2d
, Civ.
A. No. 1:12-CV-417, 2013 WL 244651, *3 (E.D. Tex. Jan. 22, 2012),
citing 5A Charles A. Wright & Arthur R. Miller, Federal Practice
and Procedure:
Civil 2d § 1356, at 294 (1990).
As noted, on a Rule 12(b)(6) review, although generally
the court may not look beyond the pleadings, the Court may examine
the complaint, documents attached to the complaint, and documents
attached to the motion to dismiss to which the complaint refers
and which are central to the plaintiff’s claim(s), as well as
matters of public record.
Lone Star Fund V (U.S.), L.P. v.
Barclays Bank PLC, 594 F.3d 383, 387 (5th Cir. 2010), citing
Collins, 224 F.3d at 498-99; Cinel v. Connick, 15 F.3d 1338, 1341,
1343 n.6 (5th Cir. 1994).
See also United States ex rel. Willard
v. Humana Health Plan of Tex., Inc., 336 F.3d 375, 379 (5th Cir.
2003)(“the court may consider . . . matters of which judicial
notice may be taken”).
Taking judicial notice of public records
directly relevant to the issue in dispute is proper on a Rule
-6-
12(b)(6) review and does not transform the motion into one for
summary judgment.
Funk v. Stryker Corp., 631 F.3d 777, 780 (5th
Cir. 2011). “A judicially noticed fact must be one not subject to
reasonable dispute in that it is either (1) generally known within
the territorial jurisdiction of the trial court or (2) capable of
accurate and ready determination by resort to sources whose
accuracy cannot reasonably be questioned.” Fed. R. Evid. 201(b).
B.
Rule 9(b)
Federal Rule of Civil Procedure 9(b) provides,
In all averments of fraud or mistake, the
circumstances constituting fraud or mistake
shall be stated with particularity. Malice,
intent, knowledge, and other condition of
mind of a person must be averred generally.
“In every case based upon fraud, Rule 9(b) requires the
plaintiff to allege as to each individual defendant ‘the nature of
the fraud, some details, a brief sketch of how the fraudulent
scheme
operated,
when
and
where
it
occurred,
and
the
participants.” Hernandez v. Ciba-Geigy Corp. USA, 200 F.R.D. 285,
291 (S.D. Tex. 2001).
Unlike the alleged fraud, Rule 9(b) allows a plaintiff
to plead intent to deceive or defraud generally.
Nevertheless a
mere conclusory statement that the defendant had the required
intent is insufficient; the plaintiff must set forth specific
facts that raise an inference of fraudulent intent, for example,
facts
that
show
the
defendant’s
motive.
Tuchman
v.
DSC
Communications Corp., 14 F.3d 1061, 1068 (5th Cir. 1994)(“Although
scienter may be averred generally, case law amply demonstrates
that pleading scienter requires more than a simple allegation that
-7-
a defendant had fraudulent intent.
a
plaintiff
must
set
forth
To plead scienter adequately,
specific
facts
that
support
an
inference of fraud.”); Melder v. Morris, 27 F.3d 1097, 1102 (5th
Cir. 1994).
The particularity requirement of Rule 9(b) also governs
a conspiracy to commit fraud.
Southwest Louisiana Healthcare
System v. MBIA Ins. Corp., No. 05-1299, 2006 WL 1228903, *5 & n.47
(W.D. La. May 6, 2006); Hernandez v. Ciba-Geigy Corp. USA, No.
Civ.
A.
B-00-82,
2000
WL
33187524,
*4
(S.D.
Tex.
Oct.
17,
2000)(“The weight of Fifth Circuit precedent holds that a civil
conspiracy to commit a tort that sounds in fraud must be pleaded
with
particularity.”);
In
re
Ford
Motor
Co.
Vehicle
Paint
Litigation, No. MDL 1063, 1994 WL 426548, *34 (E.D. La. July 30,
1996); and Castillo v. First City Bancorporation of Texas, Inc.,
43 F.3d 953, 961 (5th Cir. 1994).
The
Fifth
Circuit,
although
construing Rule 9(b)
strictly, has recognized an exception and permits the requirements
to be “relaxed” where facts relating to the fraud are “peculiarly
within the perpetrator’s knowledge”; then the alleged fraud “may
be pled on information and belief, provided the plaintiff sets
forth the factual basis for his belief.”
United States ex rel.
Russell v. EPIC Healthcare Management Group, 193 F.3d 304, 308 (5th
Cir. 1999), citing United States ex rel. Thompson v. Columbia/HCA
Healthcare Corp., 125 F.3d 899, 903 (5th Cir. 1997)(warning that
the exception “must not be mistaken for license to base claims of
fraud on speculation and conclusory allegations.”).
The relaxed
standard is not applicable where the information is available from
-8-
another source or where the plaintiff fails to allege a factual
basis for his beliefs.
Sealed Appellant I v. Sealed Appellee I,
156 Fed. Appx. 630, 634 (5th Cir. 2005)(plaintiff must allege
sufficient factual basis for his belief defendant committed fraud,
e.g., particular documents containing false statements, identified
by number, date or otherwise, or explain how he tried, but failed
to obtain the information, whom he contacted, etc.).
A dismissal for failure to plead with particularity in
accordance with Rule 9(b) is treated as a Rule 12(b)(6) dismissal
for failure to state a claim.
Lovelace v. Software Spectrum,
Inc., 78 F.3d 1015, 1017 (5th Cir. 1996). If it appears that given
an opportunity to amend the pleading, the plaintiff would be able
to state a claim upon which relief could be granted, the court
should grant leave to amend.
People’s Choice Home Loan, Inc. v.
Mora, No. 3:06-CV-1709-G, 2007 WL 708872, *4 (N.D. Tex. Mar. 7,
2007), citing Kennard v. Indianapolis Life Ins. Co., 420 F.
Supp.2d 601, 608-09 (N.D. Tex. 2006).
C.
The
Exchange
Act
and
the
PSLRA’s
Heightened
Pleading
Requirements
The PSLRA heightened the particularity requirements to
plead securities fraud in two ways:
(1) the plaintiff must
“specify each statement alleged to have been misleading and the
reason or reasons why the statement is misleading . . .,” 15
U.S.C. § 78u-4(B)(1)(B); and (2) for “each act or omission
alleged” to be false or misleading, the plaintiff must “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-9-
4(b)(2).
Indiana Elec. Workers’ Pension Trust Fund IBEW v. Shaw
Group, Inc., 537 F.3d 527, 533 (5th Cir. 2007). Rule 9(b) requires
the
plaintiff
in
a
securities
fraud
suit
to
“‘specify
the
statements contended to be fraudulent, identify the speaker, state
when and where the statements were made, and explain why the
statements were fraudulent.’”
Southland Securities Corp. v.
INSpire Ins. Solutions, Inc., 365 F.3d 353, 362 (5th Cir. 2004),
quoting Williams v. WMX Technologies, Inc., 112 F.3d 175, 177-78
(5th Cir. 1997), cert. denied, 522 U.S. 966 (1997).
See 15 U.S.C.
§ 78u-4. In other words, “‘[p]leading fraud with particularity in
this circuit requires ‘time, place and contents of the false
representations, as well as the identity of the person making the
misrepresentation and what [that person] obtained thereby.’”
Williams, 112 F.3d at 177 (5th Cir. 1997), quoting Tuchman, 14 F.3d
at 1068.
“‘In cases concerning fraudulent misrepresentation and
omission of facts, Rule 9(b) typically requires the claimant to
plead the type of facts omitted, the place in which the omissions
should have appeared, and the way in which the omitted facts made
the representations misleading.’”
Carroll v. Fort James Corp.,
470 F.3d 1171, 1174 (5th Cir. 2006), quoting United States ex. rel.
Riley v. St. Luke’s Hosp., 355 F.3d 370, 381 (5th Cir. 2004).
These facts “must be laid out before access to the discovery
process is granted.”
Williams, 112 F.3d at 178.
The Fifth Circuit does not permit group pleading in
securities fraud suits.
Owens v. Jastrow, 789 F.3d 529, 537 (5th
Cir. 2015), citing Southland, 365 F.3d at 365 (“[T]he PSLRA
requires the plaintiffs to distinguish among those they sue and
-10-
enlighten each defendant as to his or her particular part in the
alleged fraud. . . . [W]e do not construe allegations contained in
the [second amended complaint] against ‘defendants’ as a group as
properly
imputable
to
any
particular
defendant
unless
the
connection between the individual defendant and the allegedly
fraudulent statement is specifically pleaded.”).6
Group pleading
or group publishing doctrine fails to satisfy the heightened
pleading standards of the PSLRA.
II.
Southland, 365 F.3d at 363 n.9.
Relevant Substantive Law
Exchange Act and the PSLRA
“[T]o state a claim under section 10(b) of the 1934
[Exchange] Act and Rule 10b-5, a plaintiff must allege, in
connection with the purchase or sale of securities, ‘(1) a
misstatement or an omission (2) of material fact7 (3) made with
6
The group pleading or group publishing doctrine
permits plaintiffs to presume that statements in prospectuses,
registration statement, annual reports, press releases, etc. are
collectively attributable to persons with direct involvement in
the regular business of the company. Southland, 365 F.3d at363
n.9. In its most expansive form it allows “unattributed corporate
statements to be charged to one or more individual defendants
based solely on their corporate title. Under this doctrine, the
plaintiff need not allege any facts demonstrating an individual
defendant’s participation in the particular communication
containing the misstatement or omission where the defendants are
‘insiders or affiliates’ of the company.” Id. at 363.
7
In Amgen, Inc. v. Connecticut Retirement Plans and
Trust Funds, 133 S. Ct. 1184, 1191, 1196-97 (2013), the Supreme
Court held that plaintiffs do not have to prove materiality at the
class certification stage in a securities fraud suit based on a
fraud on the market theory because Federal Rule of Civil Procedure
23(b)(3) requires only that common questions “predominate over
questions affecting only individual members” and materiality is a
question common to all putative class members.
There is no
requirement that materiality be resolved on the merits before
class certification. Id.
-11-
scienter (4) on which plaintiff relied (5) that proximately caused
[the plaintiff’s] injury.’”
Nathenson v. Zonagen, Inc., 267 F.3d
400, 406-07 (5th Cir. 2001), quoting Tuchman v. DSC Communications
Corp., 14 F.3d 1061, 1067 (5th Cir. 1994).
See also Stoneridge
Investment Partners, LLC v. Scientific-Atlanta, Inc., 552 U.S.
148, 157 (2008)(to state a claim that a defendant made material
misrepresentations or omissions in violation of § 10(b) and Rule
10b-5, a plaintiff must allege “(1) 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
omission; (5) economic loss; and (6) loss causation.”).
or
The
PSLRA, 15 U.S.C. § 78u-4(b)(1) mandates,
In any private action arising under this
chapter in which the plaintiff alleges that
the defendant-–
(A) made an untrue
material fact; or
statement
of
a
(B) omitted to state a material fact
necessary
in
order
to
make
the
statements made, in the light of the
circumstances in which they were made,
not misleading;
the complaint shall specify each statement
alleged to have been misleading, and, if an
allegation
regarding
the
statement
or
omission is made on information and belief,
the complaint shall state with particularity
all the facts on which that belief is formed.
See, e.g., ABC Arbitrage Plaintiffs Group v. Tchuruk, 291 F.3d
336, 349-50 (5th Cir. 2002).
-12-
An untrue statement is “material” under section 10(b) of
the Exchange Act and Rule 10b-58 if there is a “‘substantial
likelihood that’ the false or misleading statement ‘would have
been viewed by the reasonable investor as having altered the
‘total mix’ of information made available,’” or in other words,
8
Rule 10b-5, adopted by the SEC pursuant to its
authority under section 10(b) of the Exchange Act, 15 U.S.C.
10(b)-5.§ 78j(b), states,
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,
(b) To 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, or
(c) To engage in any act, practice or course
of business which operates as a fraud or
deceit upon any person,
in connection with the purchase or sale of
any security.
It forbids three kinds of fraud when they are “material” (when
there is “a substantial likelihood that the [statement or
omission] . . . would have been viewed by the reasonable investor
has having significantly altered the ‘total mix’ of information
available”, Basic, 485 U.S. at 231-32): misstatements, misleading
statements, and omissions (silence) when there is a duty to
disclose. 17 C.F.R. § 240.10b-5. Although the Exchange Act does
not provide for a private cause of action for § 10(b) violations,
the Supreme Court has held that a right of action is implied in
the language of the statute and its implementing regulation.
Superintendent of Ins. of N.Y. v. Bankers Life & Casualty Co., 404
U.S. 6, 13 & n.9 (1971). Only actual purchasers and sellers of
securities have an implied private cause of action under Rule 10b5. Blue Chip Stamps v. Manor Drug Stores, 421 U.S. 723, 730-31
(1975).
-13-
“if there is a substantial likelihood that a reasonable investor
would consider the information important in making a decision to
invest.”
Nathenson, 267 F.3d at 418, quoting Basic, Inc. v.
Levinson, 485 U.S. 224, 231-32 (1988); R&S Technical Servs. Ltd.
v. Commodity Futures Trading Comm’n, 205 F.3d 165, 169 (5th
Cir.)(citing TSC Industries, Inc. v. Northway, Inc., 426 U.S. 438,
449 (1976)), cert. denied, 531 U.S. 817 (2000).
For the “made with scienter” requirement, the PSLRA, 15
U.S.C. § 78u-4(b)(2), states, “In any private action under this
chapter in which the plaintiff may recover money damages on proof
that the defendant acted with a particular state of mind, the
complaint shall, with respect to each act or omission alleged to
violate this chapter, state with particularity facts giving rise
to a strong inference that the defendant acted with the required
state of mind.”
Nathenson, 267 F.3d at 407.
In Ernst & Ernst v.
Hochfelder, 425 U.S. 185, 194 n.12 (1976), without determining if
scienter included recklessness, the Supreme Court defined scienter
in the context of securities fraud as “‘a mental state embracing
intent to deceive, manipulate or defraud.’”
Id. at 408.
The
Fifth Circuit has since held that “severe recklessness” satisfies
the scienter requirement.
Nathenson, 267 F.3d at 407, citing
Broad v. Rockwell Intern. Corp., 642 F.2d 929, 961-62 (5th Cir.
1981)(“‘Severe
recklessness
is
limited
to
those
highly
unreasonable omissions or misrepresentations that involve not
merely simple or even inexcusable negligence, but an extreme
departure from the standards of ordinary care, and that present a
danger of misleading buyers or sellers which is either known to
-14-
the defendant or is so obvious that the defendant must have been
aware of it.’”), quoting Sundstrand Corp. v. Sun Chemical Corp.,
553 F.2d 1033, 1039-40 (7th Cir.), cert. denied, 434 U.S. 875
(1977).
Plaintiffs may satisfy the scienter requirement by
allegations of intentional misconduct or of severe recklessness,
which
“resembles
misconduct.”
a
slightly
lesser
species
of
Nathenson, 267 F.3d at 408-09.
intentional
Circumstantial
evidence of such conscious behavior or severe recklessness is
sufficient to support a strong inference of scienter. Id. at 410,
citing Greebel v. FTP Software, Inc., 194 F.3d 185, 195 (1st Cir.
1999)(“Congress plainly contemplated that scienter could be proven
by
inference,
thus
acknowledging
circumstantial evidence.”).
the
role
of
indirect
and
Usually “‘the mere publication of
inaccurate accounting figures, or failure to follow GAAP, without
more, does not establish scienter.’” Shaw Group, 537 F.3d at 534,
quoting Barrie v. Intervoice-Brite, Inc., 397 F.3d 249, 264 (5th
Cir. 2005).
“To plead scienter adequately, plaintiffs must state
with particularity facts giving rise to a strong inference that
the
party
knew
that
it
was
publishing
materially
false
information, or that the party was severely reckless in publishing
such information.”
Id.
Plaintiffs may not rely on a general
assertion that Defendants knew about a particular bribe or a
specific accounting violation or internal control problem because
of their positions in the company, because they are officers, or
because of their day-to-day involvement in the company; instead
there must be specific allegations of facts showing that they
actually knew about a particular accounting violation, bribe, or
-15-
internal
control
problem.
Abrams,
292
F.3d
at
432;
Fin.
Acquisition Partners, LP v. Blackwell, 440 F.3d 278, 287 (5th Cir.
2006); Shaw Group, 537 F.3d 540-41.
In
rejecting
the
Second
Circuit’s
“motive
and
opportunity” pleading standard, the Fifth Circuit has concluded,
“What must be alleged is not motive and opportunity as such, but
particularized
scienter.
facts
giving
rise
to
a
strong
inference
of
Appropriate allegations of motive and opportunity may
meaningfully enhance the strength of the inference of scienter,
but it would seem to be a rare set of circumstances indeed where
those allegations alone are both sufficiently persuasive to give
rise to a scienter inference of the necessary strength and yet at
the same time there is no basis for further allegations also
supportive of that inference.” Id. at 412. In evaluating whether
pleaded facts give rise to a strong (i.e., “a powerful or cogent”)
inference of scienter, the court must “assess all the allegations
holistically,” following a three-step procedure “geared to the
PSLRA’s twin goals:
to curb frivolous, lawyer-driven litigation,
while preserving investors’ ability to recover on meritorious
claims.”
Tellabs, Inc. v. Makor Issues & Rights, 551 U.S. 308,
326, 322 (2007).
As the first step, the court accepts factual
allegations in the pleadings as true; second, the court must
review the entire complaint, including documents incorporated by
reference and matters of which the court should take judicial
notice;
and
third,
the
court
must
consider
all
plausible
inferences, both supporting and opposing a strong inference of
scienter. Id. at 322-23 (“The inquiry is inherently comparative:
-16-
How likely is it that one conclusion, as compared to others,
follows from the underlying facts.”).
To be a “strong” inference
of scienter an inference must be more that merely plausible or
reasonable under the Iqbal standard; it will survive a motion to
dismiss “only if a reasonable person would find it cogent and at
least as compelling an any opposing inference that could be drawn
from the facts alleged,” taken collectively.
Id. at 324 “The
inference that the defendant acted with scienter need not be
irrefutable . . . or even the ‘most plausible of competing
inferences.’ . . . Yet the inference must be more than merely
‘reasonable’ or permissible’-–it must be cogent, thus strong in
light
of
other
explanations.”
Id.
at
324
omitted)(holding that “[a] complaint will survive . .
(citations
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.”).
Circumstantial evidence can support a
strong inference of scienter.
The
Fifth
Circuit
Nathenson, 267 F.3d at 410.
has
held
that
“‘pleading[s]
of
scienter may not rest on the inference that defendants must have
been aware of the misstatement based on their positions with the
company.’”
Shaw Group, 537 F.3d at
535, quoting Abrams v. Baker
Hughes, Inc., 292 F.3d 424, 432 (5th Cir. 2001).
If
the
plaintiff
fails
to
satisfy
this
scienter
requirement, the district court “‘shall,” on defendant’s motion,
‘dismiss the complaint.’”
Id. at 407, citing § 78u-4(b)(3).
