Southern District Of New York Dismisses Putative Class Action Against Building Materials Company For Failure To Adequately Allege Misstatements And Scienter
07/23/2019On July 12, 2019, Judge Valerie Caproni of the United States District Court for the Southern District of New York dismissed a putative securities class action brought against the building materials company Cemex and certain of its officers, asserting claims under the Securities Exchange Act of 1934. Schiro v. Cemex, S.A.B. de C.V., No. 18-CV-2352 (VEC), 2019 WL 3066487 (S.D.N.Y. July 12, 2019). Plaintiffs alleged that defendants misrepresented the company’s internal controls and compliance with anti-bribery laws and failed to disclose an alleged bribery scheme involving the company’s Colombian subsidiary. The Court held the misrepresentations in question were either not actionable or were inadequately pleaded with respect to scienter, and therefore dismissed the complaint in its entirety, while granting leave for plaintiffs to amend.
Plaintiffs alleged that the company made various misrepresentations in its 2014 and 2015 SEC filings regarding its internal controls and compliance, as well as its efforts to purchase land, mining rights and achieve tax benefits in Colombia, that were misleading in light of the company’s late 2016 announcement that an “internal audit process” had uncovered irregular payments in connection with efforts to build a new cement plant, and that the payments were in violation of the company’s policies and, potentially, Colombian law. This disclosure led to the termination of certain executives at the subsidiary, as well as to SEC and DOJ subpoenas as part of an investigation into potential violations of the Foreign Corrupt Practices Act. Id.
The Court held that most of the alleged misstatements were not actionable. The Court rejected plaintiffs’ argument that the company had taken on a duty to disclose the bribery scheme as a result of generic statements that it was “strengthening [its] footprint with expansion projects” such as the cement plant in question and that its “solid asset base together with [its] unique portfolio of building solutions, [would] allow [it] to continue promoting growth in [its] markets.” Id. at *5. The Court also determined that the company’s statements regarding its commitment to compliance—such as that it “rejected all forms of corruption” and “does not tolerate bribery”—to be “classic puffery,” and bore clear indications that they were statements about goals, not statements of facts. Id. at *6. In addition, the Court held that statements that management had concluded that internal controls over financial reporting had been effective were not actionable because plaintiffs did not actually allege that they were false—i.e., that management had not so concluded. Id. at *7.
However, the Court determined that plaintiffs did sufficiently allege an actionable omission with respect to the company’s statements regarding ongoing litigation in Colombia. Id. at *4. The Court noted that a company has a duty to disclose “uncharged, unadjudicated wrongdoing” only if “its statements are or become materially misleading in the absence of disclosure,” and that more is needed than that “a criminal conviction would have an adverse impact on the corporation’s operations … or the bottom line”; for such a duty to arise, there must be a sufficient nexus between the wrongdoing and the misleading statements. Id. The Court held that a sufficient nexus existed because a reasonable investor could conclude that the bribery scheme might affect the likely outcome of litigation that had been disclosed. Id.
With respect to that alleged omission, plaintiffs attempted to plead scienter based on three categories of allegations: first, that certain executives resigned or were terminated following the discovery of the improper payments; second, various “red flags” indicating a “culture of corruption” at the Colombian subsidiary; and third, the actions, statements and positions of the named individual defendants. The Court rejected all of these theories.
With respect to the terminated officers of the subsidiary, the Court determined that, while the plaintiffs had adequately alleged that these individuals (who were found to be responsible for the improper payments) had acted with scienter, plaintiffs failed to allege that their knowledge was attributable to the corporate parent. Id. at *9. The Court noted that these officers were not senior enough to serve as a proxy for the parent and that they worked at a minor subsidiary of the company. Id. at *10. With respect to the resignation of the subsidiary’s CEO on the same day that the misconduct was disclosed, the Court found that such a resignation, standing alone, did not raise a more compelling inference that the CEO acted with scienter than the alternative non-culpable inference, namely, that, when corporate misconduct is disclosed, members of management may resign for any number of reasons, including accountability for negligence or for market optics. Id. at *11. The Court also declined to infer that any scienter on the part of the subsidiary’s CEO could be attributed to the parent, as the subsidiary was not sufficiently central to the overall business that the CEO would be considered part of the parent’s senior management. Id. at *12.
Moreover, the Court rejected plaintiffs’ proposed inference of scienter based on alleged “red flags”—indications of wrongdoing derived largely from the statements of confidential witnesses, or otherwise related to developments in the Colombia litigation. With respect to the allegations from confidential witnesses, the Court found their allegations to be “too vague, speculative, and conclusory to contribute to an inference of scienter.” Id. at *12-13. The allegations concerning the Colombian litigation also failed to raise a compelling inference of scienter because the litigation was initiated to resolve property rights and there was “no indication that it had anything to do with fraud or wrongdoing.” Id.
In addition, the Court held that the conduct of the individual defendants failed to raise a compelling inference of scienter. The Court found that plaintiffs’ allegations based on the Company’s disclosures that its executives had reviewed internal controls and found them adequate “establish[ed] nothing” because they failed to show that the defendants knew at the time the statements concerning these practices were made that those practices were inadequate. Id. at *13. The Court further concluded that the Company’s periodic updates regarding the general status of the cement plant in question did not imply its knowledge of the alleged bribery scheme. Id. at *14. The Court also rejected plaintiffs’ arguments that the individual defendants acted with scienter because, as “senior executives,” they had access to information about the alleged bribery scheme; rather, the Court emphasized that plaintiffs failed to specifically identify contradictory reports or statements that these defendants received or had access to. Id. Finally, the Court found that plaintiffs failed to identify any specific facts suggesting the company’s stated belief that the Colombian litigation would not have a material adverse impact on the company was false when made. Id.
While the Court granted plaintiffs leave to amend, the Court noted that it was “skeptical that the flaws in the Amended Complaint can be remedied.” Id. at *15.