(Article from Securities Law Alert, July 2019)
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On July 12, 2019, the Southern District of New York dismissed a securities fraud action alleging that a multinational conglomerate “fraudulently failed to disclose [an] alleged bribery scheme.” Schiro v. Cemex, S.A.B. de C.V., 2019 WL 3066487 (S.D.N.Y. 2019) (Caproni, J.). The court underscored that “a company has a duty to disclose uncharged, unadjudicated wrongdoing” only if there is “a direct nexus between the alleged wrongdoing and the company’s statements.” The court further held that the scienter of the officers of one of the company’s subsidiaries officers could not be imputed to the company because there were no allegations that the officers served as proxies for the company, or that the company “possessed some degree of control over, or awareness about, the fraud.”
A Duty to Disclose Uncharged, Unadjudicated Wrongdoing Does Not Arise Merely Because a Criminal Conviction Would Adversely Impact the Company
The court explained that the duty to disclose uncharged, unadjudicated wrongdoing arises only if there is “a connection between the illegal conduct and the misleading statements beyond the simple fact that a criminal conviction would have an adverse impact upon the company’s operations in general or the bottom line.” For example, the court recognized that “[a] duty to disclose uncharged wrongdoing may . . . arise when a corporation puts the reasons for its success at issue, but fails to disclose that a material source of its success is the use of improper or illegal business practices.”
The court held that statements “attribut[ing] the [c]ompany’s growth to broad trends and corporate strengths, without pointing to any specific factors or sources of revenue,” did not trigger a duty to disclose the alleged bribery scheme because the statements were “far too generic to be actionable under the securities laws.” The court similarly found that statements concerning the company’s Code of Ethics and its anti-bribery policies were “classic puffery.” The court noted that “[m]any of the statements were preceded by explicitly aspirational language (e.g., ‘committed to’; ‘tr[ies] to ensure’), thus unmistakably signaling that they were statements about goals, not statements of fact.” The court also found inactionable statements concerning the company’s internal controls because the company “did not state that the [c]ompany’s internal controls were effective” but “only that management had concluded as much.” The court also held that the company had no duty to disclose the alleged bribery payment in its financial statements because “a violation of federal securities laws cannot be premised upon a company’s disclosure of accurate historical data.”
The court did, however, find that the company’s statements concerning litigation over rights to a Columbian plant triggered a duty to disclose the company’s alleged payment of a bribe to acquire the plant’s assets. The court determined that “[t]he alleged bribery scheme bears a direct nexus” to the company’s statements concerning the litigation. The court reasoned that “in the mind of a reasonable investor, both the scheme and the proceeding could have raised serious doubts about” the legal enforceability of the company’s rights to the plant’s assets.
Plaintiffs’ Allegations Were Insufficient to Impute the Scienter of the Subsidiary’s Officers to the Company
The court held that plaintiffs did not adequately allege that the scienter of officers of the company’s subsidiary should be imputed to the company. The court explained that “[t]he mere existence of a parent-subsidiary or affiliate relationship is not on its own sufficient to impute the scienter of the subsidiary to the parent or its affiliate.” The court found that the subsidiary’s officers “were not sufficiently senior within [the parent company] to serve as a proxy for the [c]ompany.” Moreover, there were no allegations that the officers “participated in the overall management of the [c]ompany, reported directly to [the company’s] senior managers, or otherwise served as proxies for the [c]ompany.” The court found it significant that the subsidiary “comprises less than 6 percent of the total assets, and less than 13 percent of the total net sales” of the company. “Given the tiny share of [the company’s] business that [the subsidiary] comprises,” the court held that “the scienter of officers of [the subsidiary] cannot, without more, be fairly attributed to” the company.