Court Opinion

ID: 1010809
Source: CourtListenerOpinion
Date Created: 2013-07-04 20:17:23.394878+00
Date Added: 2024-06-11T09:40:31.817146
License: Public Domain

UNPUBLISHED

UNITED STATES COURT OF APPEALS
                 FOR THE FOURTH CIRCUIT

MICHAEL J. SVEZZESE, JR.,                
Individually And On Behalf Of All
Others Similarly Situated; LOUISIANA
SCHOOL EMPLOYEE RETIREMENT
SYSTEM,
                Plaintiffs-Appellants,
                                               No. 02-1587
                  v.
DURATEK, INCORPORATED, formerly
known as GTS Duratek; ROBERT E.
PRINCE; ROBERT F. SHAWVER,
              Defendants-Appellees.
                                         
            Appeal from the United States District Court
             for the District of Maryland, at Baltimore.
                  Marvin J. Garbis, District Judge.
                         (CA-01-1830-MJG)

                        Argued: May 6, 2003

                       Decided: June 12, 2003

       Before LUTTIG, MOTZ, and SHEDD, Circuit Judges.

Affirmed by unpublished per curiam opinion.

                             COUNSEL

ARGUED: Glen DeValerio, BERMAN, DEVALERIO, PEASE,
TABACCO, BURT & PUCILLO, Boston, Massachusetts, for Appel-
2                       SVEZZESE v. DURATEK, INC.
lants. Steven F. Barley, HOGAN & HARTSON, L.L.P., Baltimore,
Maryland, for Appellees. ON BRIEF: Leslie R. Stern, Patrick T.
Egan, BERMAN, DEVALERIO, PEASE, TABACCO, BURT &
PUCILLO, Boston, Massachusetts; Charles J. Piven, Marshall N. Per-
kins, LAW OFFICES OF CHARLES J. PIVEN, P.A., Baltimore,
Maryland, for Appellants. Mark D. Gately, HOGAN & HARTSON,
L.L.P., Baltimore, Maryland, for Appellees.

Unpublished opinions are not binding precedent in this circuit. See
Local Rule 36(c).

                                OPINION

PER CURIAM:

   Plaintiffs Michael J. Svezzese, Jr. and the Louisiana School
Employee Retirement System ("Plaintiffs") filed this class action on
behalf of themselves and all other persons or entities who purchased
the common stock of Duratek Inc., f/n/a GTS Duratek ("Duratek")
during the period March 8, 2000 through March 13, 2001 (the "class
period"). Plaintiffs allege that during the class period, defendants
Duratek, Robert E. Prince (Duratek director, CEO and President), and
Robert F. Shawver (Duratek CFO and Executive Vice President)
engaged in a scheme and course of conduct to inflate Duratek’s stock
price through a series of false and misleading misrepresentations and
omissions in the company’s public statements and financial filings in
violation of section 10(b) of the Securities Exchange Act of 1934, 15
U.S.C.A. §§ 78j(b) (West 1997 & Supp. 2003), Rule 10b-5, 17 C.F.R.
§ 240.10b-5 (2003), and section 20(a)of the Securities Exchange Act
of 1934, 15 U.S.C.A. § 78t(a) (West 1997). Because we agree with
the district court that Plaintiffs have failed to allege facts sufficient to
provide the necessary strong inference that the defendants acted with
scienter, we affirm its order dismissing the complaint.

                                     I.

   Duratek provides radioactive waste management services, includ-
ing waste transportation, storage, processing, and disposal for govern-
                       SVEZZESE v. DURATEK, INC.                       3
ment and commercial clients. These services are generally provided
under fixed-price, long-term contracts. Such services constitute
between one-third and one-half of Duratek’s total revenues.

   Duratek operates two major waste processing facilities, both of
which are in Tennessee. After processing the waste at these facilities,
Duratek then ships the waste to designated burial sites in South Caro-
lina and Utah. The amount of waste that can be kept on site at the pro-
cessing facilities is strictly regulated, requiring that Duratek maintain
a timely flow of waste through the processing facilities and to the off-
site disposal sites.

