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From Securities Regulation Daily, June 23, 2015

Audio gear firm must face class suit over analyst calls, annual report

By Mark S. Nelson, J.D.

A class securities fraud suit led by Arkansas Public Employees’ Retirement System (Arkansas PERS) against audio equipment maker Harman International Industries, Inc. (Harman) can proceed now that a D.C. Circuit panel has decided to send the case back to the trial judge who dismissed it over a year ago. The appeals panel said the district judge erred by finding the complaint failed to allege actionable misstatements or omissions, loss causation or controlling person liability (In Re: Harman International Industries, Inc. Securities Litigation, June 23, 2015, Rogers, J.).

PE deal faltered. Harman announced its likely acquisition by a private equity firm led by Kohlberg Kravis Roberts and a Goldman Sachs affiliate on April 26, 2007, the same day its CEO, Sidney Harman (S. Harman), told analysts that Harman’s FY 2007 sales looked rosy. Two months later, Harman’s annual report likewise emphasized the company’s rosy future. Moreover, a September 2009 analyst call featured Harman CFO Kevin Brown proclaiming the company’s “very strong” FY 2008 sales, especially in Europe, despite an analyst question seemingly challenging this outlook.

Lead plaintiff Arkansas PERS bought Harman shares between April 26, 2007 and February 5, 2008, the date on which Harman issued its second corrective disclosure noting below forecast sales and earnings per share. During the interim, news of the impending acquisition, S. Harman’s and Brown’s remarks to analysts, and Harman’s annual report sent its shares soaring, only to crater when Harman and the private equity firm gave up on the acquisition in September 2007, and again each time Harman corrected its prior disclosures in January and February of 2008.

Forward-looking and meaningful? The district court found S. Harman’s and Brown’s statements to analysts fell within the safe harbor for forward-looking statements. In fact, each analyst call was preceded by a warning from the moderator about the forward-looking nature of the information to be discussed. But the D.C. Circuit picked up on a different aspect of this issue, emphasizing instead that cautionary information accompanying these types of statements must be meaningful.

Despite Arkansas PERS’ having forfeited the argument over whether Harman’s statements during the two analyst calls were forward-looking, the court said it could find the complaint plausibly alleged those statements were not accompanied by meaningful cautionary language under Exchange Act Section 21E(c)(1)(A). The absence of historical data from Harman’s statements about the obsolescence of its products and how that fact could impact sales made its CEO’s and CFO’s statements misleading because they were not meaningful. The court noted that “meaningful” in this context requires the statements to be specifically tailored to the company’s forward-looking statement.

No puffery here. Harman’s FY 2007 annual report on Form 10-K said the company’s aftermarket sales, especially PNDs, was “very strong,” despite later contrary revelations. Still, the district judge concluded that “strong,” as Harman used it, is a “chest-beating adjective” leaving too much to the imagination for any objective comparisons. The D.C. Circuit panel disagreed.

The appeals court said the key inquiry in judging if a statement is immaterial puffery is whether it would mislead a reasonable investor. Harman’s specificity about which product and the timing of expected sales gains in its annual report took its “strong” statement out of the realm of the immaterial and placed it within the category of statements that can plausibly be read to refer to historical facts. As a result, the plaintiff plausibly alleged the materiality of the company’s statements about a small part of one of its biggest divisions.

Loss causation. According to the D.C. Circuit, a class action securities fraud suit can get past a motion to dismiss if it alleges either cause-in-fact with the attendant adverse market reaction (the plaintiff’s theory here) or that any loss was foreseeable. But a corrective disclosure, the panel noted, need not be the “mirror image” of a prior disclosure. The court found that the complaint adequately pleaded loss causation based on the company’s later revelation of information about a specific product’s sales that was not part of its prior disclosures, and the resulting stock drops.

Significantly, the appeals panel noted that the district judge had not ruled on loss causation. The trial judge had concluded there was no need to reach this question because the complaint failed to allege an actionable misrepresentation or omission, and had fallen short of pleading scienter. Instead, the D.C. Circuit was persuaded by Arkansas PERS’ corrective disclosure theory of loss causation.

Controlling persons. The D.C. Circuit opted not to choose a particular standard for controlling person liability, despite facing a split of authority pitting the Second and Third Circuits against the Fourth, Fifth, Seventh, Eighth, Ninth and Eleventh Circuits. According to the court, the individual defendants’ making of actionable statements and their signing the company’s annual report was enough to allege that they culpably participated in the underlying fraud.

The case is No. 14-7017.

Attorneys: Daniel S. Sommers (Cohen Milstein Sellers & Toll PLLC) for Arkansas Public Employees Retirement System. Tim Battin (Straus & Boies, LLP) for City Of Boca Raton General Employees Pension Plan. Thomas Francis Cullen, Jr. (Jones Day) for Harman International Industries Inc.

Companies: Harman International Industries, Inc.; Arkansas Public Employees’ Retirement System; City of Boca Raton General Employees Pension Plan; Kohlberg Kravis Roberts; Goldman Sachs

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