Wyche v. Advanced Drainage Sys., Inc.
17-743-cv
| 2d Cir. | Oct 13, 2017Background
- Plaintiff Christopher Wyche brought securities-fraud claims under Section 10(b)/Rule 10b-5 and a derivative Section 20(a) claim against Advanced Drainage Systems, Inc. (ADS) and two officers, Joseph Chlapaty and Mark Sturgeon.
- Wyche alleged defendants made GAAP violative accounting decisions (inventory costing and lease classification) to avoid breaching loan covenants and to present stronger preliminary financial results.
- He asserted motive based on (a) avoiding covenant defaults, (b) executives’ bonus incentives tied to preliminary performance, and (c) Sturgeon’s insider stock sales in May 2015.
- The District Court dismissed for failure to plead scienter with the particularity required by Rule 9(b) and the PSLRA; Wyche appealed.
- The Second Circuit reviewed whether the complaint sufficiently alleged scienter (motive or conscious recklessness) and whether corporate scienter could be imputed to ADS; it affirmed the dismissal.
Issues
| Issue | Plaintiff's Argument | Defendant's Argument | Held |
|---|---|---|---|
| Whether Wyche pleaded defendant scienter via motive to avoid loan covenant breaches | ADS risked breaching covenants under GAAP, creating motive to misstate results | Allegations lack particularity; no facts showing imminent or inevitable default | Motive allegation insufficient—no particularized facts of imminent default |
| Whether executives’ bonus incentives support motive to inflate results | Bonuses tied to preliminary results created concrete, personal motive | Bonus motives are not the kind of concrete personal benefit that supports scienter | Rejected—bonus allegations do not establish the necessary concrete personal benefit |
| Whether Sturgeon’s insider stock sales support inference of scienter | Sturgeon sold shares while company misrepresented performance, suggesting fraud | Sales were small, not unusual in timing or amount, and not corroborated by other insider sales | Rejected—sales were not unusual and do not support scienter inference |
| Whether allegations of conscious misbehavior/recklessness or corporate scienter suffice | GAAP departures and internal concerns show recklessness and allow imputation to ADS | No allegations that execs were told of accounting concerns or directed fraudulent acts; circumstantial facts weak | Rejected—allegations insufficient to raise a strong inference of scienter for individuals or the corporation; Section 20(a) claim fails without primary violation |
Key Cases Cited
- Tellabs, Inc. v. Makor Issues & Rights, Ltd., 551 U.S. 308 (standard for pleading a strong inference of scienter)
- ECA & Local 134 IBEW Joint Pension Tr. of Chi. v. JP Morgan Chase Co., 553 F.3d 187 (PSLRA/Rule 9(b) pleading applied)
- Kalnit v. Eichler, 264 F.3d 131 (motive must be concrete and personal; pleading scienter via motive or recklessness)
- Acito v. IMCERA Group, Inc., 47 F.3d 47 (insider sales must be unusual to support scienter)
- Novak v. Kasaks, 216 F.3d 300 (GAAP departures alone do not establish fraudulent intent)
- Teamsters Local 445 Freight Div. Pension Fund v. Dynex Capital Inc., 531 F.3d 190 (corporate scienter requires strong inference someone with the corporation’s intent acted with scienter)
- ATSI Communications, Inc. v. Shaar Fund, Ltd., 493 F.3d 87 (Section 20(a) depends on primary Section 10(b) violation)