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On September 10, 2018, the Southern District of New York dismissed a securities fraud class action against an Argentinian real estate company and related defendants. Sachsenberg v. IRSA Inversiones y Representaciones Sociedad Anónima, 2018 WL 4308546 (S.D.N.Y. 2018) (Broderick, J.).[1] Plaintiffs alleged that the company failed to disclose its control over a recently-acquired Israeli holding company and failed to consolidate the financial statements of the Israeli holding company into its own financial statements. The court held that plaintiffs failed to allege any material misstatement or omission because the Argentinian company did not have control over the Israeli entity during the time period at issue due to an ongoing arbitration concerning the acquisition.

Pursuant to International Financial Reporting Standard 10, which the parties agreed was the governing rule, “the test for consolidation . . . is actual practical control over the subsidiary free of any barriers (economic or otherwise) that prevent an investor from exercising control.” The court found that because of the ongoing arbitration, the Argentinian company “lacked the practical ability to exercise control” over the Israeli entity and thus had no obligation to consolidate that entity into its financial statements.

The court further held that plaintiffs failed to allege scienter. With respect to plaintiffs’ suggestion that defendants sought to avoid consolidating the Israeli entity to avoid breaching the Argentinian company’s debt covenants, the court explained that “the desire to comply with financial covenants in loan agreements is insufficient to support a strong inference of scienter through motive and opportunity.” The court also noted that the Argentinian company subsequently consolidated the Israeli entity into its financial statements, yet no noteholder had claimed a breach of any debt covenant since then. The court deemed “circular” plaintiffs’ argument that defendants were reckless in failing to consolidate.

The court held that plaintiffs could not allege scienter based solely on the theory that the alleged fraud involved the company’s “core operations.” The court explained that “since the enactment of the [Private Securities Litigation Reform Act of 1995], the Second Circuit has expressed doubt as to the continued independent viability of the core operations doctrine.” The court stated that it could consider plaintiffs’ “core operations allegations to constitute a supplementary, but not an independent, means to plead scienter.” The court held plaintiffs “fail[ed] to provide any basis for a conclusion that [d]efendants had a motive to defraud,” and further found plaintiffs’ “allegations of conscious misbehavior or recklessness . . . virtually nonexistent.”