   Duratek’s profitability hinges on its ability to control burial costs
per unit of waste processed. Because its waste disposal contracts typi-
cally charge clients by the pound of waste processed while burial
costs are incurred on a volumetric basis, increasing the density of the
waste shipped to the burial site (i.e., mass per unit of volume) trans-
lates directly into increases in gross margins on the waste manage-
ment contracts. Tracking the waste as it is processed and shipped to
the burial sites is thus essential in order for Duratek to estimate costs
and project future earnings. During 2000, Duratek apparently failed
to follow procedures necessary to track its waste processing opera-
tions and thus maintain an accurate balance sheet. These accounting
failures provide the basis for this litigation.

   After discovering its accounting problems, Duratek issued a press
release in April 2001 restating previously reported financial results
for the first three quarters of 2000 and its consolidated financial
results for 1999. Specifically, the restatement resulted in a sixty-one
percent reduction in Duratek’s reported net income for the first three
quarters of 2000. The press release explained that the restatement of
financial results was necessary "to reflect the reconciliation of unpro-
cessed waste to revenues and costs for such periods and certain other
adjustments." The press release also stated that "the Company’s sys-
tems did not reveal the operation issues associated with the new waste
processing strategies in a timely manner," and that the restatement
was driven by failure to follow proper accounting practices. Duratek’s
stock price suffered accordingly.

  The problem with Duratek’s financials stemmed largely from an
improper accounting of costs and revenues associated with its long-
4                      SVEZZESE v. DURATEK, INC.
term, fixed-price waste management contracts. Like many other firms
operating under long-term contracts, Duratek utilized the so-called
"percentage-of-completion" ("POC") method of revenue recognition,
which allowed Duratek to record revenue as it performed the contract.
The basic principles and requirements for the POC method are
detailed in the Generally Accepted Accounting Principles (GAAP).
SEC regulations require that companies maintain proper internal pro-
cedures that allow preparation of financial statements in accordance
with GAAP. In essence, the POC method requires that the company
first estimate the total costs of performing the contract and then com-
pare or reconcile that estimate with accrued actual costs at regular
intervals (i.e., quarterly) over the life of the contract. The comparison
yields an estimate of the portion of the contract that has been com-
pleted, providing a benchmark for the corresponding amount of reve-
nue that would then be recorded on the company’s books. Although
the POC method is the preferred method of accounting for long-term
contracts, its successful application depends on the ability to make
reasonably dependable estimates of contract costs and progress
toward the completion of the contract.

   In this case, Duratek allegedly failed to track and compare the
actual costs of processing radioactive waste at its facilities, which
turned out to be higher than expected, with its estimates of total costs.
At least part of the reason for this arose from the fact that Duratek
was receiving more waste for processing than it could handle in a
timely manner, forcing the company to move processed waste off-site
as quickly as possible. According to the complaint, these time pres-
sures led Duratek to package the waste for shipment inefficiently (i.e.,
below the normal density) thus leading to cost overruns and reduced
profits. Because Duratek failed to catch these problems and the
related cost overruns in its accounting, the company overstated its
actual revenues in press releases and SEC filings by a significant
amount.

   Plaintiffs allege that these failures grew out of a lack of Duratek’s
failure to apply internal controls necessary to form reliable estimates
of the costs of processing and disposal of waste at its facilities, even
though the information needed to perform this accounting was readily
available in Duratek’s own records. Simply put, Plaintiffs maintain
that without adequate procedures in place to reconcile quarterly
                       SVEZZESE v. DURATEK, INC.                        5
inventories of unprocessed waste with deferred revenues and accrued
expenses, Duratek had no way of knowing whether it was actually
making any money under the contracts.

   According to the complaint, these accounting failures constituted
securities fraud in violation of section 10(b) of the 1934 Act, 15
U.S.C.A. § 78j(b), and Rule 10b-5, 17 C.F.R. § 240.10b-5. The com-
plaint also alleges that defendants Prince and Shawver acted as con-
trolling persons in violation of section 20(a) of the 1934 Act, 15
U.S.C.A. § 78t(a). The complaint does not contain any allegations of
insider trading or self-dealing on the part of Duratek managers or
directors.

                                   II.

   We review de novo a district court’s dismissal of a complaint pur-
suant to Fed. R. Civ. P. 12(b)(6). See Mylan Labs., Inc. v. Matkari,
7 F.3d 1130, 1134 (4th Cir. 1993). Dismissal for failure to state a
claim should not be granted unless it appears certain that the plaintiff
can prove no set of facts that would support its claim and would enti-
tle it to relief. In considering a motion to dismiss, the court should
accept as true all well-pleaded allegations and should view the com-
plaint in the light most favorable to the plaintiff. Id.

