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From Securities Regulation Daily, September 15, 2014

Court shuts down claims against electronics corp.

By Rodney F. Tonkovic, J.D.

A fraud complaint sparked by an electronics manufacturer's internal controls deficiencies was dismissed by a district court. The complaint charged that IEC Electronics Corp. (IEC), and its CEO and CFO, made material misrepresentations and omissions that caused the class to purchase IEC's securities at artificially inflated prices. IEC's motion to dismiss was granted after the court found that the complaint failed to plead scienter (Hensley v. IEC Electronics Corp., September 11, 2014, Furman, J.).

Background. IEC manufactures electronic items such as circuit cards and harness assemblies for a variety of industries. In 2010, IEC acquired Southern California Braiding, Inc. (SCB), which IEC described at the time as a “well run company with strong margins” and expressed high hopes for its growth. SCB began to show signs of trouble in late 2011, but through early 2013 IEC and CEO W. Barry Gilbert continued to state that SCB's performance was strong and that its prospects were good.

In May 2013, however, IEC revealed an "error in accounting for work-in-process inventory," requiring a restatement of its consolidated financial statements for FY2012 and quarterly reports for the 2012 and the first quarter of 2013. The error resulted in a $2.2 million aggregate understatement of cost of sales and an aggregate overstatement of gross profit during the relevant period. The following weeks saw similar disclosures followed by drops in IEC's stock price.

The restatement explained that IEC had overcapitalized labor and overhead costs in SCB’s work-in-process inventory. IEC blamed the restatement on weaknesses in its internal controls over financial reporting. The company also stated that it had implemented remedial measures, but that those measures would need some time to take effect.

Scienter. The court found that the plaintiffs failed to satisfy the scienter pleading requirement. The court first rejected the plaintiffs' "core operations" theory, noting that even if the doctrine survived the enactment of the PSLRA, it did not apply in this case. The court explained that to find scienter, a court would have to find that the operation would have to constitute nearly all of a company's business, and, in this case SCB contributed about 15 percent of IEC's revenue.

In the alternative, the plaintiffs pointed to the size, timing, and duration of the accounting errors as circumstantial evidence of defendants’ knowledge. Regarding the timing, the court noted that the errors occurred before the CFO joined IEC. The arguments regarding the size and duration of the accounting errors failed because the error was not large or fundamental enough to show scienter. The court remarked that the error was highly technical, did not affect the entire company, and was discovered, disclosed, and corrected by the defendants.

Conclusion. Having failed to plead a primary violation of the securities laws, the plaintiffs' controlling person claim was also dismissed. The court also denied a leave to amend which it described as "perfunctory" and ultimately futile.

The case is No. 13-cv-4507.

Attorneys: Robin Bronzaft Howald (Glancy Binkow & Goldberg LLP) for Kevin Doherty. Brian Philip Murray (Glancy Binkow & Goldberg LLP) for Raymond Jason Hensley. John Arak Freedman (Arnold & Porter LLP) for IEC Electronics Corp.

Companies: IEC Electronics Corp.

MainStory: TopStory FraudManipulation NewYorkNews

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