Opinion ID: 781005
Heading Depth: 3
Heading Rank: 2

Heading: Sufficiency of Scienter Allegations

Text: 77 Plaintiffs argue that the District Court erred in concluding that the Second Amended Complaint failed to raise a strong inference of scienter. In this Circuit, the required scienter is deliberate or conscious recklessness. Silicon Graphics, 183 F.3d at 979. Mere motive and opportunity are insufficient. Id. Under Silicon Graphics and its progeny, we examine all the circumstances in determining whether a strong inference of scienter has been raised. See id. at 984-87 (examining the plaintiff's allegations regarding internal reports and stock sales); see also In re Vantive Corp. Sec. Litig., 283 F.3d 1079 (9th Cir.2002) (examining the plaintiffs' allegations of misrepresentations, accounting manipulations, stock sales, and corporate transactions). Each allegation should be supported by particularized facts and corroborating details. Silicon Graphics, 183 F.3d at 985. Beyond each individual allegation, we also consider whether the total of plaintiffs' allegations, even though individually lacking, are sufficient to create a strong inference that defendants acted with deliberate or conscious recklessness. Lipton, 284 F.3d at 1038. In doing so, we must consider all reasonable inferences to be drawn from the allegations, including inferences unfavorable to the plaintiffs. Gompper v. VISX, Inc., 298 F.3d 893, 897 (9th Cir.2002) (emphasis in original) (discussing the tension between Rule 12(b)(6) and the heightened pleading standard set forth under the PSLRA). 78
79 Plaintiffs allege that numerous individuals and the two controlling shareholders engaged in massive insider trading during a three month time period. In particular, Plaintiffs alleged that four of America West's top officers — Howlett (Vice President of Public Affairs), Aramini (Senior Vice President of Operations), Garel (Senior Vice President of Marketing and Sales), and Carreon (Vice President and Controller) — and three of America West's directors — Bollenbach, Fraser, and Ryan — sold over 167,819 shares for over $4.5 million. Plaintiffs also allege that Coulter and Schifter, both of whom served as officers for TPG and directors for America West, sold 332,733 shares for over $9 million. In addition, Plaintiffs allege that Continental sold 317,140 of its publicly-traded Class B stock (100% of its publicly traded stock) for almost $9 million, based on insider information. Finally, Plaintiffs assert that TPG sold 1,613,586 shares of its publicly traded Class B stock (over 99% of its publicly-traded stock) for over $44 million, also based on insider information. 80 The District Court concluded that the stock sales by the officers, directors, and controlling shareholders were not suspicious and failed to raise a strong inference of scienter. As to the individuals, the District Court found it dispositive that none of the officers or directors (outside of Aramini) who allegedly engaged in insider trading made any of the false or misleading statements. As to the controlling shareholders, the District Court found the restrictions imposed by the Stockholder's Agreement rendered the sale unsuspicious. We disagree and find that the allegations raised a strong inference. 81 `[U]nusual' or `suspicious' stock sales by corporate insiders may constitute circumstantial evidence of scienter.... Silicon Graphics, 183 F.3d at 986 (citation omitted). However, insider stock sales are only suspicious when they are `dramatically out of line with prior trading practices at times calculated to maximize the personal benefit from undisclosed inside information.' Id. (quoting In re Apple Computer Sec. Litig., 886 F.2d 1109, 1117 (9th Cir.1989)). Among the relevant factors to consider are: (1) the amount and percentage of shares sold by insiders; (2) the timing of the sales; and (3) whether the sales were consistent with the insider's prior trading history. Id. (citing Provenz v. Miller, 102 F.3d 1478, 1491 (9th Cir. 1996)). In addition, in determining whether the trading pattern is suspicious, we may consider an insider's ability to trade. Ronconi, 253 F.3d at 436 (citation omitted). 82 Before applying these factors to the individual defendants, we note that the District Court erred in summarily dismissing Plaintiffs' argument based solely on the fact that most of the individual officers and directors had not made the alleged misrepresentations or misleading omissions. An insider's silence as to the statements is not dispositive. Rather, it is merely another factor that should be considered in determining whether a strong inference of scienter has been raised. See Vantive, 283 F.3d at 1094 (considering the defendant's failure to utter a word as one factor); cf. Silicon Graphics, 183 F.3d at 987-88. 