UNITED STATES DISTRICT COURT FOR THE NORTHERN DISTRICT OF OHIO EASTERN DIVISION Florida Carpenters Regional Council Pension Plan, et al., Plaintiff, Case No. 1:12-cv-02001-PAG v. Judge: Hon. Patricia Gaughan Eaton Corporation, et al., Defendants. MEMORANDUM OF LAW IN SUPPORT OF DEFENDANTS EATON CORPORATION, ALEXANDER M. CUTLER, MARK M. MCGUIRE, TARAS G. SZMAGALA, JR., AND DONALD J. MCGRATH’S MOTION TO DISMISS THE CONSOLIDATED AMENDED CLASS ACTION COMPLAINT Joseph A. Castrodale (0018494) Frances Floriano Goins (0018631) Andrew G. Fiorella (0077005) ULMER & BERNE LLP 1660 West 2nd Street, Suite 1100 Cleveland, Ohio 44113-1448 Telephone: (216) 583-7000 Facsimile: (216) 583-7203 [email protected][email protected][email protected]Attorneys for Defendants Eaton Corporation, Alexander M. Cutler, Mark M. McGuire, Taras G. Szmagala, Jr., and Donald J. McGrath Case: 1:12-cv-02001-PAG Doc #: 39-1 Filed: 03/01/13 1 of 41. PageID #: 312
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UNITED STATES DISTRICT COURTFOR THE NORTHERN DISTRICT OF OHIO
EASTERN DIVISION
Florida Carpenters RegionalCouncil Pension Plan, et al.,
Plaintiff, Case No. 1:12-cv-02001-PAG
v. Judge: Hon. Patricia Gaughan
Eaton Corporation, et al.,
Defendants.
MEMORANDUM OF LAW IN SUPPORT OFDEFENDANTS EATON CORPORATION, ALEXANDER M. CUTLER, MARK M.
MCGUIRE, TARAS G. SZMAGALA, JR., AND DONALD J. MCGRATH’S MOTIONTO DISMISS THE CONSOLIDATED AMENDED CLASS ACTION COMPLAINT
Joseph A. Castrodale (0018494)Frances Floriano Goins (0018631)Andrew G. Fiorella (0077005)ULMER & BERNE LLP1660 West 2nd Street, Suite 1100Cleveland, Ohio 44113-1448Telephone: (216) 583-7000Facsimile: (216) [email protected]@[email protected]
Attorneys for DefendantsEaton Corporation, Alexander M. Cutler,Mark M. McGuire, Taras G. Szmagala, Jr.,and Donald J. McGrath
Table of Authorities ....................................................................................................................... iii
Table of Abbreviations ................................................................................................................ viii
Statement of Issues to be Decided ................................................................................................. ix
Summary of the Arguments Presented ............................................................................................x
Certification of Compliance........................................................................................................... xi
I. Introduction..........................................................................................................................1
II. Facts .....................................................................................................................................3
A. Lead Plaintiff and The Florida Carpenters Regional Council Pension Plan............3
B The Defendants ........................................................................................................3
C. Eaton, Its Success, and Its Share Price During the Putative Class Period ...............4
D. The Well-Publicized Eaton v. Frisby Litigation in Mississippi ..............................5
1. Frisby Hires Former Engineers Who Stole Eaton’s Aerospace Designs.....5
2. Eaton’s Agreement with Whistleblower Milan Georgeff ............................5
3. Detailed Facts about Frisby Were Publicly Reported beforethe Beginning of the Putative Class Period..................................................6
4. Eaton’s Claims in Frisby Were Dismissed More than Two Years Ago ....11
E. Just Days before the Alleged “Corrective Disclosures,” Eaton Announces an$11.8 Billion Acquisition and Its Credit Rating is Downgraded ...........................12
F. Plaintiffs’ Allegations ............................................................................................13