Finally, regarding the reliance element in section 10(b)
of the Exchange Act and Rule 10b-5, the Fifth Circuit opined in
-17-
Abell v. Potomac Ins. Co., 858 F.2d 1104, 1117-18 (5th Cir. 1988),
vacated on other grounds sub nom. Fryar v. Abell, 492 U.S. 914
(1989),
“The element of reliance is the subjective
counterpart to the objective element of
materiality.
Whereas materiality requires
the
plaintiff
to
demonstrate
how
a
‘reasonable’ investor would have viewed the
defendants’
statements
and
omissions,
reliance requires a plaintiff to prove that
it actually based its decisions upon the
defendants’ misstatements or omissions.
‘Reliance is causa sine qua non, a type of
“but for” requirement:
had the investor
known the truth he would not have acted.”
Huddleston [v. Herman and MacLean, 640 F.2d
534[, 549] (5th Cir. 1981), rev’d in part on
other grounds, 459 U.S. 375 . . . (1983).
Nathenson, 267
F.3d at 414, quoting Abell, 858 F.2d at 1117-18.
“Reliance, in other words, generally requires that the plaintiff
have known of the particular misrepresentation complained of, have
believed it to be true and because of that knowledge and belief
purchased or sold the security in question.”
Id.
Proof of
reliance is necessary to establish a “‘proper connection between
a defendant’s misrepresentation and a plaintiff’s injury.’”
Amgen, Inc. v. Connecticut Retirement Plans and Trust Funds, 133
S. Ct. 1184, 1192 (2013), citing Erica P. John Fund, Inc. v.
Halliburton Co., 563 U.S. 2179, 2184 (2011).
Because the Supreme Court determined that requiring
direct
proof
of
individualized
reliance
“would
place
an
unnecessarily unrealistic evidentiary burden on [a] plaintiff who
has traded in an impersonal market,” and “effectively would”
prevent plaintiffs “from proceeding with a class action” under
Rule 23(b)(3), in Basic, Inc., 485 U.S. at 241-42, 245, the
-18-
Supreme Court approved of a rebuttable presumption of classwide
reliance by recognizing the “fraud-on-the-market theory” in an
efficient market.
As an alternative and practical way to balance
“the substantive requirement of proof of reliance in securities
cases against the procedural requisites of Federal Rule of Civil
Procedure 23 and to meet the reliance requirement, the theory
presumes
that
potentially
significant,
information is reflected in the
publicly
price of a stock.
distributed
The high court
described it succinctly as follows:
“The fraud on the market theory is based on
the hypothesis that, in an open and developed
securities market, the price of a company’s
stock is determined by the available material
information regarding the company and its
business. . . . Misleading statements will
therefore defraud purchasers of stock even if
the purchasers do not directly rely on the
misstatements. . . . The causal connection
between the defendants’ fraud and the
plaintiffs’ purchase of stock in such a case
is no less significant than a case of direct
reliance on misrepresentations.”
Peil v.
Speiser, 806 F.2d 1154, 1160-61 (CA3 1986).
Id. at 989.
See also Amgen, Inc. v. Connecticut Retirement Plans
and Trust Funds, 133 S. Ct. 1184, 1192 (2013)(“In Basic, we held
that if a market is shown to be efficient, courts may presume that
investors who traded securities in that market relied on public,
material misrepresentations regarding those securities.”).
“[A]
plaintiff must make the following showings to demonstrate that the
presumption of reliance applies in a given case:
(1) that the
alleged misrepresentations were publicly known, (2) that they were
material, (3) that the stock traded in an efficient market, and
(4) that the plaintiff traded the stock between the time the
-19-
misrepresentation was made and when the truth was revealed.”
Halliburton Co. v. Erica P. John Fund, Inc., 134 S. Ct. 2398, 2408
(2014).
The presumption can be rebutted by “any showing that
severs the link between the alleged misrepresentation and either
the price received (or paid) by the plaintiff, or his decision to
trade
at
a
fair
market
price,”
e.g.,
that
“the
alleged
misrepresentation did not, for whatever reason, actually affect
the market price, or that a plaintiff would have bought or sold
the stock even had he been aware that the stock’s price was
tainted
by
fraud.”
Id.
The
high
court
explained
that
“[r]equiring proof of individualized reliance from each member of
the proposed plaintiff class effectively would have prevented
respondents from proceeding with a class action, since individual
issues then would have overwhelmed the common ones.”
at 242.
Basic, Inc.
Where a case depends on the “fraud-on-the-market”
presumption, “the complained of misrepresentation or omission
[must] have actually affected the market price of the stock.”
Nathenson, 267 F.3d at 415.
Under the PSLRA plaintiffs bear the burden of showing
that the defendants’ act or omission caused the economic loss for
which plaintiffs seek to recover damages.
4(b)(4).
15 U.S.C. § 78u-
Under Rule 10b-5 Plaintiffs must allege proximate
causation as well as economic loss.
544 U.S. 336, 338 (2005).9
Dura Pharm., Inc. v. Broudo,
Artificially inflated purchase price,
9
At times courts consider the reliance element of a
Rule 10b-5 action to be part of the causation element. In this
contest, “transaction causation “ refers to the requirement that
the defendant’s fraud must precipitate the investment decision. .
-20-
by itself, will not constitute or proximately cause the requisite
economic loss because at the time of purchase, plaintiff has not
suffered a loss because the price is offset by ownership of the
share at that time and because any link between the inflated price
and any later economic loss is usually weak.
the
Supreme
establish
Court
did
not
discuss
what
Id. at 342.10
must
be
While
pleaded
to
the causation and economic loss elements, it generally
. . On the other hand, ‘loss causation’ refers to a direct causal
link between the misstatement and the client’s economic loss.”
Huddleston v. Herman and MacLean, 640 F.2d 534, 549 n.24 (5th Cir.
1981), rev’d in part on other grounds, 459 U.S. 375 (1983). In
contrast, reliance means that the plaintiff knew of a particular
misrepresentation that he complained of, believed it to be true,
and because of that knowledge and belief purchased or sold the
security at issue. Nathenson, 267 F.3d at 413.
10
The Supreme Court explained,
[I]f . . . the purchaser sells the shares
quickly before the relevant truth begins to
leak out, the misrepresentation will not have
led to any loss. If the purchaser sells
later after the truth makes its way into the
marketplace, an initially inflated purchase
price might mean a later loss. But that is
far from inevitably so. When the purchaser
subsequently resells such shares, even at a
lower price, that lower price may reflect,
not the earlier misrepresentation, but
changed
economic
circumstances,
changed
investor expectations, new industry-specific
or firm-specific facts, conditions, or other
events, which taken separately or together
account for some or all of that lower price.
(The same is true in respect to a claim that
a share’s higher price is lower than it would
otherwise have been . . . .) Other things
being equal, the longer the time between
purchase and sale, the more likely that this
is so, i.e., the more likely that other
factors caused the loss. . . . [T]he most
logic permits us to say is that the higher
purchase prices will sometimes play a role in
bringing about a future loss.
-21-
stated that the complaint must provide defendants “with notice of
what the relevant economic loss might be or of what the causal
connection might be between that loss and the misrepresentation.”
Id. at 347.
The
Fifth
Circuit
has
opined
that
under
Dura
Pharmaceuticals and Twombly, the plausibility standard in Rule
8(a) would apply to pleading causation and economic loss.
Public
Employees Retirement System of Mississippi, Puerto Rico Teachers
Retirement System v, Amedisys, Inc., 769 F. 3d 313, 320 (5th Cir.
2014), cert. denied, 135 S. Ct. 2892 (2015).
The Fifth Circuit
has held that to demonstrate loss causation,
[T]he plaintiff must allege that when the
‘relevant truth’ about the fraud began to
leak out or otherwise make its way into the
marketplace, it caused the price of the stock
to depreciate, and, thereby, proximately
caused the plaintiff’s economic harm. Loss
causation in fraud-on-the-market cases can be
demonstrated
circumstantially
by
‘(1)
identifying a ‘corrective disclosure’ (a
release of information that reveals to the
market
the
pertinent
truth
that
was
previously concealed or obscured by the
company’s fraud); (2) showing that the stock
price dropped soon after the corrective
disclosure;
and
(3)
eliminating
other
possible explanations for this price drop, so
that the fact finder can infer that it is
more probable than not that it was the
corrective disclosure--as opposed to other
possible depressive factors--that caused at
least a ‘substantial’ amount of price drop.”
Id. at 320-21, quoting FindWhat Investor Group v. FindWhat.com,
658 F.3d 1282, 1311-12 (11th Cir. 2011). The corrective disclosure
may be comprised of “a series of partial disclosures.” Lormand v.
US Unwired, Inc., 565 F.3d 228, 261 (5th Cir. 2009).
See also
Greenberg v. Crossroads Sys., Inc., 364 F.3d 657, 665 (5th Cir.
-22-
2004)(In demonstrating reliance and loss causation, “plaintiffs
cannot trigger the presumption or reliance by simply offering
evidence of any decrease in price following the release of
negative information.
Such evidence does not raise an inference
that the stock’s price was actually affected by an earlier release
of positive information.
To raise an inference through a decline
in stock price that an earlier false, positive statement affected
a stock’s price, the plaintiffs must show that the false statement
causing the increase was related to the statement causing the
decrease.”).
In the Fifth Circuit, “the testimony of an expert--
along with some kind of analytical research or event study--is
required to show loss causation.”
Fener v. Operating Engineers
Const. & Misc. Pension Fund (Local 66), 579 F.3d 401, 409 (5th Cir.
2009).
not
Nevertheless, opined the Fifth Circuit, “[N]either Fener
Halliburton
even
considers
whether
internal
non-public
disclosures from Defendants can provide the basis for establishing
loss
causation.
As
such,
these
cases
do
not
disturb
the
established principle that proof of loss causation in the context
of a fraud-on-the-market regiment is drawn from public data and
public filings.” In re TETRA Technologies, Inc. Sec. Litig., Civ.
A. No. 4:08cv0965, 2010 WL 1335431, at *3 (Bnkrty. S.D. Tex. Apr.
5, 2010)(finding the Fifth Circuit’s “bar for demonstrating loss
causation” to be “a high one” and allowing additional merits
discovery as a matter of law prior to submission of Plaintiff’s
expert report and seeking class certification).
Plaintiffs in a
private securities fraud suit do not have to prove loss causation
(i.e.,
that
the
defendant’s
deceptive
-23-
conduct
caused
the
investors’ claimed economic loss) before they can obtain class
certification.
Erica P. John Fund, Inc., 134 S. Ct. 2398,
abrogating Oscar Private Equity Investments v. Allegiance Telecom,
Inc., 487 F.3d 261 (5th Cir. 2007)(holding that plaintiffs must
prove defendants’ alleged misrepresentations were the proximate
cause of their economic loss to qualify for class certification).
As to the requirement that an allegation of a statement
or omission “made on information and belief” requires that the
complaint “state with particularity all facts on which that belief
is
formed,”
the
Fifth
Circuit
adopts
the
Second
Circuit’s
interpretation in Novak v. Kasaks, 216 F.3d 300, 313 (2d Cir.),
cert. denied, 531 U.S. 1012 (2000), which held that “‘plaintiffs
who rely on confidential sources are not always required to name
those sources, even when they make allegations on information and
belief
concerning
false
or
misleading
Arbitrage, 291 F.3d at 351-54.
statements.’”
ABC
Observing that “‘the applicable
provision of the law as ultimately enacted requires plaintiffs to
plead only facts and makes no mention of the sources of these
facts,’” the Second Circuit in Novak held,
“More fundamentally, our reading of the PSLRA
rejects any notion that confidential sources
must be named as a general matter. In our
view, notwithstanding the use of the word,
‘all,’ paragraph (b)(1) does not require that
plaintiffs plead with particularity every
single
fact
upon
which
their
beliefs
concerning false or misleading statements are
based.
Rather, plaintiff need only plead
with particularity
sufficient
facts to
support those beliefs.
Accordingly, where
plaintiffs rely on confidential personal
sources but also on other facts, they need
not name their sources as long as the latter
facts provide an adequate basis for believing
-24-
that the defendants’ statements were false.
Moreover, even if personal sources must be
identified, there is no requirement that they
be named, provided they are described in the
complaint with sufficient particularity to
support the probability that a person in the
position occupied by the source would possess
the information alleged.
In both these
situations, the plaintiffs will have pleaded
enough facts to support their belief, even
though some arguably relevant fact have been
left out. Accordingly, a complaint can meet
the new pleading requirement imposed by
paragraph (b)(1) by providing documentary
evidence
and/or
a
sufficient
general
description of the personal sources of the
plaintiffs’ beliefs.”
ABC Arbitrage, 291 F.3d at 351-52, quoting Novak, 216 F.3d at 31314. The Fifth Circuit, id. at 352, further quoted Novak, 216 F.3d
at 314 n.1:
“Paragraph (b)(1) is strangely drafted.
Reading
‘all’
literally
would
produce
illogical results that Congress cannot have
intended. Contrary to the clearly expressed
purpose of the PSLRA, it would allow
complaints to survive dismissal where ‘all’
the
facts
supporting
the
plaintiff’s
information and belief were pled, but those
facts were patently insufficient to support
that belief.
Equally peculiarly, it would
require dismissal where the complaint pled
facts
fully
sufficient
to
support
a
convincing inference if any known facts were
omitted.
Our reading of the provision
focuses on whether the facts alleged are
sufficient to support a reasonable belief as
to the misleading nature of the statement or
omission.”
The “other facts” can be documentary evidence (for which the
plaintiff specifies the internal report(s), the person(s) who
prepared them, when, which company officer reviewed them) that
“provide[s] an adequate basis for believing that the defendants’
statement or omissions were false or misleading” or “descriptions
-25-
of personal sources” with sufficient particularity “to support the
probability that a person in the position occupied by the source
would possess the information pleaded to support the allegations
of false or misleading statements made on information and belief.”
Id. at 353.
Therefore only “if the other facts, i.e., do not
provide an adequate basis for believing that the defendants’
statements were false and the descriptions of the personal sources
are not sufficiently particular to support the probability that a
person in the position occupied by the source would possess the
information
pleaded
to
support
the
allegations
of
false
or
misleading statements made on information and belief,” must the
complaint name personal sources.
Id. at 353.
See also Shaw
Group, 537 F.3d at 535.
Nevertheless in the wake of Tellabs, 551 U.S. at 757,
which
requires
consideration
defendant’s
of
comparative
weighing
plausible
nonculpable
conduct
to
determine
if
of
allegations
explanations
there
is
a
for
cogent
and
a
and
compelling inference of scienter, the Fifth Circuit opined in Shaw
Group., id. at 535, that
Following Tellabs, courts must discount
allegations from confidential sources.
Higginbotham v. Baxter Int’l Inc., 495 Fed.
Cir.
2007).11
Such
753,
756-57
(7th
11
In Higginbotham, a skeptical Chief Judge Easterbrook
opined for the unanimous Seventh Circuit panel, concealing names
in the complaint “does nothing but obstruct the judiciary’s
ability to implement the PSLRA. 551 U.S. 564. He continued, “It
is hard to see how information from anonymous sources could be
deemed ‘compelling’ or how we could take account of plausible
opposing inferences. Perhaps these confidential sources have axes
to grind.
Perhaps they are lying.
Perhaps they don’t even
exist.” 551 U.S. at 757. While “allegations from ‘confidential
-26-
[confidential] sources afford no basis for
drawing the plausible competing inferences
required by Tellabs.
Id. at 757 (“Tellabs
requires judges to weigh the strength of
plaintiffs’ favored inference in comparison
to other possible inferences; anonymity
frustrates that process.”).
At the very
least, such sources must be described “with
sufficient particularity to support the
probability that a person in the position
occupied by the source . . . would possess
the information pleaded. . . .”
ABC
Arbitrage Plaintiffs Group v. Tchuruk, 291
F.3d 336, 353 (5th Cir. 2002); see also
Central Laborers’ [Pension Fund v. Integrated
Elec. Services, Inc.], 497 F.3d [546,] 552
[(5th Cir. 2007].
See also Local 731 I.B. of T. Excavators and Pavers Pension Trust
Fund v. Diodes, Inc., 67 F. Supp. 3d 782, 788 (E.D. Tex. 2014)
(“The Fifth Circuit cautions against reliance on confidential
witnesses, even at the pleading stage. See [Shaw Group], 537 F.3d
at 535.
In order to establish the reliability of confidential
witness
statements,
Plaintiff’s
allegations
must
include
‘particular job descriptions, individual responsibilities, and
specific employment dates for the witnesses.
See Cent. Laborers’
Pension Fund v. Integrated Elec. Servs., Inc., 497 F.3d 546, 552
(5th
Cir.
2007).
But
even
if
described
‘with
sufficient
particularity to support the probability that a person in the
position
occupied
by
the
source
.
.
.
would
possess
the
information pleaded,’ the Court discounts allegations based on
confidential
witnesses.
ABC
Arbitrage,
291
F.3d
at
witnesses’ must be ‘discounted’ rather than ignored,” the majority
concluded, “Usually that discount will be steep.” Id.
-27-
353.”)(Schneider, J.)12; Dawes v. Imperial Sugar Co., 975 F. Supp.
2d 666, 692-93 (S.D. Tex. 2013)(Rosenthal, J.).
Where a plaintiff relies on documentary evidence with
company-generated statistics instead of personal sources, the
Fifth Circuit followed the Second Circuit’s standard in In re
Scholastic Corp. Securities Litigation, 252 F.3d 63, 72-73 (2d
Cir.), cert. denied sub nom. Scholastic Corp. v. Truncellito, 534
U.S. 1071 (2001).
ABC Arbitrage, 291 F.3d at 356.
While
declining to require as a threshold requirement in every case that
plaintiffs provide details about purported “negative internal
reports, such as report titles, when they were prepared, who
prepared them, to whom they were directed, their content, and the
sources from which plaintiffs obtained this information,” the
Fifth Circuit did agree that an “‘unsupported general claim of
existence of confidential company sales reports that revealed the
large decline in sales is insufficient to survive a motion to
dismiss.’”
ABC Arbitrage, 291 F.3d at 355-56.
A sensible
standard pleading on information and belief would require, “beyond
bare pleadings,” “specifying who prepared the internal company
reports, how frequently the reports were prepared and who reviewed
them”; it would not require the pleading of detailed evidentiary
matter.
Id. at 356, quoting Scholastic, 252 F.3d at 73-74.
12
In Central Laborers’ the Fifth Circuit concluded that
where a confidential source’s statements lack sufficient detail
“such as particular job descriptions, individual responsibilities,
and specific employment dates,” there is an insufficient basis to
evaluate the information and will not support a strong inference
of fraud. 497 F.3d at 552.
-28-
Allegations
of
a
conversation
between
one
party’s
unnamed high ranking official/top executive and a named executive
of another is sufficient to meet the Novak standard for a source
if the unnamed person in such a position would possess the
information pleaded and that this executive was the source for the
information.
Id. at 357.