   In order to prevail on a claim brought under section 10(b) and Rule
10b-5, the plaintiff carries the burden of proving that: "‘(1) the defen-
dant made a false statement or omission of material fact (2) with
scienter (3) upon which the plaintiff justifiably relied (4) that proxi-
mately caused the plaintiff’s damages.’" Phillips v. LCI Int’l, Inc.,
190 F.3d 609, 613 (4th Cir. 1999) (quoting Hillson Partners Ltd.
P’ship v. Adage, Inc., 42 F.3d 204, 208 (4th Cir. 1994)).

   This case turns on whether Plaintiffs alleged sufficient facts in their
complaint to plead scienter. As defined by the Supreme Court,
"scienter refers to a mental state embracing intent to deceive, manipu-
late or defraud." Ernst & Ernst v. Hochfelder, 425 U.S. 185, 194, n.
12 (1976). The Supreme Court has expressly reserved, on two sepa-
rate occasions, the question whether recklessness suffices to meet the
scienter requirement in 10b-5 actions. Id.; Aaron v. SEC, 446 U.S.
680, 686, n. 5 (1980); see also Phillips, 190 F.3d at 620 ("[T]o estab-
6                      SVEZZESE v. DURATEK, INC.
lish scienter, a plaintiff must still prove that the defendant acted inten-
tionally, which may perhaps be shown by recklessness.").

   Under the 1995 Private Securities Litigation Reform Act (PSLRA),
a securities fraud complaint must also meet heightened pleading stan-
dards, particularly with respect to scienter. See 15 U.S.C.A. § 78u-
4(b) (West 1997). Specifically, the PSLRA requires that for any fed-
eral securities fraud action that requires proof of state of mind, "the
complaint, shall, with respect to each act or omission alleged to vio-
late this chapter, state with particularity facts giving rise to a strong
inference that the defendant acted with the required state of mind." 15
U.S.C.A. § 78u-4(b)(1). If the complaint does not meet these pleading
requirements, the district court "shall, on the motion of any defendant,
dismiss the complaint." 15 U.S.C.A. § 78u-4(b)(3)(A). Thus, Plain-
tiffs carry the burden in this case of alleging particularized facts "giv-
ing rise to a strong inference" of the required scienter.

   We have not yet adopted a specific standard as to what precisely
a plaintiff must plead in order to meet the PSLRA’s scienter require-
ment. See Phillips, 190 F.3d at 621 ("We have not yet determined
which pleading standard best effectuates Congress’s intent."). And
there are at least three different standards currently "in play" among
our sister circuits. At one end of the spectrum is the relatively lenient
standard espoused by the Second Circuit. Under that standard, a plain-
tiff may plead scienter by alleging specific facts that either (1) estab-
lish "both motive and opportunity to commit fraud" or (2) constitute
"strong circumstantial evidence of conscious misbehavior or reckless-
ness." See Kalnit v. Eichler, 264 F.3d 131, 138-39 (2d Cir. 2001). At
the other end of the spectrum is the relatively strict "deliberate reck-
lessness" standard espoused by the Ninth Circuit. See In re Silicon
Graphics Inc. Sec. Litig., 183 F.3d 970, 974 (9th Cir. 1999) (holding
"that particular facts giving rise to a strong inference of deliberate
recklessness, at a minimum, is required to satisfy the heightened
pleading standard under the PSLRA"). In between is an intermediate
standard holding that motive and opportunity, while not sufficient by
themselves, can be used to demonstrate conscious or reckless miscon-
duct. See, e.g., In re Comshare Inc. Sec. Litig., 183 F.3d 542, 550-51
(6th Cir. 1999); Greebel v. FTP Software, Inc., 194 F.3d 185, 197 (1st
Cir. 1999).
                       SVEZZESE v. DURATEK, INC.                        7
   In this case, the district court followed our decision in Phillips and
dismissed the complaint on the ground that even under the lenient
Second Circuit standard, the allegations did not meet the PSLRA
requirements. We agree with this disposition.

   Because Plaintiffs failed to allege any facts pertaining to motive,
they cannot proceed under the first "motive and opportunity" prong
of the Second Circuit standard. Thus, the key issue in this appeal is
whether the complaint contains allegations sufficient to proceed under
the second "conscious misbehavior or recklessness" prong of the Sec-
ond Circuit standard. Plaintiffs maintain that their complaint does
"state with particularity facts giving rise to a strong inference that the
defendant(s)" acted with recklessness. See 15 U.S.C.A. § 78u-4(b)(1).