III. Standard of Review............................................................................................................15
IV. Plaintiffs’ Securities Fraud Claim (Count I) Must be Dismissed ......................................16
A. The Complaint Alleges No Actionable Fraud or Misrepresentations....................16
1. Denials of Liability in Litigation Are Not Actionable...............................17
2. Eaton’s Statements Did Not Add to the Total Mix of Information ...........18
3. Plaintiffs do not Allege that Cutler Said Anything False orMisleading During his Appearance on CNBC’s Mad Money...................20
4. The May 2012 “Disclosures” Were Not Material......................................20
B. The Complaint Fails To Plead Scienter .................................................................21
1. Defendants’ Alleged Desire to “Secur[e] Their Ongoing Positions” withEaton Has Been Universally Rejected as a Basis for Scienter...................22
Garber v. Legg Mason, Inc.,347 F. App’x 665 (2d Cir. 2009) ...........................................................................19
Granada Invs., Inc. v. DWG Corp.,962 F.2d 1203, 1205 (6th Cir. 1992) .....................................................................18
I.B.E.W. v. Ltd. Brands, Inc.,788 F. Supp. 2d 609 (S.D. Ohio 2011) ..................................................................23
Ind. Elec. Workers’ Pension Trust Fund IBEW v. Shaw Group, Inc.,537 F.3d 527 (5th Cir. 2008) .................................................................................24
In re Agnico-Eagle Mines Ltd. Sec. Litig., No. 11 CIV. 7968 JPO,2013 WL 144041 (S.D.N.Y. Jan. 14, 2013) ..........................................................23
In re Apollo Group, Inc. Sec. Litig., No. CV-10-1735-PHX-JAT,2011 WL 5101787 (D. Ariz. Oct. 27, 2011)..........................................................25
In re Bristol-Myers Squibb Sec. Litig.,312 F. Supp. 2d 549 (S.D.N.Y. 2004)..............................................................23, 24
In re Ceridian Corp. Sec. Litig.,542 F.3d 240 (8th Cir. 2008) .................................................................................24
In re Citigroup, Inc. Sec. Litig., 330 F. Supp. 2d 367 (S.D.N.Y. 2004) aff'd sub nom.Albert Fadem Trust v. Citigroup, Inc., 165 F. App’x 928 (2d Cir. 2006) .............17
In re Comshare Inc. Sec. Litig.,183 F.3d 542 (6th Cir. 1999) .................................................................................21
In re Keithley Instruments, Inc. Sec. Litig.,268 F. Supp. 2d 887 (N.D. Ohio 2002)............................................................15, 28
In re K-tel Int’l, Inc. Sec. Litig.,300 F.3d 881 (8th Cir. 2002) .................................................................................22
In re NVIDIA Corp. Sec. Litig., No. C 08-04260 RS,2011 WL 4831192, (N.D. Cal. Oct. 12, 2011).......................................................24
In re Officemax, Inc. Sec. Litig., No. 1:00-CV-2432,2002 WL 33959993 (N.D. Ohio Mar. 26, 2002) ...................................................25
In re Royal Appliance Sec. Litig., No. 94-3284,1995 WL 490131 (6th Cir. Aug. 15, 1995)............................................................15
In re UBS AG Sec. Litig., No. 11225,2012 WL 4471265 (S.D.N.Y. Sept. 28, 2012).......................................................17
FED. R. CIV. P. 9(b) ........................................................................................................................16
Other Authorities
Adding to an Indus.,TheStreet.com, Jun. 4, 2012 (Ex. 1) ................................................................13, 27
Ronnie Agnew, Op-Ed.,CLARION-LEDGER (Jackson, Miss.), Apr. 5, 2009, at C3 (Ex. 2).............................7
