United States District Court, D. Kansas
WAYNE E. ANDERSON, Individually and on Behalf of All Others Similarly Situated, Plaintiff,
SPIRIT AEROSYSTEMS HOLDINGS, INC., JEFFREY L. TURNER, PHILIP D. ANDERSON, ALEXANDER K. KUMMANT, and TERRY J. GEORGE, Defendants.
MEMORANDUM AND ORDER
ERIC F. MELGREN, District Judge.
Defendants challenge whether Plaintiffs have properly pled a claim for securities fraud under the pleading standards of the Private Securities Litigation Reform Act. Plaintiffs accuse Defendants of making misleading statements that artificially inflated Spirit's stock price before Spirit recorded a $590 million forward-loss charge in 2012. To survive Defendants' motion to dismiss, Plaintiffs' consolidated complaint must properly plead that Defendants made false statements of material fact with scienter, which means having the intent to deceive or acting with recklessness. After carefully and extensively reviewing the complaint and oral argument, the Court finds that the alleged false statements were not material and that the complaint fails to raise a strong inference of scienter. Therefore, the Court grants the motion to dismiss.
I. Factual and Procedural Background
Highly summarized, this lawsuit was filed as a class action against Spirit AeroSystems, Inc., and four corporate officers, alleging violations of federal securities laws. Specifically, this lawsuit derives from Spirit's announcement of a $590 million forward-loss charge on October 25, 2012. Under generally accepted accounting principles (GAAP), a forward-loss charge is recorded when the current estimates of total contract revenue and total contract cost indicate an entire loss on the contract. The forward-loss charge is recorded in the period in which it becomes evident.
Spirit recorded forward losses for six manufacturing contracts, including $184 million for its Boeing 787 program, $162.5 million for its Gulfstream G650 program, $151 for its Rolls-Royce BR725 program, $88.1 million for its Gulfstream G280 program, $2.4 million on its Airbus A350 program, and $2.4 million for its Boeing 747 program. The announcement caused Spirit's stock price to drop by $6.55 per share (30 percent). Spirit's quarterly report to the SEC attributed the losses to performance issues at its Tulsa facility, higher cost estimates related to type certification, the decision to delay moving work to lower-cost facilities in Kinston, N.C., and Chanute, Kan., and the finalization of supplier contracts that resulted in higher costs than originally estimated. Spirit characterizes the forward-loss charges as an unforeseen business reversal, the result of a disappointing failure to achieve planned cost reductions on Spirit's new aircraft component manufacturing contracts. Defendants maintain that the forward losses did not become evident until the third quarter of 2012.
This lawsuit was filed in June 2013. In February 2014, this Court appointed co-lead Plaintiffs, the International Association of Machinists and Aerospace Workers, District 9 Pension and Welfare Trusts and the Arkansas Teachers Retirement System. They bring this action individually and behalf of those who acquired Spirit securities from November 3, 2011, through October 24, 2012. After this Court appointed co-lead Plaintiffs and co-lead counsel, a consolidated complaint (Doc. 49) was filed in April 2014. The consolidated complaint alleges securities fraud for violations of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and Securities and Exchange Commission Rule 10b-5. The picture painted by the 144-page complaint is that members of the proposed class bought Spirit stock at artificially inflated prices because of Defendants' misrepresentations and omissions of material facts related to the progress of Spirit's cost-reduction efforts from November 3, 2011, to October 24, 2012.
Plaintiffs list in the complaint 86 numbered paragraphs under the heading of "Defendants' Materially False and Misleading Statements and Omissions." The complaint attributes 28 statements to Defendant Jeffrey Turner, the chief executive officer and president of Spirit. Nineteen statements are attributed to Defendant Philip Anderson, Spirit's chief financial officer. Four statements each are attributed to Defendant Alexander Kummant, the senior vice president of Oklahoma operations, and Defendant Terry George, the vice president of Spirit's 787 program. The paragraphs are arranged as related to events during five time periods, all of which are during the class period between November 3, 2011, and October 24, 2012.
Essentially, Plaintiffs allege that Defendants falsely proclaimed success at reducing costs despite knowing that Spirit was plagued by cost overruns and production problems and failing to disclose them. Plaintiffs allege that the forward losses were evident well before the third quarter of 2012 and should have been recorded sooner instead of continuing to report zero margins. In June 2014, Defendants filed a motion to dismiss the consolidated complaint (Doc. 54) for failure to meet the pleading requirements of the Private Securities Litigation Reform Act. The Court heard oral argument in February 2015, and the matter is now before the Court.
II. Legal standard
"To survive a motion to dismiss, a complaint must contain sufficient factual matter, accepted as true, to state a claim for relief that is plausible on its face.'" "The court's function on a Rule 12(b)(6) motion is not to weigh potential evidence that the parties might present at trial, but to assess whether the plaintiff's complaint alone is legally sufficient to state a claim for which relief may be granted.'" All well pleaded facts in the complaint are assumed to be true and are viewed in the light most favorable to the plaintiff. Allegations that merely state legal conclusions, however, need not be accepted as true. The court considers the complaint as a whole, "along with the documents incorporated by reference into the complaint or publicly filed with the Securities and Exchange Commission."
