Court: District Court, E.D. Virginia; September 26, 2017; Federal District Court
Plaintiffs in a federal securities class action are asserting claims under sections 10(b), 14(a), and 20(a) of the Securities Exchange Act of 1934 against a publicly traded aerospace and defense company and four of its high-level officers. The defendants are seeking dismissal of all claims. The memorandum opinion focuses on the 10(b) claims, specifically whether the plaintiffs have sufficiently alleged a "strong inference" of scienter, as mandated by the Private Securities Litigation Reform Act (PSLRA), regarding the defendants' alleged intentional concealment or reckless disregard of significant losses on a government contract. Additionally, it examines whether the complaint adequately claims that the defendants had control over any individual liable under 10(b) as per section 20(a).
The court emphasizes that at this stage, the factual allegations in the complaint must be deemed true, and it will primarily rely on these allegations, while also considering external documents that are integral to or explicitly cited in the complaint and not challenged in authenticity by the plaintiffs. Documents such as SEC filings, certain conference call transcripts, and analyst reports are deemed appropriate for consideration. However, documents not referenced in the complaint, like a certain conference call and an analyst report, are excluded from consideration at this stage.
Orbital ATK, an aerospace and defense company based in Dulles, Virginia, was formed from the merger of Orbital Sciences Corporation and Alliant Techsystems, Inc. in February 2015. The company is publicly traded on the New York Stock Exchange under the ticker "OA." The Complaint names four individual defendants: David D. Thompson (CEO and President since the merger), Garrett E. Pierce (CFO), Blake E. Larson (COO), and Mark DeYoung (Director until March 2016). Plaintiffs allege that Thompson, Pierce, and Larson made false statements regarding Orbital ATK's financial success post-merger, specifically failing to disclose significant losses related to the Lake City Contract with the U.S. Army, which reportedly cost the company hundreds of millions of dollars. According to the Complaint, Orbital ATK's accounting policies and GAAP required timely disclosure of such losses. On August 10, 2016, the defendants announced a restatement of financial statements to account for nearly $400 million in losses from the Army contract, acknowledging that these losses should have been reported earlier. These alleged misrepresentations are central to the plaintiffs' claims under Section 10(b) of the Exchange Act. The background context includes financial pressures faced by both predecessor companies prior to the merger, with Alliant under pressure to renew a major contract and Orbital Sciences experiencing financial difficulties, which the Complaint argues contributed to the misleading statements made by the defendants regarding Orbital ATK's financial performance after the merger.
Plaintiffs’ claims against Alliant center on the Lake City Contract with the U.S. Army, initiated in 2000, under which Alliant produced billions of rounds of small caliber ammunition, accounting for 13% of its revenues in fiscal year 2010. Alliant received a four-year renewal for the contract in 2010 and subsequently bid to retain it beyond 2013 amid competitive pressure from BAE Systems, which was also vying for the contract. The plaintiffs allege that Alliant and its representative, DeYoung, submitted an "aggressive" low-ball bid that ultimately secured the renewal on September 28, 2012, for a seven-year term with a three-year extension option, commencing production on October 1, 2013. However, the plaintiffs assert that profit margins would be squeezed due to reduced production volumes and increased overhead costs under the new contract. Despite assurances to investors about cost monitoring, DeYoung acknowledged the potential for margin pressure and revenue reductions due to the aggressive bidding strategy. Steps taken to enhance profitability included workforce reductions and the introduction of commercial ammunition production.
Additionally, Orbital Sciences faced significant challenges prior to its merger with Alliant, including lower-than-expected revenues, multiple revenue guidance reductions, and a failed rocket launch jeopardizing a NASA contract. The planned merger, announced on April 29, 2014, would result in Orbital ATK, with Orbital Sciences shareholders exchanging shares for Orbital ATK stock, while Alliant shareholders retained their shares, and Alliant was rebranded as Orbital ATK. Thompson was designated CEO of Orbital ATK, Pierce as CFO, and DeYoung as CEO and Chairman of Vista, a spin-off encompassing Alliant’s sporting segment, which did not acquire the Lake City Contract. The contract remained with Orbital ATK.