A “forward-looking statement” is defined in 15 U.S.C. §
77z-2(i)(1) in relevant part as:
(A) a statement containing a projection of
revenues, income (including income loss),
earnings (including earnings loss) per share,
capital expenditures, dividends, capital
structure or other financial items;
(B) a statement of the plans and objectives
of
management
for
future
operations,
including plans or objectives relating to the
products or services of the issuer;
(C)
a
statement
of
future
economic
performance, including any such statement
contained in a discussion and analysis of
financial condition by the management or in
the results of operations included pursuant
to the rules and regulations of the
Commission . . . .
The PSLRA creates a safe harbor for forward looking
statements, whether written or oral, under § 78u-5(c)(1) if “(A)
the forward-looking statement is--(i) identified as a forwardlooking statement, and is accompanied by meaningful cautionary
statements identifying important factors that could cause actual
results to differ materially from those in the forward-looking
statement; or (ii) immaterial; or (B) the plaintiff fails to prove
that the forward-looking statement (i) if made by a natural person
was made with actual knowledge by that person that the statement
-29-
was false or misleading; or (ii) if made by a business entity:
was--(i) made by or with the approval of an executive officer13 of
that entity; and (ii) made or approved by such officer with actual
knowledge
by
misleading.”
that
officer
that
the
15 U.S.C. § 78u-5(c)(1).
statement
was
false
or
See generally Southland
Securities Corp. v. INSpire Ins. Solutions, Inc., 365 F.3d 353,
371-72 (5th Cir. 2004).
“Meaningful” requires “‘substantive’
company-specific warnings based on a realistic description of the
risks applicable to the particular circumstances, not merely a
boilerplate
litany
of
generally
Southland, 365 F.3d at 372.
applicable
risk
factors.”
Oral statements can satisfy the safe
harbor requirements if “(i) the statement is accompanied by a
cautionary statement that the ‘particular’ oral statement is
forward-looking and that actual results could differ materially .
. .; (ii) the statement is accompanied by an oral statement that
additional information that could cause actual results to differ
materially is contained in a readily-available document; (iii) the
statement identifies the document or portion thereof containing
the additional information; and (iv) the identified document
itself contains appropriate cautionary language.
U.S.C.
§§
77z-2(c)(2),
77u-5(c)(2).
13
Such
Id., citing 15
readily
available
For purposes of the Exchange Act and the rules
promulgated under it, “[t]he term ‘officer’ means a president,
vice president, secretary, treasurer or principal financial
officer, comptroller or principal accounting officer, and any
person routinely performing corresponding functions with respect
to any organization whether incorporated or unincorporated.” 17
C.F.R. 240.3b-2.
-30-
documents can include those filed with the SEC or generally
disseminated.
Id., citing §§ 77z-2(c)(3), 77u-5(c)(3).
Nor do statements of material fact include puffery,
i.e.,
generalized,
competitive
positive
strengths,
statements
experienced
about
the
management,
company’s
and
future
prospects that are too vague, optimistic, and lacking in concrete
factual or material misrepresentations to support a securities
fraud claim.
Southland, 365 F.3d at 372, citing inter alia
Rosenzweig v. Azurix Corp., 332 F.3d 854, 869 (5th Cir. 2003).
No
reasonable
or
investor
would
misleading statements.
rely
on
such
obviously
false
Rosenzweig, id.
In order to prevent costly discovery until the court can
determine whether a filed securities fraud suit has merit, with
two rare exceptions the PSLRA instituted an automatic, mandatory
stay of discovery in 15 U.S.C. § 78u-4(b)(3)(B), which provides,
In any private action arising under this
chapter, all discovery and other proceedings
shall be stayed during the pendency of any
motion to dismiss, unless the court finds
upon
the
motion
of
any
party
that
particularized discovery is necessary to
preserve evidence or to prevent undue
prejudice to that party.
See, e.g., Davis v. Duncan Energy Partners, LP, 802 F. Supp. 2d
589 (S.D. Tex. 2011)(Lake J.).
Rule 10b-5's implied private right of action does not
apply to suits against aiders and abettors.
Janus Capital Group,
Inc. v. First Derivative Traders, 564 U.S. 135, 131 S. Ct. 2296,
2302-03 (2011), citing Central Bank of Denver, N.A. v. First
Interstate
Bank
of
Denver,
N.A.,
-31-
511
U.S.
164
(1994),
and
Stoneridge Investment Partners, LLC v. Scientific-Atlanta, Inc.,
552 U.S. 148, 152-53 (2008).
Section 20(a) of the Exchange Act,
15 U.S.C. § 78t, imposes a derivative liability on persons who
control those primarily liable under the Exchange Act and those
who aid and abet them:
Every person who, directly or indirectly,
controls
any
person
liable
under
any
provision of this chapter or 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.
For a violation of § 20(a), a plaintiff must show (1) an
underlying, primary violation of § 10(b) of the Exchange Act and
Rule 10b-5 and (2) direct or indirect control of the violator by
the defendant.
Southland, 365 F.3d at 383-84.
The plaintiff
bears the burden of establishing control, while the defendant
bears the burden of proving a good faith affirmative defense;
therefore, for a prima facie case of control person liability, the
plaintiff
is
not
required
defendant acted in bad faith.
to
plead
facts
showing
that
the
In re Enron Corp. Sec., Derivative
& ERISA Litig., 258 F. Supp. 2d 576, 598 (S.D. Tex. 2003), citing
G.A. Thompson & Co. v. Partridge, 626 F.2d 945, 958 & nn. 22 and
23 (5th Cir. 1981).
Pleading standards for claims for control
person liability are relaxed:
the heightened pleading standards
of Rule 9(b) do not apply, as neither fraud nor scienter is an
element of such a claim.
On Longhorn Land I, LP v. Defendant FF
-32-
Arabian LLC, No. 4:15cv203-RC-CMC, 2015 WL 7432360, at *2 (E.D.
Tex. Nov. 23, 2015).
Moreover in the Fifth Circuit the plaintiff
only has to allege that the defendant possessed the power to
control the primary violator, not that he exercised that power.
In re Enron Corp. Sec., Derivative & ERISA Litig., Civ. A. No. H01-3624, 2004
WL 764664, at *5 (S.D. Tex. Mar. 31, 2004).
Control person liability is derivative:
if a plaintiff
fails to state a claim for a primary violation of section 10(b) or
Rule 10b-5, any claim for control person liability fails.
ABC
Arbitrage, 291 F.3d at 348 n.57; Thomas Lee Hazan, The Law of
Securities Regulation § 13.15 (1990).
B.
FCPA
The FCPA is both a civil and a criminal statute.
Penalties for knowingly violating the FCPA can be civil and
criminal and include monetary penalties and imprisonment.
U.S.C. § 78ff.
15
The U.S. Sentencing Guidelines are used to
determine the criminal penalty range.14
The application of these
14
See David E. Dworsky, Foreign Corrupt Practices Act,
40 Am Crim. L. Rev. 671, 688 (Spring 2009)(footnotes omitted)
describes the punishment for individuals violating the FCPA:
Sentencing for individual who violate the
FCPA’s accounting provisions are determined
under section 2B1.1 of the Guidelines, which
includes fraud sentencing provisions. Factors
that may increase the offense level include
committing a substantial part of a scheme
from
outside
the
United
States
or
substantially jeopardizing the safety and
soundness of a financial institution.
The
FCPA
statutory
provisions
state
that
individuals who willfully violate the FCPA
accounting provisions may be fined up to
$5,000,000 and imprisoned for up to twenty
years.
-33-
Guidelines
will
lower
a
corporate
fine
if
the
corporation
“‘reported the offense to appropriate governmental authorities,
fully cooperated in the investigation, and clearly demonstrated
recognition and affirmative acceptance of its responsibility for
its
criminal
conduct.’”
Mike
Koehler,
The
Facade
of
FCPA
Enforcement, 41 Fed. J. Int’l L. 907, 927 ((Summer 2010), quoting
U.S. Sentencing Guidelines Manual § 8C2.5(g)(2009).
The FCPA, an amendment to the Exchange Act,15 contains
both (1) anti-bribery provisions and (2) auditing and accounting
provisions, the latter comprised of (a) the “books and records”
provision
and
(b)
the
“internal
controls”
provisions.
The
Department of Justice (“DOJ”) and the SEC share enforcement
Bribery
sentences
for
individuals
are
determined under section 2B4.1 of the
Guidelines.
Individuals who willfully
violate the bribery provisions may receive no
more than a $100,000 fine and five years in
prison under the FCPA, although application
of the alternative fines provisions of the
Sentencing Reform Act has resulted in higher
penalties.
For corporations he explains, id. at 688-89,
Sentencing of corporations that have violated
the FCPA is determined under Chapter Eight of
the Guidelines.
Under Chapter Eight, an
effective compliance program will reduce the
culpability score, while the participation of
high-level officials in the illegal action
will raise the culpability score.
Under the Act, the maximum penalty for
corporations for willful violations of the
FCPA accounting provisions is $25,000,000.
The maximum corporate liability for breach of
the anti-bribery provisions is $2,000,000.
15
Pub. L. No. 95-231, 91 Stat. 1495 (1977)(codified as
amended at 15 U.S.C. §§ 78m, 78dd-1 to -3 (2012).
-34-
authority for both.
The anti-bribery provisions are criminally
enforced by the DOJ with criminal penalties over “issuers” (public
companies) and their officers, directors, employees, agents or
stockholders acting on the company’s behalf, while the DOJ also
enforces both criminally and civilly the anti-bribery provisions
over
“domestic
concerns,”
i.e.,
those
including
“(a)
U.S.
citizens, nationals, and residents and (b) U.S. businesses and
their officers directors, employees, agents or stockholders acting
on the domestic concern’s behalf–-and certain foreign persons and
businesses that act in furtherance of an FCPA violation while in
the territory of the United States.”
A Resource Guide to the U.S.
Foreign Corrupt Practices Act, at p.4, put out by the DOJ and the
SEC on November 14, 2012 (“DOJ/SEC Resource Guide”), available at
www.sec.gov/spotlight/fcpa/fcpa-resource-guide.pdf).
responsible for civil enforcement of the FCPA.
The SEC is
Id. at pp. 4-5.
The FCPA controls bribery by (1) prohibiting any U.S.
citizen (individual or corporate) from bribing a foreign official,
15 U.S.C. § 78dd-1; and (2) establishing record-keeping rules for
issuers of securities of publicly held corporations registered
under the Exchange Act, 15 U.S.C. § 78m(b)(2).
The latter (2) is
composed of two categories: (1) the issuers are required to “make
and keep books, records and accounts which, in reasonable detail,16
accurately and fairly reflect the transactions and dispositions of
the issuer,“ §78m(b)(2)(A), and (2) the issuers must “devise and
16
“Reasonable detail is “such level of detail . . . as
would satisfy prudent officials in the conduct of their own
affairs.” § 78m(b)(7).
-35-
maintain a system of internal accounting controls sufficient to
provide reasonable assurances of compliance,” § 78m(b)(2)(B).
“Records” under § 78m(b)(2)(A) include “accounts, correspondence,
memorandums, tapes, discs, papers, books, and other documents or
transcribed information of any type, whether expressed in ordinary
or machine language.”
25 U.S.C. § 78c(a)(37).
There is no
scienter requirement for record-keeping violations under § 13 of
the Exchange Act, 15 U.S.C. § 78m(b)(2).
More specifically, the anti-bribery provisions of the
FCPA, 15 U.S.C. § 78dd-1(a),17 prohibit issuers of registered
17
In whole, § 78dd-1(a)(Prohibition) states,
It shall be unlawful for any issuer which has
a class of securities registered pursuant to
section 78l of this title or which is
required to file reports under section 78o(d)
of this title, or for any officer, director,
employee, or agent of such issuer or any
stockholder thereof action on behalf of such
issuer, to make use of the mails or any means
or instrumentality of interstate commerce
corruptly in furtherance of an offer,
payment, promise to pay, or authorization of
the payment of any money, or offer, gift,
promise to give, or authorization of the
giving of anything of value to-–
(1) any foreign official for purposes of-–
(A)(i) influencing any act or decision
of such foreign official in his official
capacity (ii) inducing such foreign
official to do or omit to do any act in
violation of the lawful duty of such
official, or (iii) securing any improper
advantage; or
(B) inducing such foreign official to
use his influence with a foreign
government or instrumentality thereof to
affect or influence any act or decision
of such government or instrumentality,
-36-
securities from attempting to influence foreign officials by
offering, promising, or giving “anything of value” to a foreign
official to secure “any improper advantage” “in order to assist
that issuer in obtaining or retaining business for or with, or
directing business to, any person,” i.e., in other words bribe a
foreign official to obtain or retain business. 15 U.S.C. §§ 78dd1(a) and 78dd-2(a). See, e.g., Midwestern Teamsters Pension Trust
Fund v. Baker Hughes, Inc., Civ. A. No. H-08-1809, 2009 WL
6799492, at *1 (S.D. Tex. May 7, 2009).
broadly
defined
as
“any
officer
or
A “foreign official” is
employee
of
a
foreign
government or any department, agency, or instrumentality thereof,
or of a public international organization, or any person acting in
an official capacity for or on behalf of any such government or
department, agency or instrumentality, or for or on behalf of any
such public international agency.”
Id. § 78dd-1(f)(1)(A).
From 1977 to 1979 the SEC mainly focused on anti-bribery
provisions of § 78dd-1(a)(1), but subsequently it has focused its
enforcement
section
proceedings
13(b)(2)(A),
violations,
and
on
on
as
the
the
books
amended,
internal
15
and
records
U.S.C.
controls
§
provision,
78m(b)(2)(A)
provisions,
78m(b)(2)(B) that breach the statute’s two requirements:
§
“(1) a
company must keep accurate books and records reflecting the
transactions and dispositions of the assets of the issuer, and (2)
a company must maintain a reliable and adequate system of internal
in order to assist such issuer in obtaining
or retaining business for or with, or
directing business to, any person.
-37-
accounting controls.”
SEC v. World-wide Coin Investments, Ltd.,
567 F. Supp. 724, 748 (N.D. Ga. 1983).
The “books and records”
provision, section 13(b)(2)(A) of the FCPA, provided the SEC with
complete authority over the financial management and reporting
requirements of publicly held United States corporations.
World-
wide Coin, 567 F. Supp. at 746. The FCPA also imposes accounting
controls for companies subject to either the registration or the
reporting provisions of the Exchange Act.
Midwestern Teamsters,
2009 WL 6799492, at *1. Observing that “investors are entitled to
rely
on
the
implicit
representations
that
corporations
will
account for their funds properly and will not channel funds out of
the corporation or omit to include such funds in the accounting
system
so
there
are
no
checks
possible
on
how
much
the
corporation’s funds are being expended in the manner management
later claims,” the Honorable Robert L. Vining quoted Section
13(b)(2) of the FCPA to demonstrate the internal accounting
controls on every issuer having a class of securities registered
pursuant to section 12 of the Exchange Act, id.:
“(a) Make and keep books, records, and
accounts which, in reasonable detail,18
accurately19
and
fairly
reflect
the
transactions and dispositions of the assets
of the issuer; and
18
“Reasonable detail” is defined as “such level of
detail and degree of assurance as would satisfy prudent officials
in the conduct of their own affairs.” 15 U.S.C. § 78m(b)(7).
19
“Accurately” does not mean with exact precision; the
records should “reflect transactions in conformity with generally
accepted accounting principles or other applicable criteria.” S.
Rep. No. 95-114, S. Rep. No. 114, 95th Cong., 1st Sess. 1977, 1977
U.S.C.A.A.N. 4098, 1977 WL 16144 (Leg. Hist.) at 8 (1977)
-38-
(b) Devise and maintain a system of internal
accounting controls sufficient to provide
reasonable assurances that
(i) transactions are being executed with
management’s
general
or
specific
authorization;
(ii) transactions are recorded as
necessary (l) to permit preparation of
financial statements in conformity with
generally
accepted
accounting
principles,
and
(ll)
to
maintain
accountability for assets;
(iii) access to assets is permitted only
in accordance with management’s general
or specific authorization; and
(iv) the recorded accountability for
assets is compared with the existing
assets at reasonable intervals and
appropriate action is taken with respect
to any differences ....
An “issuer’s” books and records for purposes of accounting control
requirements include those of the subsidiaries and affiliates
under its controls, including foreign subsidiaries and joint
ventures.
DOJ/SEC Resource Guide at p. 43.
Section 13(b)(2) of the FCPA and the rules promulgated
under it “are rules of general application which were enacted to
(1) assure that an issuer’s books and records accurately and
fairly reflect its transactions and the disposition of assets, (2)
protect the integrity of the independent audit of issuer financial
statements that are required under the Exchange Act, and (3)
promote the reliability and completeness of financial information
that
issuers
are
required
to
file
-39-
with
the
Commission
or
disseminate to investors pursuant to the Exchange Act.”
World-
wide Coin, 567 F. Supp. at 747.20
In
Litigation,
In
486
re
F.
Nature’s
Supp.
2d
Sunshine
1301
(D.
Products
Utah
Securities
2007),
a
court
recognized for the first time control person liability in the
context of an FCPA enforcement action.
Here the FCPA allegations, which cite ever increasing
enforcement actions by the SEC and the DOJ in recent years, in
Lead Plaintiff’s view serve to show the heightened risk of Key’s
investment and of doing business in Mexico and Russia, as well as
misrepresentations by Defendants, given Key’s repeated statements
that Key fully complied with FCPA provisions, yet its internal
controls were so inadequate as to “underscore[], at minimum, the
gross recklessness with which Defendants misled investors.”
at ¶¶ 5-6.
#37
Lead Plaintiff asserts that ultimately Key revealed
that the SEC was investigating Key for potential FCPA violations
in its Russian operations, with the result that Key’s share price
and the company suffered significant economic loss.
20
Id. at ¶¶ 9-
The rules promulgated under section 13(b)(2) are the
following: Rule 13b2-1 provides “No person shall, directly or
indirectly, falsify or cause to be falsified, any book, record or
account subject to Section 13(b)(2)(A) of the Securities Exchange
Act; and Rule 13b2-2 states, “No director or officer of an issuer
shall, directly or indirectly, (a) make or cause to be made a
materially false or misleading statement or (b) omit to state, or
cause another person to omit to state any material fact necessary
to make statements made, in light of the circumstance under which
such statements were made, not misleading to an accountant in
connection with (1) any audit or examination of the financial
statements of the issuer required to be made pursuant to this
subpart or (2) the preparation or filing of any document or report
required to be filed with the Commission pursuant to this subpart
or otherwise.” World-wide Coin, 567 F. Supp. at 747-47.
-40-
13. The complaint states that because of this SEC’s investigation
of
its
Russian
operations,
“Key
discovered
potential
FCPA
violations in Mexico that required self-disclosure to both the DOJ
and SEC, and that Key recorded a massive impairment to goodwill
and other assets at its Russia reporting unit.”
#37 ¶ 73.
There is no implied private right of action under the
FCPA.
Lamb v. Phillip Morris, Inc., 915 F.2d 1024 (6th Cir.
1990)(relying on Cort v. Ash, 422 U.S. 66, 78 (1975)), cert.
denied, 498 U.S. 1086 (1991); J.S. Service Center Corp. v. Gen.
Elec. Technical Services Co., Inc., 937 F. Supp. 216 (S.D.N.Y.
