Fries v. N. Oil & Gas, Inc.

Citation: 285 F. Supp. 3d 706Docket: 16 Civ. 6543 (ER)

Court: District Court, S.D. Illinois; January 9, 2018; Federal District Court

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A class action lawsuit has been initiated against Northern Oil and Gas, Inc. and its executives, Michael L. Reger and Thomas W. Stoelk, for alleged violations of the Securities Exchange Act of 1934, specifically Sections 10(b) and 20(a) and Rule 10b-5. Lead plaintiff Matthew Atkinson claims that the Defendants made false and misleading statements in public filings during the Class Period, from March 1, 2013, to August 15, 2016. The court has received and is considering the Defendants' motion to dismiss the Consolidated Amended Complaint (CAC) under Federal Rule of Civil Procedure 12(b)(6), which has been granted without prejudice.

The plaintiff seeks to represent all individuals who purchased Northern Oil securities during the specified period. Northern Oil, an independent energy company founded in 2006, primarily operates in the Williston Basin of North Dakota and Montana. Reger, who served as CEO until his termination on August 16, 2016, and Stoelk, who served as CFO and later interim CEO, sold significant amounts of Northern Oil stock for tax purposes during this time.

Additionally, Reger co-founded Dakota Plains Transport Inc. in 2008, which became Dakota Plains Holdings, Inc. in 2012. Although unrelated to Northern Oil, Reger and Gilbertson's control over Dakota Plains is highlighted, as they allegedly concealed their involvement by appointing family members to key positions instead of themselves. Reger controlled 21.4% of Dakota Plains stock and 33.3% of its promissory notes, while Gilbertson controlled 11% of the stock and 38.9% of the notes, utilizing multiple accounts to obscure his ownership.

Reger and Gilbertson leveraged their influence to gain financial benefits through a stock manipulation scheme without revealing their control or ownership. On February 20, 2015, Dakota Plains alerted the SEC about their potential securities law violations. Following this, Reger received a Wells Notice from the SEC related to the investigation. After informing Northern Oil about the Wells Notice, Reger was terminated on August 16, 2016, coinciding with a 6.28% drop in Northern Oil's stock. On October 31, 2016, the SEC issued a cease and desist order against Reger, who agreed to cease violating specific sections of the Securities Act of 1933 and the Securities Exchange Act of 1934, as well as to make disgorgement and penalty payments.

During the Class Period, Reger is accused of neglecting his CEO duties at Northern Oil, redirecting company resources to exert control over Dakota Plains. The plaintiff cites three confidential witnesses (CWs) to support this claim. CW 1, a former executive assistant, reports that Reger visited Northern Oil's headquarters infrequently, leaving Stoelk to effectively manage the company. Reger focused on Dakota Plains activities, including meetings with its directors and investors, and used company-sponsored tours to solicit investments for Dakota Plains. CW 2, a former vice president, confirms Reger's limited involvement in Northern Oil's operations, stating that his role at Dakota Plains was widely known, including by Stoelk. CW 3, a former Dakota Plains vice president, notes that Dakota Plains operated under Northern Oil's direction, often spending more time at Northern Oil's offices.

Defendants are accused of making fraudulent representations and omissions in public filings, particularly in their Form 10-K reports for 2012 to 2015, concerning their adherence to a Code of Business Conduct and Ethics. Northern Oil claimed that this code applied to senior executives, was available on their website, and mandated compliance with laws and ethical standards. Reger and Stoelk certified the accuracy of these filings. The Code outlines expectations for honest conduct, transparent disclosures, and adherence to regulations, emphasizing that senior executives play a critical role in upholding ethical standards. It encourages reporting of violations, mandates cooperation in internal investigations, and prohibits the misuse of company assets. Additionally, it defines and prohibits conflicts of interest, requiring employees to avoid situations that could compromise their objectivity regarding the company's interests.

Plaintiff claims that statements made by Northern Oil are materially false or misleading for several reasons: (1) the company's policies and Code of Business Conduct and Ethics failed to prevent or detect misconduct by its officers; (2) Reger's actions contradicted Northern Oil's assurances regarding executive integrity; (3) Reger misused company assets, violating commitments to investors; and (4) Reger's involvement with Dakota Plains breached the company's conflict of interest policy. Furthermore, Northern Oil allegedly misrepresented Reger's qualifications in its 10-K filings from 2012 to 2015, exaggerating his industry experience and relationships that were purportedly beneficial for strategic developments. Reger, a founder of Northern Oil and its CEO since 2007, has a long history in the oil and gas sector, which he claimed provided Northern Oil with advantages in the Williston Basin. The plaintiff contends that these representations became false or misleading due to undisclosed details regarding Reger's ownership of Dakota Plains, his SEC violations, and involvement in stock manipulation. Northern Oil's reliance on Reger allegedly allowed him to conduct unethical practices without oversight, leading investors to purchase shares at inflated prices. The procedural history notes that the complaint was filed by Jeffrey Fries on August 18, 2016, with subsequent motions leading to the appointment of Atkinson as lead plaintiff, followed by a motion to dismiss by the defendants on August 21, 2017.

