(Article from Securities Law Alert, July 2015)
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On July 24, 2015, the Second Circuit revived a securities fraud action alleging that Green Mountain Coffee Roasters, Inc. and certain of its executives had made material misstatements concerning “Green Mountain’s inventory, business performance, and growth prospects.” Emps.’ Ret. Sys. of Gov’t. of V.I. v. Blanford, 2015 WL 4491319 (2d Cir. 2015) (Chin, J.). The court determined that plaintiffs had adequately alleged misstatements based on confidential witness allegations, which the court found to be pled with "sufficient particularity to support the possibility that the witnesses possessed the information alleged." The court further found that stock trades made pursuant to 10b5-1 trading plans supported an inference of scienter because Green Mountain’s executives allegedly began participating in those plans during the class period, after the allegedly fraudulent scheme had begun.
Background
Between February 2, 2011 and November 9, 2011, defendants allegedly represented that Green Mountain “was straining to meet consumer demand for its Keurig and K-Cup products and that the company was ramping up production without accumulating excess inventory.” Plaintiffs contended that to the contrary, “Green Mountain was accumulating a significant overstock of expiring and unsold product.” Plaintiffs presented “observations from numerous confidential witnesses (‘CWs’) ― Green Mountain employees from different tiers of the company ― detailing the company’s increasing inventory buildup.” According to the CWs, defendants went to great lengths to conceal Green Mountain’s growing inventory from investors, using measures such as “phony shipment[s]” and “non-mainstream accounting practices to track [the company’s] inventory.” Plaintiffs further alleged that the company’s “senior executives capitalized on their own pronouncements of Green Mountain’s financial strength by selling their shares of company stock at peak stock prices” pursuant to their 10b5-1 trading plans.
On October 17, 2011, an investor, David Einhorn, released a report stating that “Green Mountain was engaged in a ‘variety of shenanigans that appear[ed] designed to mislead auditors and to inflate financial results.’” A few weeks later, on November 9, 2011, Green Mountain announced that it had missed its “sales and revenue expectations for the first time in eight quarters.” Green Mountain also “admitted that . . . its total inventory and obsolete inventory levels had skyrocketed 61% and 47%, respectively, from the prior quarter.”
Plaintiffs subsequently brought the instant securities fraud action. On December 20, 2013, the District of Vermont dismissed the complaint on the grounds that plaintiffs had failed to allege either material misstatements or scienter. Plaintiffs appealed.
Second Circuit Finds Plaintiffs Adequately Alleged Misstatements Concerning the Company's Inventory Levels
The Second Circuit explained that in order “[t]o satisfy the pleading standard for a misleading statement or omission under Rule 9(b), a complaint must . . . specify the statements that the plaintiff contends were fraudulent” and “explain why the statements were fraudulent.” The court further stated that “[a] complaint may rely on information from confidential witnesses if ‘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’” (quoting Novak v. Kasaks, 216 F.3d 300 (2d Cir. 2000)).
Here, the Second Circuit found that plaintiffs had alleged “specific misleading statements by [d]efendants about the status of Green Mountain’s inventory during the [c]lass [p]eriod.” The court further determined that the complaint “explain[ed] why these statements were fraudulent by detailing numerous CWs’ observations that Green Mountain’s inventory was decidedly not at ‘appropriate levels.’” For example, “[m]any witnesses described the buildup of inventory ‘up to the rafters’ and their need to throw away ‘pallet after pallet after pallet’ as the coffee products expired.” In addition to statements from lower-level employees, the complaint also “detail[ed] statements from CWs in management positions with a broader knowledge of the company’s inventory and accounting practices.” According to the complaint, “[t]hese managers reported to Green Mountain executives who discouraged questions about the inventory practices and ignored their repeated complaints.” The Second Circuit noted that the complaint “specifie[d] each witness’s position, length of employment, and job responsibilities.” The court found that plaintiffs’ allegations had “sufficient particularity to support the probability that the witnesses possessed the information alleged.”
Because the court found that “the [c]omplaint state[d] with particularity the statements it allege[d] [were] misleading and the reasons why these statements [were] fraudulent,” the Second Circuit held that “the [c]omplaint adequately allege[d] false statements of material fact.”
Second Circuit Finds Executives’ Stock Sales Supported an Inference of Scienter Even Though the Sales Were Made Pursuant to 10b5-1 Trading Plans Because Defendants Began Participating in the Trading Plans After the Fraudulent Scheme Allegedly Began
The Second Circuit stated that “the scienter requirement is met where the complaint alleges facts showing either: 1) a ‘motive and opportunity to commit the fraud’; or 2) ‘strong circumstantial evidence of conscious misbehavior or recklessness’” (quoting ATSI Commc’ns, Inc. v. Shaar Fund, Ltd., 493 F.3d 87 (2d Cir. 2007)). The court explained that “motive for scienter can ‘be shown by pointing to the concrete benefits that could be realized from one or more of the allegedly misleading statements or nondisclosures; opportunity could be shown by alleging the means used and the likely prospect of achieving concrete benefits by the means alleged’” (quoting S. Cherry St., LLC v. Hennessee Grp. LLC, 573 F.3d 98 (2d Cir. 2009)).
Applying this standard, the Second Circuit found that plaintiffs had pled “strong circumstantial evidence of Green Mountain’s intent to deceive or defraud [p]laintiffs by detailing both (1) [d]efendants’ efforts to deceive auditors and investors and conceal the true facts about Green Mountain’s excess inventory, and (2) [d]efendants’ significant personal gain from these efforts” through stock sales made soon after the “allegedly misleading statements to investors.”
Notably, the Second Circuit rejected Green Mountain’s contention that defendants’ stock sales did “not support an inference of scienter because they were made pursuant to . . . pre-determined 10b5-1 trading plans.” The court underscored the fact that defendants began participating in these plans “long after . . . Green Mountain’s fraudulent growth scheme [allegedly] began.” The court held that “[w]hen executives enter into a trading plan during the [c]lass [p]eriod and the [c]omplaint sufficiently alleges that the purpose of the plan was to take advantage of an inflated stock price, the plan provides no defense to scienter allegations.”
Here, the court pointed out that defendants had allegedly “made positive public statements about Green Mountain’s growth that drove up its stock price immediately before” scheduled sales of stock in their 10b5-1 trading plans. Although the sales “were made pursuant to their 10b5-1 trading plans,” the court found it significant that defendants “knew the dates of their scheduled sales [were] imminent when they made allegedly misleading statements to investors.”
The Second Circuit found that the complaint sufficiently alleged both “[d]efendants’ intent to craft a false growth story” and “the extraordinary opportunities for personal gain this ‘growth’ created for Green Mountain’s executives.” The court determined that the allegations as a whole gave rise to a strong inference of scienter.
The Second Circuit vacated the district court’s dismissal order and remanded for further proceedings consistent with its opinion.