83 Turning to the relevant factors, the stock sales by individual defendants appear dramatically out of line with their prior trading practices at times calculated to maximize personal benefit from undisclosed inside information. First, the amount and percentage of shares sold by individual insiders was suspicious. Most of the individuals sold 100% of their shares, with the lowest percentage being 88%. The proceeds from these sales totaled over $12 million. For each defendant, Plaintiffs outlined the individual's holdings, his class period sales, when the sales occurred, the percentage of owned shares that were sold, and the total proceeds that were generated from the sale. 84 Number of Percentage of Proceeds Defendant Shares Sold Shares Sold 16 from Sales Aramini 34,000 100% $1,007,420 Bollenbach 12,819 100% $ 379,311 Carreon 10,000 100% $ 296,300 Coulter 162,592 more than 90% $4,518,432 Fraser 12,000 93.6% $ 363,000 Garel 66,000 100% $1,779,132 Howlett 27,000 100% $ 800,010 Ryan 6,000 88% $ 183,360 Schifter 170,181 more than 90% $4,729,330 85 Although large numbers [and percentages] do not necessarily create a strong inference of fraud, the numbers and percentages presented by Plaintiffs are troubling. Vantive, 283 F.3d at 1093 (emphasis added) (holding that, although a sale of 74% was suspicious, a strong inference was not raised because analysis of the remaining factors did not raise suspicion). 86 Second, the timing of the sales also raises suspicions. Unlike other cases where there were timing gaps between the sales or where only one insider did the trading, here all nine of the individuals' sales occurred in succession over a three month period when America West officials were making optimistic statements regarding the company's financial outlook and reassuring analysts that the settlement agreement would have no economic effect. 17 Cf. Ronconi, 253 F.3d at 436 (One insider's ... sales do not support the `strong inference' required by the statute where the rest of the equally knowledgeable insiders act in a way inconsistent with the inference that the favorable characterizations of the company's affairs were known to be false when made.). Equally troubling is the fact that the stocks were sold between $26-9/16 to $30-9/16 per share, near the stock's peak at $31-5/16, and just prior to the stock's decline to $21-5/16 on August 4, 1998 and subsequent plunge to $14 on September 3, 1998. Cf. Vantive, 283 F.3d at 1093-94 (noting that there was no strong inference of scienter when the majority of the shares were sold for $20-$24 per share and the stock price increased for several months, peaking at $39); Ronconi, 253 F.3d at 435 (finding no strong inference when insiders miss[ed] the boat by selling shares for $53-$56 per share, even though the price ultimately rose to $73). 87 Third, the prior trading history of each defendant indicates that the sales during the class period was unusual and suspicious. None of the individual defendants sold stocks during the twenty months preceding the ten month class period. See Apple Computer Sec. Litig., 886 F.2d at 1117 (examining ten months preceding the ten month class period). Nor did they sell for at least four months following the class period. Thus, the sudden flurry of massive insider trading over this three month period of time, after an extended period of inactivity, appears unusual. 88 Given the large number and percentages of stocks traded, the timing of the sales, and the prior trading history of each defendant, the stock sales that occurred were clearly calculated to maximize the personal benefit from undisclosed inside information. Silicon Graphics, 183 F.3d at 986. Accordingly, the stock sales by the individual defendants were unusual and suspicious and give rise to a strong inference of scienter. 89 We next examine the stock sales by the controlling shareholders. The number and percentage of shares sold by them and the timing of the sales were suspicious. Plaintiffs allege that TPG sold 1,613,586 shares of publicly-traded Class B stock (over 99% of its Class B stock) at approximately $27-3/4 per share, for proceeds of over $44 million. Plaintiffs allege that Continental sold 317,140 shares of Class B stock (100% of its Class B stock) at $28-1/8 per share, for proceeds over $8.9 million. These sales occurred during the same three month period discussed above. 18 Given the massive volume and the timing of the sales, the first two factors indicate suspicious and unusual trading. 