District Of Nevada Grants In Part And Denies In Part Motion To Dismiss Exchange Act Claims Against Airline Company And Its Executives, Finding That Plaintiffs Adequately Alleged Scienter With Respect To Certain Alleged Statements Regarding The Airline’s Safety And Mechanical Reliability
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  • District Of Nevada Grants In Part And Denies In Part Motion To Dismiss Exchange Act Claims Against Airline Company And Its Executives, Finding That Plaintiffs Adequately Alleged Scienter With Respect To Certain Alleged Statements Regarding The Airline’s Safety And Mechanical Reliability
     
    09/17/2019
    On September 9, 2019, Judge Andrew P. Gordon of the United States District Court for the District of Nevada partially dismissed a putative securities class action brought against an airline company and certain of its current and former executives.  Brendon et al. v. Allegiant Travel Co. et al., 2:18-cv-01758 (D. Nev. Sept. 9, 2019).  Plaintiffs alleged in their first amended complaint (“FAC”) that the airline and its parent company (collectively, the “Airline”) and certain of its executives made materially misleading statements and omissions concerning the safety and mechanical reliability of its aircrafts and the competency of its maintenance staff in violation of Section 10(b) of the Securities Exchange Act of 1934 (the “Exchange Act”), Rule 10b-5 promulgated thereunder, and Section 20(a).  The Court allowed claims related to certain alleged false statements by defendants to proceed, dismissed certain of the claims that plaintiffs failed to sufficiently plead falsity and scienter, and granted plaintiffs leave to amend to address certain of the pleading deficiencies.
     
    Plaintiffs brought suit after a stock drop in 2018 following a CBS television network broadcast detailing, based in part on information obtained through FOIA requests, aircraft maintenance and repair issues experienced by the Airline beginning in 2015, which allegedly resulted in cancellations, delays, emergency landings, and aborted takeoffs.  Plaintiffs sought to represent a class of shareholders who traded in the Airline’s stock between June 8, 2015, and May 9, 2018.  According to plaintiffs, the Airline was profitable because it flew second-hand aircraft that cost much less than new models, but that such aircrafts required “far greater maintenance than new planes.”  Relying on statements from former Airline employees, plaintiffs alleged that in order to increase profits, the Airline “understaffed its maintenance department, hired inexperienced and unqualified maintenance personnel, failed to adequately train its maintenance employees, and had a culture that ‘compromised maintenance . . . for profits.’” 
     
    Plaintiffs further alleged that despite these issues, the Airline and the individual defendants repeatedly assured investors and the public through various false or misleading statements that the Airline and its fleet were safe and reliable.  These alleged misstatements included:  (i) the Airline’s 2015 10-K filing in which the CEO and CFO attested that they “believe[d] their aircraft are, and will continue to be, mechanically reliable,’ and that its “technicians . . . have appropriate experience” and were provided “comprehensive training”; (ii) the Airline’s current CEO and COO’s statements during a January 2016 conference with analysts that the Airline was a safe operation in the past and continued to be; (iii) the Airline’s statement that its maintenance personnel were “highly-trained” in denying allegations from local news reporting in 2015 and early 2016 that the Airline had operational problems caused by maintenance issues and that a maintenance employee quit due to a “worrisome culture” at the company; (iv) the Airline’s code of ethics, which stated that the Airline was required to “provide safe working conditions” to employees and “pursue growth and earnings objectives while adhering to ethical standards”; and (v) shareholder letters sent by the CEO in 2016 and 2017 assuring investors that the Airline placed its “focus on safety and reliability,” had a “proven, seasoned model,” and that safety was its “core fundamental.”  Defendants moved to dismiss the FAC, arguing that plaintiffs failed to adequately allege material misrepresentation, scienter, and loss causation.
     
