Securities – Lack of scienter dooms fraud claims

Where shareholders alleged they purchased shares of a technology company at inflated prices because corporate officers made materially misleading statements about the company’s financial health, their suit was dismissed because there was insufficient evidence of scienter.

Background

Plaintiffs appeal the dismissal of their class action suit alleging securities fraud under the Securities Exchange Act of 1934 and a regulation promulgated thereunder against DXC Technology Company and its two principal executives, J. Michael Lawrie and Paul N. Saleh. Specifically, plaintiffs allege that they purchased shares of DXC at inflated prices after DXC, Lawrie and Saleh made false and misleading statements concerning DXC’s financial health.

The district court dismissed their complaint, ruling that plaintiffs failed to allege that defendants made actionable false and misleading statements and failed to allege facts leading to the strong inference that defendants acted with the requisite scienter.

Individual analysis

Plaintiffs rely on five categories of allegations that they claim demonstrate scienter. Plaintiffs first rely on a lawsuit a former DXC senior executive, Stephen Hilton, filed against DXC. Plaintiffs contend this complaint showed that defendants deliberately deceived investors by making statements about the success of Hilton’s division while knowing that they could not meet their revenue projections.

But these allegations support only a weak inference of scienter. Perhaps DXC or Lawrie realized that Hilton’s division as a whole was underperforming. But this inference is less persuasive than the competing inference that Hilton was fired because Hilton—not his division—was performing poorly due to his “material misconduct” and “substantial and willful failure to render services.” Further, Hilton’s allegations in his lawsuit tend to show only that Hilton believed the cuts he was being asked to make were misguided—not that Lawrie or Saleh agreed with that assessment.

Plaintiffs next offer statements from former employees who believed DXC was heading in the wrong direction before and during the class period. However these allegations do not raise a strong inference of scienter because the former employees, for the most part, do not allege that they passed their concerns on to Lawrie or Saleh or that the individual defendants were otherwise aware of the problems alleged. To the limited extent the employees allege that they did notify Lawrie or Saleh of their concerns, plaintiffs’ allegations are vague and conclusory, and lack particularized facts demonstrating defendants intentionally or recklessly misled investors.

Third, plaintiffs raise the specter of insider trading to support their scienter allegations, pointing to Lawrie’s and Saleh’s sales of shares of DXC’s stock during the class period. The insider-trading allegations do not raise a strong inference of scienter, as they must to support plaintiffs’ claim. For a start, this court did not previously find a strong inference of scienter from a CFO’s “nearly de minimis” sale of 13% of his holdings in the company during the class period. Moreover, Saleh’s sale of $9.5 million worth of shares during the class period is less than the $14.8 million of stock he sold during the control period. When the sale of stock during the class period is not substantially out of line with the sale of stock during the control period, the inference of scienter is lessened.

Plaintiffs next argue the court should draw an inference of scienter from the fact that defendants allegedly made false statements concerning DXC’s move into the digital space and investments in its human capital after representing that those issues were key concerns for the company. Even if such broad corporate strategies can constitute core operations, no core-operations inference can be appropriately drawn from these allegations. Without particularized allegations regarding defendants’ knowledge of shortcomings regarding the digital space and investments in employees, plaintiffs are simply asking the court to assume scienter because part of DXC’s business plan was not going smoothly. This the court cannot do.

Finally, plaintiffs point to the temporal proximity between some of defendants’ allegedly false statements or omissions and the subsequent disclosure of the truth. While such temporal proximity is relevant to the scienter inquiry, the court follows other circuits in declining to draw a strong inference of scienter based solely on there being a short amount of time between positive announcements and statements announcing negative financial information. Here, plaintiffs’ use of the period between defendants’ allegedly false statements or omissions and the subsequent disclosure of the truth “amounts to little more than pleading fraud by hindsight.”

Holistic analysis

Holistically analyzing plaintiffs’ allegations as to scienter, the non-fraudulent inference—that DXC unexpectedly stumbled, leading to reduced revenue and other greater-than-expected operational difficulties—is more compelling than the requisite inference that defendants knowingly or recklessly misled investors about the company’s financial health.

While there is some reason to believe defendants acted with the requisite intent— including the individual defendants’ stock sales and the speed with which DXC’s business outlook changed—there is not enough to create a strong inference of scienter. Furthermore, plaintiffs’ own allegations fully explain why DXC did not hit all of its business-growth goals.

Additionally, when defendants disclose risks and newly discovered weaknesses to investors this counts against an inference of scienter. Here, defendants announced DXC’s significant revenue decline to its investors in a timely manner. Further, while defendants announced a downward revision in revenue projections, they also announced an increase in earnings per share.

Affirmed.

KBC Asset Management NV v. DXC Technology Company (Lawyers Weekly No. 001-202-21, 19 pp.) (James A. Wynn Jr., J.) Case No. 20-1718. Dec. 1, 2021. From E.D. Va. at Alexandria (Anthony John Trenga, S.J.) Gregg S. Levin for Appellants. Jamie L. Wine for Appellees.