In Re Honeywell International Inc. Securities Litigation

Citations: 182 F. Supp. 2d 414; 2002 U.S. Dist. LEXIS 424Docket: Civ. 99-2231(DRD)

Court: District Court, D. New Jersey; January 15, 2002; Federal District Court

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This case involves a securities class action for purchasers of Honeywell International Inc. stock between December 20, 1999, and June 19, 2000, asserting claims under the Securities Exchange Act of 1934. Defendants, including Honeywell and several senior officers, have moved to dismiss the consolidated complaint, while plaintiffs seek to strike certain exhibits submitted by the defendants. The court partially grants the defendants' motion to dismiss and denies the plaintiffs' motion as moot.

The defendants argue that the complaint does not adhere to the requirements of a "short and plain statement" under Federal Rule of Civil Procedure 8 and instead constitutes "puzzle pleading" that fails to meet the particularity standards of Rule 9(b) and the Private Securities Litigation Reform Act. However, the court finds that while the complaint is lengthy, it is sufficiently coherent. 

Central to the complaint is an overarching misrepresentation regarding the financial implications of the Honeywell-Allied Signal merger, which was announced in early 1999 and completed on December 1, 1999. The merger aimed to create a substantial conglomerate with a diverse product range and significant revenue potential. The Individual Officers named in the complaint held key leadership roles in the merged entity. Despite the merger's potential, the investment community expressed skepticism about the integration challenges and the anticipated accelerated revenue and earnings growth that the CEO, Bonsignore, had promised.

Bonsignore and his management team faced intense pressure to demonstrate the success of Honeywell's merger, particularly to achieve promised synergies and earnings per share (EPS) gains, which were critical for boosting Honeywell's stock price. The Individual Officers’ compensation was directly linked to Honeywell's EPS, revenue growth, and stock price, incentivizing them to present favorable financial results. Throughout the Class Period (December 20, 1999 - June 19, 2000), they portrayed the merger as highly successful, claiming that integration was progressing well and that substantial cost savings of $750 million were expected from the merger, exceeding previous estimates. They reported record financial results and projected strong EPS growth of 20% in 2000, with significant free cash flow anticipated.

Notably, they claimed that the acquisition of Pittway Corp. would enhance Honeywell's EPS and cash flow without diluting growth. However, the Complaint alleges that these representations were misleading. In reality, the merger faced significant integration challenges, particularly with financial systems, leading to increased costs and a lack of anticipated synergies. Workforce reductions caused chaos, resulting in lost contracts worth $200-$500 million, as customers hesitated to engage with Honeywell amid layoffs. Additionally, the use of "pooling" accounting restricted the company from divesting underperforming business segments, further harming its financial performance.

The Pittway acquisition negatively impacted Honeywell, contrary to the defendants' positive claims. Defendants were aware that Pittway had inflated its revenues through unreasonable sales to uncreditworthy customers, leading to over $200 million in delinquent receivables, which harmed Honeywell's cash flow rather than enhancing it. By early 2000, Pittway's management issues and a nearly 50% drop in sales, compounded by three major customers reducing purchases, further diluted Honeywell's earnings per share (EPS).

In the Performance Materials unit, announced price increases faced significant customer resistance, leading to discounts and erosion of margins due to product commoditization and rising raw material costs, which also negatively affected Honeywell's financial results and EPS growth forecasts.

Defendants misrepresented the health of Honeywell's Aerospace Solutions Unit, which accounted for 37% of sales and faced severe supply shortages affecting its ability to meet demand, particularly for Boeing, with shortages not expected to resolve until late 2000. Similarly, the Power and Transportation Products unit struggled with poor sales and component shortages, particularly related to Turbocharger products, resulting in estimated losses of $80-100 million.

Additionally, the Specialty Chemicals business was underperforming, losing its competitive edge and incurring $40-60 million in losses, prompting considerations for divestiture. Defendants concealed these issues to maintain the perception of Honeywell's success.

