Auto. Indus. Pension Trust Fund v. Textron Inc.: Pleading Fails To Meet the Scienter Element Under Heightened PSLRA Standards
On June 7, 2012, the First Circuit Court of Appeals affirmed the district court’s decision to grant Textron Inc.’s (“Textron”) motion to dismiss Appellees’ securities fraud class action claim. Auto. Indus. Pension Trust Fund v. Textron Inc., No. 11-2106, 2012 WL 2038098 (1st Cir. 2012). Automotive Industries Pension Trust Fund was the lead appellee for a class of plaintiffs (collectively, “Appellees”) who invested in Textron.
According to the complaint, Textron, which wholly owns Cessna Aircraft Company (“Cessna”), made statements over the course of 2007 and 2008 assuring its investors of its financial strength due to the depth of its backlog of orders at Cessna. For instance, Textron allegedly stated that the backlog would carry the company through difficult economic times. For sixteen months leading up to January 2009, Textron management reassured investors that its backlog was resilient and cancellations were minimal. On January 29, 2009, however, Textron reported a disappointing fourth quarter in 2008, with “few orders, 23 cancellations, and ‘an unprecedented number of deferrals’ of delivery dates by customers.” After the report’s release, Textron stock declined thirty-one percent.
To allege a claim under Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5, plaintiffs must plead “1) material misrepresentation or omission; 2) scienter; 3) a connection to the purchase or sale of a security; 4) reliance on the representations; 5) economic loss; and 6) loss causation.” To reduce the number of securities lawsuits, Congress enacted the Private Securities Litigation Reform Act (“PSLRA”), which requires plaintiffs to allege each specific misleading statement, state why it is misleading, and allege a “strong inference” that the defendant acted with scienter. Adequate scienter is the “intent to deceive, manipulate, defraud” or act recklessly with an indifference to deceit.
Appellees’ claim relied on twenty-three confidential witnesses who allegedly revealed weaknesses in Cessna’s backlog. The weaknesses included lowered credit standards for buyers, customer deposits that Cessna fully financed, and generous loan repayment terms. Cessna encouraged customers to delay their orders instead of canceling them; additionally, many customer orders were contingent, intended only to be delivery placeholders and not actual orders. Appellees alleged that Textron made false statements about cancellation figures, including an announcement that Cessna had only two cancellations as of July 2008. Appellees’ main claim, however, was that Textron failed to disclose information about the weakness of its backlog orders.
The court held that Appellees’ complaint failed to plead facts sufficient to infer scienter. Nothing in the complaint implied that Textron’s management believed, or was reckless in not knowing, that the backlog had been compromised by loose underwriting standards. Allegations that Textron’s management was unaware of Cessna’s unstable backlog would establish negligence, but negligence was not sufficient to prove scienter under PSLRA standards. The court stated that a concealed change in company policy could support an inference of scienter; however, Appellees did not plead those facts.
A strong inference of scienter can also arise from stock sales that are unusual in amount. Appellees highlighted some stock sales by Textron management during the class period, but Appellees did not provide comparative sales from outside the class period to suggest that these were unusual. Additionally, the confidential witness statements about backlog cancellations occurring “suddenly” in “late summer” corroborated Textron’s statements and did not establish scienter. None of Appellees’ scienter allegations were sufficient to meet the burden of the PSLRA’s heightened pleading standards; therefore, the appellate court affirmed the dismissal of the claim.
The primary materials for this case may be found on the DU Corporate Governance website.