District Of New Jersey Largely Upholds Claims In Putative Class Action Alleging Misleading Asbestos-Related Liability Projections
On May 18, 2020, Judge William J. Martini of the United States District Court for the District of New Jersey denied a motion to dismiss a putative class action asserting claims under Section 10(b) of the Securities Exchange Act and Rule 10b-5 promulgated thereunder against a consumer and industrial products company and certain of its executives. Kanefsky v. Honeywell Int’l Inc., No. 18-cv-15536, slip op. (D.N.J. May 18, 2020), ECF No. 106. Plaintiff alleged that the company made misrepresentations in SEC filings and public statements regarding the projected asbestos liability arising from its acquisition of a manufacturer of automobile brakes. The Court held that plaintiff adequately alleged falsity, scienter, and loss causation as to certain alleged misstatements.
Plaintiff alleged that the company had falsely stated that it could only make reasonable estimates of asbestos related liability five years out, when, in truth, the company allegedly knew or could have reasonably estimated all of its asbestos liability. Id. at 1–2. Plaintiff further alleged that the company deliberately limited its projections in order to conceal the liability until it could be “passed on” to another company. Id. In support of its allegations, plaintiff quoted correspondence with the SEC in which the company allegedly first asserted that it should and could only disclose the potential liabilities over a five-year period under the relevant accounting standards. But the company ultimately informed the SEC that was incorrect and that it had “not appropriately applied” the standard, but it deemed the adjustment immaterial and therefore revised the prior year financial statements the next time they were filed, as opposed to restating them. Id. at 2–3. Plaintiff further alleged that the company attempted to “blunt the effect” of having to revise its projected liabilities by also making announcements at the same time regarding two spinoffs which would include an indemnification that purportedly would cover 90% of the company’s asbestos liabilities for the next 30 years. Id. at 4.
The Court first addressed whether the company’s reporting of projected losses was actionable. Id. at 5. While the Court noted that such estimates constitute an opinion, the Court concluded that plaintiff sufficiently alleged that the company did not subjectively believe those estimates and they lacked a reasonable basis. Id. at 5–6. In particular, the Court highlighted that while the company’s prior disclosures had indicated that it did “not believe that [it had] a reasonable basis for estimating asbestos losses beyond the next five years,” the company’s later correspondence with the SEC showed that it had obtained but chose not to use data that would have provided a reasonable basis to project losses for a longer period. Id. at 6. For similar reasons, the Court concluded that plaintiff’s allegations were sufficient to allege falsity regarding the company’s Sarbanes-Oxley Act (“SOX”) certifications of its SEC reports. Id.
In addition, plaintiff argued that a 10-Q filing made while the company’s communications regarding the projections were ongoing with the SEC was misleading because it did not mention those communications or “that the SEC was contemplating an investigation or legal proceeding.” Id. at 6.
While the company argued it had no obligation to disclose the communications or the potential of an SEC action, the Court concluded that disclosing the SEC’s inquiry “could have alleviated the misleading nature” of the disclosures “under the facts alleged,” but also noted that if the evidence ultimately shows the disclosures were “at least truly-held beliefs,” the Court would revisit whether the alleged omission of the SEC’s involvement was independently actionable. Id. at 7.
The Court, however, dismissed as non-actionable puffery plaintiff’s allegations relating to an investor call on which the company’s executives allegedly stated that its business was “performing well” and that the “SEC process” was also “going well.” Id. at 6.
With respect to scienter, the company argued that its projections were the result of a “good-faith, if unsuccessful, effort to apply subjective accounting guidelines to complex asbestos liabilities.” Id. at 7. The Court, however, rejected this argument, emphasizing that the company had purportedly admitted to the SEC that it had made the “incorrect judgment” to limit the time period of its projections based on “what the data would have otherwise indicated,” which the Court determined “comes close to admitting manipulative intent.” Id. The Court also observed that a number of other factors supported an inference of scienter, including the size of the revision, the fact that the company used a different time horizon for other projections, and the timing of the company’s corrective disclosures and spinoffs. Id.
Regarding loss causation, plaintiff alleged that, after each alleged corrective disclosure, the company’s stock “performed worse than it would have if the negative news had not been revealed.” Id. at 8. The Court concluded that plaintiff’s loss causation allegations were plausible and that at the pleadings stage, plaintiff “need not disaggregate the damage caused by the alleged fraud from changes due to other market forces.” Id. Moreover, the Court rejected the company’s argument that its disclosure that it had received notice that it was under investigation by the SEC could not qualify as a corrective disclosure because the company had not previously misstated anything about the SEC’s inquiry. Id. at 8–9. The Court observed that there was a clear stock price decline following the disclosure, and that, under the “materialization of the risk” theory of loss causation, the SEC’s investigation and the resulting stock drop was a foreseeable consequence of the company’s alleged misstatements. Id.