Complaints asserting securities fraud claims are held to a higher standard of pleading beyond plausibility. A plaintiff bears a heavy burden under the Private Securities Litigation Reform Act, which mandates a more stringent pleading standard for securities fraud actions. To state a claim under Section 10(b) of the Securities Exchange Act of 1934,  a plaintiff must allege five elements:
(1) the defendant made an untrue or misleading statement of material fact, or failed to state a material fact necessary to make statements not misleading; (2) the statement complained of was made in connection with the purchase or sale of securities; (3) the defendant acted with scienter, that is, with intent to defraud or recklessness; (4) the plaintiff relied on the misleading statements; and (5) the plaintiff suffered damages as a result of his reliance.
The statutory language of the Private Securities Litigation Reform Act requires that "the complaint shall specify each statement alleged to have been misleading, the reason or reasons why the statement is misleading, and, if an allegation regarding the statement or omission is made on information and belief, the complaint shall state with particularity all facts on which that belief is formed." The complaint also must "state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind, " which, in this case, is with scienter or, in other words, with intent to defraud or recklessness. A complaint alleging fraud also must satisfy Federal Rule of Civil Procedure 9(b), which requires that the plaintiff "must state with particularity the circumstances constituting fraud or mistake." That means that such a complaint "must identify the time, place, and content of the allegedly fraudulent representation, identify the person responsible for it, " and identify its consequences. In other words, Rule 9(b) requires that a complaint include the "who, what, when, where and how" of the fraud alleged.
Section 10(b) of the Securities Exchange Act of 1934, found at 15 U.S.C. § 78j(b), and Rule 10b-5, found at 17 C.F.R. § 240.10b-5, prohibit fraudulent acts involving securities transactions. Section 10(b) makes it unlawful "[t]o use or employ, in connection with the purchase or sale of any security... any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the Commission may prescribe." Rule 10b-5, prescribed by the Securities Exchange Commission, specifically makes it unlawful "[t]o make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading... in connection with the purchase or sale of any security." Plaintiffs also seek to hold each Defendant liable under Section 20(a), found at 15 U.S.C. § 78t(a), which holds each person who controls any person liable for securities fraud jointly and severally liable to the same extent as the controlled person.
Spirit challenges whether the complaint has pled facts showing falsity, materiality, and scienter. Spirit argues that the statements are not false or misleading. Second, Spirit argues that the allegedly untrue statements are not material because statements of corporate optimism and forward-looking statements are not actionable. Further, Spirit argues that Plaintiffs do not plead facts demonstrating a strong inference of the required state of mind, or scienter, either with intent to defraud or recklessness. Overall, Spirit argues that Plaintiffs' have pled fraud by hindsight, which is not enough to show a strong inference of fraud.
A. Whether the Complaint Alleges False and Misleading Statements
The first issue is whether Plaintiffs have properly alleged that Defendants made false and misleading statements. The complaint sets out more than 40 allegedly misleading statements and specifies why the statements are claimed to be misleading in paragraphs 62, 74, 94, 111, and 131. The complaint points to statements made in earnings releases and conference calls related to the third quarter of 2011, the fourth quarter of 2011, the first quarter of 2012, and the second quarter of 2012 in addition to statements made at the 2012 investor conference. The complaint also identifies the consequences of each group of statements: an allegedly inflated stock price that went up after each event. In other words, the complaint identifies the time, place, and content of the alleged false statements, identifies the person responsible for each one, and identifies the consequences.
The complaint must state the reasons why the statements are misleading. A plaintiff must "identify in the complaint specific facts that support the allegations about the misleading nature of the defendants' statements." The statute requires that the complaint "state with particularity all facts on which that belief is formed." A statement may be deemed false, for the purpose of an allegation surviving a motion to dismiss, if a reasonable person would understand that a statement is inconsistent with the facts on the ground.
Here, most of the statements alleged to be false are statements related to Spirit's ability to achieve cost reduction goals on the Boeing and Gulfstream programs made while there were undisclosed ongoing problems that led to severe cost overruns. Regarding the Boeing and Gulfstream programs, Plaintiffs allege that Defendants repeatedly assured investors that the projects were "on track, " "tracking per plan, " "going really well, " "really screaming down the cost curves, " and that "cost reduction is right on plan" and allege that these statements were false when made.
In paragraph 62 of the complaint, Plaintiffs allege that Defendants had already understated costs by 16 percent at the time they made positive statements about the Boeing 787 program in November 2011. Plaintiffs allege that Defendants failed to account for these cost overruns in the third quarter of 2011 so that they could artificially report a zero margin and avoid recording a forward loss on the 787 and Gulfstream projects. Paragraph 74 outlines similar allegations about statements made in February 2012. For example, Plaintiffs allege that Anderson stated that Spirit was making "good progress on 787 cost reduction initiatives, " which was inconsistent with internal cost analysis at the time. Plaintiffs make similar allegations in paragraph 94 about statements made in March 2012, in paragraph 111 about statements made in May and June 2012, and in paragraph 131 about statements made in September 2012. Plaintiffs allege that Defendants "lacked a reasonable basis for their positive statements" about Spirit and its outlook.