On December 17, 2014, Alliant and Orbital Sciences submitted a joint proxy statement to the SEC regarding their merger, which was approved by shareholders in special meetings on January 27, 2015, and announced on February 9, 2015. Post-merger, Orbital ATK shifted its fiscal year from March 31 to December 31. The Class Period commenced on May 28, 2015, with Orbital ATK's first financial report following the merger. The Complaint alleges that defendants made a series of misleading statements about the company's financial performance post-merger, categorized as follows:
1. **Merger Synergies**: Between May 28, 2015, and May 11, 2016, executives made claims about the merger’s synergies, including cost savings and improved profit margins. The Complaint contends these statements were misleading because they failed to disclose that the benefits were overshadowed by a $375 million loss on the Lake City Contract, which negatively impacted profit margins and violated accounting policies by not recording the loss when it became apparent.
2. **Lake City Contract Performance**: Defendants also made statements asserting the success and profitability of the Lake City Contract, which were alleged to be false because Orbital ATK was, in reality, incurring losses by selling products at a significant deficit. Claims regarding the contract's profit margins and rates of production were misleading, as the contract was actually operating at negative margins.
These misleading statements form the basis for the 10(b) claim in the Complaint.
Between June 1, 2015, and May 9, 2016, defendants allegedly issued numerous false and misleading statements regarding Orbital ATK’s financial results in SEC filings and press releases. The Complaint claims these inaccuracies stemmed from the Lake City Contract, which was underpriced by hundreds of millions of dollars, leading to a failure to record a $375 million forward loss in accordance with GAAP and the company's accounting policies. Consequently, reported financial figures were incorrect, including an understatement of current liabilities by $264 million, an overstatement of retained earnings by $255 million, an overstatement of net receivables by $119 million, and an overstatement of total equity by $255 million.
Additionally, between May 28, 2015, and May 9, 2016, the Complaint alleges that defendants made false statements about Orbital ATK’s internal financial controls. These claims were misleading as Orbital ATK had not successfully integrated the accounting systems of its predecessor companies, resulting in inaccurate financial reporting. The company’s financial controls reportedly exhibited several material weaknesses, particularly within its Defense Systems Group and Small Caliber Systems Division, and failed to address the significant losses from the Lake City Contract.
The situation deteriorated on August 10, 2016, when Orbital ATK announced it could not timely file its quarterly report for the second quarter of 2016, that prior financial statements were unreliable, and that it needed to restate its financial statements due to material misstatements related to the Lake City Contract. The company also acknowledged ineffective internal financial controls on that date and filed a Form 8-K report to elaborate on the misstatements.
The Form 8-K indicates that the Company is obligated under generally accepted accounting principles to recognize the entire expected forward loss provision for a contract in the period the loss is evident. The Company contends that such a provision should have been recorded for the Contract in fiscal 2015, marking the start of large-scale production. It identified "one or more material weaknesses" in its internal controls over financial reporting and disclosure during the Restated Periods, which contributed to the misstatements. The estimated impact of these misstatements includes a reduction in pre-tax operating income of approximately $400 million to $450 million and after-tax net income reduction of about $260 million to $280 million. Additionally, revenues were overstated by $100 million to $150 million, mainly in fiscal year 2015. Orbital ATK plans to file an amended Form 10-K for the 2015 transition period and a Form 10-Q for the quarter ending April 3, 2006, having received an extension from lenders until November 14, 2016.
During an August 10, 2016 conference call, executives discussed the necessity for restating earnings. Thompson revealed that the Lake City Contract had been in a substantial loss position since 2014, contrary to earlier records. Pierce noted that despite efforts to improve productivity, the contract remained unprofitable due to fixed material costs limiting cost reduction options primarily to labor and overhead. Larson mentioned that the cost reduction achieved was only partially aligned with bid expectations. Following these disclosures, Orbital ATK's stock dropped over 20%, prompting analysts to lower their ratings and highlight the unexpected magnitude of the earnings revision.