Robert Broens, Eaton’s Acq. of Cooper Indus. Creates Sig. Upside Potential,seekingalpha.com, May 29, 2012 (Ex. 3) ..............................................................13
Fitch May Cut Cooper Indus. Ratings (Ex. 4) .........................................................................13, 27
Gabelli & Company, Inc. 5/22/12 Eaton Report (Ex. 5) ...............................................................13
Jimmie E. Gates, Former DA Under Scrutiny,CLARION-LEDGER (Jackson, Miss.), Feb. 26, 2008, at A1 (Ex. 6).......................7, 8
Jimmie E. Gates, Counts Tossed in Theft Case,CLARION-LEDGER (Jackson, Miss.), May 12, 2008, at A1 (Ex. 7) ..........................7
Jimmie E. Gates, Info Sought to Clarify ex-DA’s Role in $1B Suit,CLARION-LEDGER (Jackson, Miss.), July 29, 2008, at B1 (Ex. 8) ...........................9
Jimmie E. Gates, Hold Sought on $1B Lawsuit,CLARION-LEDGER (Jackson, Miss.), July 29, 2008, at B1 (Ex. 9) ...........................9
Jimmie E. Gates, Report Heightens Scrutiny of Judge,CLARION-LEDGER (Jackson, Miss.), Nov. 24, 2008, at A1 (Ex. 10)....................8, 9
Jimmie E. Gates, Watchdog Probe Ongoing,CLARION-LEDGER (Jackson, Miss.), Feb. 14, 2009, at B1 (Ex. 11) .......................10
Jimmie E. Gates, Judge Puts Hold on Trade Theft Case,CLARION-LEDGER (Jackson, Miss.), Mar. 5, 2009, at B1 (Ex. 12) ........................10
James R. Hagerty & Bob Tita, Rivals Strike $11.8 Billion Merger,WALL ST. J., May 21, 2012 (Ex. 13) ......................................................................13
Hinds Judge Questions Former DA Work in Trade Secrets Case,ASSOCIATED PRESS, Feb. 26, 2008 (Ex. 14).............................................................7
Hinds Official Quits Special Court Post,COMM. APPEAL (Mem., TN), Jan. 31, 2008, at 2 (Ex. 15).......................................8
Mississippi: Judge Enters Plea,NEW YORK TIMES, Jul. 31, 2009, at A16 (Ex. 17) .................................................10
Jerry Mitchell, Feds Expand Bribery Probe,CLARION-LEDGER (Jackson, Miss.), Jan. 28, 2008, at A1 (Ex. 18) .........................7
Jerry Mitchell, Court: Charges Rightly Tossed,CLARION-LEDGER (Jackson, Miss.), Aug. 14, 2008, at B1 (Ex. 19) ........................9
Adam Nossiter, Civil Rights Hero, Now a Judge, Is Indicted in a Bribery Case,N.Y. TIMES, Feb. 14, 2009, at A12 (Ex. 20) ..........................................................10
Dan Shingler, Eaton Suit Over Trade Secret Theft May be Dead Due to Improprieties,CRAIN’S CLEVELAND BUSINESS, Jan. 17, 2011, at 1 (Ex. 21) ................................12
S&P Revises Eaton Corp. Outlook to Negative (Ex. 22).........................................................13, 27
Special Master Steps Down in DeLaughter-Related Lawsuit,ASSOCIATED PRESS, MAY 25, 2008 (Ex. 23)............................................................8
“Eaton v. Frisby” or “Frisby” ..................................Eaton Corp., et al. v. Jeffrey D. Frisby, et al.,Cir. Ct. Hinds Cty. Miss. Case No. 251-04-642
“Frisby Compl.” ................................July 9, 2004 Original Complaint in Eaton v. Frisby (Ex. 31)
“Individual Defendants” ............................................................Alexander Cutler, Mark McGuire,Taras Szmagala, Jr., and Donald McGrath
“Miss. Order” ................. Dec. 22, 2010 Rulings of the Ct. Relating to the Defs’ Mot. to Dismiss,the Defs.’ Mot. to Dismiss, as Supplemented, the Nov. 25, 2009
Report and Recommendation of the Special Master, and the Aug. 11, 2010Report and Recommendation of the Special Master in Eaton v. Frisby (Ex. 32)
“Private Securities Litigation Reform Act” or “Reform Act”..... The Private Securities LitigationReform Act of 1995, Pub. L. 104-67, 109 Stat. 737
(codified as amended in scattered sections of 15 U.S.C.)