Honeywell's chip packaging manufacturing faced significant issues, particularly with its ASTI technology pilot operation, which failed to yield commercial products, resulting in losses of $40-60 million and a subsequent $100 million write-off. Despite this, company officials misrepresented the operation as a contributor to 2000 revenue growth. They concealed the sale of hundreds of millions of dollars in products under unusual terms, including extended payment options, to artificially inflate revenues, leading to over $400 million in overdue receivables that negatively affected cash flow.

To hide these financial problems, Honeywell executives falsified financial statements in violation of Generally Accepted Accounting Principles (GAAP). They manipulated revenues, expenses, and reserves, falsely reporting "record" financial results while engaging in fraudulent practices within the Home and Building Control business, such as recording revenue from fictitious clients and improperly managing expenses by delaying invoice payments and misclassifying costs.

Additionally, they artificially boosted first-quarter earnings per share (EPS) by reversing excessive merger reserves, which were not justifiable. Price increases imposed on the Performance Materials unit provided temporary revenue but were unsustainable, as customers began to reject these hikes. Despite knowing the forecasts for EPS and cash flow were unrealistic, executives continued to make positive statements, leading to a surge in Honeywell's stock price, which peaked at $58 7/16 per share in April 2000.

During this period of inflated stock value, six individual officers sold over 338,000 shares, profiting more than $18 million from these transactions, while the overall market faced declines.

In June 2000, following the sale of over 338,000 shares in April, defendants disclosed that Honeywell would not meet its second quarter earnings per share (EPS) forecasts due to component shortages in Honeywell Aerospace and the negative effects of rising oil prices and interest rates. The investment community suspected deeper issues with the merger, but Honeywell withheld detailed information until a conference on July 10. During this period, Honeywell's stock fell significantly, losing $16.87 billion in market capitalization between June 2 and June 23. 

At the July conference, Honeywell's Bonsignore acknowledged a credibility gap and admitted that management had not reacted swiftly enough to mitigate revenue and income disappointments. The company reported a cash flow decline from $513 million in Q2 1999 to $339 million in Q2 2000, largely due to poor working capital management, with $400 million in overdue receivables. Honeywell's polymers division faced substantial volume erosion despite price increases, while the pharmaceuticals sector underperformed due to competition affecting high-volume generic drugs. 

Honeywell also struggled with proprietary technology investments in semiconductor-circuit board interfaces, resulting in a $100 million write-off after closing its pilot operation. Revenue in automation and control was lower than expected, particularly with the Pittway fire and security unit, which saw a slowdown in growth. Aerospace revenue declined by 3% due to a supplier issue related to outsourced printed circuit cards. Overall, Honeywell's operational challenges across multiple segments and the complexity of integrating two large companies contributed to its inability to meet financial targets.

Overly ambitious objectives and multiple adverse factors impacted Honeywell's situation. The complaint details a timeline of how false and misleading statements were communicated to investors and the public. On December 20, 1999, key executives attended a meeting in New York City where they positively discussed Honeywell's acquisition of Pittway, the Allied Signal-Honeywell merger, anticipated synergies, and expected EPS growth for fiscal year 2000. Following this meeting, several investment firms issued favorable reports on Honeywell, based on misleading information. 

On January 19, 2000, Honeywell released its fourth-quarter and annual results, reiterating the false statements about the company's prospects during a conference call. Subsequently, on February 23, 2000, Honeywell submitted a Form 10-K to the SEC that misrepresented its financial results. Between February 23 and March 31, 2000, investment firms like Warburg Dillon Read, Merrill Lynch, and Sanford C. Bernstein published optimistic reports, despite the executives reviewing these documents, which contained the same misrepresentations. 

Honeywell's 1999 Annual Report, released on March 31, 2000, also included misleading claims and was referenced by Merrill Lynch in an April 5 report. Following an April 13 release that reiterated false predictions, Bonsignore and other executives held further discussions with investment houses, resulting in additional misleading reports. 

