Shearman & Sterling LLP | Securities Litigation Blog | Central District Of California Denies Motion To Dismiss Putative Securities Class Action Against El Pollo Loco Restaurant Chain, Finding Plaintiffs’ Allegations Purportedly Based On Confidential Witnesses Taken Together Raised Strong Inference Of Scienter<br >  
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  • Central District Of California Denies Motion To Dismiss Putative Securities Class Action Against El Pollo Loco Restaurant Chain, Finding Plaintiffs’ Allegations Purportedly Based On Confidential Witnesses Taken Together Raised Strong Inference Of Scienter
     

    08/15/2017
    On August 4, 2017, United States District Judge David O. Carter of the United States District Court for the Central District of California denied a motion to dismiss a putative securities fraud class action against El Pollo Loco Holdings, Inc. (“EPL”), certain of its directors and officers, and EPL’s controlling shareholders.  Turocy, et al. v. El Pollo Loco Holdings, Inc., et al., No. SACV-15-1343-DOC (C.D. Cal. Aug. 4, 2017).  Plaintiffs alleged that defendants violated Sections 10(b), 20(a) and/or 20A of the Securities Exchange Act of 1934 (the “Exchange Act”), and Rule 10b-5, by failing to disclose material facts and making materially false or misleading statements as part of a scheme to artificially inflate the stock price of EPL between May 15, 2015 and August 13, 2015, and/or selling their personally held shares in EPL shortly after making the alleged false or misleading statements despite having not sold any shares during the previous six months and not selling the shares pursuant to any Rule 10b5-1 trading plan.  After dismissing without prejudice the original and amended complaints in this action, the Court held that plaintiffs sufficiently alleged misstatements and a strong inference that defendants were aware of the falsity of such statements, and denied defendants’ motion to dismiss the third amended complaint.

    Plaintiffs alleged that defendants misled investors about EPL’s waning sales and customer traffic in the second quarter of 2015, and that certain individual defendants and controlling shareholder defendants sold more than $130 million dollars of their personally held shares of EPL stock at the allegedly resulting inflated stock prices.  In previously dismissing plaintiffs’ Section 10(b) claims, the Court stated that it was “not convinced Defendants omitted any information or warnings to investors that would be misleading.”  In assessing plaintiffs’ third amended complaint, however, the Court found that plaintiffs had adequately pled the existence of materially misleading statements and omissions, including:  (i) allegedly misleading statements by the company about causes of its poor performance in the first half of 2015, which the company publicly attributed to ancillary issues rather than the alleged real cause, i.e., its increased menu prices and the removal of a popular $5 combo menu; (ii) allegedly misleading statements by the company about the company’s own internal “value scores,” used by the company to track its self-designated positioning as a “quick service restaurant plus” (i.e., a fast food restaurant with higher quality food and service); and (iii) alleged misstatements about the company’s same store sales growth expectations, when EPL’s CFO stated in an analyst call that EPL’s forecast for the second quarter of 2015 was 3% growth despite having reviewed EPL’s internal forecast that predicted only 2.5% growth.   

    The Court next considered whether plaintiffs had adequately stated with particularity facts giving rise to a strong inference under the PSLRA that defendants acted with scienter.  In its prior decisions dismissing the complaint without prejudice, the Court had determined that the three alleged confidential witnesses’ statements, analyzed individual by individual, were not indicative of scienter.  In this decision, however, the Court, citing the Ninth Circuit’s recent ruling in In re Quality Systems, Inc. Sec. Litig., No. 15-55173, slip op. (Dkt. 42) (9th Cir. July 28, 2017), noted that it would assess whether, taken together, the confidential witnesses’ statements raised a strong inference of scienter.  The Court found that, considered collectively, the statements, if taken as true, established that the individual defendants had access to information and data tracking the chain’s decreasing sales and transactions and customer feedback – and such access to the disputed information raised a strong inference of scienter.  In addition, the Court found that the timing of certain defendants’ stock sales – the first possible day they could sell pursuant to various lock-up agreements following the alleged false and misleading statements – was further evidence in support of scienter.   Of note, however, in assessing whether plaintiffs had pled actionable misstatements which could support a claim against certain individual defendants, the Court found that courts in the Ninth Circuit have largely concluded that group pleading is not compatible with the PSLRA’s requirements, and the Court concluded similarly.  Having found that plaintiffs sufficiently pled false or misleading statements as well as facts supporting a strong inference of scienter, the Court denied defendants’ motion to dismiss the Section 10(b) and Rule 10b-5 claims.

    The Court similarly denied defendants’ motion to dismiss the Section 20(a) and 20A claims, noting that defendants’ sole argument as to those claims was that there was no primary violation under Section 10(b), which the Court rejected for the reasons above.

    This decision highlights the evolving implementation in district courts regarding the assessment of confidential witness statements in determining whether scienter has been adequately pled in securities fraud actions, as well as the trend in Ninth Circuit courts regarding group pleading in the context of such actions.

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