“Q2 2012” ..........................................................Apr. 24, 2012 Eaton Corporation Quarterly reportfor the quarterly period ended June 30, 2012 on Form 10-Q (Ex. 33)
ISSUE ONE: Whether Plaintiffs’ Count I, for violations of Section 10(a) of the
1934 Act, 15 U.S.C. § 78j(b), and Rule 10b-5, 17 C.F.R. § 240.10b–5, must be dismissed where:
Plaintiffs, led by sophisticated investment fund manager KBC, have failedto plead facts under the heightened Reform Act pleading requirementssufficient to allow the Court to conclude that there was any actionablefraud or misrepresentation by Eaton or any of the Individual Defendants indenying liability for litigation misconduct in a trade secrets case in whichEaton was the plaintiff;
Plaintiffs have failed to plead facts under the heightened Reform Actpleading requirements sufficient to allow the Court to conclude that anyalleged “misstatement” would have been material to a reasonable investorin light of the constant countervailing mix of press reports, litigationfilings, and Mississippi trial court order dismissing the trade secrets casein Mississippi;
Plaintiffs have failed to plead facts under the heightened Reform Actpleading requirements sufficient to allow the Court to conclude that therewas scienter or any plausible motive for Eaton or any of the IndividualDefendants to engage in securities fraud; and
Plaintiffs have failed to plead facts under the heightened Reform Actpleading requirements sufficient to allow the Court to conclude that thereis a causal connection between either Defendants’ statements and a rise inEaton’s share price, or the minor, non-material disclosures they allege“corrected” the market in May and June 2012 (18-19 months after theMississippi case was dismissed and amidst market furor over Eaton’s$11.8 billion acquisition of Cooper Industries) and a drop in Eaton’s shareprice.
ISSUE TWO: Whether Plaintiffs’ Count II, for so-called “control person”
liability under Section 20(a) of the 1934 Act against the Individual Defendants must be
dismissed where Plaintiffs have failed to allege any primary securities law violation,
a prerequisite for “control person” liability, and alternatively dismissed as to McGrath and
Szmagala because they are not adequately alleged to be control persons.
A. Lead Plaintiff and the Florida Carpenters Regional Council Pension Plan
Both Lead Plaintiff KBC and Plaintiff the Florida Regional Council Pension Plan
are experienced and sophisticated investors. KBC manages investment funds. In 2011, for
example, KBC held 148 million Euros (€) in assets under management. (See KBC Fin. Report,
available at https://www.kbcam.be/PBL/CC028/~E (Ex. 39).) At a Euro-to-Dollar conversion
rate of €1:$1.33, that is $197 million. Moreover, based on its representations to the Court, KBC
purchased and sold Eaton shares 221 times during the putative class period. (See Mot. of KBC,
Ex. C (Docket No. 16-5) (Ex. 40).) Those transactions included 102 sales, including eight sales
during the last month of the putative class period, May 2012, but no sales after the close of the
class period. (Id.)
Plaintiff Florida Carpenters is a large pension fund. It represented to this Court
that it did not even own Eaton shares until February 2012, including purchasing 2,090 shares
after the Cooper acquisition was announced. (See Mot. of Fl. Carpenters, Ex. B (Docket No. 15-
2) (Ex. 41).) Those purchases were years after Frisby was dismissed and after Eaton’s supposed
“misrepresentations” had been fully countered in court filings and the press.1
B. The Defendants
In addition to Eaton, there are five individual Defendants in this case:
Alexander Cutler (chairman and CEO), Mark McGuire (General Counsel), Taras Szmagala, Jr.
(in-house counsel), Donald McGrath (director of communications); and Victor Leo (former in-
house counsel). (¶ 2.) (Defendant Leo is not a party to this Motion and is not represented by the
undersigned counsel.)
1 To the extent that Lead Plaintiff and Plaintiff Florida Carpenters’ extensive trading allowed themto benefit from the alleged “inflation” in Eaton’s share price for they did not sell until the market price went backup, they might be unable to show an actual loss from the conduct alleged in the Complaint.
about Eaton’s products. (See ¶ 39.) Plaintiffs allege that Eaton then “entered into a contract with
Georgeff,” in which Eaton promised to “pay Georgeff’s expenses, defend any possible criminal
or civil litigation brought against him, reimburse him for his time,” and employ him as an
engineer. (Id. ¶ 40.)