90 Both TPG and Continental contend, however, that the sales are consistent with their prior trading history, especially in light of the restrictions provided in the Stockholder's Agreement. Our prior decisions have noted that restrictions on an insider's ability to trade are important in determining whether the trading pattern is suspicious. Ronconi, 253 F.3d at 435. In Silicon Graphics, we held that one reason that an insider who traded 75.3% of his holdings had not engaged in suspicious trading was because he was legally forbidden to trade for the period before the alleged insider trading. 183 F.3d at 987 (emphasis added). Similarly, in Ronconi, we held that the seven month trading period prior to the class period offered by plaintiffs to prove the defendants['] pattern of trading does not prove much about their trading habits, since they were not able to trade during some or much of that time under SEC regulations. 253 F.3d at 436. 91 The restriction in this case was clearly less stringent than the prohibitions in Silicon Graphics and Ronconi. The Stockholder's Agreement required that both TPG and Continental retain two shares of Class B common stock for every share of supervoting Class A stock until May 20, 1998. During the restricted period, both companies could have sold their Class B stock, as long as they maintained the 2:1 ratio. In addition, they could have converted their Class A stock into Class B stock at any point, thus allowing them to sell a greater percentage of stocks prior to the May 20, 1998 expiration of the restriction. Unlike Silicon Graphics or Ronconi, neither defendant was legally forbidden from selling stock. Thus, the restriction in the Stockholder Agreement does not meaningfully detract from the strong inference of scienter that arises from the massive stock sales. 92 TPG and Continental's argument that they had engaged in stock sales prior to the class period is equally ineffective in undermining the inference of scienter. Both TPG and Continental argue that their prior sales of Class B stock and warrants demonstrate their effort to reduce their equity stake in America West. 19 They assert that the sale of almost 2 million shares in May and June 1998 were merely part of this continuing effort to protect themselves from exposure. 93 In response, Plaintiffs urge us to limit our review to the ten months prior to the class period, citing to Apple Computer Securities Litigation, 886 F.2d at 1117, in which we compared sales that occurred during the ten-month class period with the sales during the ten months preceding. In light of our prior caselaw, we accept this limitation as appropriate. See id.; cf. Vantive, 283 F.3d at 1095 (comparing sales during the nine months preceding the fifteen-month class period). Therefore, the only sale relevant to our discussion is TPG's warrant sale to America West in March 1997. Under this analysis, the prior trading history of TPG and Continental indicates that their sales during the class period were suspicious. 94 However, even without limiting our discussion to the ten months preceding, the sales during the class period appear suspicious. None of the prior sales were comparable to those that occurred during the class period. For example, warrants are merely options, and these warrant sales did not occur on the open market. Rather, they occurred in a private transaction with America West. The same concern is borne out in the private sales of Class B stock to the underwriters. Because none of the previous sales were comparable to those that occurred during the class period, they are less relevant in determining whether the May and June 1998 sales were unusual. 95 Viewing the relevant facts in the light most favorable to Plaintiffs, TPG and Continental's sales of stock during the class period appear dramatically out of line with prior trading practices and calculated to maximize the personal benefit from undisclosed insider information, thus supporting a strong inference of scienter. Ronconi, 253 F.3d at 435 (internal quotation marks and citation omitted). Although it is possible that the controlling shareholders were trying to limit their equity exposure through their sales in May and June 1998, this is a question for the jury, or at least one that should be explored during discovery. 96
97 In addition to the suspicious sales, one of Plaintiffs' major contentions is that the individual defendants and controlling shareholders knew of the ongoing maintenance problems and deferred expenses and, thus, knew that the statements to analysts and the public were allegedly false or misleading. In their Second Amended Complaint, Plaintiffs allege that the shortfall in the third quarter of 1998 was caused by both systemic operational problems and the FAA's inspection and investigation of America West, which Defendants hid from investors through misleading statements and omissions while individual defendants and the controlling shareholders engaged in large-scale insider trading. 