Automotive Industries Pension Trust Fund v. Textron Inc.

United States Court of Appeals
For the First Circuit
No. 11-2106
AUTOMOTIVE INDUSTRIES PENSION TRUST FUND,
Plaintiff, Appellant.
__________
CITY OF ROSEVILLE EMPLOYEES' RETIREMENT SYSTEM,
Plaintiff,
v.
TEXTRON INC.; LEWIS B. CAMPBELL; TED R. FRENCH,
Defendants, Appellees.
__________
ANGELO BUTERA; THOMAS F. CULLEN; BUELL J. CARTER, JR.;
DOUGLAS WILBURNE; TEXTRON FINANCIAL CORP.,
Defendants.
APPEAL FROM THE UNITED STATES DISTRICT COURT
FOR THE DISTRICT OF RHODE ISLAND
[Hon. Paul J. Barbadoro, U.S. District Judge]
Before
Boudin, Circuit Judge,
Souter,* Associate Justice,
and Thompson, Circuit Judge.
Douglas Wilens with whom David J. George, Robert J. Robbins,
Samuel H. Rudman and Robbins Geller Rudman & Dowd LLP were on brief
for appellant.
*
The Hon. David H. Souter, Associate Justice (Ret.) of the
Supreme Court of the United States, sitting by designation.
Mitchell A. Karlan with whom Brian M. Lutz, Gibson, Dunn &
Crutcher LLP, John A. Tarantino, Patricia K. Rocha, Nicole J.
Benjamin and Adler Pollock & Sheehan P.C. were on brief for
appellees.
June 7, 2012
BOUDIN, Circuit Judge. This appeal arises from a
securities fraud class action against Textron, Inc. ("Textron") and
several of its senior officers. The relevant Textron businesses
are Cessna Aircraft Company ("Cessna"), a wholly owned subsidiary
accounting for approximately 40 percent of Textron's 2008 revenues,
Textron Financial Corporation ("TFC"), which finances Textron's
various ventures, and TFC's dedicated Cessna Finance arm. Lewis B.
Campbell was President and CEO of Textron, and chaired its board;
Ted R. French and Buell J. Carter were senior executives and
Douglas Wilburne headed investor relations.1
Over the course of 2007 and 2008, on the edge and outset
of the recession, Textron made public statements assuring its
investors of the strength and depth of the backlog of orders at
Cessna, which Textron represented would help carry it through
difficult economic times. In July and October 2007, and January,
July and November 2008, Textron reported record levels of "aircraft
and defense" backlog. Campbell and Wilburne also assured investors
that Cessna did not permit customers to sell delivery positions,
that is, the customer's priority in receiving ordered aircraft.
1
The defendants in the district court, in addition to
Campbell, were French, Executive VP and CFO of Textron and
President and CFO of TFC; Carter, President and COO of TFC; Thomas
Cullen, Executive VP and CFO of TFC; Wilburne, VP of Investor
Relations at Textron; and Angelo Butera, Chief Credit Officer at
TFC.
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Attesting to the backlog's strength, Campbell said in
January 2008 that Cessna was seeing "unusually low cancellations."
In a July 17, 2008, conference call with investors, Campbell and
Wilburne said Cessna had only seen two cancellations in the first
two quarters of 2008. Again in October 2008, Campbell said that
"[c]ancellations are not even noteworthy." As late as November
2008, Campbell said "on the cancellations front, which is
encouraging and interesting, we aren’t seeing any more
cancellations than we did last year or the year before at this
time. So we don’t have a huge buildup of cancellations."
In December 2007, Reuters quoted Campbell as saying "[i]f
we were running on a very low backlog, I'd be nervous, but the
converse is true." In a conference call on April 17, 2008, French
told investors "[o]rders is not really going to be the driver. It
is backlog." The backlog--whose "size and resiliency" Campbell
emphasized in the July 2008 call--was also invoked as compensating
for a fall-off in Textron's financial services business. And when
Textron revised downward Cessna's jet aircraft production schedule
on November 4, 2008, Campbell said:
[W]e believe our record aerospace and defense
backlog and pending customer orders of nearly
$30 billion will provide a cushion and ballast
to weather the uncertainties we face as we go
forward.
Nevertheless, three months later, on January 29, 2009,
Textron reported substantial cuts to Cessna's production levels due
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to a disappointing fourth quarter 2008: few orders, 23
cancellations, and "an unprecedented number of deferrals" of
delivery dates by customers. Textron stock closed at $9.09 that
day, down 31 percent from the previous day, and 87 percent from the
class period high. Shortly thereafter, Campbell stepped down as
President (remaining as CEO and Chairman), and French and Carter
departed.
