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From Securities Regulation Daily, August 20, 2015

KFC shareholders unsuccessful on fraud appeal

By Amanda Maine, J.D.

A panel of the Sixth Circuit Court of Appeals found unpersuasive arguments made by shareholders of KFC’s corporate owner that the company made false and misleading statements in violation of the federal securities antifraud laws. The statements made by the company about its food safety standards and protocols were not actionable, and the shareholders were also unable to demonstrate that the defendants acted with the requisite level of scienter (Bondali v. Yum! Brands, Inc., August 20, 2015, McKeague, D.).

Background. Shareholders in Yum! Brands, Inc. (Yum), the parent company of restaurant chain KFC, sued the company and three senior officers, alleging that Yum and the executives knew that batches of chicken being supplied to Yum’s KFC China subsidiary had tested positive for drug and antibiotic residues and that Yum’s statements were false or misleading under the federal securities laws because they did not disclose adverse results and system failures to the public. Upon disclosure of these alleged failures, the price of Yum stock dropped 17 percent. The district court dismissed the class action complaint, finding that the plaintiffs failed to allege both actionable misstatements and scienter. The plaintiffs appealed.

Misrepresentations. The plaintiffs’ amended complaint cited a number of alleged misrepresentations and omissions by the company relating to Yum’s food safety standards and protocols, its responses to negative publicity, its risk disclosures about food safety issues, and its statements about its own falling sales. The appellate panel agreed with the lower court’s conclusion that none of these statements were actionable under the federal securities laws. Despite the complaint’s assertions disparaging the company’s standards and protocols, the panel found that it actually detailed how Yum did impose requirements regarding food safety. Yum’s response to negative publicity that arose about its food safety program indicated that it did take action to rectify the situation, the panel noted. Other statements made by Yum about its risk disclosures were cautionary in nature and thus not actionable. The panel also declined to adopt the plaintiffs’ argument that the “sum total” of the company’s statements created a misleading impression of an effective monitoring system, deeming it “a misinterpretation of the case law.”

Scienter. The panel also rejected the plaintiffs’ arguments regarding scienter. While the plaintiffs had established that the officer defendants had the motive and opportunity to conceal knowledge about the issues regarding Yum’s chicken supply, they had not pleaded with particularity facts giving rise to a strong inference that the executives received notice of the test results about the chickens or that they knew or should have known that statements made by Yum discussing investment risks or touting the company’s safety protocols were false or misleading.

In addition, the panel rejected the plaintiffs’ corporate scienter argument, noting that the complaint would have to establish scienter on the part of another agent, which it failed to do.  

The case is No. 15-5064.

Attorneys: Jonathan Gardner (Labaton Sucharow LLP) for Frankfurt-Trust Investment GMBH. James Ducayet (Sidley Austin LLP) and Peter M. Cummins (Frost Brown Todd) for Yum! Brands, Inc.

Companies: Frankfurt-Trust Investment GMBH; Yum! Brands, Inc.

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