98 Plaintiffs proffered the following evidence of Defendants' knowledge of these problems: (1) internal reports (including the identity of the person who directed the preparation of the reports); 20 (2) meetings with the FAA (including the dates, content, and participants); (3) FAA letters to America West regarding the ongoing maintenance problems and the agency's increasing frustration with the company (including the dates, case numbers of the investigations, content, and who they were sent to); and (4) the settlement agreement. They also proffer the following evidence that the problem was severe enough that Defendants must have been aware of it: (1) FAA reports regarding the severity of the problems (including case numbers of the investigations and content); (2) FAA letters describing penalties arising from investigations of specific incidents (including the dates, case numbers of the investigations, content, and to whom they were sent); and (3) charts documenting maintenance difficulties. These charts show the scope and the effects of the deferred maintenance and compare the company's performance to that of other major commercial carriers. The charts also compare the number of maintenance labor hours, the rate of maintenance deferred items, hours spent conducting quality assurance, the amount expended on parts inventory, the amount expended on inspection of airplanes, the failed inspection rate, the aircraft utilization rate, the percentage of on-time arrivals, and the number of FAA enforcement actions. 99 As required under the PSLRA, Plaintiffs have set forth adequate corroborating details and facts to support their allegations. Cf. Silicon Graphics, 183 F.3d at 985 (It is not sufficient for a plaintiff's pleadings to set forth a belief that certain unspecified sources will reveal, after appropriate discovery, facts that will validate her claim.). Viewing the allegations as a whole, we find that they raise a strong inference that Defendants knew that the maintenance problems were ongoing and, thus, that the statements made by America West officers were false. 100 Both TPG and Continental argue that the Second Amended Complaint fails to allege any facts showing that either company or any of their officers knew about America West's maintenance issues or communications with the FAA. As to TPG, this argument is without merit. Two TPG officers, Coulter (Director and Vice President) and Schifter (Vice President), served as members of America West's Board of Directors. The Board held eleven meetings in 1997, of which Coulter and Schifter attended 71% and 65% respectively, and the Board held nine meetings in 1998. Coulter was also a member of the Executive Committee in 1997 and 1998. Schifter served as one of the four directors on the Compensation Committee, which met six times in 1997. In light of these facts and the general allegations set forth above, Plaintiffs provide sufficient and particularized factual allegations that TPG and its officers knew about the maintenance and operational problems and the misstatements made by America West's officers. 21 101 However, the issue of whether Plaintiffs have sufficiently alleged scienter as to Continental is more troubling. Plaintiffs allege that: (1) Continental held 8.3% of the Class A stock, making it America West's second largest shareholder; (2) Continental, in conjunction with TPG, was able to select nine of the fifteen board directors and three out of the four directors on the Compensation Committee because of its shareholding power; (3) Continental and America West shared a special relationship because Continental helped America West emerge from bankruptcy; (4) Continental constantly monitored America West's operations by way of conversations and internal reports; and (5) the Form 10-K statement regarding the possibility of influence by controlling shareholders. Alone, these facts may be insufficient to raise a strong inference of scienter. However, in light of the large sale of stocks discussed above, we hold that Plaintiffs have sufficiently raised a strong inference of deliberate recklessness on the part of Continental. Accord Florida State Bd. of Admin. v. Green Tree Fin. Corp., 270 F.3d 645, 660 (8th Cir.2001) (finding that, in insider trading cases, the timing of trades shows circumstantial evidence of scienter). 102