On November 1, 2016, Orbital ATK filed another Form 8-K, stating that the majority of the Lake City Contract loss provision should have been recorded at the contract's inception in fiscal 2013, rather than in fiscal 2015. The preliminary loss estimate was subsequently revised downward, with anticipated reductions in pre-tax operating income now estimated at $350 million and after-tax net income at about $220 million.
Orbital ATK filed its Amended Form 10-K on February 24, 2017, restating financial statements for several periods due to misstatements related to the Lake City Contract. The restatement indicated that previous financial statements should no longer be relied upon. Orbital ATK's initial bid for the Lake City Contract was significantly low, aimed at achieving substantial cost reductions, but these reductions ultimately did not lead to profitability. Senior management identified misstatements in 2016 during a company-wide effort to improve accounting controls, revealing that costs would exceed revenues over the contract's life. The complaint noted that $32 million of anticipated loss should have been recognized in 2013 and $342 million in 2014, when losses became evident. An internal investigation found that personnel failed to adhere to company standards, exhibiting biases to maintain profit targets and suppressing negative information regarding cost overruns.
The Amended Form 10-K also disclosed a non-public SEC investigation, suggesting potential government enforcement actions or litigation following the restatement. Subsequently, plaintiffs filed a complaint on April 24, 2017, asserting four claims against the defendants related to post-merger statements and alleged negligence in preparing the Joint Proxy Statement issued prior to the merger. The claims include violations of 10(b) and 20(a) of the Exchange Act against all defendants, and additional violations against specific officers. Defendants moved to dismiss all claims under Rule 12(b)(6) and the PSLRA, arguing the complaint lacks sufficient facts to establish a strong inference of scienter, a contention plaintiffs dispute, asserting their complaint meets the PSLRA standard. The dismissal motion has been fully briefed, argued, and is awaiting a decision.
Section 10(b) of the Exchange Act prohibits manipulative or deceptive practices in the sale of securities, as enforced through Rule 10b-5. This rule makes it unlawful to: (a) engage in schemes to defraud; (b) make material misstatements or omissions; or (c) conduct business practices that defraud others in connection with securities. To establish a 10(b) claim, plaintiffs must demonstrate: (1) a material misrepresentation or omission; (2) scienter; (3) a connection between the misrepresentation and the securities transaction; (4) reliance on the misrepresentation; (5) economic loss; and (6) loss causation.
The defendants' motion to dismiss challenges only the scienter element, requiring allegations that suggest intentional or severely reckless conduct. The Private Securities Litigation Reform Act (PSLRA) mandates a heightened pleading standard, requiring specific factual allegations that support a strong inference of scienter. Courts must consider plausible opposing inferences when assessing whether the pleaded facts create a strong inference of scienter, allowing the complaint to survive dismissal only if the inference is as compelling as any opposing inference.
The complaint presents various facts to support the inference that defendants Thompson, Larson, DeYoung, and Pierce, as well as Orbital ATK, acted with the necessary scienter, including: (1) their senior roles and awareness of the Lake City Contract; (2) indicators that the contract was unprofitable; (3) their experience with the accounting method used; (4) the significance of the financial restatement; (5) employee departures and government investigations; and (6) motivations related to personal profit and the success of a merger.
Defendants assert that the allegations presented by plaintiffs do not sufficiently support an inference of scienter, arguing that they acted in good faith and, therefore, cannot be held liable. Following Fourth Circuit precedent, the analysis will first consider the individual facts and defendants’ arguments regarding the allegations' ability to suggest scienter. If a strong inference of scienter arises, it will then be evaluated in a holistic manner, recognizing that some allegations may collectively satisfy the Private Securities Litigation Reform Act (PSLRA) even if individually insufficient.
The complaint's initial allegations focus on the defendants’ senior executive roles at Orbital ATK, which allegedly granted them oversight of the Lake City Contract, merger synergies, and internal controls linked to misstatements. Plaintiffs claim these roles provided access to confidential financial information and oversight responsibilities for public statements and SEC filings. However, the court emphasizes that such allegations, based solely on defendants’ positions as executives, do not meet the PSLRA's particularity requirement. The Fourth Circuit has ruled that mere executive status does not imply intentional or reckless conduct regarding accounting issues.
