Opinion ID: 781005
Heading Depth: 3
Heading Rank: 1

Heading: Sufficiency of Factual Allegations Supporting Claim

Text: 55 Plaintiffs argue that the District Court erred in determining that they failed to sufficiently allege misleading omissions and misrepresentations as required by Section 10(b) and Rule 10b-5. Plaintiffs allege that Defendants schemed to artificially inflate America West's stock price by May 20, 1998, the date on which the major shareholders could freely sell their Class B publicly-traded stock under the Stockholder's Agreement. Plaintiffs allege that, in order to accomplish this goal, Defendants deferred maintenance costs and operational expenses while overstating America West's operating income and making numerous optimistic statements regarding its financial condition. These statements failed to inform investors of America West's continuing maintenance problems, 9 its deferral of maintenance costs, 10 the ongoing FAA investigations, and the settlement negotiations. In addition, Plaintiffs allege that Defendants misrepresented that the original maintenance issues and operational problems caused by its outsourcing to Tramco had been solved. 56 Plaintiffs further contend that, following the public announcement of the $5 million settlement agreement on July 14, 1998, Defendants made misleading and false statements reassuring investors that America West remained an attractive investment and that the settlement agreement would not have a substantial effect on the company. For example, on the day of the announcement, America West issued a press release, stating that all of the problems cited by the FAA had been fully addressed and that the settlement agreement's provisions would not have a material adverse effect on the Company's operations or financial results. On July 21, 1998, Goodmanson stated that America West was not anticipating any major increase in maintenance costs or cost of oversight as a result of the settlement agreement. 57 In support of its allegations, Plaintiffs cite to (1) press releases and reports published by America West; (2) statements made by America West officials; (3) America West's financial statements; 11 (4) various correspondence from FAA employees to America West officials; (5) internal email messages between FAA employees discussing the maintenance issues at America West; (6) analyst reports regarding the financial condition of America West; (7) portions of the settlement agreement; (8) comparisons of America West's maintenance and repair costs between 1997 and 1998 and comparisons of inspection costs and aircraft utilization rates with those of other airlines; (9) America West's announcement on September 3, 1998 that it would not meet third quarter earnings because of unsatisfactory operational performance; and (10) analyst's reactions to the announcement. 58 Despite these allegations, the District Court determined that Plaintiffs failed to provide a sufficient factual basis for its fraud claim. In particular, the District Court found that any alleged omissions regarding the maintenance issues, FAA negotiations, and the settlement agreement were immaterial because the market failed to react immediately to the public announcement on July 14, 1998. In addition, the District Court concluded that the Plaintiffs failed to adequately account for the effects of the labor dispute between America West and its maintenance workers during the class period and its effects on America West's third quarter earnings. Because the parties' briefs primarily address the District Court's findings, we discuss each in turn. 59
60 The District Court found that the alleged omissions and misrepresentations regarding America West's maintenance issues, the FAA investigation, and the FAA settlement agreement were immaterial as a matter of law because the market did not immediately react, either after the June 23, 1998 Wall Street Journal disclosure of the potential FAA fines or after the July 14, 1998 announcement that the FAA had levied a $5 million fine. In doing so, the District Court applied the bright line rule suggested by the Third Circuit in Oran v. Stafford, 226 F.3d 275 (3d Cir.2000). Id. at 282 (finding that misrepresentations or omissions are immaterial as a matter of law if the market does not react immediately upon disclosure of the information). 61 Defendants urge us to adopt this per se rule, i.e., if there has been no immediate change in the stock price, the alleged misrepresentations or omissions must have been immaterial. However, we decline to do so because adoption of such a rule would contravene the Supreme Court's holdings in Basic, Inc. v. Levinson, 485 U.S. 224, 108 S.Ct. 978, 99 L.Ed.2d 194 (1988) and TSC Industries, Inc. v. Northway, Inc., 426 U.S. 438, 96 S.Ct. 2126, 48 L.Ed.2d 757 (1976). 62 In Basic, the Supreme Court expressly adopted the reasonable investor standard set forth in TSC Industries for determining materiality in the Section 10(b) and Rule 10b-5 context. 