A complaint may be dismissed under Federal Rule of Civil Procedure 12(b)(6) for failing to state a claim upon which relief can be granted. In considering such a motion, the court must accept all factual allegations in the complaint as true and draw reasonable inferences in favor of the plaintiff, but it need not accept conclusory statements or bare recitals of claims. To survive dismissal, a complaint must contain enough factual matter to present a plausible claim for relief. A claim is considered plausible if it allows the court to reasonably infer that the defendant is liable for the alleged misconduct. The court may consider documents referenced in the complaint, those relied upon by the plaintiffs, and public disclosure documents, particularly those filed with the SEC that are relevant to the case.

For allegations of securities fraud, a heightened pleading standard applies under Rule 9(b) and the Private Securities Litigation Reform Act (PSLRA). This requires plaintiffs to state the circumstances of the fraud with particularity, including identifying the fraudulent statements, the speaker, the context of the statements, and the reasons why they are deemed fraudulent. While conditions of mind, such as intent, may be alleged generally, the PSLRA further mandates that securities fraud claims specify misleading statements, provide a factual basis for the belief that these statements are misleading, and present facts that suggest the defendant acted with the necessary state of mind.

Heightened pleading standards require plaintiffs to provide detailed allegations that support a plausible inference of securities law violations, as established in cases such as Slayton v. American Express Co. The legal framework under Section 10(b) of the Securities Exchange Act of 1934 and SEC Rule 10b-5 prohibits manipulative or deceptive practices in securities transactions. To assert a claim under these provisions, a plaintiff must demonstrate that the defendant made a material misrepresentation or omission with scienter in connection with the purchase or sale of a security, and that the plaintiff relied on this misrepresentation or omission, resulting in economic loss.

Defendants contend that the plaintiff did not sufficiently allege actionable misstatements or omissions. Specifically, the plaintiff claims misstatements regarding Northern Oil's Code of Business Conduct and Ethics and the significance of an individual named Reger. However, the court finds that merely adopting a code of ethics does not mislead investors if there are no assurances that employees comply with it. Prior rulings indicate that the existence of a code does not imply compliance, and disclosures of potential breaches are not required unless accompanied by affirmative statements of compliance.

An undisclosed breach of a corporate code of conduct is not actionable if the defendants did not guarantee adherence to the code or represent prior compliance. Courts have established that a code of ethics is aspirational and cannot lead to liability for every violation, especially since adoption of such a code is often mandatory. In this case, the Consolidated Amended Complaint (CAC) lacks allegations that defendants made any guarantees about compliance with the Code of Business Conduct and Ethics. The code, which outlines Northern Oil's policies and employee conduct expectations, does not imply liability for violations. 

The plaintiff's claim that defendants misled shareholders by promoting the code does not hold, as there are no allegations of specific assurances made by the defendants beyond stating the adoption of the code. The court notes that while some assurances of integrity amid known violations may be actionable, no such assurances were alleged here.

Furthermore, the plaintiff alleges that defendants misled investors regarding the CEO, Reger, by highlighting his importance while failing to disclose his misconduct. However, defendants maintain no obligation exists to disclose uncharged criminal conduct or corporate mismanagement unless such omissions render other statements misleading. The legal precedent indicates that mere corporate mismanagement is not actionable under Section 10(b), and only deceptive conduct related to mismanagement may lead to claims under federal securities laws. The CAC does not sufficiently allege any actionable misstatement or omission regarding either the code or Reger's conduct.

Courts must evaluate whether omitted information regarding mismanagement or uncharged criminal behavior is sufficiently linked to existing disclosures made by defendants. A duty to disclose arises in three scenarios: (1) when a corporation attributes its success to improper or illegal practices while failing to disclose these practices, (2) when a statement can be reasonably interpreted by investors as denying ongoing illegal conduct, and (3) when an opinion misleads investors about material facts without proper disclosure. In this case, the Plaintiff alleges that Defendants made various statements about Reger's expertise and industry relationships, asserting that Northern Oil relied on his knowledge. However, the Plaintiff does not claim these statements are inherently inaccurate and fails to demonstrate that the omitted facts undermine Northern Oil's reliance on Reger's expertise or suggest improper activities on his part. Previous case law supports that a duty to disclose does not arise simply from revealing partial truths, and the highlighted statements do not imply that Reger was involved in undisclosed misconduct. Therefore, the Court concludes that the Plaintiff has not sufficiently alleged actionable misstatements or omissions concerning Defendants' representations about Reger.