    In evaluating the sufficiency of the FAC’s allegations of a material misrepresentation, the Court first considered and rejected defendants’ truth-on-the-market defense.  Defendants, citing the Third Circuit’s decision in In re Merck & Co. Securities Litigation, 432 F.3d 261 (3d Cir. 2005), argued that plaintiffs failed to plead an actionable false statement because “the market would have already incorporated the [damaging] information into [the company’s] share price” because the CBS program reported on information that was already disclosed in local news reports in 2015 and 2016.  The Court rejected this argument, agreeing with plaintiffs that Merck could be distinguished because the CBS program relied on previously undisclosed information obtained through CBS’s FOIA requests, and finding that, in any event, plaintiffs pled sufficient facts to show that the local news reports from 2015 and 2016 were not “comprehensive or credible enough to counterbalance [the Airline’s] alleged misrepresentations.”
     
    The Court next considered whether each of the alleged statements were false or misleading.  Regarding the Airline’s 2015 10-K, the Court found that the “statements regarding [the Airline’s] reliability, staffing, and training are capable of objective verification” and were therefore “false and misleading,” because, as alleged in the FAC, “‘[the Airline] maintenance technicians were inexperienced and insufficiently trained,’ resulting in substandard repairs and false certification that maintenance had been performed, and ‘[the Airline’s] maintenance department was grossly understaffed,’ resulting in rushed repairs and false certifications that maintenance had been performed.”  The Court similarly found actionable the statements by the CEO and COO on the 2016 investor call that the Airline was a “safe operation,” because “they address specific questions on aspects of [the Airline’s] operation” that the CEO and COO “allegedly knew to be performing badly.”  Alternatively, the Court found such statements could be “characterized as opinion statements with an embedded fact,” which would also be actionable.  The Court thus denied defendants’ motion regarding the 2015 10-K and 2016 investor call statements.
     
    The Court, however, granted defendants’ motion regarding the other alleged misstatements.  Specifically, the Court found that plaintiffs failed to specifically allege in the FAC that the Airline’s statement that its maintenance personnel were “highly-trained” was false or misleading.  While the Court could not make such an inference under the PSLRA, it granted plaintiffs leave to amend to add specific allegations.  The Court next found that the Airline’s statements in its code of ethics regarding the importance of safety were “inherently aspirational” and its statements in the shareholder letters regarding the Airline’s “focus on safety and reliability” were not “capable of being objectively false,” and denied leave to amend those allegations because it would be futile.    
     
    Having found some actionable statements, the Court next considered the issue of scienter.  Plaintiffs argued that they adequately alleged scienter because:  (i) the former employee allegations sufficiently plead defendants’ recklessness regarding the Airline’s maintenance practices and safety; (ii) the core operations doctrine permits an inference that defendants were aware of the maintenance and safety issues; (iii) the CEO’s stock sales and formation of a Rule 10b5-1 trading plan permit an inference of scienter; (iv) the CEO’s bonus structure incentivized fraud; and (v) the former COO’s unexpected resignation further supports an inference of scienter.
     
    First, the Court found that the “FAC describes each [former employee] ‘with sufficient particularity to support the probability that a person in the position occupied by the source would possess the information alleged,” noting that the FAC “specifies job titled, locations, responsibilities, dates of employment, and supervisors for each” former employee, and that the former employees “corroborate each other across [Airline] stations and seniority levels, thus bolstering their reliability.”  The Court gave significant credibility to the former employees’ allegation that “senior management (including the individual defendants) knew of the maintenance issues,” highlighting that two of the former employees alleged “direct contact with individual defendants in daily briefings on the ‘status of aircraft’ and ‘monthly reliability meetings to discuss new and ongoing reliability issues and mechanical problems with the fleet,’” and found that these “‘particularized allegations that defendants had actual access to the disputed information . . . raise a strong inference of scienter.’”
     