At its annual meeting on May 1, 2000, Honeywell maintained optimism about the merger. Bonsignore's presentation at a May 9 conference echoed this sentiment, leading to more favorable reports from investment firms. Even on June 7, 2000, during another conference, he reiterated claims of successful merger integration and projected significant savings, despite the overarching pattern of misrepresentation.

Merger synergies and savings for Honeywell were expected to increase throughout 2000, with projections of a second-quarter 2000 EPS of $3.25, at least 17% EPS growth in 2001, and compounded growth of at least 18% over the next three years. The acquisition of Pittway was deemed successful, not diluting Honeywell's 2000 EPS and positively impacting EPS for 2001-2002. Despite a sharp decline in Honeywell shares attributed to general sector weakness rather than company-specific issues, analysts maintained a positive outlook on earnings, citing successful merger integration. However, statements made from May 1 to June 8, 2000, were later revealed as false, leading to a significant drop in Honeywell's stock price after disclosures on June 19. 

In terms of legal standards for securities fraud claims, heightened pleading requirements apply under both Fed. R. Civ. P. 9(b) and the Reform Act. Rule 9(b) mandates that fraud allegations be stated with particularity. The Reform Act requires plaintiffs to specify misleading statements, the reasons for their misleading nature, and to provide detailed facts supporting any allegations made on information and belief. For proving scienter, which reflects the defendant's mental state, the complaint must demonstrate facts that create a strong inference of the required state of mind. Failure to meet these standards can lead to dismissal of the complaint. Key case law, including In re Advanta Corp. Securities Litigation and Ernst v. Hochfelder, elaborates on the definitions of scienter and the requisite standards of conduct, emphasizing that recklessness involves an extreme departure from ordinary care that poses a risk of misleading investors.

The court in Advanta affirmed that establishing liability requires sufficient grounds, specifically regarding the pleading of scienter. It is adequate for plaintiffs to allege facts that demonstrate a motive and opportunity to commit fraud or provide circumstantial evidence of reckless or conscious behavior. Following the Reform Act, allegations of motive and opportunity must be supported by facts stated with particularity that lead to a strong inference of scienter, moving away from blanket assertions that previously sufficed. Consequently, generalized claims of defendants benefiting from wrongdoing are insufficient unless they detail facts that create a strong inference of intent.

In assessing motions to dismiss, the court accepts well-pleaded factual allegations as true and construes them favorably toward plaintiffs, but does not accept legal conclusions or unfounded inferences. Dismissal is warranted only if it's evident that no facts could support the plaintiffs' claims.

Regarding material misrepresentations, the plaintiffs allege that Honeywell Defendants are liable for securities fraud under 10(b) of the Exchange Act and SEC Rule 10b-5 for knowingly or recklessly making misleading statements connected to Honeywell's financial disclosures, which inflated stock prices. Plaintiffs argue they would not have purchased the stock at the inflated prices had they known the truth, resulting in monetary damages. To succeed, plaintiffs must prove that the defendants made a material misstatement or omission with scienter, in connection with the sale of securities, upon which they relied, leading to their losses. The current motions focus on the first three elements of this claim. Plaintiffs assert that the Honeywell Defendants engaged in a fraudulent scheme that misled investors and inflated stock prices while selling their shares at those inflated prices. The specific misrepresentations and omissions are detailed in the complaint, which the defendants contest as lacking actionable claims.

Defendants assert that their overly optimistic projections do not constitute fraud, arguing that a company cannot be held liable for erroneous future predictions. However, allegations suggest these statements were knowing misrepresentations, evolving from mere optimism to deliberate deceit as circumstances worsened without any correction of the initial claims. The complaint is criticized for being "puzzle pleading" yet is deemed complex rather than dismissible for verbosity or perceived irrelevance. Defendants also argue the complaint lacks specificity regarding allegations made on information and belief; however, the complaint clearly asserts its claims based on publicly available records and statements, allowing for reasonable inferences. Furthermore, defendants challenge the complaint for not detailing why each misrepresentation was misleading. Specific examples from December 1999 onward highlight false claims regarding the success of a merger and the performance of the Pittway acquisition, which allegedly involved inflated revenues and profits. The complaint provides sufficient detail to support its claims, countering the defendants’ assertion that it reflects mere hindsight rather than actionable fraud.

