Abrams v. Baker Hughes Inc.
| Citation | 292 F.3d 424 |
| Decision Date | 21 May 2002 |
| Docket Number | No. 01-20514.,01-20514. |
| Parties | David ABRAMS, etc.; et al., Plaintiffs, YMCA Retirement Fund; Howard University; Federated National Insurance Company; Headwaters Capital LLC; Frank D. Timmons, Plaintiffs-Appellants, v. BAKER HUGHES INC.; Max L. Lukens; George Stephen Finley; Andrew Szescila, Defendants-Appellees, E.L. Mattson, Appellee. |
| Court | United States Courts of Appeals. United States Court of Appeals (5th Circuit) |
Daniel James Petroski, Jr., Vahldiek, Cano, Grayson, Hovenkamp & Petroski, Houston, TX, Vincent R. Cappucci (argued), Entwistle & Cappucci, New York City, for Plaintiffs-Appellants.
David D. Sterling (argued), Michael Paul Graham, Samuel Woolin Cooper, Katherine Traverse Vukadin, Baker Botts, Houston, TX, for Defendants-Appellees.
Appeal from the United States District Court for the Southern District of Texas.
Before ALDISERT1, DAVIS and PARKER, Circuit Judges.
The plaintiffs appeal from a dismissal under F.R.C.P. 12(b)(6) of their securities fraud class action under §§ 10(b) and 20(a) of the Exchange Act. The district court dismissed the case based on its conclusion that the plaintiffs failed to adequately allege particularized facts to establish the necessary element of scienter. Finding no error, we affirm.
This securities fraud class action is brought on behalf of all investors who purchased common stock of Baker Hughes from February 1, 1999 through December 8, 1999 (the "Class Period"). Baker Hughes is a diversified oil and gas services company headquartered in Houston, Texas, whose stock trades on the New York Stock Exchange under the symbol "BHI." Defendant Lukens was Baker Hughes' president, chairman and chief operating officer. Defendant George Finley was its chief financial officer. The plaintiffs contend generally that the defendants' Class Period press releases and SEC filings contained false and misleading statements and omissions. Specifically, the plaintiffs allege that the defendants deceived the investing public regarding the adequacy of Baker Hughes' internal financial controls, the fiscal discipline with which the company operated and the company's financial condition. They contend that these misstatements artificially inflated the price of the company's common stock during the Class Period. Thus, they allege that they were harmed when they purchased Baker Hughes stock at artificially high prices.
The complaint contains the following chronology of events and allegations regarding scienter. The complaint alleges that in 1998, Baker Hughes' revenues and earnings were suffering. Years of growth through mergers and acquisitions had left Baker Hughes' accounting systems in disarray with no unified accounting system and a lack of proper internal controls. The primary problems were in the INTEQ division, located in Venezuela which produced approximately 20% of company revenues. During 1999, Baker Hughes initiated Project Renaissance. The purpose of the project was to cut costs and streamline internal control systems. The project was built around a new information system called SAP which was designed to unify all accounting and data management systems at the company.
Problems were encountered in the implementation of the new system which the defendants allegedly kept quiet so as not to jeopardize their incentive compensation or the success of a scheduled $200 million debt offering. During the Class Period internal controls were inadequate and unreliable but the defendants repeatedly touted the adequacy of the company's internal controls. The lack of internal controls caused Baker Hughes to issue false and misleading financial reports throughout the Class Period. Based on the company's reported financial results and the apparent success of the implementation of SAP, the price of Baker Hughes' stock increased throughout the Class Period and analysts upgraded their ratings of the stock.
For example, in March 1999, the company filed its 1998 Form 10-K with the SEC. The report included a letter from the defendants that indicated that the company had in place an extensive system of internal controls to prevent material errors or irregularities in the reports. In May 1999, Baker Hughes announced favorable first quarter results and the stock price rose from $29.785 per share on April 30, 1998 to $31.83 per share on May 3, 1999. Also in May, Schroder & Co., Inc. issued a report raising its rating for Baker Hughes in reliance on a conversation with Baker Hughes management that SAP was on track to produce significantly improved returns. The next day, defendant Finley sold 21,574 shares of Baker Hughes stock at $30.88 per share. Finley was largely responsible for the implementation of SAP. Two weeks later, Finley was appointed chief financial officer and senior vice president of finance and administration.