485 U.S. at 231-32, 108 S.Ct. 978. The Court held that a fact is material if there is a `substantial likelihood' that a reasonable investor would consider it important in his or her decision making. Id. at 231, 108 S.Ct. 978 (quoting TSC Indus., 426 U.S. at 449, 96 S.Ct. 2126). The Court explained that, to fulfill the materiality requirement, there must be a substantial likelihood that the disclosure of the omitted fact would have been viewed by the reasonable investor as having significantly altered the `total mix' of information made available. Id. at 231-32, 108 S.Ct. 978 (citation omitted). In other words, materiality depends on the significance the reasonable investor would place on the withheld or misrepresented information. Id. at 240, 108 S.Ct. 978; see United States v. Bilzerian, 926 F.2d 1285, 1298 (2d Cir.1991). 63 Pursuant to Basic, we reject Defendants' argument for adoption of a bright-line rule requiring an immediate market reaction. The market is subject to distortions that prevent the ideal of a free and open public market from occurring. 485 U.S. at 246, 108 S.Ct. 978 (internal quotation marks and citation omitted). As recognized by the Supreme Court, these distortions may not be corrected immediately. See id. at 248 n. 28, 108 S.Ct. 978. Because of these distortions, adoption of a bright-line rule assuming that the stock price will instantly react would fail to address the realities of the market. Thus, we decline to adopt a bright-line rule, and, instead, engage in the fact-specific inquiry set forth in Basic. 12 Id. at 240, 108 S.Ct. 978. 64 Applying this fact-specific inquiry to the present case, Plaintiffs have sufficiently pleaded the materiality of America West's misrepresentations regarding its maintenance issues, the FAA investigation, and the FAA settlement agreement. See Warshaw v. Xoma Corp., 74 F.3d 955, 959-60 (9th Cir.1996) (finding that the company's optimistic statements, which failed to disclose concerns regarding the safety of a product and unlikelihood of agency of approval, were material). A reasonable investor would find significant the information regarding a company's deferred maintenance costs, unsafe maintenance practices, and possible sanction. In addition, a reasonable investor would consider the potential effects of each of these facts on the overall economic health of the company as significantly alter[ing] the `total mix' of information made available. TSC Indus., Inc., 426 U.S. at 449, 96 S.Ct. 2126. Moreover, although America West's disclosures of the settlement agreement had no immediate effect on the market price, its stock price dropped 31% on September 3, 1998 when the full economic effects of the settlement agreement and the ongoing maintenance problems were finally disclosed to the market. This reaction, even if slightly delayed, further supports a finding of materiality. This is particularly true because Plaintiffs offer a reason for the delay, i.e., America West continued to reassure analysts that the settlement agreement and compliance therewith would not have noticeable economic effects on the company. 13 65
66 In determining that the Plaintiffs' factual allegations were insufficient, the District Court reasoned that Plaintiffs completely ignore[d] the other factual events that occurred during the class period and the impact of those events on America West and its stock prices. In particular, the District Court expressed its concern that Plaintiffs had overlooked the labor dispute between America West and its maintenance workers during the class period in determining what factors caused America West to miss its forecasted third quarter earnings. 67 However, in reaching this finding, the District Court failed to accept Plaintiffs' allegations as true and construe them in the light most favorable to Plaintiffs. See Silicon Graphics, 183 F.3d at 983. In their Second Amended Complaint, Plaintiffs pleaded with sufficient particularity its allegations that America West's missed earnings were caused in part by its deferral of maintenance costs and then its later obligation under the settlement agreement to alleviate the problems caused by its unsafe practices. Plaintiffs adequately allege that numerous maintenance issues were caused by outsourcing of maintenance, faulty maintenance procedures and practices, inadequate supervision, lack of spare parts and airplanes, and overutilization of airplanes. Beyond the $5 million fine, Plaintiffs further support their claim by citing to remedial actions taken by America West and statements made by it in the third quarter. 68 Moreover, although the lower than expected third-quarter earnings may be partially attributable to the labor disputes, other alleged operational problems cannot be explained solely by this factor. For example, in its September 3, 1998 announcement regarding its third quarter earnings, America West admitted to unsatisfactory operational performance and described its purchase of parts and airplanes, its hiring of additional maintenance employees, and its increase in the number of maintenance facilities to address the problems it faced. Contemporary opinions of analysts indicate the labor issues, the FAA's presence due to the company's safety problems, and operational problems contributed to decreased earnings. Although not the sole cause, it appears that the ongoing maintenance issues cited by Plaintiffs may have played a substantial role. Thus, the District Court erred in finding that the existence of other factors, such as the labor disputes, precluded Plaintiffs' argument that systemic maintenance issues also contributed to America West's failure to meet its forecasted third quarter earnings 69
