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From Securities Regulation Daily, May 15, 2015

Suit against plane parts maker crashes on materiality, scienter requirements

By Rodney F. Tonkovic, J.D.

The plaintiffs accused Spirit AeroSystems, Inc. and four of its officers of making misleading statements that artificially inflated Spirit's stock price before the company recorded a loss. The court found that the alleged false statements were not material and that the complaint failed to raise an inference of scienter (Anderson v. Spirit Aerosystems Holdings, Inc., May 14, 2015, Melgren, E.).

Background. In October 2012, Spirit recorded a $590 million forward-loss charge for six manufacturing contracts. A forward-loss is recorded when it becomes evident that estimates of contract revenue and cost indicate a total loss on the contract. Spirit characterized the loss as an unforeseen failure to achieve planned cost reductions on new aircraft component manufacturing contracts.

The complaint alleged that the members of the proposed class bought Spirit stock at artificially inflated prices due to the defendants' misrepresentations and omissions related to Spirit's cost-reduction efforts. According to the plaintiffs, the forward losses were evident to Spirit well before they were actually recorded. Spirit, however, proclaimed success at reducing costs despite knowledge of cost overruns and production issues.

Misrepresentations. The complaint alleged more than 40 misleading statements in earnings reports, conference calls, and investor conferences. The court assumed for the purposes of this motion to dismiss that the plaintiffs sufficiently pleaded false and misleading statements, but found that they failed to plead materiality because the statements were too vague to be material and could not be objectively verified. Moreover, according to the complaint, the average cost per unit for certain planes decreased each quarter, so it was not clear to the court that statements touting progress and improvement on cost-reduction efforts were false statements. The court additionally found no duty to disclose any information about cost overruns or production problems because there were no materially misleading statements giving rise to that duty.

Scienter. The court then found that the complaint failed to plead scienter. Spirit's position was that it suffered a number of serious, unanticipated setbacks that caused it to reevaluate its profitability estimates. After Spirit determined that it could not achieve planned cost reductions, it promptly notified investors that it would recognize a substantial loss. The plaintiffs' allegations, in other words, were fraud by hindsight, Spirit maintained.

First, the court found that the allegations failed to meet the standard for recklessness. According to the court, even if the defendants had made materially false statements, their materiality would have been so marginal it was unlikely that the defendants would have been aware that nondisclosure would mislead investors. Further, much of the information about the risk of recording a forward-loss charge was reported, but the complaint failed to mention this fact, having omitted the full context of many of the statements. The defendants, in fact, "continually hedged their optimism," the court said, which was far from the required extreme departure from the standards of ordinary care required for recklessness.

The court also found no motive for the defendants to conceal problems or delay taking the forward-loss charges. The plaintiff's alleged that the defendants were motivated by financial gain: preserving Spirit's credit, a compensation structure based on performance, and retention of executive positions. The court found that it was not clear what the officer defendants stood to gain by delaying the recording of the forward-loss charges. While Spirit's stock price plummeted after the loss was announced, the court assumed this would have happened even if the charges were recorded earlier.

Finally, taken collectively, the plaintiffs' allegations based on core operations, confidential witness testimony, the magnitude of the understated costs, GAAP violations, and post-class admissions collectively fail to raise a strong inference of scienter, the court found. The opposing inference that the defendants were simply overly optimistic was much stronger than the inference of fraud. Spirit's motion to dismiss was accordingly granted.

The case is No. 13-2261.

Attorneys: Austin P. Brane (Robbins Geller Rudman & Dowd LLP) for Wayne E. Anderson. Aaron F. Miner (Kaye Scholer LLP)and Toby Crouse (Foulston Siefkin LLP) for Spirit AeroSystems Holdings, Inc., Jeffrey L. Turner, Philip D. Anderson, Alexander K. Kummant and Terry J. George.

Companies: Spirit AeroSystems Holdings, Inc.

MainStory: TopStory FraudManipulation KansasNews

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