Middle District Of Florida Dismisses Securities Fraud Action Against Foodservice Equipment Company For Failure To Plead Scienter
On February 6, 2020, Judge James S. Moody, Jr. of the United States District Court for the Middle District of Florida dismissed a putative class action asserting violations of Section 10(b) of the Securities Exchange Act of 1934 (“Exchange Act”) and Rule 10b-5 promulgated thereunder against a foodservice equipment company (the “Company”) and certain of its former officers. Metropolitan Transportation Authority Defined Benefit Pension Plan Master Trust v. Welbilt Inc., No. 8:18-cv-03007 (M.D. Fl. Feb. 6, 2020). Plaintiffs alleged that the Company made misleading statements about its disclosure controls in quarterly and annual reports from February 2017 to November 2018, and that its share price fell after it revealed that its financial statements should not be relied upon because of various accounting and reporting errors. The Court dismissed the complaint without prejudice, holding that plaintiffs failed to plead sufficient facts to give rise to a strong inference of scienter.
In 2016, the Company spun off from another foodservice company and became an independent, publicly-traded company. From February 2017 through November 2018, the Company filed quarterly and annual financial statements with the U.S. Securities Exchange Commission disclosing that (1) its chief executive officer and chief financial officer had evaluated the effectiveness of its disclosure controls and procedures, (2) its controls were effective, and (3) the Company was enhancing its systems and expanding its accounting, reporting and auditing departments. On November 5, 2018, the Company announced that its 2016 financial statements were unreliable due to errors that understated its U.S. tax liability. That same day, the Company’s stock price declined by 26.19%. The Company subsequently disclosed more errors in prior reporting periods and concluded that its controls were defective as of December 31, 2017.
Plaintiffs made several allegations related to scienter, pointing to the following circumstantial evidence: (1) the individual defendants’ personal interests as officers; (2) the scope and duration of alleged errors in income tax accounting controls; (3) the fact and amount of the financial restatements and discrete nature of accounting errors; (4) the timing and method of discovering the control deficiencies; (5) the individual defendants’ contemporaneous resignations; (6) the individual defendants’ financial statement certifications; and (7) continued remediation efforts.
The Court ruled that these allegations were insufficient to meet the heightened pleading standard under the Private Securities Litigation Reform Act. First, the Court ruled that plaintiffs failed to allege specific facts as to each individual defendant to support a strong inference of scienter and that plaintiffs could not rely on group pleading to plead scienter.
Second, the Court ruled that, when considering all of the facts collectively, plaintiffs’ allegations did not give rise to a strong inference of scienter compared to non-fraudulent inferences that may be drawn from the allegations. The Court rejected plaintiffs’ argument that the restatement itself was sufficient to plead scienter and instead ruled that the strongest inference to draw from the restatement was that the Company was pursuing truth and not attempting to deceive investors.
Finally, although it dismissed the action because plaintiffs failed to plead scienter, the Court ruled that plaintiffs adequately pleaded the element of loss causation. Plaintiffs attributed the drop in the Company’s stock price to the revelation of the truth in its Form 8-K filing. Defendants disagreed and noted that the Company also announced in the 8-K financial results that fell short of analyst expectations and lowered its anticipated earnings per share based on updated 2018 financial guidance. The Court ruled that although plaintiffs fail to address the financial earnings report and lowered expectations for future earnings, plaintiffs sufficiently alleged that the disclosure about the accounting errors was a substantial or significant contributing cause of the stock drop.