The agreement with Georgeff was not initially produced or disclosed in the Frisby
case, but was eventually produced by Georgeff in separate litigation against Frisby brought by
him in North Carolina. (¶¶ 44-46.) On January 4, 2006, the Frisby defendants filed a motion to
dismiss and for sanctions. (See Miss. Order, at 2.) That motion argued that Eaton had provided
“unlawful compensation to Milan Georgeff, a fact witness and ‘whistleblower’.” (Id.)
DeLaughter referred the task of determining “whether there was a discovery violation, whether it
was intentional, and who was responsible” to Special Master Jack Dunbar. (¶ 48.)2
3. Detailed Facts about Frisby Were Publicly Reported beforethe Beginning of the Putative Class Period
As to Eaton’s alleged role in the case, the events that followed the Georgeff
matter are still in dispute. The allegations as to Eaton and its officers’ conduct are repeated here
only to demonstrate the availability of information to Eaton’s investors and to the market, not as
an endorsement of what Eaton considers to be incomplete and inaccurate facts. Moreover, Eaton
disagrees with Plaintiffs’ characterizations of the events.
What is certain, however, are the fulsome public disclosures both before and
during the putative class period (August 2, 2009 to June 4, 2012) of revelations adverse to Eaton,
including that former Judge DeLaughter had gone to prison, Mississippi attorney Ed Peters (who
for a short time represented Eaton) had surrendered his law license, and a new Judge had
2 Eventually, on January 6, 2011, the Mississippi trial court sanctioned Eaton more than $1.5million “relating to the Georgeff issue(s).” (Miss. Order, at 10.) The court later found that those “monetarysanctions made [the Frisby] Defendants’ whole in regards to Georgeff.” (Id.)
In January 2009, in the wake of Dogan’s Recommendation, Peters agreed to
surrender his law license. Jimmie E. Gates, Hold Sought on $1B Lawsuit, CLARION-LEDGER,
July 29, 2008, at B1 (Ex. 9). The same report quoted Frisby’s counsel as arguing that the “fact
of wrongdoing by counsel for Eaton has now been conclusively established.” Id. (emphasis
added). “Peters . . . has now admitted he engaged in improper ex parte contact with Judge
DeLaughter while Judge DeLaughter presided over this case.” Id.
In February 2009, DeLaughter was indicted on bribery charges in the case
unrelated to Frisby.3 Adam Nossiter, Civil Rights Hero, Now a Judge, Is Indicted in a Bribery
Case, N.Y. TIMES, Feb. 14, 2009, at A12 (Ex. 20). In response, Frisby’s counsel was quoted as
saying that Peters and DeLaughter’s actions in the Frisby case were “eerily similar” to that case.
Jimmie E. Gates, Watchdog Probe Ongoing, CLARION-LEDGER, Feb. 14, 2009, at B1 (Ex. 11).
In March 2009, the Frisby case was stayed until Peters’ influence on
DeLaughter’s rulings and his role with Eaton could be determined. Jimmie E. Gates, Judge Puts
Hold on Trade Theft Case, CLARION-LEDGER, Mar. 5, 2009, at B1 (Ex. 12); ¶ 80. Again, it is
publicly reported that Eaton was accused of hiring Peters with the intent to influence
DeLaughter.
Circuit Judge Swan Yerger . . . ruled Wednesday the lawsuitshould be put on hold until it can be determined whether Petersimproperly influenced DeLaughter’s rulings and the role theformer attorney had with Eaton Corp. and its attorneys . . . .Frisby’s argument is that it needs to be determined whetherEaton hired Peters with expressed intent to influenceDeLaughter.
Judge Puts Hold on Trade Theft Case (Ex. 12) (emphasis added).
3 On July 31, 2009, DeLaughter pleaded guilty to a federal obstruction of justice charge.Mississippi: Judge Enters Plea, NEW YORK TIMES, Jul. 31, 2009, at A16 (Ex. 17.)
2010 article); see also ¶ 95 (Jan. 17, 2011 article paraphrasing a non-defendant Eaton employee
as saying essentially the same thing).4
Plaintiffs also allege that Defendant Cutler appeared on CNBC’s Mad Money on
January 28, 2011 in “an effort to downplay the Mississippi decision” from December 2010, but
without citing any statements to such effect. (¶ 96.) (A transcript of Defendant Cutler’s
interview on that program is attached as Exhibit 38.) No statements by any of the other
Individual Defendants are alleged.
