Eastern District Of New York Grants Motion To Dismiss Exchange Act Claims Against Airline Company Holding Plaintiffs Did Not Adequately Plead Material Misstatements Or Omissions Or Scienter
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  • Eastern District Of New York Grants Motion To Dismiss Exchange Act Claims Against Airline Company Holding Plaintiffs Did Not Adequately Plead Material Misstatements Or Omissions Or Scienter

    On April 12, 2022, Judge Rachel P. Kovner of the Eastern District of New York granted a motion to dismiss a putative securities class action asserting claims under Section 10(b) of the Securities Exchange Act of 1934 (the “Exchange Act”) and Rule 10b-5 thereunder, as well as Section 20(a) of the Exchange Act against an airline company (the “Company”) and certain of its officers and directors.  In re GOL Linhas Aéreas Inteligentes S.A. Securities Litigation, No. 1:20-cv-04243-RPK-TAM (E.D.N.Y. Apr. 12, 2022).  Plaintiffs alleged that defendants made materially misleading statements and omissions regarding the Company’s financial strength in an earnings report issued in the early days of the COVID-19 pandemic, despite allegedly knowing that its auditor would be issuing a report emphasizing a going concern and raising material weaknesses concerning the Company’s internal controls.  The Court granted defendants’ motion to dismiss, holding that plaintiffs failed to adequately plead material misstatements or omissions as well as scienter.

    According to the amended complaint, the Company’s Q1 2020 earnings report published on May 4, 2020, acknowledged the “unprecedented situation” presented by the COVID-19 pandemic, but contained statements touting the Company’s strategic response, its expected liquidity, and its profitability.  Approximately six weeks later, on June 16, 2020, the Company disclosed that its outside auditor had informed it and the Company’s audit committee that the auditor’s upcoming report on the Company’s consolidated financial statements (1) would likely emphasize the Company’s ability to continue as a going concern and (2) would likely include one or more material weaknesses.  On June 29, 2020, the Company filed a Form 20-F that contained the auditor’s report and disclosed that its auditor had “substantial doubt” that the Company could continue as a going concern in light of the pandemic.  The Company also disclosed that the audit report identified four material weaknesses related to the Company’s earnings, calculations, and financial reporting.  Specifically, the report noted that these control deficiencies “resulted in material misstatements that were corrected in the 2019 consolidated financial statements[,]” but the “error was corrected prior to the issuance of the financial statement for 2019.”  Plaintiffs alleged that the Company’s May 2020 earnings report was materially misleading because it failed to disclose the concerns identified in the audit report, which plaintiffs allege defendants must have known about prior to filing the earnings report.

    Defendants moved to dismiss, arguing that plaintiffs failed to adequately allege any statements in the May 2020 earnings report were materially false or misleading when made, and that plaintiffs failed to plead corporate or individual scienter.

    The Court first held that plaintiffs failed to adequately plead materially misleading statements or omissions, finding that plaintiffs failed to point to any specific reports that illustrated defendants’ knowledge of the auditor’s conclusions prior to the May 2020 earnings report, and that plaintiffs’ “unsupported general claim” that defendants knew of the concerns as early as February 2020 were insufficient to survive a motion to dismiss.  The Court also rejected plaintiffs’ theory that the auditor must have informed the Company about its findings by the time of the May earnings report pursuant to a public company auditing standard that requires auditors to disclose similar deficiencies “in a timely manner” and “prior to the issuance of the auditor’s report.”  According to the Court, while this standard supported an inference that the auditor would have informed the Company prior to the June audit report being issued, there was no basis for concluding that the auditor would have informed the Company prior to the May earnings report.  Moreover, the Court rejected plaintiffs’ attempt to sustain its allegations by pointing to the fact that the same auditor had acknowledged a “going concern” in April 2020 a different airline it was auditing.  According to the Court, even if the allegations concerning the auditor’s audit of the other airline were true, “it says little about when [the auditor] reached its going-concern conclusion for the separate airline at issue in this case, much less when it communicated that conclusion to any of the defendants.”

    The Court similarly held that plaintiffs failed to adequately plead scienter because plaintiffs did not adequately allege defendants received or otherwise knew of the auditor’s findings prior to the May 2020 earnings report.  Plaintiffs argued that the Company’s subsequent decision to terminate the auditor in June 2020 provided an inference of fraudulent intent; however, the Court held that, “[w]ithout additional allegations suggesting a culpable explanation, the mere fact the [Company] terminated [the auditor] does not support an inference of conscious misbehavior or recklessness[,]” and, in any event, it would seem more logical that the Company would have terminated the auditor before filing the audit report if the termination was related to alleged fraud on the part of defendants.

    Having dismissed the Section 10(b) claims, the Court dismissed plaintiffs’ control-person liability claims under Section 20(a), finding no predicate violations of the Exchange Act.  The Court granted plaintiffs leave to amend.