Court Opinion

ID: 4765811
Source: CourtListenerOpinion
Date Created: 2021-08-14 00:00:20.727517+00
Date Added: 2024-06-11T09:15:08.214268
License: Public Domain

Case: 20-20538      Document: 00515978486          Page: 1     Date Filed: 08/13/2021

              United States Court of Appeals
                   for the Fifth Circuit                                United States Court of Appeals
                                                                                 Fifth Circuit

                                                                               FILED
                                                                         August 13, 2021
                                    No. 20-20538                          Lyle W. Cayce
                                                                               Clerk

   Zhang Yang,

                                                             Plaintiff—Appellant,

                                        versus

   Nobilis Health Corporation; Harry Fleming; David
   Young; Kenneth J. Klein,

                                                           Defendants—Appellees.

                   Appeal from the United States District Court
                       for the Southern District of Texas
                             USDC No. 4:19-cv-145

   Before Jolly, Duncan, and Oldham, Circuit Judges.
   Per Curiam:*
          A putative class of stockholders of Nobilis Health Corporation sued
   the company and three of its corporate officers, claiming the company
   engaged in unlawful and fraudulent misrepresentation of the company’s
   financial condition to inflate its stock price. The district court found that the

          *
            Pursuant to 5th Circuit Rule 47.5, the court has determined that this
   opinion should not be published and is not precedent except under the limited
   circumstances set forth in 5th Circuit Rule 47.5.4.
Case: 20-20538      Document: 00515978486           Page: 2   Date Filed: 08/13/2021

                                     No. 20-20538

   amended complaint failed to adequately plead scienter under the Private
   Securities Litigation Reform Act of 1995 (“PSLRA”) and dismissed the case
   for failure to state a claim. We affirm.
                                              I.
          Nobilis was a publicly traded healthcare development and
   management company with 30 locations across Texas and Arizona.
   Defendant Harry Fleming served as CEO from January 2017 until December
   2018, and later served as chairman of the board. Defendant David Young
   served as the company’s CFO from February 2017 until October 2018. And
   Defendant Kenneth Klein served as interim CFO from October 2018 until
   January 2019.
          The plaintiffs claim Nobilis struggled financially but deceptively
   concealed its declining position with half-true press releases and flawed
   financial reports. In its March 2016 10-K, Nobilis admitted that it had failed
   to employ personnel with the requisite knowledge or training in the
   application of Generally Accepted Accounting Principles (“GAAP”), and
   that it failed to appropriately oversee the company’s accounting and financial
   reporting departments. In particular, Nobilis confessed problems with
   “management of third-party billing and collections of aged receivables,” and
   noted its efforts to remediate operational defects by hiring staff with GAAP
   experience.
          But according to the plaintiffs, the company’s announced remedial
   efforts were all smoke and mirrors. The plaintiffs claim that the company
   continued to flout GAAP rules and failed to write down accounts receivable
   the company knew to be uncollectable. Worse yet, the plaintiffs allege the
   company fraudulently blamed a change in GAAP rules for financial failures
   and missed targets, rather than alerting investors and analysts that the
   financial difficulties were caused by uncollectable accounts receivable.

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                                     No. 20-20538