In a February 2009 analyst report, J.P. Morgan wondered
"how we go from 3.5 years of backlog six months ago to a 20% y/y
production decline for 2009 that is only 80% sold out." Automotive
Industries Pension Trust Fund ("the Fund") answers that for over 18
months, Textron had misstated the strength of Cessna's backlog.
After another investor initiated the lawsuit now before us, the
Fund served as lead plaintiff for a class of all purchasers of
Textron securities between July 19, 2007, and January 29, 2009, who
charge Textron under the securities laws with intentionally false
or misleading statements.2
The complaint does not challenge the technical accuracy
of most of Textron's statements, for example, the precise dollar
2
Section 10(b) of the Securities Exchange Act of 1934, 15
U.S.C. § 78j(b), Rule 10b-5 promulgated thereunder, 17 C.F.R.
§ 240.10b-1, and (as to the individual defendants) Section 20(a) of
the Exchange Act, 15 U.S.C. § 78t(a). The claim under section
20(a) is derivative, ACA Fin. Guar. Corp. v. Advest, Inc., 512 F.3d
46, 67–68 (1st Cir. 2008), and needs no separate discussion.
Additional counts alleging violations of sections 11 and 15 of the
Securities Act of 1933, 15 U.S.C. §§ 77k(a), 77o, were dismissed by
agreement and are not at issue here.
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figures of backlog. Rather, plaintiffs charged--so far as is
pertinent to this appeal--that the Cessna backlog was artificially
inflated, that Textron deliberately omitted material information
revealing this fact, and that Textron's officers could not have
believed in the truth of their unrelentingly positive avowals of
the backlog's strength. Plaintiffs relied on 23 confidential
witnesses to show the following weaknesses in the backlog:
-Cessna implemented lowered underwriting
standards sometime before June 2007, thus
providing loans to highly risky customers. A
former Credit Manager at Cessna Finance said
his number of declined loans dropped by 90%,
and that the new credit standards were
"absurd" because Cessna Finance was approving
loans for customers who were "barely cash-
flowing."
-In April 2007, Cessna began financing 100% of
customer deposits. A former Cessna Customer
Solutions Manager said deposit financing was a
sure sign the customer could not actually
afford the aircraft.
-Around the same time, Cessna began providing
generous loan repayment terms and extended the
standard amortization schedule from 12 to 20
years.
-Over 2007 and 2008, Cessna accepted more
orders from international Authorized Sales
Representatives (ASRs), which were merely
contingent because they involved no end-buyers
at time of order. A former Business Finance
Partner at Cessna said it was well-known that
many orders were contingent and that customers
were essentially buying "delivery positions."
-Cessna placed increasing pressure on buyers
to delay rather than cancel orders altogether.
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The Fund also says that certain of Textron's factual
statements about cancellation figures were false when made--for
example, that Cessna had only two cancellations as of July 2008, or
that as of November 2008 cancellations did not exceed the prior
year's figures. However, the main thrust of plaintiffs' complaint
and the evidence recounted in it concerned the failure to disclose
information about the weakness of the backlog due to relaxed
financing arrangements and other practices.
On Textron's motion to dismiss, Fed. R. Civ. P. 12(b)(6),
the district court found the allegations insufficient to show that
material information was omitted. The court ruled that the
allegations of relaxed underwriting standards were too vague; that
plaintiffs failed to explain clearly how the standards changed, how
many loans were affected, or whether the allegedly risky loans
translated into cancellations or losses; and that generous
financing did not show that a customer could not afford an
aircraft. City of Roseville Emps.' Ret. Sys. v. Textron, Inc., 810
F. Supp. 2d 434 (D.R.I. 2011).
As for the plaintiffs' claims that a few statements were
literally false, the court said that nothing indicated that reports
of only two year-to-date cancellations as of July 17, 2008, were
false, even though there was evidence of a sudden increase in
cancellations in "late summer 2008." According to the court, the
complaint also failed to include cancellation figures from prior
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years that could contradict the November 2008 statement about year-
to-date cancellations. Textron, 810 F. Supp. 2d at 445.
The Fund now appeals, saying that the complaint was
sufficient to withstand a motion to dismiss. Our review is de
novo. Miss. Pub. Emps.' Ret. Sys. v. Boston Scientific Corp., 523
F.3d 75, 85 (1st Cir. 2008). We conclude that the complaint was
deficient but regard the materiality issue as a close call and rest
instead on the failure of the complaint to plead facts justifying
a reasonable inference of scienter. The scienter issue was
briefly mentioned by the district court, which did not have to
reach it, but it was argued below and fully briefed on appeal.