    Second, the Court considered the core operations doctrine, under which it could “infer ‘that facts critical to a business’s core operations . . . are known to a company’s key officers.’”  Finding the doctrine applicable, the Court noted that the FAC “contains particularized allegations from the [former employees] that the individual defendants knew of the airline’s maintenance issues” and that the Airline’s 10-Ks (attested to by the CEO and CFO) state that “management closely supervises all maintenance functions performed by our personnel and contractors employed by us, and by outside organizations.”  Having found that such allegations sufficiently allege scienter, the Court further noted that “it would also be ‘absurd’ to suggest that the management of any airline, much less an airline experiencing significant operational challenged, would not be aware of pervasive maintenance issues like those alleged by the plaintiffs.” 
     
    Third, turning to the alleged stock sales, the Court found that the CEO’s stock sales and his Rule 10b5-1 trading plan, standing alone, would not raise a strong inference of scienter, emphasizing that plaintiffs failed to allege the stock trading plan was created for suspect reasons and did not provide a comparison of the CEO’s sales before, during, and after the putative class period to support the inference that any such sales were suspicious.  Moreover, while the Court found that the years-long class period suggests that the timing of the sales was not suspicious, it granted plaintiffs leave to amend to add further allegations in support of scienter. 
     
    Fourth, the Court found that plaintiffs failed to show that the CEO’s bonus structure supported any inference of scienter.  While plaintiffs contended that the CEO was motivated by his bonus in engaging in the alleged deception, the Court noted that the FAC merely alleged that the 2015 bonus was “a figure far above his usual payout,” but that such allegations were insufficient to support an inference of scienter.  The Court, however, granted leave to amend these allegations because it found that it was not clear that amendment would be futile. 
     
    Fifth, the Court found that the former COO’s unexpected resignation one week after a media report on a former Airline mechanic’s allegations, and the press release suggesting that the “resignation as tied to operational challenges at the company,” suggests that the resignation was accompanied by suspicious circumstances, and thus supports an inference of scienter.
     
    Having found that the FAC sufficiently alleged scienter, the Court next considered whether there was any stronger opposing inference from the alleged facts.  Notably, the Court agreed with defendants’ argument that the former employee accounts “support the proposition that [the Airline’s] senior management paid a great deal of attention to airline safety and maintenance” and that the individual defendants “participated in daily conference calls, monthly reliability meetings, quarterly Town Hall events, and annual leadership conferences to discuss staffing, reliability, and mechanical issues.”  Finding that this inference stronger than plaintiffs’ proposed inference, the Court found that plaintiffs failed to plead scienter regarding the statements by the CEO and COO on the investor call that the Airline “ran a safe operation,” and granted the motion to dismiss, but granted leave to amend those allegations.  However, the Court found that the allegations “do not permit an opposing inference that the individual defendants were unaware of [the Airline’s] specific maintenance understaffing and training issues,” and thus allowed the claims based on the representations in the Airline’s 10-K to proceed. 
     
    Separately, the Court further found that plaintiffs adequately alleged loss causation because the stock price dropped in correlation to the three alleged corrective disclosures: first, the announcement of the CBS program; second, the release of the expose; and third, the Department of Transportation investigation into the Airline that followed after the CBS program.
     
    The Court next turned to defendants’ claims that the former COO (who later resigned) did not make false statements under Janus Capital Group, Inc. v. First Derivative Traders, 564 U.S. 135 (2011).  Janus held that one can be held liable under Section 10(b) of the Exchange Act only if he or she is the “maker of a statement” and that the one signing a corporate filing could be considered a maker with “ultimate control” as to what is conveyed.  In dismissing Section 10(b) claims against the former COO, the Court held that given he did not sign the 10-K and left the Airline prior to the filing, he could not be considered under Janus as someone with “authority” over the statements, and plaintiffs’ allegations as to his authority therefore were conclusory and insufficient under the heightened pleading standards of FRCP 9(b).
     
    Finally, in considering the control person liability claims under Section 20(a), the Court found that plaintiffs adequately alleged that the CEO, CFO, and COO had control over the Airline, but that the former COO could not be held liable because he had left the Airline prior to the issuance of the 10-K. 
    CATEGORIES: Exchange ActScienter

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