103 Another premise of Plaintiffs' claim is that Defendants knew that America West would have to spend millions of dollars by the end of 1998 to comply with the July 1998 settlement. The District Court found that Plaintiffs have failed to provide any factual support for this allegation. We disagree. 104 Plaintiffs provide circumstantial evidence that leads to a strong inference of Defendants' knowledge that the FAA fine imposed in the settlement agreement would be costly. Plaintiffs cite to certified letters that Goodmanson received from the FAA for each infraction that occurred during and prior to the settlement agreement. In June 1998, the FAA sent a letter to Goodmanson, proposing civil penalties of up to $11 million as a result of these investigations. During the settlement negotiations, America West was informed that the maintenance problems caused by the outsourcing had not been solved and that the present problems were extensive. In its briefs, America West admits that it received the FAA investigation file with the full incident reports as early as June 1998. These reports indicate that the FAA had extensive concerns regarding America West's policies, practices, procedures, and the attitude of upper management regarding these concerns. Later, America West agreed to settle for a fine of $5 million, the largest FAA fine in history. Finally, the settlement agreement recognized that organizational changes are required, and that America West needed to devise comprehensive corrective actions for problems discovered. These allegations indicate that Defendants were aware that fulfilling its duties under the settlement agreement would be extremely costly. 105
106 One of the District Court's overall concerns with Plaintiffs' allegations was that the America West officers who made the alleged misstatements were not the same persons who engaged in insider trading. Thus, the District Court found it illogical that they would make deliberately misleading statements. We disagree. 107 Scienter can be established even if the officers who made the misleading statements did not sell stock during the class period. Hanon v. Dataprods. Corp., 976 F.2d 497, 507 (9th Cir.1992); cf. Provenz, 102 F.3d at 1491 (finding a genuine issue of material fact regarding the scienter of an individual defendant who made many allegedly false and misleading statements, even though he sold a minimal number of shares). In other words, the lack of stock sales by a defendant is not dispositive as to scienter. 108 Although Franke, Goodmanson, and Parker (the America West officers who made the alleged misstatements) did not engage in insider trading, a strong inference of scienter can be inferred from Plaintiffs' allegations. Plaintiffs assert that Franke, Goodmanson, and Parker were motivated to inflate America West's financial results and stock prices because their eligibility for stock options and executive bonuses were based principally on the company's financial performance. None of the executive officers received options awards in 1997 for the previous year. In contrast, America West awarded Franke 350,000 options in February 1998 and America West awarded 110,000 options to Goodmanson, 35,000 options to Parker, and 20,000 options to Garel in March 1998. 22 In addition, the Compensation Committee (three out of four of whose members were chosen by TPG and Continental) reviewed all aspects of compensation and promotion of the officers who made the alleged misrepresentations. As controlling shareholders, TPG and Continental could easily choose three of its four members. In fact, as aforementioned, TPG Vice President Schifter was a member of the Compensation Committee. Although generalized assertions of motive, without more, are inadequate to meet the heightened pleading requirements of Silicon Graphics [,] Plaintiffs have provided specific, particularized allegations. Lipton, 284 F.3d at 1038. 109 Plaintiffs also offer one other possible motive, which we find insufficient to establish scienter. They argue that Franke, Goodmanson, and Parker all knew that America West would become much less profitable once it complied with the FAA mandated requirements and settlement agreement. Thus, they contend that the officers planned to sell the troubled airline and reap a multimillion dollar windfall under the `change in control' provisions of their employment contracts and incentive compensation plans. The change in control provisions would have allowed Franke, Goodmanson, and Parker to be paid over $5 million. In support of this allegation, Plaintiffs proffer evidence that, in January 1999, America West had been contacted by several airlines, including United Airlines, regarding the possibility of merger or creation of alliances. The District Court summarily rejected this golden parachute argument. We also reject this argument because the allegations are too generalized to establish scienter. 110
111 In sum, although recognizing that some of Plaintiffs' allegations are individually lacking, we hold that the allegations in their totality are sufficient to meet the stringent pleading standard set forth in the PLSRA. Thus, the District Court erred in dismissing Plaintiffs' claim under Section 10(b) and Rule 10b-5.