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District Of Connecticut Dismisses Putative Class Action For Failure To Adequately Allege Material Misrepresentations, Scienter, and Loss Causation
03/31/2021On March 19, 2021, Judge Stefan R. Underhill of the United States District Court for the District of Connecticut dismissed with prejudice a putative class action asserting claims under the Securities Exchange Act of 1934 against a transportation and logistics company and certain of its executives. Labul, et al. v. XPO Logistics, et al., No. 3:18-cv-2062 (SRU), slip op. (D. Conn. Mar. 19, 2021). Plaintiffs alleged that the company misrepresented the extent to which it relied on a single customer to drive revenue growth and the financial impact of declining business from that customer. The Court held that plaintiffs failed to adequately allege the existence of material misrepresentations, scienter, or loss causation, and therefore dismissed the action.
Plaintiffs alleged that the company made various statements regarding its revenue growth in the first quarter of 2018, which were allegedly misleading because they omitted that the company’s largest customer “accounted for more than half” of total growth during that time. Id. at 12-13. In addition, plaintiffs alleged that, after that customer began withdrawing a portion of its business, the company made misrepresentations by reaffirming its financial targets, stating that there were “no material changes to the risk factors previously disclosed,” and by attributing declining shipping volume to causes other than the decline in that customer’s business. Id. at 32-33.
With respect to the statements regarding revenue growth, the Court held that plaintiffs’ allegations regarding growth in 2017 and 2019 were insufficient to establish the portion of growth that the customer contributed in the first quarter of 2018. Id. at 13. Moreover, the Court determined that the alleged misstatements concerning customer diversification and the contribution of different business lines to revenue growth would not be rendered misleading even if the largest customer had accounted for a large portion of revenue growth. Id. at 14-15. The Court further held that plaintiffs failed to establish that statements regarding the company’s financial targets and declining shipping volume were false when made; the fact that one customer was withdrawing some business was not enough, the Court held, to show that the company would not meet its financial projections or that overall shipping volume would decline. Id. at 34.
The Court also concluded that plaintiffs failed to plausibly allege that the alleged omissions were material. The Court emphasized that plaintiffs’ allegations failed to quantify the extent of the customer’s contribution to revenue growth in the quarter in question or the “scale of the alleged discontinuation” by the customer, and there was no indication that the alleged misrepresentation changed the underlying financials of the company. Id. at 17-18, 39. Moreover, rejecting plaintiffs’ argument that the materiality of the growth-related statements was shown by a subsequent stock drop, the Court noted that the stock drop followed an announcement that the customer had pulled back a portion of its business, and that the “drop in stock price therefore does not suggest that the disclosure of [the company’s] alleged reliance on [a single customer], without more, would have triggered a similar market reaction.” Id. at 18-19. While plaintiffs alleged that the company ultimately “would be losing two-thirds of $900 million projected business” from the customer, the Court observed that the ultimate decrease in the company’s overall revenue was only 3.7% in 2019, and the complaint did not “shed adequate light on the likelihood of [the customer] pulling two-thirds of its business” at the time of the challenged statement. Id. at 40. For the same reasons, the Court rejected plaintiffs’ argument under Item 303 of Regulation S-K—requiring the disclosure of “known trends or uncertainties”—holding that plaintiffs failed to establish any material omission or that defendants had “actual knowledge” of a trend. Id. at 41-42.
The Court also concluded that plaintiffs failed to adequately plead scienter. First, the Court rejected plaintiffs’ allegation that the company had a motive to conceal its reliance on its largest customer so as to inflate its stock price prior to pursuing an acquisition of another company. Id. at 22. The Court explained that this argument was speculative and that a “‘generalized desire’ to achieve a lucrative acquisition” is not the sort of “concrete benefit” that can be used to infer scienter. Id. at 23-24. The Court also rejected plaintiffs’ attempt to establish scienter through allegations of recklessness, concluding that plaintiffs’ allegations “may establish that [one executive] had a broad understanding of [the company’s] diversification levels, sources of growth, and [the company’s] largest customers,” but did not specifically address the customer’s role in the company’s growth. Id. at 26-27. In addition, the Court explained that the fact that one executive “had access to reports providing overall tonnage numbers” was “irrelevant” because those numbers did not indicate that a specific customer was reducing its business with the company, and a statement that the company knew the customer “wasn’t going to stay … forever and ever” did not show that the executive knew of specific plans for the customer to leave at the time he made the challenged statements. Id. at 43-44.
With respect to the element of loss causation, the Court held that plaintiffs’ allegations relating to revenue growth were insufficient because none of the alleged corrective disclosures specifically mentioned the customer’s role in generating the company’s growth. Id. at 29-30. The Court rejected the theory that the losses alleged were a “foreseeable materialization of the risk concealed,” because plaintiffs had not quantified the extent to which the omitted information contributed to the losses. Id. at 28, 30. The Court stated that for similar reasons plaintiffs failed to allege loss causation with respect to their allegations relating to the decline in business from the primary customer. Id. at 46.
Because the Court had previously permitted plaintiffs to replead, the Court dismissed the complaint with prejudice. Id. at 48.
