PSLRA Class Action Defense Cases–Akerman v. Arotech: New York Federal Court Denies Motion To Dismiss Securities Fraud Class Action Finding Class Action Complaint Adequately Alleged Materiality, Scienter And Particularity

Apr 8, 2009 | By: Michael J. Hassen

Securities Fraud Class Action Survives Motion to Dismiss because Class Action Complaint Adequately Alleged that Defendants Failed to Timely Discover and/or Disclose Material Adverse Information New York Federal Court Holds

Plaintiffs filed a class action against Arotech Corporation, a defense contractor, and three of its officers alleging violations of federal securities laws; the class action complaint violations Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5, and seeking to hold the individual defendants liable as “control persons” under Section 20(a) of the Act. Akerman v. Arotech Corp., ___ F.Supp.2d ___ (E.D.N.Y. March 30, 2009) [Slip Opn., at 1]. According to the allegations underlying the class action, defendants made materially false statements and withheld materials facts concerning Arotech’s financial condition, id. The class action centered on Arotech’s acquisition of Armour of America (AofA) in August 2004 for $19 million in cash “with additional possible earn-outs if AofA is awarded certain material contracts” up to a maximum of $40 million. Id., at 2-3. Arotech’s total revenue in 2003 was only $17.3 million, but its revenue in 2004 increased to $50.4 million, id., at 3-4. Defense attorneys moved to dismiss the class action complaint “principally on the grounds of materiality, scienter and particularity” as required by the Private Securities Litigation Reform Act (PSLRA). Id., at 1. The district court concluded that the class action complaint adequately alleged securities fraud.

The class action complaint cited various confidential witnesses who alleged that “Arotech’s pre-acquisition due diligence did not reveal all material information about AofA before the acquisition.” Akerman, at 4. In particular, the confidential witnesses cited the federal government’s cancellation of a substantial helicopter contract with AofA based on a “termination for default” (T4D), that is, the government’s belief that AofA had overstated the armor weight of the helicopters. Id., at 4-5. The T4D, together with stigma accompanying the T4D, created a “domino effect” at AofA that seriously impacted sales, id., at 5. The class action alleged that defendants had access to this information, despite the fact that AofA did not disclose it, id., at 5-6. Additionally details may be found in the district court opinion at pages 6 through 11.

After summarizing the various standards and case law governing defendants’ Rule 12(b)(6) motion, see Akerman, at 13-17, the district court turned to the issue of materiality. The district court found that the class action’s allegations satisfied this test because, if true, defendants failed to disclose the T4D for as long as possible because management would be “embarrassed by the discovery that a company it had just gambled a year’s worth of the company’s revenues acquiring bore this stigma,” id., at 18. Management selectively disclosed financial numbers and “made some disclosures of negative information that were either untimely – or, if not untrue per se, not the whole of the story – all the while withholding news of the T4D, the one fact that would have cast the light of true accuracy on all the other disclosures.” Id. At the pleading stage, these allegations were sufficient to defeat defendants’ motion to dismiss, id., at 18-19.

The federal court’s ruling on materiality dictated the outcome of its analysis on the issue of scienter, because while the company disclosed the termination of the government’s contract, it failed to disclose the nature of the default. Akerman, at 20. Indeed, the allegations in the class action complaint established (if true) that the company failed to disclose material adverse information, id., at 21-22. And the district court similarly found that plaintiffs had adequately pleaded securities fraud with particularity. See id., at 26-28. Accordingly, it denied defendants’ motion to dismiss the class action, id., at 28.

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