On May 21, 1999, the former senior vice president and chief financial officer as well as the controller resigned. Baker Hughes stated that these officials left "to pursue other interests." Platt's Oilgram News reported that the CFO left because of cost overruns and operations glitches associated with the SAP conversion. The resignations raised concerns in the investment community. On the same day Merrill Lynch issued a favorable report on Baker Hughes based on conversations with management. The report noted the resignations but assured that there are "no accounting issues" at the company. Baker Hughes stock price rose to $31.125 per share. In June 1999, Schroder & Co. issued another favorable report after meetings with defendant Lukens. Baker Hughes price rose $1 per share to $34.5625. On September 27, 1999, Baker filed a shelf registration for the future issuance of debt and equity securities totaling one billion dollars. The plaintiffs claim that it was critical for Baker to raise capital to cover fixed charges that could not be covered by earnings.
The alleged deceptions were brought to light beginning in December, 1999. On December 1, 1999, Baker Hughes announced that results for the 4th quarter would be poor and the company would record a $130 million pre-tax charge to dispose of assets and equipment due to adverse market conditions. On December 8, 1999, the company announced the existence of accounting irregularities at INTEQ one of its major subsidiaries, that would adversely affect the company's financial statements by $40 to $50 million pre tax. The company canceled the previously announced note offering. On December 9, 1999, Baker Hughes stock closed at $19.25 per share. During the Class Period the stock traded as high as $36.125 per share.
On December 16, 1999, the president of INTEQ resigned. On January 24, 2000, the company's general counsel resigned. On January 31, 2000, Baker Hughes announced that it had fired defendant Lukens from his position as Chairman and Chief executive officer. Also on that day, the company announced that the head of the company's Western Geophysical, Baker Atlas and INTEQ divisions resigned.
On February 17, 2000, the company announced that it would restate previously filed financial reports for periods dating back to December 31, 1997. The restatement reduced profit by $31 million, $24.2 million of which was related to INTEQ. The writeoffs related to uncollectible accounts receivable, inventory write downs and unrecorded employee compensation. More details regarding the writeoffs were disclosed on March 16, 2000 when Baker Hughes filed its 1999 10-K. The report noted that the misstatements "were primarily the result of noncompliance with the Company's accounting and operating procedures and that such noncompliance was isolated primarily to INTEQ's operations in Venezuela." On April 10, 2000, Baker Hughes filed amended quarterly reports for 1999.
The defendants filed a motion to dismiss the case on the grounds that the plaintiffs failed to adequately allege particularized facts as to defendants' scienter and that the plaintiffs failed to show that the alleged misleading public statements were material. Without the benefit of the Zonagen decision, discussed later in this opinion, the district court analyzed case law from this and other circuits and concluded, properly that a strong inference of scienter is not raised where a plaintiff merely alleges facts of a defendants' motive and opportunity to commit fraud. Rather, the plaintiffs must plead specific facts constituting strong circumstantial evidence of conscious misbehavior or recklessness and motive and opportunity may be considered as a factor in determining whether a strong inference has been raised.
The district court proceeded to analyze the three claims raised by the plaintiffs: (1) the defendants had the motive and opportunity to commit fraud based on the need to raise capital, incentive compensation contingent on the successful implementation of SAP and Finley's insider stock sales; (2) the defendants engaged in conscious misbehavior or were reckless as to their public representations because Lukens and Finley were intimately familiar with the company's inadequate internal controls, and (3) the defendants violated generally accepted accounting principles. The district court concluded that the "totality of the Plaintiffs' facts has failed to raise a strong inference of scienter." The court went on to say that although the facts were insufficient in the aggregate, it was not error for the court to compartmentalize the allegations and "wipe the slate clean after considering each component." The district court accordingly dismissed the plaintiffs 10(b) and 10b-5 claims. Because the plaintiffs failed to raise a strong inference of scienter, it declined to reach the issue of materiality. Although not sought by the parties, the district court further held that dismissal of the 10(b) and 10b-5 claims required dismissal of the 20(a) claim.
The plaintiffs appeal.
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