PSLRA Class Action Defense Cases–In re Hutchinson: Eighth Circuit Affirms Dismissal Of Class Action Holding Class Action Complaint Failed To Meet Heightened Pleading Requirements Under The Private Securities Litigation Reform Act (PSLRA)

Sep 22, 2008 | By: Michael J. Hassen

Securities Class Action Properly Dismissed because Allegations in Class Action Complaint Failed to Meet PSLRA’s Heightened Pleading Requirements Eighth Circuit Holds

Plaintiff filed a class action complaint against Hutchinson Technology and six of its officers and directors alleging violations of federal securities law; the class action complaint asserted claims under Section 10(b) of the Securities Exchange Act of 1934 and under Rule 10b-5 of the Securities and Exchange Commission implementing regulation, as well as control person liability under Section 20 of the 1934 Act. In re Hutchinson Technology, Inc. Securities Litig., 536 F.3d 952, 954-55 (8th Cir. 2008). Defense attorneys filed a motion to dismiss the class action complaint on the ground that it failed to meet the heightened pleading requirements of the Private Securities Litigation Reform Act (PSLRA). Id., at 955. The district court granted the motion and denied plaintiff’s request for leave to file an amended class action complaint. Id. Plaintiff appealed, and the Eighth Circuit affirmed.

Very briefly, Hutchinson manufactures and supplies suspension assemblies for computer hard disk drives. In re Hutchinson, at 955. In 2005, the company’s five largest customers accounted for 90% of its revenue, and sales of suspension assemblies accounted for 95% of its total revenue. Id. After giving guidance of $0.10 earnings per share (EPS) for the fourth quarter of 2004, the company reported EPS of $0.15 to $0.20 for that quarter and announced that it expected an increase in product demand in the first quarter of 2005. Id. Hutchinson stock price increased more than 10% on the news, from $30.93 to $34.09. Id. Thereafter, despite releasing positive information, Hutchinson’s stock price dropped to about $30 per share; also during this time, certain officers sold a total of 137,750 shares of stock at $29-$30 per share for a total of about $6 million, and later sold another 26,820 shares at $33.55-$34 per share for a total of about $1 million. Id., at 956. We do not summarize further additional positive guidance provided by the company, or additional shares of stock sold by insiders. See id., at 956-57. But on August 30, 2005, the company issued a press release disclosing lower demand and a reduction in sales and earnings for fourth quarter 2005: in response, the company stock price dropped from $31.51 to $26.16. Id., at 957. In addition to the financial allegations, the class action complaint contained allegations from five confidential witnesses. Id., at 957-58. In granting the defense motion to dismiss the class action complaint, the district court “[held] that the complaint did not meet the heightened pleading standards for falsity and scienter required by the PSLRA.” Id., at 958. Additionally, it dismissed the Section 20 class action claim (concerning “control person” liability) as derivative of the class action’s Section 78j(b) claim. Id. Finally, the district court denied leave to amend the class action complaint because it found that amendment would be futile, id.

The Eighth Circuit analyzed de novo whether the class action met the requirements of the PSLRA, which requires that a complaint “‘specify each statement alleged to have been misleading, the reason or reasons why the statement is misleading, and, if an allegation regarding the statement or omission is made on information and belief, the complaint shall state with particularity all facts on which that belief is formed’” and “‘with respect to each act or omission alleged to violate this chapter, state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind.’” In re Hutchinson, at 958 (citations omitted). Plaintiff argued that the class action complaint adequately alleged two types of misleading statements: (1) that the company’s EPS announcements improperly understated return allowances, and (2) that individual defendants “made false and misleading statements regarding customer demand, Hutchinson’s ability to meet demand, and sales and earnings projections.” In re Hutchinson, at 959. The Eighth Circuit rejected of these claims, explaining that “the backbone” of the class action’s allegations came from confidential witnesses, and that they “fail[ed] under the PSLRA because they are either bare allegations or allegations supported by anecdotal information about specific customers with no historical context.” Id. At the very least, the class action should have alleged that the returns materially exceeded the company’s return allowances; in other words, the class action complaint failed to “plead facts that showed that the allowances were ultimately inadequate”; specifically, “Hutchinson has never restated its financials, and there are no people, documents, or sources that say Hutchinson’s numbers were false.” Id., at 960.

With respect to the company’s public statements regarding demand, and sales and earnings projections, the Eighth Circuit “agree[d] with the district court that nothing in the complaint explains how or why” the challenged statements are false. In re Hutchinson, at 960. On the contrary, the company was experiencing growth in demand and did plan to expand production capacity to meet that demand. Id. Similarly, the class action complaint was devoid of facts showing that the company’s statements about future sales and earnings were false when made. Id., at 961. Accordingly, the class action “failed to allege that Hutchinson made any materially false or misleading statements with the specificity required by the PSLRA.” Id. And the fact an officer believed the company was “well-positioned on a number of new disk drive programs that will be transitioning into volume production in the coming months” was too vague support the class action claims. Id. Having so held, the Eighth Circuit easily affirmed the district court’s dismissal of the class action’s control-person liability claim because the claim “is derivative and requires an underlying violation of the 1934 Act.” Id. Because the district court properly dismissed the other class action claims, the Section 20 claim failed. Id., at 961-62.

Finally, the Eighth Circuit held that the district court properly denied leave to amend. In re Hutchinson, at 962. Specifically, the Circuit Court held that the amendments proposed by plaintiff “would not save the complaint.” Id. In part, the Court explained at page 962, “The mere existence of an SEC investigation does not suggest that any of the allegedly false statements were actually false and it does not render [the company officer’s] statements that Hutchinson was ‘well-positioned’ material nor does it add an inference of scienter.” Accordingly, the Eighth Circuit affirmed the dismissal of the class action complaint and denial of leave to amend. Id.

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