898 F.3d 648
5th Cir.2018Background
- Hanger, Inc., a large provider of orthotic/prosthetic services, overstated pre-tax income by $87 million and restated financials for 2010–2014 after internal and Audit Committee investigations.
- The Fund (Alaska Electrical Pension Fund) alleged 93 false/misleading statements during the Class Period (July 27, 2011–Feb 26, 2016) about same-store sales, Medicare audit success, reserves, Janus rollout disruptions, and adequacy of internal controls.
- Audit Committee 8-Ks (Feb and June 2016) disclosed fabricated inventory records, ~$40M overstatement of accounts receivable/understated reserves, eleven material weaknesses, and concluded that former executives (including Kirk and CFO McHenry) set an “inappropriate tone at the top” and that some officers/employees engaged in inappropriate accounting to enhance results.
- District court dismissed the §10(b) and §20(a) claims with prejudice for failure to plead scienter; plaintiffs appealed. The TAC incorporated the Audit Committee findings and added Kirk as a defendant.
- The Fifth Circuit evaluated scienter under Tellabs/PSLRA standards (must plead particularized facts giving rise to a strong inference of intent or severe recklessness) and considered loss causation and control-person liability.
Issues
| Issue | Plaintiff's Argument | Defendant's Argument | Held |
|---|---|---|---|
| Scienter as to CFO McHenry | Audit Committee findings, magnitude/duration of restatement, SOX certifications, and other facts show McHenry intentionally or with severe recklessness manipulated accounting | Audit Committee language is non-specific/passive; alternative nonculpable explanations exist; alleged facts don’t show McHenry’s particular intent | Reversed as to McHenry: collectively the June 8‑K and other allegations give a strong, cogent inference of scienter for McHenry (but only as to his statements) |
| Scienter as to CEO Kirk and CEO/President Asar | Same pattern of allegations (restatement size, tone at top, Medicare/Janus problems, stock sales, SOX certifications) establish scienter | Audit Committee does not attribute specific wrongful acts to them; allegations are group-based or equivocal; stock sales explained by 10b5‑1 and tax needs; no "special circumstances" to impute knowledge | Affirmed as to Kirk and Asar: allegations do not establish a strong inference of scienter for them |
| Loss causation (did corrective disclosures cause investor losses?) | A series of partial disclosures (Aug 2014 sales decline, Nov 2014 delay, Feb 2016 8‑K) revealed the truthful problems and precipitated price drops, making loss causation plausible | Defendants argued corrective truth was already known or unrelated to alleged misstatements | Rejected defendant challenge: the disclosure series plausibly revealed the fraud and the resulting price drops adequately plead loss causation |
| Control‑person (§20(a)) liability | Individual defendants who controlled Hanger should be liable if primary §10(b) claims survive | Control liability is secondary and depends on primary violation; defendants gave only cursory arguments | Remanded: because §10(b) liability survives for McHenry and Hanger (re: McHenry’s statements), district court should decide §20(a) claims in first instance |
Key Cases Cited
- Tellabs, Inc. v. Makor Issues & Rights, Ltd., 551 U.S. 308 (holding that plausible scienter in securities cases must be cogent and as compelling as any nonculpable inference)
- Public Employees Retirement System of Mississippi v. Amedisys, Inc., 769 F.3d 313 (series of partial disclosures may together satisfy loss‑causation pleading)
- Southland Securities Corp. v. INSpire Ins. Sols., Inc., 365 F.3d 353 (defendants’ positions alone do not establish scienter; limitations on group pleading)
- Central Laborers' Pension Fund v. Integrated Elec. Servs. Inc., 497 F.3d 546 (10b5‑1 plans and other documents can be considered at pleading stage to weigh competing inferences)
- Owens v. Jastrow, 789 F.3d 529 (describing scienter/severe‑recklessness standard and Rule 9(b)/PSLRA pleading requirements)