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From Securities Regulation Daily, January 16, 2015

Investors’ dig for class action gold comes up empty

By Mark S. Nelson, J.D.

The Tenth Circuit upheld the dismissal with prejudice of a securities fraud class suit that claimed Gold Resource Corporation (GRC) misled investors about precious metal production at its Mexican mine. The unanimous panel said the district judge correctly held that the complaint did not allege scienter with the needed particularity. The panel also upheld the dismissal of related controlling person claims and said it need not deal with the company’s gripe that the suit was based on statements that were not misleading (Banker v. Gold Resource Corporation, January 16, 2015, Seymour, S.).

Hoping, “stoping,” and restating. GRC, based in Denver, Colorado, operated both open-pit and underground mines at six sites in Oaxaca, Mexico. The underground mine in particular required GRC to employ the “stoping” and “long-hole stoping” techniques to cost-effectively get to large ore deposits.

GRC told investors of its ambitious plans for the Mexican mines, while shareholders hoped for the big dividends the company said it would pay them. The class suit against GRC alleged that the company restated its financials after hiding assay variances in metals for its only buyer and production issues that forced GRC to reduce output.

No silver (gold) lining for investors. The Tenth Circuit said the plaintiffs’ allegations were insufficient to plead scienter. For one, six GAAP-related claims fell short of the required particularity because they did not allege other facts to support them. This suit was different, said the court, from its 2003 opinion in Adams v. Kinder-Morgan, Inc., where the court said other particularized facts backed up the plaintiff’s GAAP allegations.

The court also said the plaintiffs’ favored holistic view of the allegations here still would not be enough to meet the PSLRA’s pleading standard. According to the court, a conference call cited by the plaintiffs showed that GRC’s CEO had related the company’s long-standing relationship with its buyer, and that GRC initially believed variances in assays of the metals for its buyer were mistaken (later “umpire assays” would find actual variances).

But the court said the variance allegations could be explained in a way that avoids liability for GRC and its executives. Specifically, in the Tellabs context, a nonculpatory explanation would be that a reasonable executive might wish to investigate any variance like the one’s GRC experienced before publicly announcing them.

Moreover, the plaintiffs’ allegations of fraudulent Sarbanes-Oxley Act certifications by GRC’s CEO and CFO were deficient because they would at most be negligent. The seeming simplicity of the GAAP provision at issue (i.e., deliver product before recognizing revenues) also was of no help to the plaintiff. Likewise, the delay between when GRC’s employees in Mexico learned of assay variances and the time that information reached GRC’s U.S. executives implied a plausible, nonculpable explanation, or at most negligence, which still fell short of the PSLRA’s requirements.

As for GRC’s production woes, the court similarly found the plaintiffs’ allegations wanting. The complaint had claimed that GRC’s output fell because the company failed to deal with key infrastructure issues at its Mexican mines. The court noted that mining is a risky business because one never knows for sure what a dig will lead to.

A conference call by GRC’s CEO, and another call by both GRC’s CEO and president, emphasized the court’s point: GRC’s CEO told analysts the company had shifted resources from its troubled mine to a lower grade, but safer mine, and GRC had hired more skilled employees to deal with infrastructure issues; two months later GRC’s president told investors “we tripped up in the second quarter…,” right after GRC’s CEO said “surprises” are legion in the mining business.

Lastly, the court noted that GRC’s 2011 annual report on Form 10-K indicated just how tough the mining business is by citing risk factors about hazards beyond GRC’s control. The court also said in a footnote that the lack of any alleged class period sales of GRC’s securities by its executives (who own 18 percent of GRC’s stock) further deflated the plaintiffs’ scienter claims.

The case is No. 13-1323.

Attorneys: John Michael DeStefano III (Hagens Berman Sobol Shapiro LLP for Nittesh Banker, Scott Cantor, and Robert D. Rhodes. Peter A. Wald (Latham & Watkins LLP) for Gold Resource Corporation, Jason D. Reid, William W. Reid, David C. Reid, and Bradley J. Blacketor.

Companies: Gold Resource Corporation

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