Plaintiff's claims fail due to inadequate pleading of scienter, which is necessary to establish an intent to deceive under Section 10(b) and Rule 10b-5. To meet the PSLRA's requirements, a plaintiff must allege specific facts that create a "strong inference" of the defendant's fraudulent intent, surpassing mere plausibility. This assessment considers all allegations collectively rather than in isolation. For corporate defendants, the inference must stem from the actions of individuals whose intent can be attributed to the corporation. Although typically easier to establish by alleging intent for an individual defendant, it may be possible to infer corporate scienter without individual allegations. A plaintiff can demonstrate scienter through evidence of motive and opportunity or strong circumstantial evidence of reckless behavior. In this case, the Plaintiff does not assert that Defendants had motive but relies solely on claims of conscious misbehavior or recklessness.

Conscious misbehavior includes deliberate illegal actions, while recklessness refers to highly unreasonable conduct deviating significantly from ordinary care standards. To establish a claim of recklessness, plaintiffs must show defendants' knowledge of contradicting facts or failure to verify information they were obligated to monitor. Specifically, if plaintiffs argue that defendants had access to contrary facts, they must identify the relevant reports or statements. Corporate mismanagement alone does not equate to recklessness.

In this case, the plaintiff aims to demonstrate that Northern Oil and Stoelk acted recklessly based on testimonies indicating Reger's frequent presence at Northern Oil, involvement in Dakota Plains matters, minimal day-to-day operational engagement, and awareness by Stoelk and others of Reger's role in Dakota Plains. However, the allegations do not clarify whether Northern Oil and Stoelk knew of any illegal actions by Reger or breaches of Northern Oil's ethical guidelines. It remains ambiguous whether their relationship with Dakota Plains was cooperative or conflicted. The plaintiff admits that Reger pursued acquisitions as Northern Oil's CEO and fails to show that his actions were reckless enough to mislead shareholders. Dakota Plains is characterized as unrelated to Northern Oil, and an SEC settlement regarding Reger's nondisclosure of his Dakota Plains control, occurring after the Class Period, implicated him only in negligent conduct. Allegations of breaches of the Code of Business Conduct and abdication of responsibilities do not demonstrate fraudulent intent but rather suggest mismanagement, as established in prior case law rejecting the inference of scienter from reckless behavior that constitutes poor governance rather than securities fraud.

Plaintiff alleges that Reger made false or misleading statements and that Stoelk engaged in conscious misbehavior by certifying Form 10-Ks. However, the mere claim of incomplete disclosures or omissions does not suffice to establish scienter based on conscious misbehavior or recklessness, as highlighted in legal precedents. The overall inferences drawn from Plaintiff's allegations do not compellingly suggest fraudulent intent when considered against nonfraudulent motives. Furthermore, Defendants' failure to disclose Reger's uncharged involvement with Dakota Plains is justified by the belief that his actions would benefit Northern Oil investors. The termination of Reger following a Wells Notice from the SEC further undermines allegations of scienter. 

Regarding Section 20(a) of the Exchange Act, liability for controlling persons is contingent upon a primary violation of securities law. Since Plaintiff has not adequately pleaded a primary violation under Section 10(b), the Section 20(a) claims against Defendants are dismissed. 

Plaintiff requested leave to amend the complaint if the court found the allegations insufficient. Courts may deny such requests for valid reasons, including futility or undue delay. Denial based on futility occurs only when no colorable grounds support the proposed claim. The Second Circuit has emphasized a preference for resolving disputes on their merits under the liberal amendment principles of Federal Rule of Civil Procedure 15.

The Second Circuit emphasized the importance of allowing a plaintiff to amend a complex commercial complaint that has not yet been judged for specific defects. Consequently, the court granted the defendants' motion to dismiss without prejudice, allowing the plaintiff to amend the complaint by January 25, 2018. The court accepted the allegations in the complaint as true for the motion's purposes.

Key allegations include that Reger and Gilbertson caused Dakota Plains to issue promissory notes, which they largely purchased, and used some proceeds to pay themselves dividends. Gilbertson, with Reger's consent, included a provision in the notes for additional payments to noteholders based on Dakota Plains’ stock price, leading to a disclosed entitlement of $32,851,800 for noteholders. However, Dakota Plains did not disclose that Reger and Gilbertson were the primary beneficiaries of this provision.

The document also mentions a Wells Notice from the SEC, indicating forthcoming enforcement actions based on investigations. The plaintiff contended that Northern Oil's executives complied with regulations, but the complaint did not substantiate this claim. It merely referenced the executives' roles in ensuring ethical conduct, which does not guarantee compliance.

Additionally, the plaintiff alleged insider trading against Reger and Stoelk for selling securities based on nonpublic information. However, SEC filings indicated their sales were for tax purposes, and no evidence was presented to suggest otherwise. The court noted that sales for tax reasons do not typically indicate fraudulent behavior and found that the plaintiff could not base his claims under Section 10(b) and Rule 10b-5 on these transactions. The court recognized that Dakota Plains and Northern Oil operate in distinct sectors without inherent conflict, despite the plaintiff's assertions about their business relationships.