          The district court determined that the plaintiffs’ allegations fell short
   of the heightened scienter pleading requirements of the PSLRA and thus
   dismissed the case for failure to state a claim. The plaintiffs appealed. Our
   review is de novo. Heinze v. Tesco Corp., 971 F.3d 475, 479 (5th Cir. 2020).
                                          II.
          The elements of a private securities fraud claim based on violations of
   15 U.S.C. § 78j(b) and 17 C.F.R. § 240.10b–5 are: (1) a material
   misrepresentation or omission by the defendant; (2) scienter; (3) a
   connection between the misrepresentation or omission and the purchase or
   sale of a security; (4) reliance upon the misrepresentation or omission; (5)
   economic loss; (6) loss causation. See Erica P. John Fund, Inc. v. Halliburton
   Co., 563 U.S. 804, 809–10 (2011) (quotation omitted). Only scienter is
   relevant to this appeal.
          Analyzing scienter is a holistic enterprise that asks “whether all of the
   facts alleged, taken collectively, give rise to a strong inference of scienter.”
   Tellabs, Inc. v. Makor Issues & Rights, Ltd., 551 U.S. 309, 323 (2007). A court
   first considers “the contribution of each individual allegation to a strong
   inference of scienter.” Owens v. Jastrow, 789 F.3d 529, 537 (5th Cir. 2015). If
   “any single allegation, standing alone, create[s] a strong inference of scienter,
   the case should proceed”; but if not, the court must then follow the
   individualized analysis with a holistic review of all scienter allegations
   together. Ibid. A complaint will survive only if the plaintiffs “plead facts that
   give rise to a ‘strong’—i.e., a powerful or cogent—inference” of intent or
   severe recklessness. Tellabs, 551 U.S. at 323. We begin with an individualized
   analysis of plaintiffs’ allegations. Then we turn to a holistic review.
                                          A.
          The plaintiffs offer three pieces of information in support of their
   scienter allegations. First, they allege that Fleming and Young signed the

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                                    No. 20-20538

   company’s 2018 Sarbanes-Oxley (“SOX”) certifications in their official
   capacities as corporate executives. But our court has been clear that SOX
   certifications standing alone are insufficient to make out a compelling
   inference of scienter. See Cent. Laborers’ Pension Fund v. Integrated Elec.
   Servs. Inc., 497 F.3d 546, 555 (5th Cir. 2007).
          Next, the plaintiffs allege that the GAAP violations coupled with
   Young’s position as CFO are sufficient to show he knew or was severely
   reckless in ignoring the company’s faltering financial state. But GAAP
   violations standing alone do not make out a cogent and compelling case for
   scienter. See Ind. Elec. Workers’ Pension Tr. Fund IBEW v. Shaw Group, Inc.,
   537 F.3d 527, 534 & n.3 (5th Cir. 2008) (“[A] failure to follow GAAP, without
   more, does not establish scienter.” (quotation omitted)).
          Last, the plaintiffs offer confidential-witness testimony from three
   Nobilis employees who claimed that the company retained a backlog of
   unpaid claims executives knew to be uncollectable. For a confidential witness
   testimony to be credited towards a finding of scienter, the complaint must
   indicate how or when the officers became aware of what the confidential
   source allegedly knew. See Shaw Group, 537 F.3d at 542. The confidential
   testimony here doesn’t do that. Stripped down, the testimony of the
   confidential witnesses makes some conclusory allegations about corporate
   knowledge, but none of the testimony indicates how or when corporate
   officers became aware of the relevant information. See Owens, 789 F.3d at 545
   (finding no scienter where the complaint “contain[ed] no particularized
   allegations of . . . warnings to [defendants]” of alleged fraud); Shaw Group,
   537 F.3d at 545 (finding no scienter where the plaintiff failed to plead facts
   showing that the defendants were “on notice” as to their alleged
   misstatements).