1996); Lewis on Behalf of Nat. Semiconductor Corp. v. Sporck, 612
F. Supp. 1316 (N.D. Cal. 1985); Scientific Drilling International,
Inc. v. Gyrodata Corp., 215 F.3d 1351 (table of Decisions without
Reported Opinion), Nos. 99-1077, 99-1084, 1999 WL 674511, at *3-4
(Fed. Cir. Aug. 30. 1999)(concluding that “the Fifth Circuit would
likely follow the Sixth Circuit’s decision in Lamb”).
III.
Allegations of the Consolidated Amended Complaint (#37)
With the continuing downturn in its domestic oil and gas
operations, by 15.4% just in 2013, in 2011 Key had begun
a couple
of years earlier aggressively expanding its international business
and subsequently during the Class Period as part of its business
and
growth
advantage
markets,
of
strategies,
Defendants
international
especially
Russia
growth
and
urged
investors
opportunities
Mexico,
even
to
in
though
take
foreign
these
operations involved high risk because of substantial official
corruption, inadequate rule of law, and a lack of transparency in
the accounting/bookkeeping.
-41-
In its 2009 Form 10-K, filed with the SEC on February
26, 2010, Key reported that in the United States in 2009, it had
“1.8 million rig hours and 1.7 million trucking hours, which was
a decrease of 35.2% and 28.2%, respectively, from 2008 activity
levels and 28.1% and 24.8%, respectively from 2007 activity
levels.”
#37, ¶ 14.
At the same time, it reported this decline
as offset by “our expansion into Mexico and Russia during 2009,
and the full year effect of acquisitions completed during 2008.”
Id.
It further stated that it expected Petroleos Mexicanos
(“PEMEX”), Mexico’s state-owned oil company and Key’s biggest
international client, “will maintain their level of workover
activity and that the rigs we have currently operating in Mexico
will be utilized for all of 2010.”
Id.
In its 2010 Form 10-K, filed with the SEC on February
28, 2012, Key emphasized the significance of its international
expansion, pointing out that the revenues for its Well Servicing
segment increased 14% over 2009, attributable to “international
expansion, improved pricing and additional revenues from 2010
acquisitions,
to
our
operations in Mexico due to a decrease in work for [PEMEX].”
#37
at ¶ 36.
offset
by
lower
revenues
attributable
It also stated that in 2009, while revenues in that same
segment fell significantly because of commodity prices and the
financial crisis, “the expansion of our operations in Mexico and
incremental rig hours from our Russian joint venture in 2009"
partially compensated for this downward trend.
Id.
Although there was a slowdown in its Mexican operations
that year, purportedly caused by budget issues at PEMEX, Key still
-42-
predicted continued growth in Mexico in 2011.
#37 at ¶ 37.
In
its 2010 Form 10-K, Key represented that PEMEX had commenced
operations under its 2011 capital budget, and Key’s activity
started to increase from its depressed 2010 levels. Key therefore
stated that it “anticipate[d] strong demand through most of 2011
for our rigs currently deployed in Mexico, primarily in the
Chicontepec region.”
Id.
At the Pritchard Capital Energize Conference in San
Francisco, California on January 4, 2012, Whichard reported,
“Internationally our presence continues to grow. . . . As we exit
Q4, we’ll have 24 rigs operating in Mexico with PEMEX demanding
more equipment.”
#37 at ¶ 38.
In a press release on February 16, 2012, in announcing
its financial results for the fourth quarter and full year of 2011
Key represented that “[t]he strong improvement in international
results in 2011 was driven by higher rig activity in Mexico . . .
“
#37, ¶ 39.
The next day in a conference call for analysts and
investors, Alario bragged of Key’s success in Mexico:
“When we
first entered the Mexico market back in 2007 with three rigs, we
believed then that it could become a 40- to 50 rig market for Key.
I am pleased to report that our activity in Mexico should more
than double in 2012, with at least 40 rigs for the year compared
to an average of 18 rigs in 2011.”
Id.
In its Form 10-K for the year 2011, filed with the SEC
on February 29, 2012, Key indicated, “We generate significant
revenue from our contracts with” PEMEX, and “in Mexico we were
awarded two $90 million contracts for work in the Aceite Terciario
-43-
del Golfo (“ATG”) field. The contracts led us to increase our rig
count in the country during 2011 with additional rigs planned for
the country in 2012, doubling our rig count in the country.”
at ¶ 41.
Id.
In the same document, buttressing its emphasis on the
importance of Key’s expansion into Mexico, Key noted that while
“no
single
customer
accounted
for
more
than
10%
of
our
consolidated revenues” in 2010 or 2011, in the year that “ended
December 31, 2009, [PEMEX] accounted for approximately 11% of our
consolidated revenues. No single customer accounted for more than
10% of our consolidated revenues for the year ended December 31,
2009.”
At the same time, “[r]eceivables outstanding from [PEMEX]
were approximately 10% of our total accounts receivable as of
December 31, 2011. No single customer accounted for more than 10%
of our total accounts receivable as of December 31, 2010. [PEMEX]
accounted for approximately 25% of our total accounts receivable
as of December 31, 2009.
No other customers accounted for more
than 10% of our total accounts receivable as of December 31, 2011
and 2009.”
Id. at ¶ 42.
Whichard again bragged about Key’s Mexican business at
the Raymond James Institutional Investors Conference in Orlando,
Florida on March 6, 2012, representing that “[o]ur international
revenue doubled year-over-year, if you pull Argentina out of the
mix.
And 80% of our increase came from Mexico and increases in
the Middle East as well as Columbia [sic] . . . . PEMEX has a
strong demand for additional workovers.
double our presence there.
They’ve asked us to
We did.” #37 at ¶ 43 (emphasis in the
complaint).
-44-
Key issued a press release on June 26, 2012 announcing
second quarter 2012 financial results:
“The revenue and margin
improvement was driven primarily by higher activity in Mexico.”
#37
at
¶
44
(emphasis
in
complaint).
Alario
stated,
“Internationally, our second quarter results improved considerably
driven primarily by the full deployment of assets in Mexico where
demand for our services continues to grow.”
Id.
In sum, Key represented that its growth was largely
based on positive trends in its Mexico operations and that Mexico
was driving, and was expected to continue driving, its financial
successes.
Despite these optimistic statements, however, the
complaint asserts that Key’s internal controls were not strong,
Defendants’ representations were thus not made in good faith, and
Defendants were grossly reckless in misleading investors.
¶ 45.
#37 at
Indeed, “had Key’s compliance machinery been as developed
and stringent as Defendants represented, it would have been
impossible for Defendants not to know that its success in certain
international markets was, at least in part, the result of rampant
FCPA violations.”
Id.
The substantial increase in recent years in United
States’ regulation and enforcement of the FCPA should have given
Key ample warning of the need for great vigilance in doing
business abroad and for essential internal compliance controls.
For instance, on November 16, 2010, Assistant Attorney General
Lanny A. Brewer admonished at the 24th National Conference on the
FCPA, “FCPA enforcement is stronger than it’s ever been-–and
getting stronger.
We are in an era of FCPA enforcement; and we
-45-
are here to stay.”
#37 at ¶ 57.
The severity of penalties for
violations also “skyrocketed,” and companies worldwide “are now
well aware of the increasingly severe criminal and civil penalties
imposed by the DOJ and SEC in FCPA cases.”
Id. at ¶ 58.
The
risks were highly publicized when Key was expanding further into
international markets. In 2009 in an article in the International
Trade Law21 Journal Veronica Foley & Catina Haynes warned, “As U.S.
Companies move more aggressively into Latin American markets, they
quickly learn bribery is often seen as a normal part of the
business; however, operating with a ‘when in Rome’ mentality can
easily lead to violations of the [FCPA] and associated sanctions’
AND “[a] number of FCPA enforcement actions have recently focused
on
U.S.
business
conduct
in
Brazil,
Venezuela, Mexico and Ecuador.”
Costa
#37, ¶ 60.
Rica,
Argentina,
Iris E. Bennett,
Cross Border Issues-Corruption remains a business risk, National
Law Journal (March 31, 2008), wrote, “Latin America, as a whole,
and certain countries in particular--including those with the
three largest economies, Mexico, Brazil and Argentina--suffer from
entrenched public corruption and weak law enforcement.”
61.
For additional examples see id. ¶62.
corruption similarly proliferated.
67.
#37, ¶
Warnings about Russian
See examples, Id. at ¶¶ 63-
Key paid little attention and continued to portray itself as
well prepared to deal with the notoriously corrupt Russian and
Mexican markets.
21
The FCPA and Its Impacts in Latin America, Int’l Trade
L.J. 27, 27 (Summer 2009).
-46-
Key’s Board of Directors adopted a Code of Business
Conduct (“Code”) with an introductory letter by Alario stating
that all Key employees “must commit to always acting lawfully,
ethically and with integrity,: and summarizes, “Do the right thing
without exception.”
#37, ¶¶ 94-95.
The Code “applies to the
Company and its subsidiaries and affiliates[,] . . . including all
business units in all of our offices and locations around the
world[, but] [a]ll employees and officers in the business units
are expected to be familiar with the Code and apply it in the
daily performance of their work-related responsibilities.”
95.
Id. ¶
An Ethics Committee (composed of representatives from the
Company’s Internal Audit, Legal, Human Resources, and Operations
departments) and the Board of Directors’ Audit Committee monitor
and oversee compliance with “applicable laws and regulations.”
Id. ¶ 96.
The Code especially highlights the Audit Committee’s
oversight role:
The Audit Committee . . . shall have
oversight of the administration of the Code
and responsibility for the Ethics and
Compliance program within the Company.
Significant or material events related to the
Company’s Ethics & Compliance program shall
be reported immediately to the chair of the
Audit Committee. At least once a year, the
Ethics Committee or Director-Internal Audit
shall report to the Audit Committee regarding
the Company’s Ethics & Compliance program
activities, and of the occurrence of all
significant events relating to the Code.
Id.
The Code instructs Key employees about limitations on gifts
given to governmental officials (“In the U.S., an employee may not
give gifts of more than nominal value ($100.00) to an actual or
prospective customer, supplier, or contractor of the Company, or
-47-
any governmental official, in an attempt to establish dealings
with the Company providing such gifts, without written approval of
the employee’s supervisor.”), and admonishes they must “[n]ot
offer bribes or accept kickbacks from our suppliers, contractors,
or customers for any reason.”
#37 ¶ 97.
It also informs
employees that the FCPA “prohibits payments to foreign officials
for the purpose of obtaining or keeping business” and that under
the FCPA “a ‘foreign official’ is any officer or employee of an
instrumentality of a foreign government, including state-owned or
controlled energy companies, such as Petroleos Mexicanos, SA
(‘PEMEX’), as well as political officers and candidates for
political office.
Further description and examples, as well as
instructions for proper transaction of business inside the U.S.
are found on-line in the Company’s FCPA Compliance Manual.”
#39
¶ 98.
Key’s Foreign Corrupt Practices Act Compliance Manual
(“FCPA Compliance Manual”), effective June 6, 2008, also contains
an introductory letter signed by Alario:
It is our policy that the Company, as well as
each
person
or
entity
acting
as
a
representative or advisor to the Company,
shall fully comply with all applicable
provisions of the FCPA. Employees, officer,
directors, agents, and representative who
transact
business
for
the
Company
internationally are expected to understand
and comply with the provisions in this
Compliance Manual, to avoid inadvertent
violations, and to recognize potential issues
in time for them to be appropriately
addressed.
#37 ¶ 99.
The Manual is
and “FCPA Procedures.”
divided into two parts:
#37 ¶ 100.
-48-
“FCPA Policy”
The policy of Key and its subsidiaries and affiliates is
that
“the
Company
and
each
person
or
entity
acting
as
a
representative or advisor to the Company shall fully comply with
all applicable provisions of the [FCPA]” and prohibits “use of
Company funds or assets for any unlawful, improper or unethical
purpose,” noting that any “[i]mproper gifts, payments or offerings
of anything of value to foreign officials could jeopardize the
growth and reputation of the Company, and will not be tolerated.”
#37 ¶ 101.
The FCPA Compliance Manual governs “all financial
record-keeping activities to which Key is subject by virtue of the
federal and state securities laws, including the U.S. Securities
and [sic] Exchange Act of 1934.”
#37 ¶ 102.
The FCPA describes the responsibilities of different
parties as follows:
Employees.
All Company employees who are
involved in any way in transactions in
foreign countries, or who work temporarily
outside the United States, as well as all
employees located in the corporate offices in
Midland and Houston, Texas, are required to
read and comply with the FCPA Compliance
Manual. All international employees who are
authorized to expend funds on behalf of the
Company (not assigned in field positions) are
required to read and comply with the FCPA
Compliance Manual.
Third Parties. Agents and representatives of
the Company who are involved in any way in
transactions in foreign countries, or who
work outside the United States are required
to read and comply with the FCPA Compliance
Manual.
Accounting Department,
The Accounting
Department
shall
maintain
accounting
procedures to ensure that no false or
misleading entry is made in the Company’s
books and records for any reason.
The
-49-
Accounting Department should also maintain
financial reporting and controls to prevent
FCPA violations.
Audit Department.
The Internal Audit
Department, in conjunction with the FCPA
Compliance Officer, will develop an annual
FCPA plan, as approved by the Audit
Committee. Internal Audit will implement the
audit plan and also perform other random
compliance audits as may be requested from
time to time by management, the Audit
Committee or the FCPA Compliance Officer.
FCPA Compliance Officer.
Appointed by the
Company’s
General
Counsel,
the
FCPA
Compliance Officer will be responsible for
the FCPA Compliance Manual, implementing and
monitoring the Company’s FCPA compliance
program, including compliance certifications,
and providing training to employees and third
parties concerning the FCPA.
The FCPA
Compliance
officer
[sic]
shall
also
investigate and approve the employment of all
foreign agents, any gifts or entertainment
with foreign officials, and the commencement
of significant business operations outside
the United States.
The FCPA Compliance
Officer
shall
also
investigate
any
allegations of misconduct.
#37 ¶ 103.
Key’s FCPA Policy emphasized, “If the situation
warrants a token gift of other than nominal value, the employee
must consult with the FCPA Compliance Officer prior to offering
such a gift.
The approval of the FCPA Compliance Officer is
required to ensure that the gift is consistent with the FCPA, and
that the gift is lawful, customary, and necessary to the conduct
of business in the country where it is made. . . . Employment of
a foreign agent, commencement of significant business operations
outside the United States, gifts, or entertainment of a foreign
official must all be approved in advance by the FCPA Compliance
officer.”
#37 ¶ 104.
-50-
Last of all, the FCPA Policy “recognizes and emphasizes
the
importance
of
anti-corruption
training
component of an FCPA compliance program.
as
an
essential
To that end, Key will
provide FCPA Anti-corruption training, both in person and through
web-based programs, periodically at times to be determined by the
Company’s General Counsel.” #37 ¶ 105. Any employee who violates
the FCPA or the Company’s FCPA Policy “will be disciplined and may
be terminated.
termination.”
In
Intentional violations of the FCPA will result in
Id.
the
second
half
of
the
FCPA
Compliance
Manual
regarding procedures, the broad definitions of “foreign official”
and “anything of value,” including with respect to third parties,
as well as the need for due diligence and investigation of the
“reputation, beneficial ownership, professional capability and
experience, financial standing and credibility” and history of
compliance of any prospective Representative and any acquisitions
and joint ventures, are set out
require
Key’s
Accounting
#37 ¶¶ 106-110.
Department
to
be
The procedures
responsible
for
maintaining and enforcing Key’s accounting and record keeping
policies and Key’s Internal Audit Department with auditing Key’s
compliance with policies state in the Compliance Manual and
related policies and procedures constituting its internal control
system.
system
#37 ¶ 111.
of
internal
The procedures require Key to “maintain a
account
controls
sufficient
to
reasonable assurances” that
a. transactions are executed in accordance
with
management’s
general
or
specific
authorization; b. transactions are recorded
-51-
provide
as necessary: (i) to permit preparation of
financial statements in conformity with
generally accepted accounting principles
(“GAAP”) or any other criteria applicable to
such statements; and (ii) to maintain
accountability for assets; c. transactions
are recorded in the books in accordance and
compliance with GAAP, as well as applicable
laws and regulations; d. access to Key assets
is
permitted
only
in
accordance
with
management’s
general
or
specific
authorization;
and
e.
the
recorded
accountability for corporate assets is
compared
with
the
existing
assets
at
reasonable intervals and appropriate action
is taken with respect to any differences.
#37 ¶ 112.
The procedures require “[m]onitoring and auditing
systems” in place to detect policy violations and review personnel
records of those who deal with governmental officials or who
submit financial data that affect Key’s financial statements or
reports.
#37 at ¶ 113.
Similarly Key’s Audit Department must
conduct FCPA audits based on an annual FCPA audit plant and must
“interview persons responsible for administering, implementing and
monitoring Key’s compliance program.”
Id.
The complaint asserts that given these accounting and
controls were supposedly in place at Key through its Code of
Business Conduct and its FCPA Compliance manual, any illegal
payments made regarding its Russian or Mexican operations or
engagement of any agent, sponsor or third party in connection with
any non-U.S. business could not have been made without the
knowledge and approval of Key’s senior management.
In addition the government has provided companies with
clear guidelines on designing and implementing an effective FCPA
-52-
program, including the DOJ/SEC Resource Guide and the Federal
Sentencing Guidelines.
The Consolidated Amended Complaint charges that although
Key had compliance programs that looked strong on paper, in
actuality Key did not have an effective
program in effect and therefore
compliance or training
“created an atmosphere in which
violations of laws and regulations and the Company’s own internal
policies were ignored” and there were “rampant FCPA violations.”
#37 ¶ 133.
Key did not properly staff its compliance department
nor establish effective internal controls and internal audit
departments.
Id.
Either Defendants knew or should have known
that Key’s internal controls were nonexistent or they recklessly
disregarded the controls in place.
Id.
The Consolidated Amended Complaint alleges that six,
unidentified confidential witnesses (“CWs”) have come forward to
testify against Key with regard to its illusory compliance program
and its actual FCPA violations.
#37 at pp. 1-2. CW2, a Senior
Internal Auditor at Key from May 2012 through July 2012, who had
worked at several other large public companies and had substantial
experience conducting audits both domestically and abroad, even in
countries known for having corrupt business cultures,22 expressed
surprise at the absence of internal controls and compliance
efforts at Key:
“A lot of things were not taken care of . . .
22
#37 at pp. 1-2 states that CW2 “has specific
experience with Sarbanes-Oxley and FCPA compliance reviews,” and
he “reported to William Tobey, Director of Internal Audit, who
also reported to defendant Whichard, Key’s CFO, and then defendant
Dodson, who replaced defendant Whichard as CFO.”
-53-
.[Key doesn’t have a robust internal control function at all.”
#37 ¶¶ 134-35. (emphasis in the complaint).
CW6, a Corporate Auditor at Key from May 2011 through
May 2013,23 and who assisted in fraud investigations and expense
reimbursement
reviews,
agreed:
“Internal
controls
are
non-
existent . . . There’s no support from the CEO or the CFO for
[that] type of work.”
