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From Securities Regulation Daily, July 6, 2016

Fraud case against airline parts supplier can’t fly without scienter

By Kevin Kulling, J.D.

The Tenth Circuit Court of Appeals has affirmed the dismissal of a fraud action that claimed an aircraft parts supplier misrepresented and failed to disclose cost overruns and production delays in connection with three large projects. The court said that investors in Spirit AeroSystems, Inc., failed to sufficiently allege that the company and several executives acted with scienter and intentionally mislead investors about the status of the projects (Anderson v. Spirit AeroSystems Holdings, Inc. July 5, 2016, Bacharach, R.).

Aircraft Parts Supplier. The fraud action was brought against Spirit AeroSystems, Inc., which supplied aircraft parts to Gulfstream Aerospace Corporation for the production of its Gulfstream G280 and G650 aircraft and to the Boeing Company for the production of its Boeing 787. Each of the three projects that Spirit managed encountered production delays and cost overruns.

Spirit periodically reported to the public about the progress of the projects, acknowledging risks but expressing confidence about its ability to meet production deadlines and break even on the projects, according to the appellate court. In October 2012 Spirit disclosed that it expected to lose hundreds of millions of dollars on the three projects and eventually reported that it lost $434 million.

Allegations. Investors alleged that Spirit and four executives misrepresented and failed to disclose the project cost overruns and production delays. In an attempt to create an inference of scienter, investors pointed to a motive to lie, corroborating witness accounts, the executive defendants involvement in Spirit’s core operations, a duty to disclose, the adoption of a recovery plan, statements by the chief executive officer, disclosures of risks, accounting violations, and the size of the eventual loss.

However, the district court granted Spirit’s motion to dismiss, holding that the class of investors had failed to allege facts showing scienter. The Tenth Circuit upheld the dismissal, agreeing with the district court that there was an insufficient showing of scienter.

Scienter. To raise an inference of scienter, the complaint pointed to information supplied by corroborating witnesses, including generalized descriptions of internal meetings, cost reports, delays, and mismanagement and statements indicating that one of the defendants personally directed unrealistic cost projections.

But the appellate court agreed that the generalized descriptions of internal meetings, cost reports, delays, and mismanagement did not contribute to a cogent, compelling inference of scienter.

The court said that the complaint did not identify any particularized account showing that the executives knew that their progress reports were inaccurate. In addition, the court found allegations about the content of the quarterly costs reports to be lacking in describing the content of the reports. The court noted that the reports went through numerous layers of revision before any of the data would have reached the executives. Thus, the court concluded, the complaint shed little light on what the executives would have seen if they had read the quarterly cost reports.

In discussing corroborating witnesses used in the complaint, the court said that as relatively low-level employees, the witnesses could not provide evidence bearing on the executives’ mental states. The accounts by corroborating witnesses did not contribute to an inference of scienter. The witnesses were too far removed from the four Spirit executives and did not provide sufficiently particularized accounts of what the Spirit executives must have known, the court said.

The court also said that it could not infer scienter based only on the executives’ position in a company or involvement with a particular project. Similarly, the court said that the complaint did not establish scienter based on the fact that the executives were briefed on the underlying cost data while attending meetings where the three projects were discussed. Mere attendance at meetings does not contribute to an inference of scienter, the court said.

The case is No. 15-3142.

Attorneys: Austin P. Brane (Robbins Geller Rudman & Dowd LLP) and Benjamin Galdston (Bernstein Litowitz Berger & Grossmann LLP) for International Association of Machinists and Aerospace Workers, District 9 Pension and Welfare Trusts and Arkansas Teachers Retirement System. Toby Crouse (Foulston Siefkin LLP) and Jeffrey A. Fuisz (Kaye Scholer LLP) for Spirit Aerosystems Holdings, Inc.

Companies: International Association of Machinists and Aerospace Workers, District 9 Pension and Welfare Trusts; Arkansas Teachers Retirement System; Spirit Aerosystems Holdings, Inc.

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