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          The most particularized allegation from any of the confidential
   witnesses comes from confidential witness 3, who claims that Young’s state
   of mind can be inferred because he was present in the company’s billing office
   over the course of several months. But simply alleging that Young was in a
   particular office at a particular time does not permit this court to infer that
   Young was aware or severely reckless in failing to appreciate the
   uncollectablilty of particular accounts. Mere proximity to information does
   not automatically translate to knowledge of it. See Nathenson v. Zonagen Inc.,
   267 F.3d 400, 424 (5th Cir. 2001) (“An officer’s position with a company
   does not suffice to create an inference of scienter.”).
                                         B.
          Because plaintiffs’ allegations individually do not support a “powerful
   or cogent” inference of scienter, we turn next to a holistic review of the
   complaint to determine “whether all of the facts alleged, taken collectively,
   give rise to a strong inference of scienter.” Tellabs, 551 U.S. at 323. Our
   review is particular to each defendant. See Southland Sec. Corp. v. INSpire Ins.
   Sols., Inc., 365 F.3d 353, 365 (5th Cir. 2004) (requiring plaintiffs suing under
   the PSLRA to “distinguish among those they sue and enlighten each
   defendant as to his or her particular part in the alleged fraud” (quotation
   omitted)).
          There are no particular scienter allegations against Klein other than
   that he, by virtue of his corporate position, must’ve been aware of the
   company’s GAAP violations and the misrepresentations made in corporate
   releases. Plaintiffs urge us, in our holistic review, to infer Klein’s scienter
   based on his corporate position—but that isn’t allowed. See Nathenson, 267
   F.3d at 424.
          The allegations against Fleming are similarly thin. The plaintiffs offer
   two allegations they claims to be sufficient to allege scienter as to Fleming:

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                                         No. 20-20538

   first, Fleming’s position as CEO, and second, Fleming’s signatures on SOX
   certifications. Taken together, Fleming’s corporate position and SOX
   signature provide neither cogent nor powerful inference of scienter and are
   plainly insufficient. See ibid.; Cent. Laborers’ Pension Fund, 497 F.3d at 552.
   These allegations simply reveal a truism—that Fleming was a corporate
   director who performed official duties including signing SOX certificates. We
   know nothing about Fleming’s frame of mind, nor can we infer it based on
   the plaintiffs’ conclusory assumptions that he acted with reckless disregard
   to alleged fraud.
           That leaves Young. Taken together, the amended complaint alleges
   that Young’s scienter can be inferred on the basis of three allegations. First,
   Young’s position as CFO; second, Young’s signature on the SOX
   certifications; and third, the allegation that Young visited the business office
   on several occasions to stimulate debt collection. There is not a single
   allegation that any confidential witness or any other person informed Young
   about their subjective views of the company’s financial situation. So rather
   than presenting a “powerful or cogent” allegation of scienter, Tellabs, 551
   U.S. at 324, the plaintiffs ask us to imagine that Young acted with scienter
   based on his day-to-day involvement with the company, and the fact he was
   in proximity to people who allegedly had the relevant information. That’s
   plainly insufficient to plead scienter. See Fin. Acquisition Partners LP v.
   Blackwell, 440 F.3d 278, 287 (5th Cir. 2006) (“Corporate officers are not
   liable for acts solely because they are officers, even where their day-to-day
   involvement in the corporation is pleaded.”). †

           †
             The plaintiffs also ask us to forgive the insufficient scienter allegations in
   accordance with the special circumstances exception. In “rare case[s] . . . motive and
   opportunity allegations alone can support a strong inference of scienter.” Local 731 I.B. of
   T. Excavators & Pavers Pension Tr. Fund, 810 F.3d 951, 958 (5th Cir. 2016) (quotation
   omitted). Under that narrow exception, one must meet some combination of four

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                                         No. 20-20538

           AFFIRMED.

   considerations. First, the company must be small. See Alaska Elec. Pension Fund v. Flotek
   Indust., Inc., 915 F.3d 975, 985 (5th Cir. 2019) (“[This court] has never found special
   circumstances permitting an inference of scienter based solely on a defendant’s position
   when the company was large.”). Second, the transaction at issue is critical to the
   company’s continued vitality. See Local 731 I.B., 810 F.3d at 968. Third, the
   misrepresentation is readily apparent to the speaker. See ibid. And last, the defendants’
   statements are internally inconsistent. See Plotkin v. IP Axess Inc., 407 F.3d 690, 700 (5th
   Cir. 2005). The exception does not apply in this case because Nobilis was a large company
   with hundreds of employees, in 30 locations, and the exception does not apply in such
   circumstances. See Alaska Elec. Pension Fund, 915 F.3d at 985.

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