(Article from Securities Law Alert, May 2017)
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On April 21, 2017, the Fifth Circuit held that a disclosure made two months after an alleged misstatement by an oil and gas company’s CFO negated any inference of scienter because plaintiffs did not allege a “particular reason to lie” that “would have vanished” two months later. Neiman v. Bulmahn, 2017 WL 1423321 (5th Cir. 2017) (Higginson, J.).
The Fifth Circuit also found plaintiffs failed to raise a strong inference of scienter based on the CFO’s alleged access to internal corporate reports containing contrary information, or the CFO’s position within the company. In addition, the court held plaintiffs failed to state a claim as to alleged misstatements concerning the company’s liquidity.
Plaintiffs Must Plead a Time-Sensitive Reason for an Alleged Misstatement If Defendants Disclose the Truth Shortly Thereafter
Plaintiffs contended that the company’s CFO misrepresented production at one of the company’s oil wells (“Well #4”) in September 2011. The Fifth Circuit found the company’s disclosure of the “true production of Well #4 in November 2011, just two months after [the CFO’s] statements, belie[d] an inference of scienter.” The court reasoned that “[i]t would have made little sense for [the CFO] to lie about Well #4’s production in September only for [the company’s president] to disclose the true production in November,” particularly since plaintiffs failed to allege any timing motive. For example, plaintiffs did “not allege that [the CFO] inflated [Well #4’s] production numbers in September in order to facilitate an important business opportunity that was no longer salient in November.”
Alleging Access to Internal Reports Containing Contrary Information Is Insufficient, Standing Alone, to Raise a Strong Inference of Scienter
The Fifth Circuit rejected plaintiffs’ attempt to plead scienter based on confidential witness allegations that well production “reports were made available” to the CFO. The court explained that in order “for allegations concerning internal corporate reports alone to support a strong inference of scienter (1) the complaint must have corroborating details regarding the contents of allegedly contrary reports, their authors and recipients, and (2) the corporate reports [must] be connected to the speaking executive in a persuasive way.” Here, plaintiffs alleged that the CFO “received weekly emails containing production reports” but did not “directly allege” that the CFO actually “read the relevant section of the reports before he made” the misstatements at issue.
The Fifth Circuit found “[t]he specifics of this case make the inference that the [CFO] actually looked at Well #4’s data tenuous” because the information was contained in a weekly “productivity report listing both company-wide metrics and individual well data.” The court explained that “[f]or [the CFO] to determine that Well #4’s productivity had fallen, he would have had to open not only the email . . . containing the productivity report, but also open the productivity report, parse through data for [the company’s] other hundred or so wells, find the data for Well #4, and then notice that the data differed from his August statements in a material way.” Since there were no allegations that the CFO “was alerted to the Well #4 data in some way,” the Fifth Circuit determined that “inferring [the CFO] took those steps is less plausible than inferring that he would not have read specific entries in the emailed reports.”
An Executive’s Position Within the Company Does Not Support an Inference of Scienter Absent “Special Circumstances”
The Fifth Circuit explained that in the absence of “special circumstances,” plaintiffs may not allege scienter by asserting “that defendants must have been aware of [a] misstatement based on their positions within the company.” The court found that none of the considerations that “might tip the scales in favor of an inference of scienter” pursuant to the “special circumstances” exception applied here.
First, the Fifth Circuit found it unlikely that “corporate executives would be familiar with the intricacies of day to day operations” given the size of the company (sixty employees).
Second, the court acknowledged that Well #4 was “projected to produce 22.5% of [the company’s] total output,” but stated that its “jurisprudence requires more” to find that an asset was “critical to the company’s continued vitality.” The Fifth Circuit noted that it has previously held the “special circumstances” exception inapplicable to “statements concerning an asset that comprised 22% of the respective company’s total portfolio.” Id. (citing Owens v. Jastrow, 789 F.3d 529 (5th Cir. 2015)).
Finally, the Fifth Circuit determined that Well #4’s true production would not necessarily have been “readily apparent” to the CFO, nor were the CFO’s statements “internally inconsistent” with representations by other company executives.