4 Plaintiffs also allege that McGrath’s statement that “[n]othing we did with that whistle-blower[Georgeff] was illegal under Mississippi law” was false (see ¶ 84 (quoting McGrath in an Aug. 2, 2009 Clarion-Ledger article)), because the discovery sanctions order in January 2010 “directly” contradicted that statement (¶ 89).This cannot form the basis of Plaintiffs’ claims, however, because the Mississippi trial court refused to dismissFrisby because of the Georgeff allegations.
Based on these very slim factual allegations, Plaintiffs assert two counts:
(1) violation of Section 10(b) of the Exchange Act and Rule 10b-5 by all Defendants
(¶¶ 138-49); and (2) violation of Section 20(a) of the 1934 Act, by Eaton’s officers on a theory of
“control-person” liability (¶¶ 150-57).
III. STANDARD OF REVIEW
To survive a motion to dismiss, a complaint must allege a claim that is “plausible
on its face.” La. Mun. Police Employees Ret. Sys. v. Cooper Indus. plc, No. 12 CV 1750,
2012 WL 4958561, at *4 (N.D. Ohio Oct. 16, 2012) (dismissing claims purportedly arising from
the Eaton/Cooper merger) (Gaughan, J.) (quoting Ashcroft v. Iqbal, 556 U.S. 662, 678, 129 S. Ct.
1937 (2009)); see also Bell Atl. Corp. v. Twombly, 550 U.S. 544, 557, 127 S. Ct. 1955 (2007)
(holding that allegations must “plausibly” suggest that “the pleader is entitled to relief”).
“A claim has facial plausibility when the plaintiff pleads factual content that
allows the court to draw the reasonable inference that the defendant is liable for the misconduct
alleged.” Iqbal, 556 U.S. at 678; see also Bishop v. Lucent Techs., Inc., 520 F.3d 516, 519
(6th Cir. 2008) (“a complaint containing a statement of facts that merely creates a suspicion of a
legally cognizable right of action is insufficient”).5
Under the Iqbal-Twombly standard, the Court may not rely upon factual
allegations that are “unrealistic or nonsensical” or are speculative “in the sense of implausible
5 Defendants have separately filed a request for judicial notice of Exhibits attached to Declarationof Andrew G. Fiorella. Briefly, the Court “must consider . . . sources courts ordinarily examine when ruling on Rule12(b)(6) motions to dismiss, in particular, documents incorporated into the complaint by reference, and matters ofwhich a court may take judicial notice.” Tellabs, 551 U.S. at 322; see also In re Royal Appliance Sec. Litig., No. 94-3284, 1995 WL 490131, at *2 (6th Cir. Aug. 15, 1995) (“[w]e may consider the full texts of the SEC filings [and]analyst’s reports and statements integral to the complaint, even if not attached, without converting the motion intoone for summary judgment”) (internal quotation omitted). The Court must also “examine the other information thatwas publicly available to reasonable investors” because Plaintiffs rely on a “fraud on the market” theory. Phillips v.LCI Int’l, Inc., 190 F.3d 609, 617 (4th Cir. 1999) (considering a news article); In re UBS Auction Rate Sec. Litig.,No. 08 CIV. 2967 (LMM), 2010 WL 2541166, at *15 (S.D.N.Y. Jun. 10, 2010) (“what information was available tothe investing public . . . and when that information was made available are relevant to the Court’s consideration ofthis motion to dismiss.”). The Court may also notice historic stock prices, see, e.g., Brodsky v. Yahoo! Inc., 630 F.Supp. 2d 1104, 1111-12 (N.D. Cal. 2009), and public records of stock sales, In re Keithley Instruments, Inc. Sec.Litig., 268 F. Supp. 2d 887, 902 n.10 (N.D. Ohio 2002).
and ungrounded . . . . en route to deciding whether the complaint has enough substance to
warrant putting the defendant to the expense of discovery.” Atkins v. City of Chicago, 631 F.3d
823, 832 (7th Cir. 2011) (affirming dismissal).