Id.
He further stated, “I don’t think
internal audit [at Key] ever audited internationally.”
135.
Id. at ¶
He also stated that in some international operations it did
not have procedures in place to decide how vendors were chosen and
vetted and who approved their invoices. Id. The complaint quotes
him:
“You should have in your risk assessment process, done by
someone in management, identifying that FCPA is an issue in x,y,z
countries. . . . And then you have to audit [those countries] this
frequently--once a year, twice a year[, b]ut no, that was not
existent [at Key].”
Id.
CW2 agreed with CW6's comments:
“There
is really not a structure in place that would provide a compliance
function. . . . I never saw a single person mention compliance [at
Key].”
Id.
at ¶ 136.
He stated that the internal audit
department was “completely dysfunctional,” with a high turnover of
employees and unqualified staff.
Id.
When asked about Key’s
compliance department, CW6 could not remember its having one.
Both CWs observed that it was problematic that the head of the
23
The complaint states that CW6 in his position as
Corporate Auditor headed operation and business process audits,
and “was also responsible for conducting control tests to confirm
that the Company complied with internal controls over financial
reporting.” #37 at p.2.
-54-
internal audit department reported directly to the CFO, when it
should report to the Board of Directors’ Audit Committee.
Id.
CW6 revealed that internal auditors were sent to Mexico
several times in 2012 and 2013 to learn what kinds of control
processes needed to be implemented in such local operations as
payroll, purchasing, etc., but that the auditors did not perform
any audits of potential FCPA violations because they were not
asked to do so.
#37 ¶ 137.
CW6 also complained that “a lack of
response” from senior executives in Mexico obstructed the auditing
team’s ability to finish its job and compromised the audit’s
independence.
Id.
CW2 thought that if Key had focused its
internal audits on such critical financial processes, instead of
on safety, it would have uncovered improper activity that was
overlooked, such as Key’s Board of Directors’ request in 2012 for
an internal audit of the use of company credit cards.
Id.
An
audit conducted in 2012 uncovered widespread misuse of these for
personal expenses which CW6 substantiated.
Id.
The complaint
further asserts that the “confidential witnesses substantiated
that Key’s operations in Mexico were hampered by accounting
irregularities,” but does not identify any particular accounting
irregularities.
#37 at ¶ 167.
In addition, CW2 informed Plaintiffs that CW3, after
observing unusual numbers in the accounting records of Key’s
Mexican operations, informed CW2 that millions of dollars of
accruals were listed on these accounting records without being
cleared for much longer than the 30-day limits, indeed for over 90
or 180 days, when nothing was booked as an actual sale or payment
-55-
CW3 was told not to speak to Lead Plaintiff through his attorney.
#37 at ¶ 138.
CW424 reported that in January 2014, Defendant Wilson
informed
him
that
Key
had
abruptly
and
without
explanation
terminated its Senior Vice President of International, Global
Business Development and Technology (“SVP International”) and that
CW4 would be reporting to another Senior Vice President.
#37 a ¶
139.
When the SEC began its investigation of Key’s possible
FCPA violations in Mexico and Russia, the Board of Directors asked
CW5 to speak with the SEC and the law firm that Key hired to
conduct
an
internal
investigation.
Contrary
to
Key’s
representations that in pursuing a joint venture by acquiring a
drilling
company
named
Geostream
in
Russia,
Key
was
moving
cautiously and following the FCPA and its own policies and
procedures, while aligning them with Geostream’s, Key suddenly
24
The complaint states at p. 2 that CW4
worked at Key as a Senior Director, Global
Marketplace Performance Improvement, from
April 2012 to July 2014.
Prior to that
position, CW4 was Senior Director, West Coast
Marketplace Business Development at Key from
August 2009 to March 2012.
As Senior
Director, Global Marketplace Performance
Improvement, CW4 worked in a leadership role
for the Company’s strategic, enterprise-wide
business development initiatives.
In that
role, CW4 reported to: Guillermo Capacho,
Senior Vice President of International,
Global Business Development and Technology;
Kim
Clarke,
Senior
Vice
President
of
Administration; and Jeff Skelly, Senior Vice
President of Rig Services and Operations
Support.
-56-
purchased an initial 50% interest in Geostream in two investments
in 2008 and 2009, and then the remaining 50% on April 9, 2013,
without performing sufficient due diligences to satisfy the SEC.
#37 ¶ 141.
CW2 commented, “Due diligence was done, but it wasn’t
as thorough as it should have been” and did not provide a clear
picture of Geostream’s operations.
that
there
was
concern
about
#37 ¶ 143.
liability
He further noted
because
before
Key
purchased the remaining 50%, since Key had almost no access to
Geostream’s books; he characterized the final acquisition as “very
messy,” with “no visibility on what was going on there” since
“[i]nternal
audit
wasn’t
even
allowed
into
the
[Geostream]
building” and “[t]here were no internal audits conducted ever.”
Id.
Colleagues in Key’s Accounting Group told CW2, “Nobody could
tell how the deal was structured or where documents came from.”
Id.
The robust internal controls that Defendants touted to
investors did not exist.
CW1,25 a former Vice President of International Human
Resources at Key from 2010 to October 2013, revealed that once Key
owned
100%
of
Geostream,
Geostream’s
employees
became
25
Key’s
The complaint at p. 2 states about CW1, first employed
by Key in 2008, that his
responsibilities
included
created
and
managing the Company’s human resources
infrastructure
(including
policies
and
procedures,
compensation,
benefits,
recruitment,
talent
management,
and
leadership development), both domestically
and internationally. This CW reported to Kim
Clarke,
Senior
Vice
President
of
Administration, and Guillermo Capacho, Senior
Vice president of International, Global
Business Development and Technology.
-57-
employees, and Geostream’s CEO and other senior executives left
Geostream as the result of pressure from Key, which wanted
complete control over Geostream’s operations.
#37 ¶ 142.
After the acquisition was completed, Key allegedly
learned that Geostream’s structure and finances were far more
complicated than Key had expected.
Geostream held offshore shell
companies, among which it made transfers of ownership from one
business to the next.
#37 ¶ 144.
CW2 asserted that Geostream had
“16 companies under the Russian umbrella,” and that “[o]bviously
the FCPA was really foreign to them. . . . They have a different
kind of mentality there.”
Id.
Given Russia’s reputation for
corruption, the complaint asserts that Key was reckless at best
and that the lack of oversight obscured whether Geostream’s
employees were violating the FCPA.
Id.
Key had already acquired 100% of Geostream, which it
characterized as its primary growth strategy in Russia.
On
February 15, 2013, Alario stated in a conference call with
investors and analysts, “Russia is the second-largest oil well
inventory market in the world. So there’s great reason for Key to
be in that market.
And we’re being very, very patient, as we
learn about it and as we get better at convincing a small, select
group of customers that this highly reliable equipment that we
have over there is a better way to go.”
#37 ¶ 146.
In an October
31, 2013 conference call, Alario stated, “We believe that we can
more effectively grow in . . . Russia operating the business []
ourselves.”
#37 ¶ 145.
-58-
On May 16, 2014, when Key filed its Form 10-Q for the
quarterly period ending March 31, 2014, revealing that the SEC was
investigating Key’s operations in Russia, the market first learned
of possible FCPA violations by Key.
#37 ¶ 145-46.
Nor was the
Russian revelation of Key’s corrupt culture unique according to
the complaint.
Key gradually began to reveal problems in its
Mexican operations when on January 6, 2014 it disclosed in a press
release that PEMEX was auditing $372 million worth of Key’s
billings, resulting in Key’s having to take a charge of $2-3
million in 4Q 2013.
#137 ¶ 147.26
On February 13, 2014, Key
issued another press release, revealing that in connection with
these PEMEX audits Key had taken an even larger $3.2 million pretax charge.
Id.
Yet Key continued to be positive about its
future in Mexico. In a conference call about earnings on February
12, 2014, Alario acknowledged problems caused by PEMEX’s budget
disputes, but indicated that Key would obtain “mega tenders” and
26
Defendants object that just because the January 2014
audit resulted in Key’s taking a $3.2 million pre-tax charge does
not mean that something Defendants said in 2012 was false at that
time.
#49 at p. 23.
Moreover, the audit involved Key’s
“aggregate billings of $372 million under its contracts awarded by
PEMEX to Key’s Mexican subsidiary in 2008 and 2009" (Ex. 14, Jan.
6, 2014 Press Release at 1), which included aggregate billings
back to 2008, outside of the Class Period, so there is no reason
to infer that the charge even related to billings during the class
period. Id., n.17. Such “fraud-by-hindsight” is insufficient to
show that defendants knew beforehand what they did not disclose
until later. Lormand, 565 F.3d at 254; In re Alamosa Holdings,
Inc., 382 F. Supp. 2d 832, 866 (N.D. Tex. 2005)(“Fraud by
hindsight is not an actionable claim under the securities laws.”).
There is no basis to infer that the pre-tax charge, which
constituted less that 1% of the $372 million of billings audited,
resulted from overbillings or that Alario and Wilson knew of such
overbillings at the time they made their statements.
Thus
Plaintiff fails to plead an actionable misrepresentation based on
the PEMEX audit, insist Defendants.
-59-
“incentivized contracts” from PEMEX in the future and enjoy
continued success in the south of Mexico.
#137 ¶ 148.
On June 4, 2014, Key filed another 8-K, which disclosed,
“In
April
2014,
the
Company
became
aware
of
an
allegation
involving Key’s Mexico operations that, if true, could potentially
constitute a violation of certain Company policies, including our
Code of Business Conduct, the U.S. Foreign Corrupt Practices Act
(FCPA) and other applicable laws.”
#37 at ¶ 149.
It further
stated that it had “conducted an initial investigation of this
matter and the Board of Directors of the Company has formed a
special
committee
of
independent
directors
to
oversee
investigation” of these and “any other resulting matters.”
the
Id.
It also indicated that on May 30, 2013 Key had voluntarily made
known
the
allegation
and
information
from
its
initial
investigation to the SEC and the DOJ and that fines, criminal
penalties and/or sanctions relating to the alleged FCPA violations
could be imposed on Key.
Id.
Even though Key had not disclosed to the public any of
the reports on the FCPA investigation, the news of possible
violations impacted its financial status. #37 ¶ 150. On July 17,
2014 in a press release, Key divulged that (1) it expected “to
record a $30-35 million pre-tax charge for goodwill27 and other
27
In their motion to dismiss (#49 at p.8 n.2, citations
omitted), Defendants explain,
When the purchase price of a company or an
asset . . . exceeds the book value of its
assets, the difference is recorded as
goodwill, an intangible asset that is not
amortized or depreciated. . . . ([In other
-60-
assets impairments related to its operations in Russia”; (2) it
had incurred pre-tax expenses in the amount of $5 million related
to the FCPA investigations; and (3) after accounting for the $3035 million charge, Key expected to report a loss for the quarter
in the range of $0.35 to $0.38 per share.
Id.
Key filed its Form
10-Q for the quarterly period ending September 20, 2014 and
revealed that in addition to Mexico and Russia, the special
committee’s investigations now “include[d] a review of certain
aspects of the Company’s operations in Colombia.”
#37 at ¶ 151.
The complaint asserts that Defendants’ failure to use the FCPA
controls and compliance measures it claimed to have in place,
would
have
affirmative
prevented
defense;
these
instead
violations
its
failure
or
to
allowed
Key
maintain
an
these
practices “severely degraded the value of Key’s common stock.”
#37 ¶ 152.
words, goodwill is] the
“excess of the
purchase price over its book value,” which is
an
“intangible
asset
for
accounting
purposes”). . . . “Goodwill must ‘be tested
for impairment at least annually using a twostep process that begins with an estimation
of the fair value of a reporting unit. The
first step is a screen for potential
impairment, and the second step measures the
amount of impairment, if any.” . . . . Key
tested its Russian reporting unit every year
from 2010 to 2013 and consistently found that
the fair value of the unit exceeded the
carrying value. . . . June 2014 is the first
time that Key found that impairment had
occurred and calculated a corresponding
charge. Notably, Plaintiff does not allege
that Key was required to take an impairment
charge any sooner than it did.
-61-
In sum, Defendants’ representations throughout the Class
Period
that
Key
strictly
complied
with
the
highest
ethical
standards and complied with all applicable laws and regulations,
including the FCPA, were materially incomplete and/or false in
light of their failure to disclose inter alia “(a) the full
magnitude and consequences of the Company’s FCPA violations; (b)
that the Company’s compliance function and internal controls were
woefully inadequate or not strictly adhered to; and (c) that
violations of Key’s internal controls and corporate policy were
ignored.”
#37 at ¶ 154.
Key’s Compliance Manual and its Code of
Business Conduct contained false and misleading statements from
the beginning of the class period.
The Consolidated Amended Complaint then details a number
of other material and purportedly misleading disclosures made
during the Class Period. For example, on September 4, 2012 at the
Barclays Capital CEO Power Energy Conference in New York, Alario
represented that “the core of our story is our business with
PEMEX. . . . I don’t think there’s a better example of value
delivered by a service company to a customer than Key’s value to
PEMEX.”
#37 ¶ 160.
He also emphasized that PEMEX entrusted Key
to perform some of PEMEX’s riskiest work and “I think [that]
proves that PEMEX has got confidence in Key,” while he was leading
investors to believe that this confidence would provide future
opportunities to do business with PEMEX.
Id.
The complaint
asserts that the statements in ¶¶ 159-161 were materially false
and
misleading
because
“Defendants
-62-
failed
to
disclose
that
revenues from PEMEX were overstated due to overbilling and that
the Company’s production was in decline.”
#37 at ¶ 162.28
Regarding Key’s operations in Russia and its at-thattime 50% interest in Geostream, Alario represented that its
investment in Russia was small but “potentially a good solid
market,” explaining,
We’re trying to prove a new business plan
there on the back of the idea that reliable
equipment is more valuable to our customers
than some of the equipment that they have
over there in country [sic].
It’s taking
longer than we hoped.
But I can tell you
that over the course of the last couple of
quarters, we’ve convinced more customers than
we had in the past that’s the right business
model and, as a result, our fortunes in
Russia have improved.
#37 at ¶ 161.
The complaint asserts that these statements about
Russia and Mexico are materially false and misleading because
Alario did not disclose that Key’s growth strategy in both
countries was substantially due to or directly attributable to
conduct that violated the FCPA. See also allegations of Alario at
the December 4, 2012 Dahlman Rose & Co. Ultimate Oil Services and
E&P Conference in New York City, id, at ¶¶ 170, 172, reporting a
28
The complaint asserts similar allegations by Defendant
Wilson during a November 1, 2012 earnings call. #37 ¶ 168.
Defendants object that such statements by them are
“generalized, optimistic statements and expressions of opinion
that courts consistently have held to be inactionable puffery.”
#49 at p. 23, citing Southland, 365 F.3d at 372. Even if they
were statements of facts, there are no facts alleged that support
the claim that the statements were false when made, that Key
actually overbilled PEMEX in 2012, no less that Key’s top
officials, or anyone else at Key, knew about the alleged
overbilling at the time.
Nor does the complaint allege facts
showing that Defendants knew of any concealed decline in Key’s
production from PEMEX that year.
-63-
1% increase is share price for Key common stock to close at $6.82
on December 4, 2012, ¶ 171; allegations of a press release
announcing financial results for 4Q and FY 2012, ¶ 173, reporting
a share price increase of over 6% from $8.82 on February 14, 2013
to a closing price of $9.38 on February 15, 2013, ¶ 175; February
15, 2012
Alario’s
conference call with analysts and investors, ¶ 174;
statements
at
the
March
5,
2013
Raymond
James
Institutional Investors Conference, #37 ¶¶ 182-183; Alario’s
statements at the June 26, 2012 Global Hunter Securities GHS 100
Conference, #37 ¶¶ 191-192; the July 26, 2013 conference call in
connection with its earnings report for 2Q 2013, #37 ¶¶ 193-194
and
197-98,
resulting
in
Key’s
share
price
increasing
approximately 2% from a closing price of $6.69 on July 25, 2013 to
a closing price of $6.82 on July 26, 2013, ¶ 195; statements by
Alario and Wilson during an October 31, 2013 conference call in
connection with Key’s quarterly earnings report, #37 ¶¶ 199-202,
causing an almost 4% increase in Key’s share price from a closing
price of $7.53 on October 30, 2012
to a closing price of $7.82 on
October 31, 2013; the third quarter 2013 Form 10-Q filed with the
SEC on November 1, 2013, #37 ¶ 203.
On October 2, 2012 at the Johnson Rice Energy Conference
in New Orleans, Louisiana, Whichard bragged that Key’s “business
has doubled in Mexico year-over-year,” “we’re adding other assets
into
that
market,
such
as
coil,
wireline,
premium
rental
equipment, and PEMEX is calling on us to add more and more
equipment to their market.”
He claimed that he expected Key’s
success to continue, that Key was seeking business opportunities
-64-
not only with PEMEX but with other multinational companies, “so
we’re broadening our customer base” in Mexico and looking at
opportunities in regions in Mexico beyond Chicontepec area, known
as the ATG field.
The complaint maintains that Whichard’s
statements were materially false and misleading because he did not
disclose that Key’s rapid growth and future prospects in Mexico
were largely due or directly related to its violations of the
FCPA, that Key’s internal controls were knowingly or recklessly
inadequate, as discussed previously.
Alario and Whichard allegedly filed a 3Q 2012 Form with
certifications that were false and misleading under the SarbanesOxley Act of 2002 (“SOX Certifications,” which the complaint
quotes in full without specifying which statements Lead Plaintiff
considers
false
or
misleading
and
29
why)29
because
Alario
and
Section 304 of the Sarbanes-Oxley Act, 15 U.S.C. §
7241(a), requires the CEOs and CFOs of publicly traded companies
to certify quarterly and annually as to the accuracy of their SEC
filings and effectiveness of their internal control over financial
reporting. Shaw Group, 537 F.3d at
It does not create a private
right of action, “‘but establishes that the SEC may sue the CEO
and CFO of a company when the company has been required to restate
its earnings due to noncompliance with securities laws.’” SEC v.
Baker, No. A-12-CA-285-SS, 2012 WL 5499497, at *2 (W.D. Tex. Nov.
13, 2012), quoting Pirelli Armstrong Tire Corp. Retiree Med.
Benefits Trust ex rel. Fed. Nat’l Mortg. Ass’n v. Raines, 534 F.3d
779, 793 (D.C. Cir. 2008). It also “‘requires CEOs and CFOs to
reimburse their company for any bonus or similar compensation, or
any profits realized from the sale of company stock, for the 12month period following a false financial report if the company is
required to prepare an accounting restatement due to material
noncompliance of the [company] as a result of misconduct.’”).
Id., citing Cohen v. Viray, 622 F.3d 188, 193 (2d Cir. 2010).
The Court notes that in Shaw Group, approving and
relying on Garfield v. NDC Health Corp., 466 F.3d 1255, 1266 (11th
Cir. 2006), the Fifth Circuit concluded that “a Sarbanes-Oxley
certification, standing alone, is not indicative of scienter.”
