On February 19, 2020, Judge Pamela A. Barker of the United States District Court for the Northern District of Ohio granted a motion to dismiss a putative securities class action, asserting claims under Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 (the “Exchange Act”), and Rule 10b-5 promulgated thereunder, against an aerospace component design and manufacturing company (the “Company”) and two of its executive officers. In re TransDigm Group Inc., No. 17-cv-01677-PAB (N.D. Ohio Feb. 19, 2020). Plaintiffs alleged that defendants made materially false and misleading statements and omissions concerning the Company’s operations, business, and prospects that resulted in a drop in the Company’s stock price when the Company made certain purported corrective disclosures. The Court granted defendants’ motion to dismiss plaintiffs’ Third Amended Complaint, finding that plaintiffs failed to sufficiently allege materiality or loss causation, and denied leave to amend.
The Company is a holding company of manufacturers and suppliers that create aerospace components for commercial and military aircraft use. According to the complaint, the Company was often the only manufacturer for a part and as a result it charged prices that resulted in gross margins of as much as 80-95%. The United States’ (the “Government”) defense industry was one of the Company’s largest customers and, as such, the Company was subject to certain Government contract procurement regulations. The Company had previously been the subject of audits conducted by the Department of Defense Office of the Inspector General (“DoD-OIG”) in 2006 and 2008 to determine whether the Government had overpaid on certain contracts involving the Company, its subsidiaries, and its distributors. At the conclusion of the 2006 audit, the DoD-OIG issued a report that determined that the Government had overpaid with respect to certain contracts and recommended that the Government obtain a $2.6 million refund. At the conclusion of the 2008 audit, the DoD-OIG found that the Department of Defense had overpaid one of the Company’s distributors by $3 million for certain contracts and predicted the Department would continue to overpay if the problems identified in the audit were not addressed. According to the complaint, confidential witnesses claimed that the Company charged the Government much higher prices than what it would otherwise charge commercial customers, and that it trained its employees to avoid sharing pricing information with the Government.
The complaint alleged that the Company misled investors when it failed to disclose materially adverse facts with respect to its operations, business, and prospects in its press releases, 2016 SEC filings, and investor presentations. Plaintiffs alleged that the Company “attributed its strong financial results to its ‘value based operating strategy,’” and such statements were repeated in defendants’ communications with investors and in the Company’s quarterly and annual filings with the SEC. But according to plaintiffs, alleged corrective disclosures were eventually made through two industry research reports issued in 2017 that warned of the Company’s “price gouging,” thereby causing the Company’s stock price to drop. According to the complaint, the full extent of the Company’s fraud was not revealed until the DoD-OIG reported its findings from a 2019 audit, which was conducted as a result of calls from multiple members of Congress for an investigation into potential fraud in the Company’s process for procuring government contracts.
Addressing the Section 10(b) claim, the Court found that plaintiffs failed to adequately allege materiality of any challenged statement or alleged omission. The Court noted the statements fell into three categories: (1) statements “attributing [the Company’s] financial results” to its “value based operating strategy” and “‘strength’ and ‘quality’ of its products”; (2) statements that products were fairly priced based on the value provided; and (3) statements in the Company’s code of ethics. Taking each in turn, the Court found that plaintiffs failed to demonstrate that the statements at issue were material. Citing the Sixth Circuit’s opinion in In re Omnicare, Inc. Securities Litigation, 769 F.3d 455 (6th Cir. 2014), the Court noted that for statements or omissions to be materially misleading they must be facts that a “reasonable investor would have viewed . . . as ‘having significantly altered the total mix of information made available.’” The Court held plaintiffs failed to allege any material misrepresentations—finding the challenged statements to be no more than “corporate puffery” as the Company’s representations about its value were too generic and “inherently ambiguous . . . [and were] not tether[ed] to any kind of objective standard” such that a “reasonable investor could have found them important in the ‘total mix’ of information available.” Similarly, the Court found that the alleged statements that the Company’s “pricing of its products” was fair and in line with the value they provide were so “vague and non-specific” that they amounted to “immaterial puffery.” Moreover, the Court noted that the Company provided disclosures in its 2016 Form 10-K alerting the market that the Government “might not agree that [its] prices were ‘fair’” and, as such, a reasonable investor would not have considered these admittedly misleading statements to have “significantly altered the total mix of information.” Finally, the Court found that the Company’s statements in its code of ethics were immaterial and would not be relied upon by a reasonable investor, finding that “a code of conduct is not a guarantee,” but rather was a declaration of “corporate aspirations,” and such “statements merely set forth standards in general terms that [the Company] hoped its senior executives would adhere to.”
Turning next to plaintiffs’ allegations that defendants made material omissions by failing to disclose the Company’s “price-gouging scheme” as the source of its success rather than “its purported value-based pricing and operating strategy,” the Court found that the alleged statements “[were] too generic and innocuous to have triggered the duty to disclose” this alleged scheme. Citing Sixth Circuit precedent, the Court found that plaintiffs failed to allege that defendants “inaccurately reported any of its 2016 revenue and sales figures, either in its press releases or SEC filings,” nor did defendants’ statements “contain any implicit misrepresentations that would have misled a reasonable investor,” triggering a duty to disclose the alleged scheme. In distinguishing the Sixth Circuit’s decision in Omnicare, the Court held that the Company did not make any material misstatements regarding its model or source of revenue, and that such statements were so generic that they “would not have been important to a reasonable investor.” The Court further emphasized that the Company’s pricing model was publicly known, citing the 2006 and 2008 DoD-OIG audit reports. The Court thus held that plaintiffs failed to allege a material omission as none of defendants’ alleged statements “contain any implicit representations regarding [the Company’s] business model or source of revenue that would have misled a reasonable investor under the circumstances presented.”
The Court next addressed plaintiffs’ attempt to plead loss causation. The Court agreed with defendants that plaintiffs failed to adequately plead the Company’s stock drop “was proximately caused by the revelation of its allegedly fraudulent business practices.” In so holding, the Court found that the purported corrective disclosures from 2017 did not report any information new to the public, noting that the disclosures relied on already-published articles, the Company’s own public SEC filings, or information from prior DoD-OIG audit reports, all of which were already in the public domain. The Court also found that disclosure of the calls for investigation into the Company’s practices “[was] not sufficient to constitute a corrective disclosure in the absence of an actual revelation of fraud or admission of wrongdoing” as it merely revealed the existence of an investigation, and nothing more.
Having found that plaintiffs failed to sufficiently plead a securities fraud claim under Section 10(b), the Court dismissed the Section 20(a) control person claims, and denied plaintiffs leave to amend, noting that plaintiffs had been permitted to amend the complaint on three separate occasions and offered no explanation why they should be permitted yet another opportunity to amend.
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