To establish a strong inference of scienter, plaintiffs must provide specific allegations showing the defendants’ actual awareness of the accounting problems. The complaint predominantly relies on the defendants' corporate positions rather than demonstrating their knowledge of the Lake City Contract's accounting issues. General executive responsibilities, like monitoring operations and signing financial statements, are insufficient to indicate actual exposure to problems.
Plaintiffs argue that the Lake City Contract's significance as the largest contract in Orbital ATK's largest division warrants a strong inference of scienter. However, the Fourth Circuit has made it clear that such prominence does not alone establish scienter without further detailed allegations. In this case, plaintiffs have not shown that defendants were aware of any operational losses related to the Lake City Contract due to cost-cutting failures, rendering their claims inadequate.
Plaintiffs argue that defendants actively monitored the Lake City Contract, as evidenced by DeYoung's acknowledgment of Alliant's familiarity with the plant, monthly meetings for oversight, and regular reporting to other defendants. However, this monitoring is interpreted as diligence rather than indicative of wrongdoing. The frequency of meetings is seen as a sign of care, and there is no evidence that management had access to manipulated accounting data or was alerted to any inaccuracies in the reports. The plaintiffs also cite frequent public statements regarding the contract's production and financial impacts; however, these statements do not sufficiently demonstrate direct involvement or knowledge of issues, leading to a weak inference of scienter. The plaintiffs' claims about the defendants' roles and their review of reports do not meet the required level of specificity to support an inference of culpability. Additionally, while the plaintiffs mention "red flags" suggesting operational losses and internal control problems, these do not provide a strong basis for inferring scienter, particularly if the issues were publicly known. The Fourth Circuit's standards indicate that red flags must be significant enough to alert senior management to the unreliability of financial statements.
The red flags identified in this case were either publicly available information or insufficient to indicate the unreliability of the Lake City Contract accounting, thus failing to establish a strong inference of scienter. Many alleged red flags were publicly known, such as Affiant's extensive experience at the Lake City Plant, the competitive bidding for the contract, the retention of the contract by Orbital ATK, and the company's statements regarding profit margins. These factors do not support a strong inference of scienter.
Additionally, the remaining red flags do not sufficiently alert the defendants to accounting errors or internal control issues. For instance, while SEC rules recognize the materiality of small losses, this generality does not point to specific problems with the Lake City Contract accounting. The plaintiffs' reliance on Orbital ATK's two restatements—one in March 2016 for long-term contract errors and another in February 2017 for the Lake City Contract—does not substantiate their claims. These restatements addressed different issues, and the existence of one does not imply awareness of the other, as supported by case law.
Furthermore, other cited red flags regarding the ammunition manufacturing landscape and production cost dynamics do not demonstrate that the losses were evident from the outset or that the defendants acted with knowledge or reckless disregard of potential issues. The acknowledgment of fixed metal costs during a conference call does not establish a clear link to scienter. Overall, the evidence presented fails to adequately support the plaintiffs' claims regarding the defendants' knowledge or recklessness concerning the Lake City Contract's accounting problems.
The excerpt highlights the plaintiffs' claims regarding the individual defendants' awareness of cost-cutting challenges related to the Lake City Contract. It notes that statements from the Amended Form 10-K indicated significant losses were apparent at the contract's signing and during initial production, suggesting a belated acknowledgment of these losses by the defendants. However, the court found that the complaint lacked specific factual allegations connecting these losses to the defendants' knowledge or unrealistic cost estimates. It references a precedent where plaintiffs failed to establish scienter due to insufficient evidence of executives' prior knowledge of issues affecting project forecasts.
Furthermore, it states that Orbital ATK's ability to reduce costs significantly undermines the assertion that the defendants' goals were unrealistic or reckless. The management's disclosure of the losses suggests a good faith effort to inform the public rather than deceitful intent. The comments made during a conference call and in the Amended Form 10-K were contextualized as explanations of accounting practices rather than admissions of wrongdoing. The excerpt concludes that the public knowledge of red flags and the overall financial context of Orbital ATK diminish the significance of the alleged losses, thus failing to support a strong inference of scienter.