   In this context, however, recklessness does not equate to gross neg-
ligence. Rather, the Supreme Court has suggested that recklessness in
the 10b-5 context must embrace something like an intent to deceive.
See Hochfelder, 425 U.S. at 194 n. 12 ("In this opinion the term
‘scienter’ refers to a mental state embracing intent to deceive, manip-
ulate, or defraud. In certain areas of the law, recklessness is consid-
ered to be a form of intentional conduct for purposes of imposing
liability for some act. We need not address here the question whether,
in some circumstances, reckless behavior is sufficient for civil liabil-
ity under § 10(b) and Rule 10b-5."). In Phillips, we explicitly
acknowledged this particular understanding of recklessness:

     The securities laws generally define recklessness as an act
     "so highly unreasonable and such an extreme departure from
     the standard of ordinary care as to present a danger of mis-
     leading the plaintiff to the extent that the danger was either
     known to the defendant or so obvious that the defendant
     must have been aware of it."

Phillips, 190 F.3d at 621 (quoting Hoffman v. Eastabrook & Co., 587
F.2d 509, 517 (1st Cir. 1978)); see also Novak v. Kasaks, 216 F.3d
300, 312 (2d Cir. 2000) (stating that "the scienter requirement can be
satisfied by pleading either ‘conscious recklessness’ — i.e., a state of
mind ‘approximating actual intent, and not merely a heightened form
of negligence’ — or ‘actual intent’". (citation omitted)).
8                      SVEZZESE v. DURATEK, INC.
   In this case, the complaint contains six general allegations, which,
Plaintiffs contend, suffice to meet the scienter requirement. These are:
(1) Duratek lacked internal controls; (2) Duratek violated simple
accounting rules; (3) Duratek violated its own internal revenue recog-
nition policy; (4) Duratek’s resulting earnings restatement was of
great magnitude; (5) Duratek’s accounting "fraud" occurred at its
principal division; and (6) Duratek routinely understated expenses in
a number of ways.

   As should be apparent from this list, all of these allegations are, in
essence, allegations of accounting irregularities and violations. None
of these allegations evidence fraudulent intent or recklessness suffi-
cient to survive a motion to dismiss under the Second Circuit standard
(or either of the other two standards employed by other circuits). See
Novak, 216 F.3d at 309 ("[A]llegations of GAAP violations or
accounting irregularities, standing alone, are insufficient to state a
securities fraud claim. Only where such allegations are coupled with
evidence of ‘corresponding fraudulent intent,’ might they be suffi-
cient." (citations omitted)). Plaintiffs fail to point to any evidence that
Duratek’s management knew of or recklessly disregarded the prob-
lematic accounting practices. Without indicia of fraudulent intent,
therefore, these allegations fail to support a strong inference that
defendants acted with conscious or reckless disregard for proper
accounting practices.

   Plaintiffs argue on appeal that even if these allegations do not sup-
port a strong inference of scienter when considered individually, they
do give rise to a strong inference of reckless conduct when considered
collectively. This argument also fails. Despite plaintiffs’ efforts to
bootstrap their allegations into a strong inference of scienter through
the additive effect of the individual allegations, missing from the
complaint is the one essential ingredient necessary to establish the
strong inference — some indication that defendants acted with fraud-
ulent intent or recklessness. Without that, there is no inference, much
less a strong inference, that defendants acted with the required
scienter.

   In sum, all of the allegations in the complaint, whether considered
individually or collectively, fail to provide a sufficient basis to meet
even the most lenient PSLRA pleading standard. Upon inspection, it
                        SVEZZESE v. DURATEK, INC.                      9
is clear that Plaintiffs allege little more than accounting failures and
breakdowns in the internal procedures necessary to maintain proper
accounting practices. Without specific allegations pointing to a corre-
sponding fraudulent intent or recklessness, these allegations fail to
state a claim upon which relief can be granted. Consequently, the dis-
trict court correctly dismissed Plaintiffs’ section 10(b) claim. More-
over, because Plaintiffs’ second claim for controlling person liability
under section 20(a) must be based upon a primary violation of the
securities laws, that claim fails as well.

                                    III.

     For the reasons set forth within, the judgment of the district court
is

                                                           AFFIRMED.