Opinion ID: 4013501
Heading Depth: 2
Heading Rank: 1

Heading: The Plaintiffs’ Pleading Burden on Scienter

Text: For the plaintiffs’ claims under § 10(b) and Rule 10b-5, scienter is an essential element. In re Zagg, Inc. Sec. Litig., 797 F.3d 1194, 1200 (10th Cir. 2015). 4 Scienter consists of “‘a mental state embracing intent to The plaintiffs waived this challenge by waiting to make it in their reply brief. Reedy v. Werholtz, 660 F.3d 1270, 1274 (10th Cir. 2011). Therefore, we do not consider the plaintiffs’ § 20(a) claims. 3 The district court assumed that the plaintiffs had pleaded false and misleading statements, but the court concluded that the defendants had not made any material misrepresentations or omissions. We need not address these assumptions or conclusions. 4 The plaintiffs must also show that 1. the defendants made material misrepresentations or omissions, 2. a connection existed between the defendants’ misrepresentations or omissions and the purchase or sale of a security, 4 deceive, manipulate, or defraud,’ or recklessness.” Adams v. KinderMorgan, Inc., 340 F.3d 1083, 1105 (10th Cir. 2003) (quoting City of Philadelphia v. Fleming Cos., 264 F.3d 1245, 1259 (10th Cir. 2001)). Conduct is considered reckless only if the defendants (1) acted in “an extreme departure from the standards of ordinary care” and (2) presented “a danger of misleading buyers or sellers” that was  known to the defendants or  so obvious that the defendants must have been aware of the danger. In re Level 3 Commc’ns, Inc. Sec. Litig., 667 F.3d 1331, 1343 n.12 (10th Cir. 2012) (quoting City of Philadelphia v. Fleming Cos., 264 F.3d 1245, 1260 (10th Cir. 2001)). For scienter, the Private Securities Litigation Reform Act of 1995 creates a heightened duty for the plaintiffs to “state with particularity facts giving rise to a strong inference that the defendant[s] acted with the 3. the plaintiffs relied on the defendants’ misrepresentations or omissions, 4. the plaintiffs suffered economic loss, and 5. the defendants’ misrepresentations or omissions caused the plaintiffs’ loss. Halliburton Co. v. Erica P. John Fund, Inc., __ U.S. __, 134 S. Ct. 2398, 2407 (2014). We address only the element of scienter. 5 required state of mind.” 15 U.S.C. § 78u-4(b)(2)(A); see also In re Zagg, 797 F.3d at 1201-02 (discussing the heightened duty). We consider this statutory duty through de novo review of the dismissal. In re Gold Res. Corp. Sec. Litig., 776 F.3d 1103, 1108 (10th Cir. 2015). In conducting de novo review, we accept the complaint’s factual allegations as true. Dronsejko v. Thornton, 632 F.3d 658, 666 (10th Cir. 2011). We then assess these allegations holistically and consider “whether all of the facts alleged, taken collectively, give rise to a strong inference of scienter, not whether any individual allegation, scrutinized in isolation, meets that standard.” In re Zagg, 797 F.3d at 1201-02 (emphasis in original) (quoting Tellabs, Inc. v. Makor Issues & Rights, Ltd., 551 U.S. 308, 323 (2007)). To assess the strength of an inference of scienter, we compare the “inferences urged by the plaintiff[s]” with “competing inferences rationally drawn from the facts alleged.” Tellabs, 551 U.S. at 314. An inference of fraudulent intent must be more than “‘reasonable’ or ‘permissible’—it must be cogent and compelling.” Id. at 324. Thus, the complaint suffices “only if a reasonable person would deem the inference of scienter cogent and at least as compelling as any opposing inference one could draw from the facts alleged.” Id. With this standard in mind, we consider whether the plaintiffs adequately pleaded scienter. We conclude that they did not. 6 II. The Existence of Conflicting Inferences of Innocence and Scienter The plaintiffs urge the following inference of the defendants’ scienter: The defendants knew throughout the class period that the three projects were behind schedule and were generating so much in additional costs that a loss would be inevitable. Accordingly, the defendants knew throughout the class period that Spirit would need to announce a forward loss 5 on the projects. Nonetheless, the defendants waited to announce the forward loss until October 2012. The defendants argue that an innocent inference is more compelling even if we credit the allegations in the complaint: Despite scheduling setbacks and cost overruns, the defendants were optimistic that the three projects would meet the original cost forecasts. Near-term cost forecasts were not met, but the defendants expected revenues to exceed the total costs, avoiding the need for a forward loss. Spirit eventually realized that a future loss was likely and promptly announced a forward loss on the three projects. Our task is to determine whether the inference arising from the plaintiffs’ scienter allegations is cogent and compelling when compared to the defendants’ suggested inference. In our view, the plaintiffs’ scienter inference is not cogent and compelling. Spirit’s executives knew that Spirit had encountered problems in containing costs and meeting production deadlines. And we can assume 5 The plaintiffs allege that a “forward-loss charge” is an accounting term meaning that past production costs plus estimated future production costs will exceed the total revenues estimated on a given contract. Appellants’ App’x, vol. I at 27, 91-92. 7 (without deciding) that Spirit did not adequately communicate these problems to the public. But why didn’t Spirit adequately communicate these problems? The plaintiffs allege that the Spirit executives intentionally misrepresented or recklessly ignored economic realities. That is possible, but it is more probable that the Spirit executives were overly optimistic and failed to give adequate weight to financial red flags, for the plaintiffs supply little reason to suspect malevolence rather than benign optimism. See In re Level 3 Commc’ns, Inc. Sec. Litig., 667 F.3d 1331, 1345 (10th Cir. 2012) (holding that the plaintiffs’ scienter allegations, which were based on inconsistency between the defendants’ progress reports and internal reports, were inadequate because “the strongest inference we can draw is that defendants were negligent in failing to put together the pieces”); see also Plumbers & Pipefitters Local Union 719 Pension Fund v. Zimmer Holdings, Inc., 679 F.3d 952, 955 (7th Cir. 2012) (“Knowing of ‘problems,’ which are common, differs from [specifically] knowing that a facility must be closed and some of its products recalled.”). To establish scienter, the plaintiffs rely on  the Spirit executives’ motive to lie,  information supplied by corroborating witnesses,  the Spirit executives’ alleged involvement in the three projects as part of the company’s “core operations,” 8  a duty to disclose production delays and cost overruns,  Spirit’s implementation of a recovery plan,  admissions by the chief executive officer,  Spirit’s disclosures of risk,  Spirit’s purported accounting violations, and  the size of the announced forward loss. Together, these allegations do not create a cogent, compelling inference of scienter.