The $375 million loss on the Lake City Contract is significant but needs contextual evaluation. As of August 10, 2016, this contract accounted for only 5% of Orbital ATK's total sales, which were approximately $4.46 billion for 2016. There are no indications of similar errors in other contracts, which reduces the importance of this loss in demonstrating scienter. In contrast, the Microstrategy case involved substantial misstatements and restatements that significantly misrepresented profitability, leading to a clearer inference of fraud. Orbital ATK’s situation lacks such a drastic disparity, as the loss pertains to a single contract representing a small percentage of total revenues, thus weakening any inference of scienter.
Additionally, the plaintiffs argue that the simplicity of the percentage-of-completion accounting method indicates a strong inference of scienter. However, they fail to substantiate this claim, and courts have not consistently recognized this method as a basis for liability under 10(b). Although simpler accounting methods can sometimes imply scienter, recent rulings, like in Svezzese v. Duratek, indicate that alleged violations of this method do not automatically support strong inferences of scienter. Therefore, the plaintiffs' argument about the simplicity of the accounting method is flawed on multiple grounds.
Plaintiffs lack authority to assert that the percentage-of-completion accounting method is as straightforward as claimed. The Fourth Circuit in Svezzese dismissed similar arguments regarding the simplicity of this method and its implications for establishing scienter. Unlike in Malone, defendants did not prematurely recognize revenue from the Lake City Contract; instead, they miscalculated cost estimates, leading to contract losses. This indicates a failure to accurately estimate costs rather than an intention to mislead.
Further allegations related to DeYoung's departure from the Orbital ATK Board, employee firings, an SEC investigation, and false SOX certifications do not support a strong inference of scienter. Plaintiffs argue that DeYoung’s announcement to not seek reelection, shortly after a contract restatement, implies wrongdoing. However, without additional context linking his departure to the Lake City Contract, this timing alone is insufficient. Similarly, the firings of employees for accounting issues and the replacement of the principal accounting officer suggest corrective actions taken by Orbital ATK rather than awareness of misconduct at the time of the statements. The internal investigation revealed lower-level misconduct, further indicating that the company sought to address issues rather than conceal them. Lastly, claims regarding the SEC investigation and SOX certifications do not bolster the scienter argument.
The Fourth Circuit has determined that allegations regarding an SEC investigation and false SOX certifications do not significantly contribute to an inference of scienter, as they are considered too speculative. The circumstances surrounding firings and departures from Orbital ATK, along with the SEC inquiry and SOX issues, suggest innocent rather than malicious inferences. Plaintiffs argue that the defendants—Thompson, Pierce, and Larson—gained financially from alleged fraud through incentive compensation, insider trading, and pressure to ensure the merger's success. However, the court emphasizes that financial motivations common to corporate executives do not support a strong inference of fraud. Specifically, the potential for increased compensation tied to merger success is insufficient, as such motives are prevalent among executives. The plaintiffs' claims regarding incentive compensation lack comparative evidence to establish unusual bonuses, leading to only a modest inference of scienter.
Regarding insider trading, DeYoung's sale of nearly $14 million in stock and Thompson's sale of 5,000 shares for $435,000 are cited as evidence of personal gain. However, the court finds these assertions unconvincing, reiterating that while personal financial gain can support a scienter inference, the specific allegations in this case do not provide strong support for such a conclusion.