537 F.3d at 545. It agreed with the Eleventh Circuit that there
must be “‘facts establishing that the officer who signed the
-65-
Whichard were aware and/or recklessly disregarded the weaknesses
of Key’s internal controls that were not disclosed to investors
and which “were so woefully inadequate that it made Defendants’
public representations regarding them false and misleading.”
#37
at ¶¶ 165-167 at pp. 60-62.
In the Form 10K report filed on February 25, 2012, #37
¶¶ 177-181, Key purportedly made numerous false and misleading
statements. Key reported, “Revenues for our international segment
increase $134.2 million, or 67.4%, to $333.3 million in the year
ended December 31, 2012,” an increase “primarily attributable to
certification had a ‘reason to know or should have suspected, due
to the present of glaring accounting irregularities or other ‘red
flags,’ that the financial statements contained material
misstatements or omissions.’” Id., citing id.
To hold otherwise would mean that “scienter
would be established in every case where there
was an accounting error or auditing mistake
made by a publicly traded company, thereby
eviscerating the pleading requirements set
forth in the PSLRA. . . . Instead, the court
held that “a Sarbanes-Oxley certification is
only probative of scienter if the person
signing
the
certification
was
severely
reckless in certifying the accuracy of the
financial statements.”
There must be, in
other words, facts establishing that the
officer who signed the certification had “a
reason to know, or should have suspected, due
to the presence of glaring accounting
irregularities or other ‘red flags,’ that the
financial
statements
contained
material
misstatements or omissions.”
Id. at 545 (citations to Garfield omitted). Lead Plaintiff has
not provided facts showing “glaring accounting irregularities or
other ’red flags’” that would imply that the certifier(s) had
“reason to know or should have suspected” that “the financial
statements contained material misstatements or omissions,” also
never identified, regarding any of the certifications referenced
in the complaint.
-66-
increased activity in Mexico.” #37 ¶ 178. In its yearly goodwill
impairment analysis in the 10-K, Key reported that the goodwill
for its Russian unit at the end of 2012 was approximately $24.6
million and the fair value of these assets exceeded the carrying
value by 17.8%, while Key did not record any asset impairments in
that year.
Id. ¶ 179.
These statements were false, according to
the complaint, because Key’s violations of the FCPA significantly
impacted its revenue growth in these markets, while the statements
falsely
implied
that
business activities.
Key
had
adequate
Key’s
was
based
on
legitimate
These statements also falsely implied that
internal
procedures, in place.
success
controls,
compliance
policies
and
Id. ¶ 180-181. The Form 10-K had Sarbanes-
Oxley certifications signed by Alario and Whichard stating that
the information was accurate and all material changes to Key’s
internal controls over financial reporting were disclosed.
Id. ¶
181.
In a press release on April 25, 2013, filed the next day
with the SEC on Form 8-K, Key announced its financial results for
IQ
2013
and
revealed
that
PEMEX
had
significantly
reduced
activities in Mexico, resulting in an adverse impact on Key’s
share price, which dropped nearly 17% from a closing price of
$7.09 on April 25, 2013 to a closing price of $5.90 on April 26,
2013.
#37 ¶¶ 184-186.
In the same release Key stated that it
intended to expand operations in Russia, again not revealing that
its growth strategy was largely based on conduct that violated the
FCPA and the erroneous impression it had created that it had
adequate internal controls in place.
-67-
Id.
¶ 187.
Also, on May 3, 2013 Key filed its 1Q 2013 on Form 10-Q,
stating that its revenue from its international business had
declined because of PEMEX’s slowdown, but that its overall revenue
for that period increased by $20.6 million, or 33.3%, compared to
$82.4 million in 1Q 2012, “primarily attributable to increased
activity in Mexico” and also the purchase of the remaining 50%
interest in Geostream.
#7 ¶ 188.
These statements were also
false and misleading because Defendants did not reveal the impact
of Key’s conduct violating the FCPA that increased its revenue in
these markets and because it did not have adequate internal
controls in place, but implied the increase was due to legitimate
business activities.
Id. ¶ 189.
In 2014 there were growing losses in the price of Key’s
common stock as negative news about Key’s international business
operations gradually overwhelmed the positive. In a January 6,
2014 press release, filed the next day on Form 8-K, Key disclosed
that PEMEX was auditing $372 million of Key’s billings under its
contracts with PEMEX and that Key would take a charge of between
$2-3 million in 4Q 2013.
#37 ¶¶ 204, 206.
Even though Defendants
did not disclose its violations of the FCPA or its lack of
effective internal controls, Key’s share price dropped over 3%
from its closing price of $7.83 on January 6, 014 to $7.55 the
next day.
On
February
13,
2014
Key
issued
a
press
release
announcing its 4Q and full year 2013 financial results, which
included
quarterly
International
million, down 14.5% sequentially.
-68-
segment
revenues
#37 at ¶ 207.
of
$38.1
Despite the
loss, in a conference call the next day Alario remained upbeat
about Key’s future success in Mexico and Russia. #37 ¶¶ 208, 210.
Key’s share price increased more than 2%, rising from a closing
price of $7.81 on February 13, 2014 to $8.00 on February 14, 2014.
Id. ¶ 209.
Key’s 2013 Form 10-K, filed on February 25, 2014, warned
that Key’s “failure to comply with the [FCPA] and similar laws may
have a negative impact on our ongoing operations,” and “We could
be subject to sanctions and civil and criminal prosecution as well
as fines and penalties in the event of a find of violation of the
FCPA or similar laws by us or any of our employees,”
but also
reported the value of its goodwill in its Russian reporting unit
was around $23 million, with the fair value of these assets
exceeding the carrying value by 86%, statements that the complaint
asserts were false and misleading for the reasons discussed
previously. #37 ¶¶ 212-213. The document included Sarbanes-Oxley
certifications signed by Alario and Dodson.
Id. ¶ 214.
On April 30, 2014 Key issued a press release, filed with
the SEC the next day on Form 8-K, announcing that in the first
quarter of year 2014 its International revenues were down 15.7%
sequentially, to $32.1 million.
#37 ¶ 215.
In a conference call
on May 1, 2014, Alario stated about Key’s business in Mexico,
“We’ve reached the point where we’re willing to say that our
International business has essentially reached bottom. Mexico has
clearly been a drag on this segment.”
#37 ¶ 216.
Yet he also
expressed confidence that Key would turn the situation around:
“In Mexico we’ve also recently seen a number of opportunities from
-69-
integrated service companies under these incentive contracts, and
some of those are under negotiation now.
And hopefully, those
will, as you indicate, will [sic] get started sooner rather than
later.”
Id.
Alario did not discuss the violations of the FCPA
nor Key’s lack of adequate internal controls, but nevertheless,
the share price of Key’s common stock dropped from a closing price
of $10.04 on April 30, 2014 to a closing price of $9.14 on May 1,
2014.
Id. ¶¶ 217-218.
Finally on May 6, 2014 in its Quarterly Report of 1Q
2014 on Form 10-Q, with certifications signed by Alario and Dodson
stating that the information was accurate, Key disclosed for the
first time that it was being investigated by the SEC for possible
FCPA violations in its Russian operations.
#37 ¶ 219.
Between
May 7 and May 9, 2014 Key’s common stock share price dropped $.64,
i.e., more than 7%.
Id. ¶ 220.
On June 4, 2014 Key filed an 8-K
disclosing that it had become aware of additional potential FCPA
violations.
Id. ¶ 222.
On July 17, 2014, as indicated earlier,
Key announced in a press release providing updated guidance for 2Q
2014 that it expected a $30-35 million pre-tax charge for goodwill
and other assets impairments related to its operations in Russia,
that it had incurred approximately $5 million in pre-tax expenses
relating to the FCPA investigations, and that it expected to
report an additional loss for the quarter of between $0.35 to
$0.38 per share.
#37 ¶ 223.
The price of a share of Key common
stock dropped 16% to $1.34 per share to close at $7.03 on July 18,
2014.
Id.
-70-
On July 21, 2014, investment bank Imperial Capital
downgraded Key to In-Line from Outperform and lowered its price
target for shares to $7.50 from $10.50.
Two days later brokerage
firm Wunderlich Securities repeated a “Hold” rating on Key and
stated, “Overall it’s clear that Key is struggling even as the
domestic services market is showing overall improvement and while
it has been able to reduce debt nicely, we remain Hold rated given
the company-specific headwinds facing KEG.”
#37 ¶ 225.
To demonstrate scienter, the complaint, asserting that
at the end of the Class Period Key’s revelations first of FCPA
violations in its Mexican operations, then less than a month later
of possible violations involving its Russian operations, and
on
November 3, 2014 of investigations of its Colombia operations,30
contends that violations of the FCPA could not have occurred “in
so many different markets without the knowledge, complicity and/or
acquiescence of personnel at the highest level of the Company.”
#37 at ¶ 227. Collectively, “Lead Plaintiff’s allegations support
a strong inference of fraudulent intent on the part of Defendants”
or, at minimum, “the strong inference that Defendants’ conduct was
highly unreasonable and an extreme departure from standards of
ordinary care.”
Id.
If Key’s much touted internal controls were
working properly, its senior management would have been aware of
these FCPA violations before they materialized.
were
not
aware
of
the
violations
30
If Defendants
beforehand,
the
SEC
Defendants point out that ¶ 151 of the complaint’s
allegations that Key’s internal investigations “include[d] a
review of certain aspects of the Company’s operations in Colombia”
occurred after the Class Period and are not relevant.
-71-
investigations would have made them aware of potential violations
in Mexico and Colombia after the SEC’s increased scrutiny of Key’s
Russian operations for FCPA violations.
Id. at ¶ 228.
The complaint asserts that by virtue of their positions
at Key, Individual Defendant had access to undisclosed adverse
information about Key, its business, operations, finances, and
present and future business prospects.
They had access to such
information through internal corporate documents, conversations,
connections with other corporate officers, traders, marketing
experts,
attendance
at
management
and
Board
of
Directors’
meetings, etc. Thus, the complaint claims, “it is appropriate to
treat Individual Defendants as a group for pleading purposes and
to presume that the materially false, misleading and incomplete
information
conveyed
in
the
Company’s
public
filings,
press
releases, and public statements . . . was the result of the
collective actions of the Individual Officers identified above.”
#37 ¶ 252.
Moreover, “[a]s officers and controlling persons of a
publicly held company whose common stock was, and is, registered
with the SEC pursuant to the Exchange Act, traded on the NYSE, and
governed by the provisions of the federal securities laws, the
Individual Defendants each had a duty to promptly disseminate
accurate and truthful information . . . and to correct any
previously issued statements that had become materially misleading
or untrue, so that the market price of the Company’s publicly
traded securities would be based upon truthful and accurate
information” about Key.
#37 ¶ 254.
-72-
Moreover their positions
allowed them to control the substance of the SEC filings, press
releases, and other public statements about Key during the Class
Period.
#37 ¶ 255.
They were each given copies of the allegedly
misleading documents before or shortly after their issuance and
had the ability to prevent their issuance or correct them before
their release.
Id.
They are each liable as a participant in a
scheme, plan or course of conduct that operated as a fraud and
deceit on Class Period purchasers of Key’s securities. #37 ¶ 256.
Lead Plaintiff alleges that plaintiffs are entitled to
a presumption of reliance based on the fraud on the market
doctrine.
Because the Court does not yet address the issue of
class certification, it does not otherwise summarize allegations
relating to it.
IV.
Motions to Dismiss (#37 and 50)
The Court will address the arguments in the two motions
together, noting that Whichard has joined in that of the other
Defendants.
Defendants observe that Plaintiffs have identified four
broad categories of allegedly false and misleading statements
during the Class Period that it claims violated Section 10(b) and
Rule 10b-5:
(1) statements in the Company’s Code of Business
Conduct and FCPA Compliance Manual; (2) statements about Key’s
business in Mexico and Russia that purportedly omitted disclosing
that Key’s growth and growth strategy largely resulted because of
FCPA violations; (3) statements allegedly falsely portraying Key’s
business
in
Mexico;
and
(4)
statements
-73-
in
certifications
accompanying Key’s SEC filings that purportedly omitted internal
control deficiencies and FCPA violations at Key.
#49 at p. 10.
Furthermore Defendants assert that because the allegations in the
controlling complaint were not made based on Plaintiff’s personal
knowledge, they are based on information and belief, triggering
the PSLRA requirements that Plaintiff must plead sufficient facts
with particularity to support its claims that the statements were
false when made. ABC Arbitrage, 291 F.3d at 351.
Defendants
first
contend
that
Plaintiffs’
Amended
Complaint fails to allege falsity with the requisite particularity
under the PSLRA.
Defendants never represented that there would
never be an FCPA problem, but instead warned investors of the
risks of a FCPA violation and that the Company’s statutory FCPA
compliance depended on its compliance program and the efforts of
its employees, agents, affiliates and business partners to follow
it.
While Plaintiffs claim that statements in Key’s Code of
Business
Conduct
and
FCPA
Compliance
31
Manual31
were
material
As examples Defendants list the following: (1) the
Code establishes “high standards of ethics and legal behavior for
all employees and officers”; (2) the FCPA “prohibits payments to
foreign officials for the purpose of obtaining or keeping
business”; (3) “It is our policy that the Company, as well as each
person or entity acting as a representative or advisor to the
Company, shall fully comply with all applicable provisions of the
FCPA”; and (4) “Improper gifts, payments or offerings of anything
of value to foreign officials could jeopardize the growth and
reputation of the Company, and will not be tolerated.”). #37, ¶¶
94-99.
The complaint asserts such statements were false and
misleading because Defendants, at the time the statements were
made, were aware of and/or recklessly disregarded material
weaknesses in Key’s internal controls that were not disclosed to
the investing public.”
#37, ¶¶ 156, 158.
Very similar
allegations were rejected in City of Rockton Retirement System v.
-74-
misrepresentations and omissions, Defendants point out that courts
have recognized that statements in such documents are immaterial
puffery, not the kind of statements on which reasonable investors
rely.
See, e.g., In re Franklin Bank Corp. SEC. Litig., 782 F.
Supp. 2d 364, 381 (S.D. Tex. 2011)(“Allegations that amount to
little more than corporate ‘cheerleading’ are puffery, projections
of future performance not worded as guarantees, and are not
actionable under federal securities law because no reasonable
investor would consider such vague statements material and because
analysts are too sophisticated to rely on vague expressions of
optimism rather than specific fact.”), aff’d sub nom. Harold
Roucher Trust U/A DTD 9/21/72 v. Nocella, 464 Fed. Appx. 334 (5th
Cir. Mar. 14, 2012).
Thus “generalized positive statements about
a company’s progress” will not impose liability, and “statements
that are predictive in nature are actionable only if they were
false when made.”
Id.
See, e.g., also Nathenson v. Polycom,
Inc., No. 13-cv-3476 SC, 2015 WL 1517777, at *6 (N.D. Cal. Apr. 3,
2015)(rejecting claim based on code of conduct because “the
standards contained therein are inherently aspirational and hence
immaterial” and “[n]o reasonable investor would have construed
Avon Products, Inc., No. 11-cv-4665 PGG, 2014 WL 4832321, at *16
(S.D.N.Y. Sept. 29, 2014)(“Here, a reasonable investor would not
rely on the statements discussed above as a guarantee that Avon
would, in fact, maintain a heightened standard of legal and
ethical compliance. The aforementioned statements from the Ethics
Codes and the Corporate Responsibility Reports offer no assurance
that Avon’s compliance efforts will be successful, and do not
suggest that Avon’s compliance systems give the Company a
competitive advantage over other companies. . . . Instead, these
statements merely set forth standards in generalized terms that
Avon hoped its employees would adhere to. Such statements are not
material.”).
-75-
[the
statements]
as
not
just
an
aspirational
statement
of
intention, but a warranty that [the defendant was] compliant”).
Furthermore the complaint fails to allege any facts demonstrating
that anything in the Code and the Manual was false.
The complaint contains allegations from six purported
“confidential witnesses” (“CWs”), but the sum of their allegations
is that Key’s FCPA controls were adequate, not even close to
constituting particularized allegations showing that the Code or
Manual or something Individual Defendants said was false at the
time.
See, e.g., In re Intelligroup SEC. Litig., 527 F, Supp. 2d
262, 359-61 (D.N.J. 2007)(holding that “personal opinions void of
specific details regarding the basis [for the CW’s] personal
knowledge” add nothing to falsity or scienter); Zucco Partners,
LLC v. Digimarc Corp., 445 F. Supp. 2d 1201, 1208 (D. Or.
2006)(“[A] shared opinion among confidential witnesses does not
necessarily indicate either falsity or a strong inference of
scienter if the allegations themselves are not specific enough.”),
(quoting In re Metawave Communications Corp. Sec. Litig., 298 F.
Supp. 2d 1056, 1070 (W.D. Wash. 2003)), aff’d, 552 F.3d 981 (9th
Cir. Jan. 12,2009), as amended (Feb. 10, 2009). Specifically none
of the CWs (1) “alleges that an FCPA violation actually occurred,”
(2) “alleges that he ever reported his concerns about FCPA
controls to Key’s FCPA Compliance Officer, as required by Key’s
[FCPA] Manual” (Ex. 22),32 and (3) “allegedly ever communicated his
32
The Manual requires all employees to sign a
Certificate of Compliance that contains the following statement:
“I AGREE TO PROMPTLY CALL THE FCPA COMPLIANCE OFFICER AND PROVIDE
A WRITTEN REPORT TO THE FCPA COMPLIANCE OFFICER FULLY DESCRIBING
-76-
concerns, directly or even indirectly, to any of the Individual
Defendants--none
claims
to
have
told
any
of
the
Individual
Defendants of any problems with FCPA controls, nor did any author
any memos or see any reports decrying the state of FCPA controls
directed to Individual Defendants.”
#49 at pp. 25-26.
While the
Amended Complaint relies heavily on the allegations of CWs, they
are merely opinions that Key’s internal controls were inadequate.
Case law standardly finds such opinions add nothing to scienter
analysis.
There are no allegations that three of the four
Individual Defendants (Alario, Whichard, and Dodson) had any
communications with the CWS.33
(holding
that
confidential
See Avon, 2014 WL 4832321 at *32
witnesses’
statements
about
the
efficacy of the company’s FCPA compliance program (e.g., “Avon did
not even have an independent compliance function prior to 2009";
“by 2010 Avon still had not implemented key aspects of an FCPA
compliance program”; “Avon’s compliance efforts prior to 2009, if
any, would have been conducted by attorneys with no specialized
computer experience”; “Avon lacked the type of compliance programs
ANY CIRCUMSTANCES OF WHICH I AM AWARE THAT APPEAR TO BE IN
VIOLATION OR A POTENTIAL VIOLATION.” Ex. 22 at p. 22.
33
The only contact or communication of a CW with an
Individual Defendant was in January 2014, when CW4 reported
receiving a call from Defendant Wilson about the termination of
Key’s Senior Vice President International, Global Business
Development & Technology (“SVP International”), to whom CW4
reported. CW4 purportedly claimed that Wilson said, “you can’t
ask me any questions as to why, but [SVP International] is no
longer with the company and you will be reporting to [another
Senior Vice President].” Complaint, #37 ¶ 139. Defendants note
that the significance of this fact is unclear from the pleading
and Wilson’s comment does not demonstrate anything fraudulent on
its face or show Wilson had scienter regarding any statement that
the complaint alleges was false when he made it.
