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Eastern District Of Pennsylvania Dismisses Purported Securities Fraud Class Action Against IT Services Company For Failure To Adequately Allege Falsity, Scienter And Loss Causation
02/13/2024On February 1, 2024, Judge Gerald J. Pappert of the United States District Court for the Eastern District of Pennsylvania granted a motion to dismiss a putative securities class action against an IT solutions company that provides digital communication, cybersecurity and IT consulting services, its CEO and current and former CFOs. Connor v. Unisys Corp., et al., No. 22-4529 (E.D. Pa. Feb. 1, 2024). Plaintiff alleged that defendants made false representations about the Company’s disclosure controls and procedures and internal control over financial reporting in violation of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder. The Court dismissed the amended complaint, holding that plaintiff failed to adequately allege falsity, scienter and loss causation.
Plaintiff, on behalf of a putative class of stockholders who allegedly purchased Company stock between February 22, 2022, and November 7, 2022, alleged that the Company made several false or misleading statements in certain of its public filings in 2021, specifically by touting that the Company had “effective” disclosure controls and procedures and internal control over financial reporting. According to plaintiff, on November 7, 2022, the Company issued a press release stating it would be unable to file its Form 10-Q for the third quarter of 2022 because the audit committee of the board of directors was conducting an internal investigation regarding the Company’s disclosure controls. The Company’s stock price allegedly fell 48% the following day. Plaintiff alleged that two weeks later, the Company filed a Form 8-K disclosing that the audit committee found material weaknesses in the Company’s disclosure controls and procedures and internal control over financial reporting, which the investigation attributed to the design and maintenance of effective policies and procedures governing the timely communication of information within the Company’s departments and management. As a result, the Company amended its Forms 10-K and 10-Qs to include remedial measures, such as implementation of stricter controls, training and enhancing the Company’s relevant written policies. The Court dismissed plaintiff’s claims on several bases.
First, the Court held that plaintiff failed to adequately allege falsity with respect to alleged statements regarding the Company’s disclosure controls—such as “management assessed the effectiveness” of such controls—because plaintiff failed to articulate how such statements were indeed false at the time they were made. The Court noted that plaintiff failed to cite contemporaneous sources indicating the statements were untrue, and instead relied on hindsight arguments—for example, that the Company could not have conducted a good faith evaluation of its controls based on the remedial measures put in place following the audit committee report—which failed to sufficiently allege falsity.
Second, the Court held that plaintiff failed to adequately allege scienter. Plaintiff alleged that the Company and individual defendants were “personally responsible” for designing disclosure and internal controls, and any statements made about their design “were made on the basis of personal knowledge.” The Court held that such allegations were “all speculation,” and that despite plaintiff’s allegation that defendants “had access to contrary facts,” plaintiff did not identify any evidence of that. Rather, plaintiff pointed to defendants’ later admission of error, which the Court held is insufficient to give rise to a strong inference of scienter. The Court reasoned that “treating [plaintiff’s] allegations as sufficient would allow plaintiff[] to always speculate that control deficiencies missed initially but discovered later were within company knowledge from the start” and that “[a]ccordingly, some allegation ‘that the defendant knew he was signing a false SEC filing or recklessly disregarded inaccuracies’ is needed” because “[r]easoning otherwise would equate simple or ‘inexcusable negligence’ with recklessness, in contravention of Third Circuit precedent.”
Third, the Court held that plaintiff failed to adequately allege loss causation. In so holding, the Court reasoned that while the announcement of an investigation, standing alone, does not qualify as a corrective disclosure, it can form the basis of a viable loss causation theory if the complaint also alleges a subsequent corrective disclosure by the defendant and, in such instance, “no stock price drop need accompany the subsequent corrective disclosure.” Thus, the Court held that plaintiff’s allegations that defendants misrepresented the effectiveness of the Company’s controls, followed by the announcement of the audit committee investigation, and subsequent findings of material weakness, would plausibly establish loss causation “[h]ad [plaintiff] adequately alleged falsity and scienter.”
Finally, having found no primary liability under Section 10(b), the Court dismissed plaintiff’s derivative claim under Section 20(a) against the individual defendants. The Court did, however, grant plaintiff leave to amend.