The evaluation of motive in insider trading allegations requires contextual analysis, particularly regarding the timing and volume of trades, which must be unusual or suspicious to support an inference of scienter. Factors considered include profit made, stock traded, proportion of holdings sold, and number of insiders involved. In the case of Thompson and DeYoung, their sales are deemed to carry minimal weight in establishing scienter due to the low number of involved insiders and the nature of their sales. Thompson sold only 5,000 shares, less than 5% of his holdings, which is considered modest. DeYoung sold more shares but did so after leaving his CEO position due to a merger, suggesting his sales were not motivated by intent to defraud. Additionally, DeYoung sold his shares at prices below the class period high, further diminishing the inference of scienter. The combination of these factors implies only a weak inference of scienter. The plaintiffs’ argument regarding a motive to commit fraud for the merger's success is rejected, as the Fourth Circuit has stated that maintaining an executive position does not adequately demonstrate fraudulent intent. Similarly, the Second Circuit notes that improving terms for a merger does not imply self-serving fraud at the shareholders' expense, as shareholders also benefit from favorable transactions.
No strong inference of scienter can be drawn from the motives alleged by plaintiffs, such as incentive compensation, insider trading, or the desire for merger success. Individually, these motives do not establish the necessary strong inference of scienter. The Fourth Circuit requires a holistic evaluation of the allegations, considering whether they collectively warrant a strong inference. While allegations that do not independently create a strong inference can work together to satisfy the Private Securities Litigation Reform Act (PSLRA), the plaintiffs' overall claims still must be weighed against any opposing innocent inferences. In this case, the analysis suggests that the defendants were at most negligent regarding cost estimates and failure to detect losses related to the Lake City Contract.
Key established points include: the individual defendants' roles as high-level corporate officers overseeing the contract, the contract's importance to Orbital ATK despite not being a core operation, Alliant’s expertise and aggressive bidding for the contract, and noted weaknesses in Orbital ATK’s financial controls leading to a prior restatement. Additionally, the corporate officers' desire for merger success and stock sales prior to the announcement of losses are acknowledged. However, the overall impression derived from these allegations favors innocent interpretations over malicious ones.
In a similar case, Svezzese v. Duratek, the Fourth Circuit found analogous allegations insufficient to establish scienter, emphasizing the absence of any indication of fraudulent intent or recklessness. This Complaint similarly lacks that essential element, leading to the conclusion that the plaintiffs have not met the requisite standard for scienter.
Defendants are accused of intentionally concealing losses related to the Lake City Contract or recklessly ignoring them. However, the allegations suggest that executives Thompson, Pierce, Larson, and DeYoung were overly optimistic about cost reduction estimates and that lower-level employees concealed accurate cost information, delaying full production until fiscal year 2014. The Fourth Circuit has indicated that being overwhelmed by accounting issues does not equate to fraud. Alliant's aggressive bidding for the contract was known to the individual defendants, who recognized the need for cost reductions to profit, but they failed to achieve the necessary reductions. Errors in accounting were later discovered during an internal control review, leading to a restatement of earnings. The facts presented do not create a strong inference of scienter; instead, negligence or innocence appears more plausible. Consequently, the plaintiffs' 10(b) claims against the individual defendants must be dismissed, though they may amend their complaint to include specific facts indicating scienter.
Regarding Orbital ATK's potential liability, the plaintiffs cannot establish a strong inference of scienter for the corporation since claims against the individual defendants were dismissed. While some lower-level employees may have acted with scienter, there are no allegations that they made false or misleading statements. As such, claims against Orbital ATK also fail. However, plaintiffs may amend their complaint, particularly concerning Hollis M. Thompson, the former Vice President of Financial Reporting, whose potential liability remains unclear since he is not a defendant in the current action.
Hollis Thompson qualifies as an authorized agent whose statements may result in corporate liability, leading to the decision to allow plaintiffs the opportunity to amend their complaint to establish Orbital ATK's liability. Claims under Section 20(a) of the Exchange Act against Thompson, Pierce, and Larson, based on their control over Orbital ATK, are derivative of the failed 10(b) claims, resulting in the dismissal of both 10(b) and 20(a) claims against these defendants. However, plaintiffs are granted the chance to file an amended complaint to potentially demonstrate a strong inference of scienter regarding the company or individual officers.