-77-
that would be expected of a company of Avon’s size.”) were
insufficient to demonstrate scienter without allegations that
their concerns were raised or otherwise communicated, such that
the individual defendants “would have reason to know that the
compliance programs in place were inadequate to detect FCPA
violations”), citing In re Gentiva SEC. Litig., 932 F. Supp. 352,
378 (E.D.N.Y. 2013)(“[T]he Court must assess whether there are
allegations that the CWs were privy to the Individual Defendants’
knowledge of or access to contemporaneous information that would
show that their representations were false.”), citing In re
Citigroup
SEC.
Litig.,
753
F.
Supp.
2d
206,
245
(S.D.N.Y.
2010)(“Fatal to plaintiffs claims . . . is that they do not allege
with specificity that any of the confidential witnesses relied
upon in the Complaint presented information to the individual
defendants.”).
Furthermore
because
of
the
absence
of
particularized pleading that the statements in Key’s Code or
Manual were false when made, all claims based on Key’s Code or
Manual must be dismissed.34
34
In a footnote, Defendants provide three more reasons
why the statements in the Code and Manual are not actionable under
Section 10(b) and Rule 10b-5. First, they are merely confirmatory
because they were in place years ago (the Manual came out in June
2008, the Code in April 2009) and the Fifth Circuit long ago held
that statements confirmatory of prior statements cannot be the
basis of securities fraud claims. See Greenberg v. Crossroads
Sys., Inc., 364 F.3d 657, 665-66 (5th Cir. 2004)(explaining that
“confirmatory information has already been digested by the market
and will not cause a change in stock price.
Because the
presumption of reliance is based upon actual movement of the stock
price, confirmatory information cannot be the basis for a fraudon-the-market claim.”). Second, the statements would be barred by
the five-year statute of repose for Rule 10b-5 claims. Hall v.
Variable Annuity Life Ins. Co., 727 F.3d 372, 375 n.4 (5th Cir.
2013), citing 28 U.S.C. § 1658(b)(“[A] private right of action
-78-
Defendants contend that Plaintiffs fail to allege that
all but two of the general statements challenged by Plaintiffs
falsely reported any facts about Key’s operations in Mexico or
Russia or mischaracterized Key’s view of its prospects there.35
Defendants maintain that the assertion that the statements were
materially false and misleading because Key did not reveal that
the growth in these countries was actually driven by Key’s
violations of the FCPA fails to state a claim because Plaintiffs
failed to allege particularized facts showing that FCPA violations
actually
occurred
or
were
the
cause
investigation is not a violation.
of
Key’s
growth.
An
See In re China Valves Tech.
Sec. Litig., 11 CIV 0796 LAK, 2012 WL 4039852, at *8 (S.D.N.Y.
Sept. 12, 2012)(without facts showing an FCPA violation, “the
alleged omission of potential FCPA liability is insufficient in
its present form”); Meyer v. Greene, 710 F.3d 1189, 1201 (11th Cir.
2012)(“The announcement of an [SEC] investigation reveals just
that--an
investigation--and
nothing
more.”);
Avon,
2014
WL
that involves a claim of fraud . . . may be brought not later than
the earlier of--(1) 2 years after discovery of the facts
constituting the violation; or (2) 5 years after such
violation.”). Hall explains, id. at n.5, “‘While § 1658(b)’s 2year deadline is a statute of limitation, its 5-year deadline is
a statute of repose that completely ‘eliminate[s] the underlying
right[] when [it] lapses[s]. See Margolies v. Deason, 464 F.3d
547, 551 (5th Cir. 2006).’”
Third, the Code and Manual “are
classic examples of corporate documents with no attributed author,
and, as such, run afoul of the Fifth Circuit’s clear prohibition
on group pleading.” #49, at p. 18 n,8.
35
Defendants also note that “the vast
challenged statements were precisely the kind of
optimistic, and forward-looking statements and
opinion that courts consistently have held to
puffery.” #49, p. 20 n.13.
-79-
majority of the
generalized,
expressions of
be inactionable
4832321, at *23 (“[T]he existence of an investigation alone is not
sufficient to give rise to a requisite cogent and compelling
inference of scienter.”). Plaintiffs also fail to plead any facts
showing that there were FCPA violations, no less that they were
responsible for or an integral part of Key’s growth in Mexico and
Russia and that they generated any revenue for Key.
Furthermore, Defendants insist that Plaintiffs failed to
raise a strong inference of scienter.
There are no allegations
suggesting that Defendants had any motive to commit securities
fraud or that Defendants sold stock during the Class Period or at
unusual times and at unusual prices, or that Key used its stock to
purchase
other
companies.
Nor
do
Plaintiffs
provide
particularized allegations that anything said by any Individual
Defendant was known to be false by the Individual speaking at the
time he spoke.
Finally Plaintiffs assert that because Key and
the SEC were investigating possible FCPA violations, such FCPA
violations must have occurred and Individual Defendants must have
known about them at the time statements issued.
Here, too, such
scienter-by-inference arguments have been standardly rejected by
the
courts.
Defendants
further
allegations contradict each other:
note
that
the
complaint’s
it alleges that Key falsely
represented that its internal FCPA controls were strong when the
opposite was true, but contemporaneously alleges that Individual
Defendants must have known of the FCPA violations because a
functional FCPA compliance system would have alerted those up the
corporate
ladder
of
such
FCPA
violations.
Instead,
argue
Defendants, the complaint gives rise to a much stronger inference
-80-
that to the extent Key had FCPA problems, Individual Defendants
were not aware of them.
Last, the complaint fails to allege loss causation,
i.e., that the alleged misrepresentations caused inflation of the
price of Key’s common stock. Defendants insist that the two stock
price drops that occurred after Key revealed the “truth” about its
business in Russia and Mexico were not the result of corrective
disclosures
because
(1)
as
a
matter
of
law,
FCPA-related
investigations are not, by themselves, corrective disclosures
(Pub. Employees’ Retirement Sys. of Miss. v. Amedisys, Inc., 769
F.3d
313,
323
(5th
Cir.
2014)(“[C]ommencement
of
government
investigations on suspected fraud do not, standing alone, amount
to a corrective disclosure.”))36; and (2) the break between the
disclosures
and
the
purported
fraudulent
misrepresentations
precludes a finding that the disclosures were corrective in
nature.37
Simply alleging that Plaintiffs purchased Key’s common
stock at inflated prices and that the stock price fell after
negative news of the Company’s finances and operations came out is
insufficient to plead loss causation.
Lormand, 565 F.3d at 256.
36
In accord, Meyer, 720 F.3d at 1201 (“[T]he
commencement of an SEC investigation, without more, is
insufficient to constitute a corrective disclosure for purposes of
§ 10(b).”).
37
“A plaintiff must prove that the misstatements--not
‘other intervening causes such as ‘changed circumstances, changed
investor expectations, new industry-specific or firm-specific
facts, conditions, or other events’--were the cause of her
economic injury, unaided by any presumptions attending efforts to
prove transaction causation.”
Ludlow v. BP, PLC, 800 F.3d 674,
682 (5th Cir. 2015), petition for cert filed, No. 15-952 (Jan. 25,
2016).
-81-
Rather Plaintiffs must make a plausible showing of loss causation
that when “the ‘relevant truth’ about the fraud began to leak out
or otherwise make its way into the marketplace it caused the price
of the stock to depreciate and thereby proximately cause the
plaintiff’s economic loss.”
Id. at 255.38
Plaintiffs must allege
that the stock price declined in response to a “corrective
disclosure,” i.e., a statement demonstrating that “truth made its
way into the marketplace,” i.e., “the truth obscured by the
fraudulent statements.”
Alaska Elec. Pension Fund v. Flowserve
Corp., 572 F.3d 221, 229 (5th Cir. 2009).
Instead, here there is
a complete disconnect between the alleged fraud and the two
disclosures that precipitated the stock price drops, i.e., the
$.64 drop between May 7 and May 9 2014 after Key disclosed the
investigation for possible FCPA violations in Russia, and (2)the
$1.34 drop following Key’s July 17, 2014 disclosure that it would
take the pre-tax charge off associated with the writedown of
goodwill from the Geostream acquisition in Russia. #37 at ¶¶ 21920; 222-23.
The disclosures about the FCPA investigations into
Key’s operations in Russia and Mexico are entirely disconnected
from the alleged misrepresentation in the complaint, so the
statements are not corrective disclosures and the complaint must
be dismissed for failure to plead loss causation.
38
There must be sufficient allegations that there was
a
causal
connection
between
the
defendant’s
material
misrepresentation and the plaintiff’s economic loss, e.g., that
the market had a negative reaction to the corrective disclosure
that revealed the falsity of the defendant’s representation. Dura
Pharmaceuticals, Inc. v. Broudo, 544 U.S. 336 (2005).
-82-
Backing up the complaint’s allegations with documentary
evidence, Defendants maintain that Key was open and transparent
about its business operations in Mexico, including about the
significance of its relationship with PEMEX. Among its reports to
the SEC Key identified its reliance on PEMEX as a “Risk Factor” in
its Form 10-K in 2009.39
Ex. 2, Feb. 26, 2010 Form 10-K at 15.
When PEMEX’s budget was reduced, Key’s operations in Mexico were
also reduced in 2010.
32.
Ex. 3, Feb. 25, 2011 Form 10-K at 26-27,
In contrast Key significantly increased its activity in
Mexico and generated “significant revenue for contracts with the
Mexican national oil company” in 2011.
Id. at 6.
In September
2012 at a conference Alario spoke of PEMEX as the “core” of Key’s
Mexican business.
In 2012 Key’s business in Mexico was not as
good as the previous year, as Key reported, Ex. 6, Feb. 14, 2013
Press Release at 2, but Key was optimistic that it would rebound
because it did in 2011 from the similar earlier downturn.
Feb. 15, 2013 Earnings Call, Tr. at 2.
Ex. 7,
Key observed that it
needed to “diversify the type of work we do, who we do it for and
where we do it” to free its business in Mexico from the up and
down cycles of PEMEX,
Id. at 4.
Nevertheless in April 2013, Key
reported a 13% decrease in revenue due mainly to the “lower-thananticipated activity in Mexico,” as PEMEX reduced its spending in
the North region because it had spent its 2013 budget by the end
of 2012, including the ATG asset where Key mainly worked, into
November 2013.
Ex. 8, Apr. 26, 2012 Earnings Call Tr. at 2-3; Ex.
39
Defendants have attached copies of all SEC Forms they
reference to their motion to dismiss.
-83-
9, Nov. 1, 2012 Form 10-Q at 34, 36, 38-39.
transferring
its
operations
to
other
regions,
dependence on PEMEX’s North Region budget.
So Key began
loosening
its
Key disclosed on
January 6, 2014 that it expected to take a charge of between $2
and $3 million in the fourth quarter of 2012 with an audit of its
billings under its contracts with PEMEX.
Press Release at 1.
Ex. 14, Jan. 6, 2014
See footnote 26 of this Opinion and Order.
The alleged misrepresentations are generic, forwardlooking statements concerning Key’s overall business in Russia and
Mexico or mere puffery about Key’s internal controls. None of the
statements
is
a
guarantee
that
the
FCPA
investigations
or
violations would never occur in relation to Key’s operations in
these area, nor that Key’s internal controls were foolproof.
Furthermore statements about the materialization of risks that the
Company has previously disclosed and warned against are not
corrective disclosures.
Key contends that Russia was never a central focus of
its international growth strategy, but “a small market for Key”
according to Alario.
Ex. 7, Feb. 15, 2013 Earnings Call Tr. at 9.
Basically Key’s operations were comprised of an ownership in
Geostream, in which it gradually obtained first a 26% interest,
then 50% in March 2009, and finally 100% on May 3, 2013.
Key
reported satisfactory progress in the region until political
instability began threatening its operations in 2014.
In July of
that year Key revealed that it expected “to record a $30 million
to $35 million pre-tax charge for goodwill and other asset
impairments related to its operations in Russia.”
-84-
Ex. 18, July
17, 2014 Press Release at 1.
Key notes that it tested its Russian
reporting annually from 2010 to 2013 and found that the fair value
of the unit exceeded its carrying value until June 2014, when Key
found that an impairment had occurred and calculated the relevant
charge.
Ex. 3, Feb. 25, 2011 Form 10-K at 45, 80; Ex. 4, Feb. 29,
2012 Form 10-K at 46; Ex. 5, Feb. 25, 2013 Form 10-K at 41; Ex. 1,
Feb. 25, 2014 Form 10-K at 41; #49 at 8 n. 2.
Key emphasizes that
Plaintiff does not allege that Key was required to take an
impairment charge earlier than it did.
Key
argues
that
throughout
the
Class
Period
it
repeatedly disclosed FCPA compliance problems as a primary risk
factor
in
conducting
international
operations
that
could
negatively impact its business. See, e.g., Ex. 5, Feb. 25, 2013
Form 10-K at 16; Ex. 1, Feb. 25, 2014 Form 10-K at 17.
It adopted
its Code of Business Conduct and its FCPA Compliance Manual to
instruct employees about their obligations under the FCPA and
established procedures to be followed, but it never guaranteed
that these efforts would prevent any or all violations.
When
investigations into possible FCPA violations were initiated 2014,
first in Russia and then in Mexico, Key disclosed them in SEC
filings, it stated that it hired independent outside counsel to
address these investigations, and it self-reported to the SEC and
DOJ.
In a July 17, 2014 it also disclosed that it incurred
approximately $5 million in costs relating to the investigations.
Ex. 18, July 17, 2014 Press Release at 1.
As for the Sarbanes-Oxley Act certifications signed by
Alario and Whichard, attached to Key’s SEC filings during the
-85-
Class Period, which the complaint at ¶¶ 166-167 asserts were
materially false and misleading because Alario and Whichard “were
at the time aware of and/or recklessly disregarded material
weaknesses in Key’s internal controls that were not disclosed to
the investment public,” Defendants maintain that the allegation
confuses financial reporting controls in the Sarbanes-Oxley
certifications with the anti-corruption policies or controls
designed to ensure FCPA compliance.
See In re Invision Techs.
Inc. Sec. Litig., No. C-04-3181 MJJ, 2006 WL 538752, at *6 & n.2
(N.D. Cal. Jan 24, 2006)(rejecting allegation that purported lack
of FCPA-related controls rendered [Sarbanes-Oxley] certifications
false and misleading). Nor are there any particular facts alleged
to
show
that
Alario
and
certifying was not true.
Whichard
knew
that
what
they
were
City of Roseville Employees’ Retirement
System v. Horizon Lines, Inc.,
686 F. Supp. 2d 404, 420 (D.C.
Del. 2009)(“The Act . . . does not mandate officers certify that
their company’s reports are completely devoid of any misleading
statements or omissions.
Of course, this is not a license for
executives to simply bury their head in the sand, but it does mean
that they can only certify the truthfulness of their reports based
on the information they know, or of which they should reasonably
have been aware, at the time.”); Shaw Group, Inc., 537 F.3d at 545
(“There must be, in other words, facts establishing that the
officer who signed the certification had a ‘reason to know, or
should have suspected, due to the presence of glaring accounting
irregularities or other ‘red flags,’ that the financial statements
contained material misstatements or omissions.”). Plaintiffs have
-86-
failed to allege facts demonstrating that at the time Alario and
Whichard signed the certifications, Alario and Whichard knew of or
recklessly disregarded any weaknesses in Key’s internal controls,
so Plaintiffs’ certification claim must fail.
Nor do Plaintiffs
plead particularized facts giving rise to a strong inference of
scienter, that they knew what they were certifying was untrue.
City of Roseville, 686 F. Supp. 2d at 420 (“[Sarbanes-Oxley] does
not mandate officers certify that their company’s reports are
completely devoid of any misleading statements or omissions.
Officers are not guarantors of
their truth.
Instead, they must
certify that they personally have no knowledge of such misleading
statements and omissions.
Of course this is not a license for
executives to simply bury their heads in the sand, but it does
mean they can only certify the truthfulness of their reports based
on the information they know, or of which they should reasonably
have been aware, at the time.”).40
Indeed, Defendants highlight the fact that Plaintiffs
fail
to
allege
any
motive
for
Defendants’
alleged
misrepresentations, neither insider trading nor personal gain.
There is no allegation that any Defendant sold stock and/or
profited from the alleged fraud during the Class Period, thus
undermining any inference of scienter.
40
Nathenson, 267 F.3d at
See, e.g., In re Franklin Bank Corp. Sec. Litig., 782
F. Supp. 2d 364, 378 (S.D. Tex. 2011)(“To infer scienter from
[Sarbanes-Oxley] certifications, there must be facts establishing
that the officer who signed the certification had a “reason to
know, or should have suspected, due to the presence of glaring
accounting irregularities or other ‘red flags,’ that the financial
statements contained material misstatements or omissions.”),
citing Shaw Groups, 537 F.3d at 545.
-87-
410, 421 (“‘The fact that other defendants did not sell their
shares during the relevant class period undermines plaintiffs’
claim that defendants delayed notifying the public ‘so that they
could sell their stock at a huge profit.’”), quoting Acito v.
IMCERA Grp., Inc., 47 F.3d 47, 54 (2d Cir. 1995).
“Where . . .
the plaintiff has not alleged a clear motive for the alleged
misstatements or omissions, the strength of its circumstantial
evidence
of
scienter
must
be
correspondingly
greater.”
R2
Investments LDC v. Phillips, 401 F.3d 638, 644 (5th Cir. 2005); in
accord Tuchman v. DSC Comm’ns Corp., 14 F.3d 1061, 1068 (5th Cir.
1994). That circumstantial evidence must be very specific, e.g.,
that a specific individual knew a specific statement was false at
the time it was made, or naming specific documents, including
author, recipient, date, and contents;
allegations of unnamed
documents or regular reports that Individual Defendants received
by virtue of their positions will not suffice.
at
432
(“The
plaintiffs’
allegations
internal reports are also inadequate.
Abrams, 292 F.3d
regarding
non-specific
An unsupported general
claim about the existence of confidential corporate reports that
reveal information contrary to reported accounts is insufficient
to survive a motion to dismiss.
Such allegations must have
corroborating details regarding the contents of allegedly contrary
reports, their authors, and recipients.”).
Similarly allegations
of weaknesses in internal controls or even actual accounting
violations
are
insufficient
defendants knew about them.
without
facts
showing
The complaint fails here:
-88-
that
the
there are
no allegations that any Individual Defendant acted with scienter
in making any particular statement.
Finally, contend Defendants, because Plaintiffs have
failed to state a primary violation of § 10(b) and Rule 10b-5,
their derivative control person claims under section 20(a) must
also be dismissed.
Shaw, 537 F.3d at 545.
Whichard’s separate motion to dismiss (#50) alleges
additional grounds for dismissal of claims solely against him.
The only allegations about him are the following:
(1) Whichard
served as Key‘s CFO from March 2009 until he retired in March
2013;
(2)
Whichard
allegedly
made
false
statements
when
he
discussed Key’s international growth at the Johnson Rice energy
Conference in Orlando Florida on October 2, 2012, full transcript
attached
as
Ex.