70 Defendants raise two additional arguments regarding whether Plaintiffs have sufficiently alleged omissions, misrepresentations, or an overall scheme. Specifically, America West asserts that two of its allegedly misleading statements fall within the safe harbor provisions of the 1934 Act, while TPG and Continental assert that they are not liable because Plaintiffs failed to specifically plead their involvement in the alleged fraud. 1) Safe Harbor Provision 71 On appeal, America West contends that two allegedly misleading statements are protected under the safe harbor provisions of the 1934 Act because they are forward-looking statements. 15 U.S.C. § 78u-5(c)(1)(A)(i). The provisions provide that a person shall not be liable for any forward-looking statement that is identified as such, and is accompanied by meaningful cautionary statements identifying important factors that could cause actual results to differ materially from those in the forward-looking statement. 14 Id. A forward-looking statement is any statement regarding (1) financial projections, (2) plans and objectives of management for future operations, (3) future economic performance, or (4) the assumptions underlying or related to any of these issues. Id. § 78u-5(i). However, a person may be held liable if the forward-looking statement is made with actual knowledge... that the statement was false or misleading. Id. § 78u-5(c)(1)(B). 72 The two statements for which America West seeks safe harbor protection are: (1) the July 14, 1998 America West press release, which disclosed the FAA settlement agreement and fine, stating that the settlement agreement's provisions will not have a material adverse affect on the Company's operations or financial results; and (2) the July 21, 1998 conference call with analysts, during which Goodmanson stated, [W]e are not anticipating any major increase in maintenance costs or the cost of oversights going forward as a result of [the settlement agreement]. We need not reach the questions as to what type of meaningful cautionary statements qualifies for safe harbor under the statute because the statements by America West do not constitute forward-looking statements. Each is a disclosure of the fine imposed by the settlement agreement for past violations of FAA regulations and a description of the present effects of their imposition on the company. Moreover, even if we were to find them to be forward-looking, neither statement is accompanied by the requisite meaningful cautionary statement. 73 If we allow America West to shield itself from liability based on these statements, any corporation could shield itself from future exposure for past misconduct by making present-tense statements regarding the misconduct and its effects on the corporation. 15 Such blanket protection would eviscerate the 1934 Act altogether. 74 2) Adequacy of Fraud Allegations Against TPG and Continental 75 TPG and Continental both argue that they are not liable under Section 10(b) and Rule 10b-5 because Plaintiffs failed to specifically plead their involvement in the alleged fraud, as required by Federal Rule Civil Procedure 9(b) and the PSLRA. Both parties also note that they did not make any of the allegedly misleading statements. These arguments are unavailing, however, because both TPG and Continental were insiders in the relevant transactions. 76 Section 10(b) and Rule 10b-5 are not limited to misrepresentations or omissions of material fact. They also make it unlawful for any person directly or indirectly... [t]o employ any device, scheme, or artifice to defraud ... in connection with the purchase or sale of any security. 17 C.F.R. § 240.10b-5. Trading on material, nonpublic information qualifies as a `deceptive device' under § 10(b) ... because a relationship of trust and confidence [exists] between the shareholders of a corporation and those insiders who have obtained confidential information by reason of their position with that corporation. United States v. O'Hagan, 521 U.S. 642, 652, 117 S.Ct. 2199, 138 L.Ed.2d 724 (1997) (internal quotation marks and citation omitted) (alterations in original) (holding that a person who trades for personal profit, using confidential information misappropriated in the breach of a fiduciary duty, is guilty of violating Section 10(b) and Rule 10b-5). Individuals or corporations that engage in insider trading can be held liable under Section 10(b) and Rule 10b-5. See Herman & MacLean v. Huddleston, 459 U.S. 375, 386-87, 103 S.Ct. 683, 74 L.Ed.2d 548 (1983). Thus, the fact that neither Continental or TPG (or its officers) made any of the allegedly misleading statements does not shield them from liability.