Southern District Of New York Dismisses Securities Fraud Claims Because Plaintiffs Failed To Plead Any Material Misstatements Or Fraudulent Intent
10/11/2016On September 30, 2016, Judge Richard J. Sullivan of the United States District Court for the Southern District of New York dismissed with prejudice a putative securities class action brought against MDC Partners, Inc. (“MDC”)—an advertising agency holding company—and several of its current and former officers and directors. N. Collier Fire & Rescue Dist. Firefighter Pension Plan v. MDC Partners, Inc., No. 15 Civ. 6034 (S.D.N.Y. Sept. 30, 2016). Plaintiffs claimed that defendants violated Section 10(b) of the Securities Exchange Actmisstating the amount of compensation paid to MDC’s founder and former CEO. The Court held that the alleged misrepresentations regarding the CEO’s compensation were not qualitatively material and dismissed the claims.
Before the lawsuit was filed, MDC announced it had been cooperating with an SEC investigation into expense reimbursements and related accounting practices and that the CEO would reimburse the company for $8.6 million in expenses. The CEO later agreed to repay an additional $1.88 million in expenses, bringing the total reimbursement to $10.5 million. Plaintiffs, investors in MDC stock, claimed, among other things, that defendants failed to disclose these as unreimbursed expenses, and in particular, alleged that $2.1 million of the expenses in 2013 should have been characterized as compensation paid to the CEO.
The Court dismissed this claim on the ground that the allegedly omitted information was not material. While the Court acknowledged materiality is a “fact‑specific inquiry” and can support dismissal at the pleading stage only when “reasonable minds could not differ” about the importance of the facts at issue, it held that the “quantitative” and “qualitative” factors that assist in determining their materiality supported dismissal here. First, the Court observed that, although $2.1 million was not quantitatively material when measured against MDC’s total expenses for 2013, it was quantitatively material when measured against the CEO’s total compensation in 2013. The Court suggested it believed the comparison to total expenses was likely the more appropriate measure, but then declined to resolve the issue because the expenses were found not to be qualitatively material. In reaching this conclusion, the Court pointed to the media’s muted reaction after the payments were disclosed, holding this showed that investors already knew the former CEO “was paid like a sultan” and that it “is simply not ‘substantially likely that a reasonable shareholder would,’ in deciding whether to purchase MDC securities, ‘consider it important’ to know that [the CEO] was marginally closer to being the highest-paid advertising CEO….” Finally, Judge Sullivan held that plaintiffs failed to adequately allege scienter, including the holding that MDC’s remedial steps in response to the improper reimbursements—which companies should be encouraged to take—do not establish scienter.
The Court’s decision highlights that even the seemingly fact‑specific element of materiality may provide a basis for dismissal at the pleading stage when a defendant has credible arguments on qualitative materiality, including based on market reaction to corrective disclosures that show that the market did not attach significance to the alleged misstatements or omissions.