A41;
and
(3)
Whichard
signed
certifications
required by the Sarbanes-Oxley Act on November 7, 2012 for Key’s
third quarter 2012 filing, and on February 25, 2013 for Key’s 2012
annual report.
The complaint also alleges that Whichard made
misleading statements in Key’s 2012 Form 10-K. The complaint does
not assert any particularized facts, does not assert any facts
showing
that
Whichard
knew
of
any
violations
of
the
FCPA,
participated in any FCPA violations or benefitted from any alleged
FCPA violations.
It does not allege facts showing the he knew or
was reckless in not knowing of any misstatements in any of Key’s
41
The complaint also states that he attended two other
conferences (the Pritchard Capital Energize Conference in San
Francisco, California on January 4, 2012 and the Raymond James
Institutional Investors Conference in Orlando, Florida on March 6,
2012), but does not allege that he made any misstatements at them.
-89-
financial reporting nor that Key had to restate any financial
information while Whichard was CFO. Nor does the complaint allege
that any of the CWs communicated with Whichard about issues in
this
action.
Finally
the
complaint
does
not
provide
particularized facts that create a cogent and compelling inference
that Whichard committed securities fraud. Thus the claims against
him should be dismissed.
The complaint alleges that at the Johnson Rice Energy
Conference he made two false or misleading statements relating to
Mexico, but it misquotes them (#37 ¶ 163).
Whichard states them
in full, as evidenced by th transcript, Ex. A:
Our business has doubled in Mexico year-overyear.
And in addition to doubling of our
service rig business, we’re adding other
assets into that market, such as coil,
wireline, premium rental equipments, and
PEMEX is calling on us to add more and more
equipment into their market. (Ex. A at 3)
****************
And just focusing on international briefly, I
mentioned the growth that we’re seeing in
Mexico.
We expect it to continue.
Our
business
opportunities
are
with
PEMEX
obviously,
but
also
with
other
large
multinational companies, so we’re building
our customer base, as it were, in Mexico.
We’re looking at opportunities in other
regions of Mexico outside of the Chicontepec
areas, referred by them as the ATG field.
(Ex. A at 4)
Whichard points out that the complaint does not claim that any of
these statements is false, but only that Whichard failed to reveal
that “Key’s ‘rapid growth’ and ‘future prospects’ in Mexico were
largely attributable to or directly related to conduct that
violated the FCPA.”
#37 ¶ 164.
-90-
Whichard emphasizes that the
complaint does not provide any particularized facts showing that
(1) there was any conduct in Mexico that violated the FCPA; (2) if
there were, that Whichard was aware of it at the time he made
these statements; and (3) that the purported FCPA violation would
have rendered any of these statements misleading.
As for the certifications, which are identical in all
material respects, the complaint asserts that “Alario and Whichard
were at the time aware of and/or recklessly disregarded material
weaknesses in Key’s internal controls that were not disclosed to
the investing public.”
#37 ¶ 167.
The complaint does not
identify which of the provisions in those certifications were
allegedly false or misleading nor provide particularized facts to
support the claim.
Nor does it provide particularized facts to
show that when he signed the certifications, Whichard was aware of
any “material weaknesses” in Key’s internal controls.
“Material
weakness” in a company’s internal controls is a term of art in
accounting
that
means
“a
deficiency,
or
a
combination
of
deficiencies, in internal control over financial reporting, such
that
there
is
a
reasonable
possibility
that
a
material
misstatement of the registrant’s annual or interim financial
statements will not be prevented or detected on a timely basis.”
17 C.F.R. § 240.12b-2.
There are no facts alleged showing that
Whichard had actual knowledge of any material weakness in Key’s
internal controls over financial reporting, nor allegations that
any CW told him of any material weaknesses in internal controls.
The Sarbanes-Oxley certifications refer to “internal control over
financial reporting”; they do not relate to FCPA compliance
-91-
policies and procedure and do not make any statements about the
adequacy of systems designed to insure compliance with the FCPA.
Even if they did, the complaint states that Key had policies,
procedures, and training (including the Code, the Manual, and
anti-corruption training) to address FCPA issues and that when Key
became aware of a potential problem in Mexico, it launched an
investigation and informed the SEC and DOJ.
#37 at ¶¶ 94, 99,
105, 149. While Plaintiffs allege that CW6 stated, “I don’t think
internal audit [at Key] ever audited internationally” (¶ 135),
there is no allegation that international audits are a requirement
or that they are required for a company to have adequate internal
controls
over
financial
reporting.
Key
does
file
audited
consolidated financial statements, and its auditors not only found
that Key did not have a material weakness in internal controls for
the year ending December 31, 2012, but its independent auditors
confirmed that for that year “the Company maintained, in all
material respects, effective internal control over financial
reporting.”
Key’s Form 10-K, Ex. B at 46.
The complaint does not
point to any misstatement in Key’s financial reporting that would
have been discovered had an internal audit of international
operations been done.
The complaint also alleges that “Key’s operations in
Mexico were hampered by accounting irregularities” (#37 ¶ 167).
While the complaint alleges, “CW2 was contacted by CW3 to discuss
unusual numbers that CW3 observed in the accounting records of
Key’s Mexican operations” related to accruals on Mexican books
(id. ¶ 138), it fails to identify when these alleged observations
-92-
occurred or to what they related within the Mexican operations or
that the accruals resulted in any misstatement in Key’s financial
reporting.
Moreover the complaint itself reflects that the CW2
did not use the words “accounting irregularities,” but instead
“was contacted by CW3 to discuss ‘unusual numbers,’” and does not
define “unusual numbers.” #37 ¶ 138.
The complaint does not
allege that the accruals were the result of a lack of internal
control over financial reporting nor does it assert that Whichard
had any knowledge about the accruals.
The complaint alleges that Key’s acquisition of the last
half
of
Geostream
was
done
without
due
diligence,
a
claim
unsupported by particularized facts, but is Plaintiffs’ basis for
claiming that Whichard’s certification was false and misleading
about internal controls over financial reporting.
The complaint,
however states that the acquisition took place on April 9, 2013 (¶
55), not only after Whichard had left Key the previous month, but
months after the only two certifications the complaint asserts
that he signed.
Thus as a claim against him, it fails.
On February 25, 2013 Key filed its Annual Report on Form
10-K with the SEC, which included the following in the “Risk
Factors” section, ¶ 177:
Our ability to comply with the FCPA and
similar laws is dependent on the success of
our ongoing compliance program, including our
ability to continue to manage our agents,
affiliates
and
business
partners,
and
supervise,
train
and
retain
competent
employees.
Our compliance program is also
dependent on the efforts of our employees to
comply with applicable law and our Business
Code of Conduct.
We could be subject to
sanctions and civil and criminal prosecution
-93-
as well as fines and penalties in the event
of a finding of violation of the FCPA or
similar laws by us or any of our employees.
See
City of Brockton, 2014 WL 4832321 at *16 (“[S]tatments from
the Ethics Codes and the Corporate Responsibility Reports offer no
assurance that Avon’s compliance efforts will be successful . . .
.
Instead,
these
statements
merely
set
forth
standards
in
generalized terms that Avon hoped its employees would adhere to.
Such statements are not material.”).
The complaint also charges that the 2012 Form 10-K,
certified
by
Whichard,
was
false
or
misleading
regarding
statements (1) that Key’s revenue growth in its international
segments as “primarily due to increased activity in Mexico”
because, again, “Defendants failed to address the significance of
the conduct that violated the FCPA” in that growth, but implied
its
success
activities;
was
(2)
based
that
on
Key
entirely
did
not
on
need
legitimate
to
record
business
any
asset
impairments (¶ 179-180); and (3) that Key had adequate internal
controls in place, including some to prevent FCPA violations. The
complaint does not allege any particularized facts demonstrating
that Key’s Russian or Mexican assets should have been impaired
because of FCPA violations (which, again, are not identified) or
that Whichard purportedly knew at the time he signed the 2012 Form
10-K that Key’s Russian or Mexican assets should have been
impaired (also unsupported by facts). Nor does it allege that the
impairment should have been taken before it actually was in June
2014.
-94-
Whichard insists that the complaint fails to state a
claim under § 10(b) and Rule 10b-5 for securities fraud or for
control person liability under § 20(a) against him.
Regarding the former, Whichard contends that Plaintiffs
fail to meet pleading requirements for scienter.
Lead Plaintiff
asserts that its allegations are “grounded in eyewitness accounts
of misconduct,” but fails to specify that alleged misconduct (who
did what, where, when or why) and fails to allege that any
eyewitness witnessed any misconduct by, or discussed suspected
violations with, Whichard.
Nor have Plaintiffs identified any
specific communications with or reports to Whichard that directly
contradict his statements.
Abrams, 292 F.3d at 432; Rosenzweig,
332 F.3d at 868 (dismissing complaint where report “fail[ed] to
identify exactly who supplied the information [that contradicted
company’s
public
disclosures]
or
when
[management]
knew
the
information”).
Moreover
the
complaint
asserts
that
“Individual
Defendants,” “personnel at the highest level,” and unnamed “senior
management” must have known of the alleged violations based on
their positions.
#37 ¶¶ 227, 238, 242.
Not only may Plaintiffs
not use group pleading allegations to create an inference of
scienter as to individual defendants, but conclusory allegations
that they must have known of the alleged fraud due to their
positions and/or ability to access information are insufficient to
state a claim.
Southland, 365 F.3d at 365 (“The ‘group pleading
doctrine conflicts with the scienter requirement of the PSLRA”;
“corporate officers may not be held responsible for unattributed
-95-
corporate statements solely on the basis of their titles, even if
their
general
level
of
day-to-day
involvement
in
the
corporations’s affairs is pleaded”); Flaherty & Crumrine Preferred
Income Fund, Inc. v. TXU Corp., 565 F.3d 200, 208 (5th Cir.)(“We
have rejected the group pleading approach to scienter and instead
look to the state of mind of the individual corporate official or
officials ‘who make up or issue the statement (or order or approve
it or its making or issuance, or who furnish information or
language for inclusion therein, or the like) rather than generally
to the collective knowledge of the corporation’s officer and
employees acquired in the course of their employment.”), cert.
denied, 558 U.S. 873 (2009); Abrams, 292 F.3d at 432 (“A pleading
of scienter may not rest on the inference that defendants must
have been aware of the misstatement based on their positions
within the company”); Shaw Group, 537 F.3d at 535 (same).
Lead
Plaintiff’s assertion that all Defendants must have been aware of
unidentified
FCPA
violations
“notoriously
corrupt”
and
because
because
investigating Key also fails.
the
Mexico
SEC
and
and
Russia
the
DOJ
are
are
Key did disclose the jurisdictions
where it has business operations and warned investors of the risks
of an FCPA violation in each of its quarterly and annual SEC
filings, yet Plaintiffs ignore these admonitions.
Many American
companies conduct international business in markets like Mexico
and Russia.
Merely conducting business in one of these countries
does not show knowledge of alleged FCPA violations or make any
statement challenged in the complaint false or misleading.
-96-
Nor does the fact that an SEC investigation is ongoing
establish scienter without facts showing that a specific person
knew of any purported wrongdoing.
Plaintiff does not explain how
the ongoing investigation of Key shows that Whichard made a false
statement, no less that he had the scienter required by the PSLRA.
Nor does Plaintiff’s vague assertion that Defendants’
Sarbanes-Oxley certifications reveal scienter.
Even though the
certifications
over
relate
to
internal
controls
financial
reportings and disclosures, not FCPA compliance, Lead Plaintiff
fails to identify anything in the certifications that is false,
and
it
does
information.
had,
the
not
claim
that
Key
misstated
any
In re Invision, 2006 WL 538752 at *6.
signing
of
a
Sarbanes-Oxley
financial
Even if it
certification
that
is
required by law, by itself, does not establish a strong inference
of fraudulent intent. Instead of quoting the whole certification,
as
was
done
here,
Plaintiffs
must
identify
the
particular
statement(s) in the certification that is (are) allegedly false or
misleading and plead facts explaining why it is (they are) false
or misleading.
In re Invision Techs., 2006 WL 538752, at *6.
The
complaint fails to allege any particularized facts that clearly
contradict statements within the certifications.
Plaintiffs must
also provide facts showing that “the officer who signed the
certification had a reason to know, or should have suspected, due
to the presence of glaring accounting irregularities or other ‘red
flags.’
that
the
financial
misstatements or omissions.”
statements
contained
material
Shaw Group, 537 F.3d at 545.
such facts are pleaded here.
-97-
No
The
complaint
does
not
allege
any
motive
of
any
defendant, in making false or misleading statements, showing he
benefitted from any alleged FCPA violation, such as by selling
stock at inflated prices. Nor do Plaintiffs raise an inference of
fraudulent intent on Whichard’s part that is as cogent and
compelling
as
the
fraudulent intent.
opposing
inference
that
he
did
not
have
Tellabs, 551 U.S. at 324.
Last of all, because Plaintiffs have failed to state a
claim for a primary violation of § 10(b) and Rule 10b-5 by any
defendant, any derivative control person claim also fails.
Lead Plaintiff’s Opposition (#51)
The Court largely agrees with Defendants’ analysis of
the substantial pleading deficiencies of the complaint and finds
Lead Plaintiff’s opposition to be filled with the same problems as
the complaint.
It is comprised of generalized, indefinite,
unsupported assertions and arguments, like the allegations in the
complaint, which it simply repeats and which fail to meet the
pleading requirements which the Court has set forth in detail.
As
inadequacy
a
of
threshold
Lead
matter
Plaintiff’s
the
Court
notes
one-paragraph,
the
total
four-sentence
summary of the standard of review (#51 at p. 10), which, given the
securities fraud context of the PSLRA and Rule 9(b) (which Lead
Plaintiff seemingly ignores), incorrectly asserts, “A plaintiff
may survive a 12(b)(6) motion even if ‘recovery is very remote and
untimely.’
Twombly, 550 U.S. at 555.”
This erroneous standard
may be one reason why Lead Plaintiff’s complaint is fatally
deficient.
Moreover, since Lead Plaintiff’s allegations are made
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on information and belief, he must provide if not all, certainly
the major, material facts supporting his contentions.
Furthermore, for purposes of the pending motions to
dismiss, the Court’s review is limited to allegations in the First
Consolidated Amended Complaint and the documents referenced in or
attached to it and the motions to dismiss and relevant materials
subject to judicial notice; it may not look to matters outside
these parameters, for example to Plaintiff’s new comments about
post-Class Period events, including that Key has spent more than
$59 million on its ongoing investigation, a fact irrelevant to
state a claim of securities fraud anyway, or the generalization
that
Key
“in
the
wake
of
this
expansive
investigation,
transitioned completely away from its international business,
citing the ‘secular trend of aging horizontal wellbores’
‘options
for
the
allocation
of
the
Plaintiffs’ Opposition, #51 at p. 9.
Company’s
and
capital.’”
The Court focuses on the
specificity of material factual allegations in the complaint,
required by Rule 9(b) and the PSLRA, but clearly lacking here, and
the
case
law
interpreting
the
pleading
requirements,
which
Defendants and the Court have shown undermines many of the
Consolidated Complaint’s conclusory claims.
The complaint repeatedly claims that numerous statements
were false or misleading mainly because Key concealed that its
growth and growth strategy were large due to conduct that violated
the FCPA and because Key created the erroneous impression that it
had internal controls in place to prevent such violations. Lead
Plaintiff cannot rely on vague assertions that the SEC and DOJ
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have increased their vigilance over FCPA violations generally or
that Mexico and Russian are rife with corruption to establish that
there were violations of the FCPA in Mexico and Russia by Key
during the Class Period or vaguely to assert that during the Class
Period, Key somehow violated the statute in its operations in
these countries.
Indeed not a single specific violation of the
FCPA (identifying the nature of the violation, when, where, and
who was involved) is alleged.
Moreover, the complaint contends that Key’s Code of
Business Conduct and FCPA Compliance Manual, on which Key’s alltoo-vaguely described internal controls were based, were filled
with false representations and omissions for purposes of § 10(b)
and Rule 10b-5. Not only have the Court and Defendants shown that
courts has found such sources to be aspirational and immaterial
puffery, but Lead Plaintiff has failed to allege particular facts
demonstrating
any
breach
scienter,
any
employee
of
by
any
particular
responsibility
in
Defendant,
any
with
particular
statement set forth in those documents. In re Franklin Bank Corp.
SEC. Litig., 782 F. Supp. 2d at 381.
With
regard
to
the
Sarbanes-Oxley
certifications,
Defendants have repeatedly pointed out that they do not relate to
FCPA issues, but to the accuracy of financial reports.
The
complaint does not give a single example of a glaringly erroneous
accounting
irregularity
Defendant here.
which
was
knowingly
certified
by
a
Defendants and the Court have pointed out that
Lead Plaintiff has failed to plead requisite facts showing that
each individual who signed a certification knew how, why, and when
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an (identified) statement in the certification was false because
of identified ‘red flags’ or glaring accounting irregularities.
Nor has Lead Plaintiff adequately alleged loss causation
with regard to any disclosure statement targeted in the complaint,
but merely alleges statements and subsequent drops or rises in the
price of Key’s common stock.
As pointed out, Lead Plaintiff impermissibly indulges in
group
pleading,
in
inferring
knowledge
of
falsity
based
on
individual Defendants’ positions at Key, in failing to allege
specific facts that a give rise to a strong inference of scienter,
not to mention in failing holistically and comparatively to weigh
allegations and consider plausible nonculpable explanations for a
defendant’s conduct in the process of showing that there is a
cogent and compelling inference of scienter for each individual
defendant (Tellabs, 551 U.S. at 757).
Furthermore, to satisfy the reliance element in a fraudon-the-market securities fraud action, Lead Plaintiff must allege
facts showing not only that each alleged misrepresentation was
publicly known and was material, but that Key’s stock traded in an
efficient market, and plaintiff traded the stock between the time
when the misrepresentation was made and when the truth was
revealed.
Erica P. John Fund, 134 S. Ct. at 2408.
Lead Plaintiff has also erroneously relied too heavily
on
short,
generalized
“discounting”
them
and
statements
providing
of
unnamed
corroborating
CWs
without
“documentary
evidence and/or a sufficient general description of the personal
sources
of
the
plaintiffs’
beliefs,”
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as
the
Fifth
Circuit
recommends (Shaw Group, 537 F.3d at 535; ABC Arbitrage, 291 F.3d
at 351-52, quoting Novak, 216 F.3d at 313-14.).
Accordingly, the Court
ORDERS that Defendants’ two motions to dismiss (#49 and
50) are GRANTED.
Furthermore, the Court
GRANTS LEAVE to Lead Plaintiff to file within 20 days a
Second
Consolidated
Amended
Complaint
that
satisfies
the
heightened pleading requirements of Rule 9(b) and the PSLRA or to
inform the Court that it no longer wishes to proceed with this
suit.
SIGNED at Houston, Texas, this 31st day of March , 2016.
___________________________
MELINDA HARMON
UNITED STATES DISTRICT JUDGE
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