Material facts were allegedly withheld by some defendants to sustain Honeywell's stock price. Defendants argue that certain statements claimed by plaintiffs as false were forward-looking and thus protected under the Reform Act's safe harbor provision and the "be-speaks caution" doctrine. To be actionable, a forward-looking statement must be shown to lack belief or reasonable basis at the time made, with the issue of scienter addressed separately. Many alleged misrepresentations were oral and not identified as forward-looking, failing to meet the Reform Act's requirements for cautionary disclosures. Defendants also claimed that statements about Honeywell's past and present conditions were not actionable due to a lack of allegations of falsity; however, the complaint does assert that these statements were indeed false.

Regarding scienter, the complaint adequately alleges this against Bonsignore, Ferrari, and Wallman, but not against other Individual Officers. The Reform Act modifies how scienter must be pleaded, allowing for pleading through motive and opportunity or circumstantial evidence of reckless or conscious behavior. The plaintiffs cite Bonsignore's motive tied to achieving financial targets and his stock sales during a critical period as indicators of scienter. Nonetheless, while these factors are relevant, they alone are insufficient for a fraud charge, as incentive compensation and the desire to maintain corporate positions are typical among executives.

The excerpt addresses the legal standards for establishing "scienter" in securities fraud cases, emphasizing that mere trading activity during a class period or the desire to showcase a successful transaction is insufficient for a fraud claim. Insider trading can indicate scienter if the trading patterns are suspiciously inconsistent with past practices. In this case, the complaint lacks details about the Individual Officers' historical stock sale practices, and evidence suggests their trading was consistent. The timing of stock sales is a relevant factor but not determinative on its own.

However, regarding Bonsignore, the Chief Executive Officer of Honeywell, multiple factors support a strong inference of scienter. His high-ranking position granted him comprehensive knowledge of Honeywell's operations and the alleged misrepresentations. Bonsignore's active role in misleading communications with investors and analysts, including reviewing reports, indicates he was aware of the falsehoods in the statements made. The same reasoning applies to Ferrari and Wallman, who held significant positions within Honeywell and were involved in similar activities, thereby meeting the heightened pleading standards of the Reform Act. In contrast, the other Individual Officers lack the necessary "plus factors" to establish scienter.

During the class period, Johnson sold 40,000 shares of Honeywell stock for $2,260,000, Kreindler sold 102,369 shares for $5,428,423, and Porter sold 25,000 shares for $1,815,710. These sales alone are insufficient to establish scienter. The individuals Redlinger, Johnson, and Porter attended a December 20, 1999 analysts' conference alongside Bonsignore, Ferrari, and Wallman, but none of the latter three were in positions requiring comprehensive knowledge of Honeywell's financial status or operational issues. Each had specific ancillary roles, making it difficult to attribute knowledge of misrepresented matters to them. Allegations lack evidence of their involvement in misleading the investment community or reviewing relevant reports outside the mentioned conference. The group pleading doctrine does not apply to these officers based on the allegations presented. 

The plaintiffs sought to strike three exhibits related to a 1999 Proxy Statement and transcripts from conference calls, arguing they were unauthenticated hearsay and not referenced in the complaint, thus inappropriate for consideration under Rule 12(b)(6). The court did not consider these exhibits for the motion to dismiss but noted they could be relevant during discovery; consequently, the motion to strike was deemed moot.

The court will grant the defendants' motion to dismiss concerning Redlinger, Johnson, Kreindler, and Porter, while denying it for Honeywell, Bonsignore, Ferrari, and Wallman. The plaintiffs' motion to strike the exhibits will also be denied as moot. Sufficient grounds for the plaintiffs' allegations of scienter related to accounting fraud in various segments were established without extensive analysis.