Category Archives: Curiouser and Curiouser

How do you know when a judge does not think much of your case? When the quips start flying around in her decision.

In City of Brockton Retirement System v. The Shaw Group Inc., 2008 WL 833943 (S.D.N.Y. March 18, 2008), District Judge Colleen McMahon addressed a securities class action brought after The Shaw Group was forced to restate its 2Q 2006 financials. In particular, the restatement resulted from two accounting errors: (a) an arithmetic error related to the computation of percent complete on one contract; and (b) a failure to account properly for a minority interest in a variable interest entity. The court dismissed the case based on the plaintiffs’ failure to adequately plead a strong inference of scienter (i.e., fraudulent intent) and made its overall feelings about the claims quite clear. Here are some of the more quotable lines:

(1) “Calling the failure to catch [the simple arithmetic error] a ‘failure of accounting controls’ makes it sound sinister, but it does not change the fundamental nature of the ‘failure’ – somebody forgot to check his/her work. This is not sinister at all. Mistakes like this happen a lot in the third grade, and sometimes they happen in public companies, too. There is no reason to make a federal case out of it.”

(2) “It may not be prudent as a business matter to have an accounting department that has a hard time keeping up with new information technology, but it is not a violation of the federal securities laws to do so.”

(3) “So none of the matters cited by plaintiffs admits of an inference of fraud. Plaintiffs argue, however, that zero plus zero plus zero plus zero plus zero adds up to something. In this, its arithmetic is as faulty as Shaw Group’s was.”

Thanks to an alert reader for sending in the decision.

Everything a CEO does can effect his company’s public disclosures. Regular readers will recall the case of the company that was forced to restate its CEO’s resume. A similar type of case was decided earlier this year.

In In re Ariba, Inc. Sec. Litig., 2005 WL 608278 (N.D. Cal. March 16, 2005), the company failed to disclose that its outgoing CEO had personally, out of his own funds, paid another officer $10 million (plus $1.2 million in travel benefits and expenses) to assume the CEO position. Ariba was eventually forced to restate its financial statements to record the payments as capital contributions. In the resulting securities class action, the plaintiffs alleged that the payments were made to “create the false impression that Ariba was doing better than it was” and that “confidence in Ariba’s management would have eroded completely” had it been disclosed that the new CEO had only agreed to accept the position after receiving the payments.

The court found that the plaintiffs had failed to adequately plead that the defendants acted with a fraudulent intent (i.e., scienter). The complaint relied heavily on statements from a confidential witness identified as an “executive assistant,” the existence of GAAP violations, and the individual defendants’ positions at the company. The court held that these allegations did not “constitute the strong circumstantial evidence of deliberately reckless or conscious misconduct with respect to each omission required for Plaintiff to overcome Moving Defendants’ motion to dismiss.”

Holding: Dismissed with prejudice.

Note to companies headquartered in Kansas: be careful when telling investors that you are eager to retain your senior officers.

In a securities class action against Sprint Corp., the plaintiffs based their claims on Sprint’s March 26, 2001 statement that it had entered into new employment contracts with its CEO and COO that were “designed to insure their long-term employment with Sprint.” According to the plaintiffs, this statement was misleading because Sprint knew that it might have to fire these officers as the result of a tax avoidance issue. In its motion to dismiss, Sprint argued that it had no duty to disclose this information because its statement did not “foreclose the possibility” that the CEO and COO might later be terminated.

The court disagreed with this characterization of the statement. See State of New Jersey and its Division of Investment v. Sprint Corp., 2004 WL 1960130 (D. Kan. Sept. 3, 2004). In finding that a duty to disclose existed, the court held that “Sprint’s statements that the contracts were ‘designed to insure’ the long-term employment of [the CEO and COO] could reasonably have led an investor to conclude that the termination of [their] employment (at least in the near future) was simply not an option from Sprint’s perspective.”

Although the court may have correctly found that a duty to disclose existed, the rationale it used is curious. Did Sprint really need to say, “then again, we might fire them,” for a reasonable investor to realize that it is always possible for the employment of a CEO or COO of a corporation to be terminated? Guess so.