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Securities – Fraud Claim – Scienter – Insufficient Showing – Knowledge of Falsity

By: Teresa Bruno, Opinions Editor//November 16, 2017

Securities – Fraud Claim – Scienter – Insufficient Showing – Knowledge of Falsity

By: Teresa Bruno, Opinions Editor//November 16, 2017

Maguire Financial, LP v. PowerSecure International, Inc. (Lawyers Weekly No. 001-198-17, 18 pp.) (Allyson Duncan, J.) 16-2163; Nov. 15, 2017; USDC at Greenville, N.C. (James Dever III, C.J.) 4th Cir.

Holding: Plaintiff alleges that defendant’s CEO said defendant had “renewed” its contract with a power company when in fact defendant had contracted to start providing services in a new area (Fort Myers, Florida) rather than to continue providing services in the same area (West Palm Beach). Plaintiff thus alleges facts that permit an inference that the CEO knew his statement was false, but plaintiff then asks us to infer from that inference that the CEO acted with scienter. We decline to do so because stacking inference upon inference in this manner violates 15 U.S.C. § 78u-4(b)(2)’s mandate that the strong inference of scienter be supported by facts, not other inferences.

We affirm the trial court’s grant of defendant’s motion to dismiss.

The Private Securities Litigation Reform Act reflects Congress’s determination that liability for securities fraud should not be predicated solely on an overly optimistic view of a future which may, in fact, encounter harsh economic realities down the road.

Plaintiff must show that defendant’s CEO affirmatively sought to advance or calculatedly sought to obscure that reality. The inference that the CEO may have knowingly misspoken alone does not do so.

The CEO stated during a conference call and live webcast for securities analysts and investors that defendant was “blessed to announce securing a $49 million three-year contract renewal, both the renewal and expansion with one of the largest investor [owned] utilities in the country.” Investment analysts reacted positively to the announcement, and the next day defendant’s common stock rose more than 10 percent.

Plaintiff correctly understood from the statement that the utility company was Florida Power & Light, with which defendant had had a contract to provide services in West Palm Beach. Contrary to plaintiff’s understanding, however, the contract “renewal and expansion” did not involve continued services in West Palm.

Instead, defendant would be providing services in Ft. Myers. The expenses of setting up services in Ft. Myers were higher than defendant expected, the company announced that it had suffered a loss, and its stock price fell more than 62 percent.

In the interim, the CEO sold 200,000 PowerSecure shares from his personal holdings and transferred approximately $2.5 million of his PowerSecure stock to his wife as part of a divorce settlement.

The fact that the Ft. Myers contract eventually reduced defendant’s profitability is not evidence that the risk of diminished profitability was known beforehand.

Furthermore, a contract renewal need not be on the same terms as the prior agreement and can include replacement of the old contract with a different one. Indeed, the CEO’s description of the contract as a “renewal and expansion” undermines the inference that he used the phrase “contract renewal” in the same sentence to mislead investors into believing that the new contract was merely an extension of the original or to hide the possibility of future cost increases from investors. An expanded contract must be on different terms than the original, and by its very nature carries a risk that costs may rise due to inefficiencies in fulfilling the expansion.

Finally, the CEO did not sell his shares when their value was highest. And his transfer of shares to his wife occurred some months after the statement in question, and it was in connection with their impending divorce. These facts do not approach those that would support a strong inference of scienter.


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