Central Laborers' Pension v. Integrated Elec.

• Decision Date: 21 August 2007
• Docket Number: No. 06-20135.,06-20135.
• Parties: CENTRAL LABORERS' PENSION FUND; et al., Plaintiffs, Central Laborers' Pension Fund, Plaintiff-Appellant, v. INTEGRATED ELECTRICAL SERVICES INC.; Herbert Allen; William W. Reynolds; Jeffrey Pugh, Defendants-Appellees.
• Court: U.S. Court of Appeals — Fifth Circuit

497 F.3d 546

CENTRAL LABORERS' PENSION FUND; et al., Plaintiffs Central Laborers' Pension Fund, Plaintiff-Appellant, v. INTEGRATED ELECTRICAL SERVICES INC.; Herbert Allen; William W. Reynolds; Jeffrey Pugh, Defendants-Appellees.

No. 06-20135.

United States Court of Appeals, Fifth Circuit.

August 21, 2007.

Steven J. Toll (argued), Joshua Seth Devore, Elizabeth Shattuck Finberg, Cohen, Milstein, Hausfeld & Toll, Washington, DC, Roger B. Greenberg, Kay Johnson Hazelwood, Schwartz, Junell, Greenberg & Oathout, Houston, TX, for Plaintiff-Appellant.

N. Scott Fletcher (argued), Michael C. Holmes, Vinson & Elkins, Houston, TX, for Defendants-Appellees.

Appeal from the United States District Court for the Southern District of Texas.

Before HIGGINBOTHAM, WIENER, and CLEMENT, Circuit Judges.

EDITH BROWN CLEMENT, Circuit Judge:

Central Laborers' Pension Fund ("CLPF") appeals the district court's dismissal with prejudice of its securities fraud complaint against Integrated Electrical Services ("IES") and several of IES's executive officers for failure to meet the heightened pleading standards of the Private Securities Litigation Reform Act ("PSLRA"), 15 U.S.C. § 78u-4. We AFFIRM.

I. FACTS AND PROCEEDINGS

During the class period,¹ IES, a Houston-based publicly-traded company, provided electrical contracting services in the United States through a network of more than 40 subsidiary companies. Despite its extensive use of subsidiaries, which were managed regionally, IES held itself out as an integrated company and filed consolidated financial statements.

Starting in April 2003, IES made various statements expressing confidence in the company's financial status, and over the next 16 months the company's stock price generally increased. In early August 2004, IES publicly disclosed that it could not release its quarterly earnings numbers on time due to an ongoing evaluation of certain projects. Later in August 2004, the company acknowledged that "material weaknesses" in the company's internal controls might require restatement of prior financial figures. Ultimately, IES restated its financial results for three periods: fiscal year 2002, fiscal year 2003, and the first two quarters of fiscal year 2004.

In June 2005, Plaintiff CLPF, a stockholder, filed a consolidated amended class action complaint ("CAC") against IES, its President and CEO Herbert Allen, and two men who served as the company's CFO at different times, William Reynolds and Jeffrey Pugh, alleging violations of Sections 10(b) and 20(a) of the Securities Exchange Act,² 15 U.S.C. §§ 78j(b) & 78t(a), as well as Rule 10b-5 promulgated thereunder. The CAC alleges that a number of false or misleading statements by IES regarding the company's financial condition caused an artificial inflation in the market price of IES's securities during the class period.³ The allegedly false and misleading statements were distributed publicly through press releases, SEC filings, and "Company & Investment Profiles," which were company-created reports providing analysis about the company.

The defendants moved to dismiss the CAC under Rules 9(b) and 12(b)(6) of the Federal Rules of Civil Procedure, arguing, inter alia, that the CAC did not meet the pleading requirements of the PSLRA. CLPF opposed the motion and included in its response a request to amend the CAC if the court deemed it insufficient to avoid dismissal. The district court granted the motion and dismissed the CAC with prejudice, implicitly refusing to grant CLPF leave to amend. Specifically, the court found that the CAC did not meet the particularity requirement as to scienter.

CLPF timely appealed and raised two arguments. CLPF argues that the CAC's allegations of scienter were articulated with sufficient particularity to defeat a motion to dismiss. Second, CLPF urges that the district court abused its discretion in refusing to permit amendment of the CAC.

II. STANDARDS OF REVIEW AND APPLICABLE LEGAL STANDARDS

A. Motion to dismiss

We review de novo a district court's dismissal of a complaint under Federal Rule of Civil Procedure 12(b)(6). See Nathenson v. Zonagen Inc., 267 F.3d 400, 406 (5th Cir. 2001). We must accept all well-pleaded facts alleged in the complaint as true and must construe the allegations in the light that is most favorable to the plaintiff. Plotkin v. IP Axess Inc., 407 F.3d 690, 696 (5th Cir. 2005). Nevertheless, "[w]e do not accept as true conclusory allegations, unwarranted factual inferences, or legal conclusions." Id.