Named plaintiff Steven Knurr initiated the action against Orbital ATK and individual defendants on August 12, 2016. Subsequently, several institutional investors sought lead plaintiff status, culminating in a November 10, 2016 order appointing St. Louis Laborers as lead plaintiff and Robbins Geller Rudman Dowd LLP as lead counsel. St. Louis Laborers subsequently filed its own complaint on April 24, 2017, which remains the operative complaint in the case, naming Orbital ATK, Thompson, Pierce, DeYoung, and Larson as defendants. Additional documents submitted by defendants include SEC filings, earnings call transcripts, and analyst reports, providing a comprehensive context for the case.
Orbital ATK reported significant achievements in its financial and operational performance following its merger, particularly in its small caliber ammunition business. In February 2016, CEO Larson indicated that the company met production demands for both commercial and government customers and exceeded cost synergy targets for 2015. CFO Pierce highlighted expectations for further benefits from the merger, focusing on cost and revenue strategies to enhance profit margins. During a May 2016 conference call, Larson noted $85 million in cost reductions for 2015, with projections exceeding $100 million in 2016, contributing to improved competitiveness and profit margins.
Pierce confirmed the merger's success in achieving $80 million in cost reductions within the first nine months, with an additional $20 million anticipated. In a October 2015 release, Larson reported the Defense Systems Group delivered 300 million rounds of ammunition in the third quarter. The annual report filed in June 2015 detailed that the Lake City Contract was vital for Orbital ATK, contributing 13% of sales in fiscal 2015 and highlighting a reduced profit rate due to competitive pressures. The report also cautioned that rising ammunition costs could adversely impact operating results and profit margins.
In a follow-up call on May 5, 2016, Thompson expressed optimism about the small caliber ammunition sector, noting a significant rebound in demand and production of approximately 400 million rounds in the first quarter of 2016. He projected a reasonable increase in total sales for the year.
On March 8, 2016, Pierce represented Orbital ATK at an investors conference, asserting that the company's ammunition business was recovering and had improved cost efficiency. On May 5, 2016, Orbital ATK reported total current liabilities of $954 million and total equity of $1.99 billion in its first quarter release. The subsequent Form 10-Q, filed on May 9, 2016, detailed similar financial figures, including retained earnings of $1.36 billion and net receivables of $1.97 billion, and was co-signed by Thompson and Pierce. The 2015 Form 10-K, filed on June 1, 2015, included assurances regarding the effectiveness of disclosure controls and internal controls over financial reporting, signed by Thompson, Pierce, and DeYoung, alongside a Sarbanes-Oxley Certification affirming compliance with the Exchange Act.
On May 28, 2015, a conference call led by Thompson, Larson, and Pierce highlighted the successful integration of financial control systems post-merger, which was positively received by analysts. Following these disclosures, firms like Jefferies, Credit Suisse, and Wells Fargo gave favorable ratings to Orbital ATK’s stock, reflecting confidence in its market position and growth potential. As of March 1, 2016, analysts continued to express optimism about the company, particularly regarding its Defense Systems Group, with analysts from Barclays and Wells Fargo reiterating positive growth forecasts for small-caliber ammunition on May 6, 2016. Additionally, on November 8, 2016, Pierce acknowledged that issues concerning the Lake City Contract dated back to fiscal year 2013. The document also defines "reckless act" as a behavior so unreasonable that it poses a risk of misleading investors, highlighting the potential liability of the defendants.
Allegations concerning management's involvement in a corporate structure and their knowledge of corporate information can create a strong inference of scienter when paired with specific, detailed claims about management's access to relevant facts. A sufficient pleading of scienter under Rule 9(b) cannot rely solely on the assumption that a defendant had knowledge of fraud due to their position. For instance, in *In re Genworth Financial Inc. Securities Litigation*, plaintiffs demonstrated scienter by showing that defendants acknowledged making misstatements regarding their review timeline, were aware of adverse trends in claim data not reflected in reserves, and misrepresented the average duration of claims. Similarly, in *Kiken v. Lumber Liquidators Holdings, Inc.*, plaintiffs alleged that defendants misrepresented their profit margins as stemming from legitimate sourcing, while in reality, they derived profits from illegally harvested wood. The court found that the plaintiffs met the scienter requirement through allegations of defendants' direct involvement in the importing process, including hiring specific individuals for that purpose and making public claims about quality control measures. Conversely, in *In re Criimi Mae, Inc. Sec. Litig.*, merely holding executive positions and signing SEC filings was deemed inadequate to establish a strong inference of scienter, as the connection to the company's core operations was insufficiently demonstrated.