For the purpose of this motion, the Court assumes that Plaintiffs have sufficiently pled false and misleading statements to survive dismissal on this issue. The next question is whether any of these statements concerned a material fact or if a material fact necessary to make any of the statements not misleading was omitted, as required by Rule 10b-5.
B. Whether Misstatements and Omissions Are Material
A statement or omission is material "if a reasonable investor would consider it important in determining whether to buy or sell stock." The Tenth Circuit has recognized at least two categories of statements that generally will not be considered material: first, vague statements of corporate optimism, and second, forward-looking statements that are accompanied with sufficient cautionary language that nullify any potential misleading effect. But statements of corporate optimism and forward-looking statements may be material if the speaker knew at the time the statements were made that they were untrue or had no reasonable basis in fact.
The Tenth Circuit has concluded that statements that are "mere puffing [and] not capable of objective verification" are immaterial as a matter of law. Statements not capable of objective verification are immaterial as a matter of law because "reasonable investors do not rely on them in making investment decisions." But it is possible for some statements to "cross the line from corporate optimism and puffery to objectively verifiable matters of fact." Examples of statements capable of objective verification include terms that are measurable, such as "majority of, " "90% done, " or "most of." Also immaterial as a matter of law are broad optimistic claims that are so vague and lacking in specificity that no reasonable investor could find them important. Examples of these "rosy affirmations" include statements that certain efforts are "progressing well" or "tracking within expectations." Materiality is generally a fact-specific inquiry for a jury, but courts do not hesitate to dismiss securities claims if the representation is plainly immaterial.
Here, the complaint highlights more than 40 positive statements that Plaintiffs argue are false and misleading. Paragraphs 62, 74, 94, 111, and 131 of the complaint emphasize these phrases, which are bolded here in the context presented in the complaint as attributed to each defendant. The complaint lists the false and misleading statements as included in the following 27 paragraphs:
¶51(a): During his opening statement, Turner highlighted the "efforts to implement cost improvements on the 787" touting "the joint Boeing and Spirit teams are tracking per plan to identify and implement cost improvements, across the program on the current product structure, its producibility, efficiency, and productivity." (Turner, Nov. 3, 2011 conference call)
¶51(b): "Looking ahead, we expect to continue to benefit from the expanding demand for commercial aircraft, while achieving productivity and efficiency improvements across our business." (Turner, Nov. 3, 2011 conference call)
¶51(d): Turner stated: "We don't have any big major tent poles, that we are worried about right now, " adding "our condition of assembly is extremely good." (Turner, Nov. 3, 2011 conference call)
¶51(e): Speaking very positively about the Gulfstream programs, Turner noted: "I like the momentum that I'm seeing. I will speak a little bit about the 280, specifically, and the 650, which you guys know, have been challenging programs for us. We've got-I like the momentum that I see, I like the management team we have in place. I think we've seen major improvements in flow, on the 280." (Turner, Nov. 3, 2011 conference call)
¶54: Turner also touted the 280 and 650 programs, noting that "[t]he Gulfstream programs continue their progress, as we build the initial production wings for the G280 and G650, " and emphasized that "we are seeing growing tailwinds." (Turner, Nov. 30, 2011 investors conference)
¶55: "The 787, as you know, we've set the first block of 500 units of that at a zero margin. At this point in time, we've reserved-have a healthy management reserve on that and have focused activity to bring-to come down the cost curve on that program. If we achieve that cost curve, we will be able to convert some of that management reserve into profitability. If we don't achieve that, that cost curve, we'll have some management reserve to cushion it.
"[C]learly we believe the tailwinds are stronger now than the headwinds and we've got the opportunity to have an expansion-or expanding topline and be able to hold or improve our margins overall." (Turner, Nov. 30, 2011 investors conference)
¶57: Touting the Tulsa facility, where the Gulfstream and 787 wing programs were located, Turner assured the market that he was "very pleased with my Tulsa team, the operations team there, and the progress they're making in the factory." (Turner, Nov. 30, 2011 investors conference)
¶65(a): Anderson confirmed that Spirit had "made good progress on 787 cost reduction initiatives." (Anderson, Feb. 9, 2012 conference call)
¶65(c): Anderson then assured investors that the headwinds experienced in Spirit's development programs in 2011 would not be present, explaining that "we had some bigger challenges [in 2011], obviously. At this point, there is nothing that tells us those are going [to] repeat." One of the call participants confirmed: "So in other words you have derisked enough" on the development programs. Anderson also confirmed that "[o]ur progress on 787 has been very, very good, " and assured that for ...