IV. Plaintiffs’ Securities Fraud Claim (Count I) Must be Dismissed
Plaintiffs’ Complaint fails to plead sufficient facts that are sufficiently plausible
on their face to allow the Court to draw the reasonable inference that: (1) Defendants made a
material misrepresentation or omission; (2) Defendants acted with scienter; (3) anyone relied
upon any of the alleged “misstatement;” or (4) there was a causal connection between the
“corrective disclosures” in May 2012 and any drop in Eaton’s share price. See Dura Pharm.,
Inc. v. Broudo, 544 U.S. 336, 341–42, 125 S.Ct. 1627 (2005) (setting forth the elements
necessary to state a securities fraud claim). For these reasons, the Count I must be dismissed.6
A. The Complaint Alleges No Actionable Fraud or Misrepresentations
Plaintiffs have failed to meet the exacting pleading standard for fraud allegations
imposed by the Federal Rules of Civil Procedure and the Reform Act. Federal Rule 9(b) requires
that a party pleading fraud of any sort must state the circumstances constituting fraud with
“particularity.” FED. R. CIV. P. 9(b). In securities cases, the Reform Act further heightens the
Plaintiffs’ burden by requiring that, for each supposedly false or misleading statement, the
Complaint must “specify each statement alleged to have been misleading [and] the reason or
reasons why the statement is misleading.” 15 U.S.C. § 78u–4(b)(1); see also La. Mun. Police,
2012 WL 4958561, at *4-*5.
6 In a recent case about class certification in securities fraud cases, the Supreme Court reiteratedthat the Reform Act imposed “heightened pleading requirements” for securities-fraud actions. See Amgen Inc. v.Conn. Retirement Plans and Trust Funds, No. 11-1085, slip op. at 19-20, 568 U.S. ___ (2013).
1. Denials of Liability in Litigation Are Not Actionable
McGrath’s denials that Eaton hired Peters to influence DeLaughter cannot form
the basis for a fraud claim. “[T]he federal securities laws do not require a company to accuse
itself of wrongdoing.” In re Citigroup, Inc. Sec. Litig., 330 F. Supp. 2d 367, 377 (S.D.N.Y.
2004) (dismissing claims), aff'd sub nom. Albert Fadem Trust v. Citigroup, Inc., 165 F. App’x
928 (2d Cir. 2006); see also Mo. Portland Cement Co. v. Cargill, Inc., 498 F.2d 851, 873
(2d Cir. 1974) (“Courts should tread lightly in imposing a duty of self-flagellation”).
Moreover, the general denials at issue in this case are the sort of “puffery” that is “too general to
cause a reasonable investor to rely upon them.” In re UBS AG Sec. Litig., No. 11225, 2012 WL
4471265 (S.D.N.Y. Sept. 28, 2012).
The law does not require a company to “admit wrongdoing that it intends to
attempt to disprove.” Wolf v. Assaf, No. C.A. 15339, 1998 WL 326662, at *5 (Del. Ch. Jun. 16,
1998). Woolf, a fiduciary duty case, is instructive for analyzing Plaintiffs’ claims here. In that
case, shareholders complained that the company failed to disclose facts about an ongoing federal
securities class action. Defendants disclosed certain facts about the case and “the company’s
intention to ‘vigorously defend’ against the claim.” Id. at *3. Plaintiff claimed that the company
should have disclosed that its chairman had “admitted” in the federal securities action that he
knew of the accounting irregularities at issue in that case. Id. at *2. The court rejected this as a
basis for liability, calling the alternative a “bottomless pit of self-flagellation,”
Where can it be said that a bright line rule should apply requiring adisclosure of facts disgorged in litigation when those facts and themany inconsistent inferences that could be drawn from them arehotly contested? A bright line rule demanding that all such factsbe disclosed would suck management into a bottomless pit of self-flagellation worthy of the imagination of Dante.
4831192, at *10 (N.D. Cal. Oct. 12, 2011); In re Ceridian Corp. Sec. Litig., 542 F.3d 240, 247
(8th Cir. 2008) (“executives increased their total share holdings during the class period”);
Fishbaum v. Liz Claiborne, Inc., 189 F.3d 460 (2d Cir. 1999) (no scienter where “an insider’s
sales of stock are offset by even larger stock acquisitions during the relevant time period”).