A plaintiff must provide specific admissions from corporate executives regarding their involvement in a company's operations or witness testimony that shows their participation in creating false reports to establish scienter. General allegations about management's awareness of operations are insufficient without additional supporting details. Courts have ruled that mere attendance at meetings does not imply culpability. In the case of Orbital ATK, while some employees were aware of cost overruns, critical red flags indicated potential misconduct:
1. Alliánt's extensive experience in ammunition manufacturing.
2. An aggressive bidding strategy for the Lake City Contract that was below historical costs.
3. The decision not to assign the contract to Vista, which was better suited.
4. Statements about lower profit margins on the contract.
5. SEC rules requiring meticulous scrutiny of the contract due to material changes.
6. The necessity of two restatements to correct accounting errors.
7. Challenges in accurately identifying the loss from the contract and the fiscal year it pertained to.
8. The low-margin, high-volume nature of ammunition production.
9. Fixed production costs that limited cost-cutting options.
10. Anticipated pricing declines during the contract's lifecycle.
11. Failure to achieve projected cost savings before the Class Period.
Allegations of significant discrepancies in financial reporting, combined with violations of Generally Accepted Accounting Principles (GAAP) and ignored red flags, may be sufficient to survive a motion to dismiss. Courts have acknowledged that these factors can collectively indicate scienter.
Disclosures of red flags are deemed to significantly undermine any indication of fraud. Even if the initial earnings restatement due to accounting errors alerted Thompson, Pierce, and Larson to issues with the Lake City Contract, their delayed disclosure for several months does not strongly imply scienter. The Seventh Circuit acknowledges that taking time to resolve issues is lawful and managers are permitted to investigate before disclosing full information. An investigation revealed additional problems with the contract, aligning with precedent that executives' failures to accurately predict costs or delays do not establish scienter by themselves. Plaintiffs must demonstrate specific facts showing that executives were aware of losses at the time of public statements, which they have not done here. While a significant loss of $434.6 million is noted, previous cases have indicated that premature revenue recognition can support a strong inference of scienter. However, merely having an SEC investigation does not clarify potential inferences of wrongdoing, and general statements in a company’s 10-K or Sarbanes-Oxley certifications do not contribute meaningfully to the scienter analysis. Accepting the plaintiffs' interpretation of Sarbanes-Oxley would weaken the pleading standards for scienter under the PSLRA. A false SOX certification could indicate scienter only if the signatory was severely reckless and aware of substantial red flags regarding the financial statements.
Plaintiffs' claims fail to demonstrate scienter, even when considered alongside SOX certifications. Allowing claims based solely on a corporate defendant's motive, such as retaining a position or benefiting from stock, would expose directors to securities fraud allegations during mergers or acquisitions. While plaintiffs reference a significant 5% share sale based on the Microstrategy case, the context differs as the executives there sold a larger percentage of their holdings, and significant sales were tied to a timely disclosure of major company developments. In this case, Thompson sold shares well in advance of Orbital ATK's announcement of losses, undermining any suspicion. The gap of over ten weeks between the sales and the company's disclosure is not indicative of wrongdoing.
Some courts suggest that multiple weak indicators do not combine to support an inference of scienter; however, Fourth Circuit precedents allow for the aggregation of insufficient allegations to create a stronger inference. The losses were primarily undetected due to lower-level employees' failures, not executive misconduct. Orbital ATK faced challenges similar to those in the Svezzese case, including the need to closely monitor costs on long-term contracts and a significant earnings restatement due to accounting failures. Allegations against Orbital ATK include lack of internal controls, violation of accounting rules, and underreporting expenses. Corporate scienter can be established even without individual defendants if a company's public statements are dramatically false. However, the statements made by Orbital ATK regarding its performance and the Lake City Contract do not rise to this level of dramatic misrepresentation.