Section 10(b) requires plaintiffs to plead (1) material
misrepresentation or omission; (2) scienter; (3) a connection with
the purchase or sale of a security; (4) reliance; (5) economic
loss; and (6) loss causation. ACA Fin. Guar. Corp. v. Advest,
Inc., 512 F.3d 46, 58 (1st Cir. 2008). The Private Securities
Litigation Reform Act ("PSLRA"), 15 U.S.C. § 78u-4(b)(1), (2),
requires plaintiffs to specify each allegedly misleading statement
and why it is misleading--along with special requirements as to
scienter that are described hereafter. The PSLRA was deliberately
intended to stiffen the requirements for securities lawsuits.
Merrill Lynch, Pierce, Fenner & Smith Inc. v. Dabit, 547 U.S. 71,
81-82 (2006).
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Under section 10(b), when a company makes affirmative
statements, it must include whatever disclosures and qualifications
are needed to avoid misleading a reasonable investor. Backman v.
Polaroid Corp., 910 F.2d 10, 16 (1st Cir. 1990) (en banc). A
substantial weakening of a company's traditional requirements for
listing orders as backlogged, if slackened standards were not
disclosed, could make such backlog figures materially misleading.
Cf. Aldridge v. A.T. Cross Corp., 284 F.3d 72, 79-82 (1st Cir.
2002).
If this occurred here, Textron's general warnings about
the possibility of cancelled orders--of which there were a
number3--would not rescue it from liability. Such warnings might
insulate Textron from liability for "forward-looking statements"
like revenue projections, 15 U.S.C. § 78u-5, but not for
intentionally misleading characterizations of the present or
historical state of the backlog. Cf. In re Smith & Wesson Holding
Corp. Sec. Litig., 604 F. Supp. 2d 332, 341, 344-45 (D. Mass.
2009).
Based on the complaint, it is hard to assess whether
disclosures would have altered the total mix of available
3
In the July 2008 call, Campbell disclosed that "[p]ortions of
our backlog are susceptible to normal cancellations or deferrals.
And we'll likely see cancellations." Textron also repeatedly
warned in SEC filings and press releases of the risk of "changes in
aircraft delivery schedules or cancellation of orders," and that
"[a]ircraft customers . . . may respond to weak economic conditions
by delaying delivery of orders or canceling orders."
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information for a reasonable investor. Basic Inc. v. Levinson, 485
U.S. 224, 231-32 (1988). For example, the district court pointed
to the lack of detail surrounding the allegedly relaxed
underwriting standards and the effect on the backlog. But the line
between pleading enough facts and proving one's case in the
complaint is a hard one to draw . Plumbers' Union Local No. 12
Pension Fund v. Nomura Asset Acceptance Corp., 632 F.3d 762, 773
(1st Cir. 2011).
The district court viewed the allegations against Textron
as less compelling than those in Hill v. Gozani, 638 F.3d 40 (1st
Cir. 2011), where this court upheld the dismissal of section 10(b)
claims against the manufacturer of a new medical device. The
company there had not disclosed internal disagreement about whether
procedures using the device could be billed to insurers under
previously-accepted codes--a practice critical to the device's
financial success. Indeed, the manufacturer expressed optimism
about a favorable outcome.
But the manufacturer in Hill expressly warned that it did
not know how third-party payers--the crucial actors--would
ultimately decide the level of reimbursement. A reasonable
investor could read such warnings, consult other sources about how
the payers might view the matter and gauge likelihoods for himself.
In our case, the only information available to investors about the
Cessna backlog was what Textron told them. Cf. N.J. Carpenters
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Pension & Annuity Funds v. Biogen IDEC Inc., 537 F.3d 35, 47 (1st
Cir. 2008).
The confidential witnesses also provide at least some
indication that underwriting standards were loosened, while Textron
comforted investors with assurances of its "traditional strong
conservative underwriting process." And discovery might have
clarified issues such as the exact changes and terms of the
underwriting process, whether international ASR orders were unusual
or especially problematic, the extent and success of any campaign
to encourage deferral over cancellation, raw numbers about
cancellations, and--as to each of these phenomena--how much of the
backlog was affected.
So as to materiality, this complaint may not be "the kind
of vague prelude to a fishing expedition that Congress sought to
bar by imposing the clarity-and-basis requirement of the PSLRA."
In re Stone & Webster, Inc., Sec. Litig., 414 F.3d 187, 198 (1st
Cir. 2005). Summary judgment is usually a more appropriate
occasion to decide whether such details are of marginal interest or
so important that Textron's statements were misleading without
them. E.g., In re Smith & Wesson Holding Corp. Sec. Litig., 669
F.3d 68 (1st Cir. 2012).