In fact, not only is there “no apparent financial incentive for [Cutler] to engage in
the deceptive practices alleged in the Complaint,” but there was “a disincentive to do so” because
of his sizable holding of Eaton shares. In re Officemax, Inc. Sec. Litig., No. 1:00-CV-2432,
2002 WL 33959993, at *14 (N.D. Ohio Mar. 26, 2002) (dismissing complaint); Applestein v.
Medivation, Inc., 861 F. Supp. 2d 1030, 1043 (N.D. Cal. 2012) (no scienter even where
defendants “sold $22 million worth of stock,” because defendants “substantially increased their
stock holdings during the Class Period” and lost money when the share price fell).7
4. The More Compelling Inference is of Non-Fraudulent Intent
The more cogent and compelling inference from Plaintiffs’ allegations is that
Defendants had no fraudulent intent in responding to what Defendants continue to believe were
incorrect decisions by the Mississippi trial court. With no plausible motivation for the “fraud,”
no allegations of falsity, and no link of any kind between the ultimate outcome of the Frisby
litigation and any aspect of Eaton’s past or future performance, the substantially more
compelling inference to be drawn from Plaintiffs’ allegations is that Eaton and the Individual
Defendants acted and continue to act with non-fraudulent intent.
If anything, Plaintiffs’ allegations try to make out a conclusory and legally
insufficient mismanagement claim. (See, e.g., ¶¶ 120-21.) But such generic allegations cannot
7 Moreover, Plaintiffs make no allegations of stock sales by any of the other Defendants, althoughthey allege that all Defendants were involved in the “scheme.” (See, e.g., ¶ 139 (“Eaton and the IndividualDefendants carried out a plan” and a “scheme”). “Typically large sale amounts and corroborative sales by otherdefendants are required to allow insider trading to support scienter.” In re Apollo Group, Inc. Sec. Litig., No. CV-10-1735-PHX-JAT, 2011 WL 5101787, at *11 (D. Ariz. Oct. 27, 2011) (quotation omitted).
events, which taken separately or together account for some or all of that lower price.’”
D.E.&J. Ltd. P’ship v. Conaway, 133 F. App’x 994, 998-99 (6th Cir. 2005) (quoting Dura)
(affirming dismissal for failure to allege loss causation).
Moreover, Plaintiffs do not (and cannot) point to a restatement of earnings,
change in financial projects, or analyst criticisms related to the Frisby litigation, including after
the so-called “corrective disclosures” in May 2012. Frisby was not discussed in Eaton’s public
filings with the SEC, nor was an estimated value of the claims in that case.
In fact, Frisby (although not mentioned by name) was included with the litigation
involving Eaton that would not have a material effect, either positive or negative, on its financial
statements:
Eaton is subject to a broad range of . . . legal proceedings . . . .Although it is not possible to predict with certainty the outcome orcost of these matters, the Company believes they will not have amaterial effect on the consolidated financial statements.
(2011 10-K at 36 (emphasis added); see also 2010 10-K at 65 (same); 2009 10-K at 40 (same).)
Instead of the phantoms that Plaintiffs try to connect to the drop in Eaton’s stock
price, there were other, more concrete causes that had nothing to do with the stale news about
Frisby. In addition to the announcement of the very large and “definitely not cheap” Cooper
acquisition, the major ratings agencies, S&P and Fitch, had both just lowered Eaton’s credit
rating based in part on the acquisition costs. (See S&P Revises Eaton Corp Outlook to Negative
(Ex. 22) and Fitch May Cut Cooper Indus. Ratings (Ex. 4).) Analysts at the time blamed the
share-price drop alternatively on “the global equity correction and uncertainty about the
execution of the [Cooper] deal” or “fears of a slowdown in global growth and disappointing May
Nafta Class 8 truck orders.” Eaton’s Acq. of Cooper Indus. (Ex. 3); Adding to An Indus. (Ex. 1).
No analyst mentioned Frisby as a cause of the drop.