In order "[t]o state a claim under § 10(b) and Rule 10b-5, a plaintiff must allege, in connection with the purchase or sale of securities[:] (1) a misstatement or an omission (2) of material fact (3) made with scienter (4) on which plaintiff relied (5) that proximately [injured him]." Fin. Acquisition Partners LP v. Blackwell, 440 F.3d 278, 286 (5th Cir. 2006) (second and third alterations in original) (internal quotation omitted).

Under the PSLRA, a plaintiff alleging securities fraud must plead the substantive elements of the violation with particularity. Id. at 287. The PSLRA "appears to comport with this Court's relatively strict interpretation of Rule 9(b), which requires a plaintiff to specify the statements contended to be fraudulent, identify the speaker, state when and where the statements were made, and explain why the statements were fraudulent." ABC Arbitrage Plaintiffs Group v. Tchuruk, 291 F.3d 336, 350 (5th Cir. 2002) (internal quotation omitted). "[T]he PSLRA specifically provides in 15 U.S.C. § 78u-4(b)(1) . . . that, if an allegation regarding the statement or omission is made on information and belief, the complaint shall state with particularity all facts on which that belief is formed." Id. (internal quotation omitted). Failure to do so results in dismissal of the complaint. Id.

In any private action arising under [the PSLRA] in which the plaintiff may recover money damages only on proof that the defendant acted with a particular state of mind, the complaint shall, with respect to each act or omission alleged to violate this chapter, state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind.

15 U.S.C. § 78u-4(b)(2). Section 10(b) and Rule 10b-5 violations require proof that the defendant acted with scienter, which means "either intent or severe recklessness." Blackwell, 440 F.3d at 287. Severe recklessness is

limited to those highly unreasonable omissions or misrepresentations that involve not merely simple or even inexcusable negligence, but an extreme departure from the standards of ordinary care, and that present a danger of misleading buyers or sellers which is either known to the defendant or is so obvious that the defendant must have been aware of it.

Nathenson, 267 F.3d at 408 (internal quotation omitted).

The PSLRA did not, however, generally alter the substance of the scienter requirement for Section 10(b) and Rule 10b-5 claims. See Goldstein v. MCI WorldCom, 340 F.3d 238, 245 (5th Cir. 2003). This court also does not "require[] a plaintiff to present direct evidence of scienter in order to withstand dismissal of his securities claims. Allegations of circumstantial evidence justifying a strong inference of scienter will suffice." Id. at 246.

Furthermore, "[t]he strong-inference pleading standard does not license us to resolve disputed facts at this stage of the case." Barrie v. Intervoice-Brite, Inc., 397 F.3d 249, 258 (5th Cir. 2005). It does, however, permit the court to "engage in some weighing of the allegations to determine whether the inferences toward scienter are strong or weak." See Rosenzweig v. Azurix Corp., 332 F.3d 854, 867 (5th Cir. 2003). Importantly, the Supreme Court recently stated that "[t]o determine whether the plaintiff has alleged facts that give rise to the requisite `strong inference' of scienter, a court must consider plausible nonculpable explanations for the defendant's conduct, as well as inferences favoring the plaintiff." Tellabs, Inc. v. Makor Issues & Rights, Ltd., ___ U.S. ___, 127 S.Ct. 2499, 2510, 168 L.Ed.2d 179 (2007). The Court provided that "[t]he inference that the defendant acted with scienter need not be irrefutable, i.e., of the smoking-gun genre, or even the most plausible of competing inferences. . . . Yet the inference of scienter must be more than merely reasonable or permissible—it must be cogent and compelling, thus strong in light of other explanations." Id. (internal citations and quotations omitted). Accordingly, the Court held that a complaint will survive a motion to dismiss "only if a reasonable person would deem the inference of scienter cogent and at least as compelling as any opposing inference one could draw from the facts alleged." Id.

B. Refusal to permit amendment

This court reviews the district court's refusal to grant leave to amend the complaint for abuse of discretion. See Goldstein, 340 F.3d at 254. Federal Rule of Civil Procedure 15 favors permitting amendment; the district court's discretion, therefore, must be considered in this context. See Rosenzweig, 332 F.3d at 863.

III. DISCUSSION

A. Motion to dismiss for failure to plead scienter with sufficient particularity

CLPF contends that it pleaded scienter with sufficient particularity to avoid dismissal based on a holistic examination of the various allegations taken in the light most favorable to it. CLPF alleged insider trading, GAAP violations, failure to fix an accounting error, the making of false statements about internal controls, and pervasive knowledge of accounting problems throughout IES.

This court must examine these allegations in toto when determining whether CLPF adequately pleaded scienter. Barrie, 397 F.3d at 260.

(1) GAAP violations, public statements, and restatement of financials

The CAC describes IES's alleged GAAP violations in detail. CLPF urges that its assertions in the CAC regarding the accounting errors and internal...