We need not decide the materiality issue because the
complaint fails adequately to allege scienter. Unlike some
securities statutes, section 10(b)'s anti-fraud language, together
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with the PSLRA, requires that for each misstatement or omission the
complaint state with particularity facts creating a strong
inference that defendant acted with scienter--an intent to deceive,
manipulate, or defraud, Tellabs, Inc. v. Makor Issues & Rights,
Ltd., 551 U.S. 308, 318-22 (2007), or a high degree of recklessness
suggesting an indifference to deceit, Aldridge, 284 F.3d at 82.
Nothing in the complaint suggests that any of the named
officers believed, or was recklessly unaware, that the backlog's
significance had been undermined by weakened underwriting
standards, sales to intermediates, or any of the other flaws on
which the plaintiffs rely. And the questionable materiality of the
practices, depending importantly on matters of degree and detail,
deprives any inference of scienter of forward momentum that would
be helpful to plaintiffs. City of Dearborn Heights Act 345 Police
& Fire Ret. Sys. v. Waters Corp., 632 F.3d 751, 757 (1st Cir.
2011).
Textron's top managers may have been negligent if they
were not aware; surely French was extravagant in saying of the
backlog that Textron had "torn it apart." But negligence or
puffing are not enough for scienter, Greebel v. FTP Software, Inc.,
194 F.3d 185, 198-99, 207 (1st Cir. 1999); and warnings by
subordinates or expressions of concern by executives are notably
absent, as is an unusually compelling case on materiality. Compare
Berson v. Applied Signal Tech., 527 F.3d 982 (9th Cir. 2008)
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(failure to disclose that reported backlog included tens of
millions of dollars in stop-work orders).
The few counters offered by the Fund underscore the
absence of such evidence. For example, the Fund says Cessna
violated its non-refundable deposit policy and policy against
selling delivery slots, and alleges that sales to ASRs were an
example of effectively inflating backlog. A concealed change in
company policy might, depending on the circumstances, assist an
inference of scienter. Cf. Chalverus v. Pegasystems, Inc., 59 F.
Supp. 2d 226, 235 (D. Mass. 1999).
But Textron says financing deposits did not mean they
were refundable, and nothing shows that ASR sales were unusual.
Textron regularly made investors aware of international orders,
while plaintiffs provide no detail as to what proportion of
international orders were placed by ASRs, or whether that ratio
increased during the class period.
And Textron flatly denied agreeing that customers could
sell slots, admitting only that "[o]ccasionally one will sneak
through on us." Read closely, the complaint's more specific
allegations amounted to saying that customers wanted to sell slots
or hoped they would be allowed to do so. So, while the relatively
detailed factual proffers in the complaint go some distance toward
making a case for materiality, they are considerably weaker in
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offering any direct evidence of guilty knowledge or fraudulent
intent.
The Fund does note some stock sales by Campbell and
French during the class period, but this cannot add much to the
inference of scienter without something (e.g., points of comparison
from outside the class period) to show that these sales were
unusual. Greebel, 194 F.3d at 207. The Fund also observes that
the officers' careers and the survival of the company were on the
line, cf. In re Cabletron Sys., Inc., 311 F.3d 11, 39 (1st Cir.
2002), but this is hardly the particularized showing required by
the PSLRA.
If Campbell knowingly understated the number of
cancellations in July 2008, this would be would be "classic
evidence of scienter." ACA Fin., 512 F.3d at 65 (internal
quotations and citations omitted). But, as the district court
observed, on the crucial question of when cancellations began
piling up, cf. N.J. Carpenters, 537 F.3d at 47-48, Campbell's
statement and the confidential witness' description of
cancellations increasing "suddenly" in "late summer" are not in
conflict.
As in all dispositions under Rule 12(b)(6), the Fund had
no access to compulsory discovery and could not search company
files or depose the individual defendants. But while a trawl
through archives may sometimes catch a few fish,
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Congress--concerned about the cost and disruption--deliberately
raised the entry bar to discovery both through the PSLRA's
heightened pleading standards and by other measures. See Merrill
Lynch, 547 U.S. at 81; Hill, 638 F.3d at 54. Such trade offs based
on real-world experience are what legislative judgment is all
about.
This leaves a plaintiff's counsel with a greater than
usual burden of investigation before filing a securities fraud
complaint. Yet where district judges face promising complaints
that fall into an intermediate gray area, they have in practice
some latitude to refuse to dismiss some or all counts and allow
discovery, whether narrowly focused or in full. Nomura Asset, 632
F.3d at 774. This complaint's scienter allegations were weaker
than its materiality allegations and did not even arguably fall
into a gray area encouraging further proceedings.
Affirmed.
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