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PSLRA Class Action Defense Cases-Central Laborers’ v. Integrated Electrical: Fifth Circuit Holds Class Action Complaint Failed To Adequately Plead Scienter Under PSLRA And Leave To Amend Class Action Complaint Properly Denied

District Court Properly Concluded that Securities Fraud Allegations in Class Action Complaint did not Satisfy Heightened Pleading Requirements of the Private Securities Litigation Reform Act (PSLRA) and that Amendment of Class Action Complaint would have been Futile Fifth Circuit Holds

Plaintiff, a pension fund, filed a putative class action against Integrated Electrical and certain officers alleging violations of Sections 10(b) and 20(a) of the Securities Exchange Act, 15 U.S.C. §§ 78j(b) & 78t(a), and Rule 10b-5 based on “a number of false or misleading statements by IES regarding the company’s financial condition caused an artificial inflation in the market price of IES’s securities during the class period.” Central Laborers’ Pension Fund v. Integrated Electrical Services Inc., 497 F.3d 546, 2007 WL 2367776, *1 (5th Cir. 2007). Defense attorneys moved to dismiss the class action on the ground that it failed to plead scienter with the requisite specificity under the Private Securities Litigation Reform Act (PSLRA), id. The district court agreed that the complaint failed to meet the PSLRA’s heightened pleading standards and dismissed the class action; in so ruling, the court implicitly denied plaintiff’s request for leave to file an amended class action complaint. Id. The Fifth Circuit affirmed, holding that the PSLRA compelled dismissal of the class action complaint and that the district did not abuse its discretion in concluding that further amendment of the class action complaint would have been futile.

Integrated Electrical is a publicly-traded company that provides electrical contracting services throughout the country. Central Laborers’, at *1. Beginning in April 2003, the company “expressed confidence” in its financial status, but in August 2004 it “publicly disclosed that it could not release its quarterly earnings numbers on time due to an ongoing evaluation of certain projects.” Id. Ultimately, the company restated its financial statements for fiscal years 2002 through the first half of 2004, id. In the Fifth Circuit, “‘[t]o state a claim under § 10(b) and Rule 10b-5, a plaintiff must allege, in connection with the purchase or sale of securities[:] (1) a misstatement or an omission (2) of material fact (3) made with scienter (4) on which plaintiff relied (5) that proximately [injured him].’” Id., at *2 (quoting Fin. Acquisition Partners LP v. Blackwell, 440 F.3d 278, 286 (5th Cir. 2006)). The PSLRA requires that securities fraud must be pleaded with particularity, and alleged violations of Section 10(b) and Rule 10b-5 require proof that the defendant acted either with intent or with “severe recklessness.” Id., at *2. And appellate review of a district court order refusing leave to amend is governed by an abuse of discretion standard, id., at *3.

Turning first to the dismissal of the class action for failure to plead scienter with the requisite particularity, plaintiff argued that the district court erred because the complaint alleged “insider trading, GAAP violations, failure to fix an accounting error, the making of false statements about internal controls, and pervasive knowledge of accounting problems throughout IES.” Central Laborers’, at *4. The Fifth Circuit concluded (1) that “[the] GAAP violations, without more, do not establish scienter” but they do “provide some basis to infer scienter,“ id., at *4; (2) that “confidential source statements” may support a finding of scienter but in this case they lacked sufficient detail to create the requisite inference, id.; (3) that the stock trading by officers of IES, while certainly a factor because “[i]nsider trading can be a strong indicator of scienter if the trading occurs at suspicious times or in suspicious amounts,” id., at *5 (citation omitted), must considered in the context of “plausible nonculpable explanations, for such officer trading, as well as inferences that favor [plaintiff],” id. (citation omitted), and so considered were insufficient against one officer sold only 4% of his shares and the other officer, id., but were adequate to “contribute to an inference of scienter” as to the other officer , id., at *6; and (4) that the Sarbanes-Oxley certifications signed by the officers, see 15 U.S.C. § 7241(a)(4), on the facts of this case “do not permit an inference of scienter,” id., at *7. Based on this analysis, the Circuit Court held that the collective impact of the class action allegations “fail[ed] to meet the pleading requirements of the PSLRA and [so the class action complaint] must be dismissed.” Id., at *8.

Finally, the Fifth Circuit concluded that the district court did not abuse its discretion in denying plaintiff leave to amend the class action complaint. Laborers’, at *8-*9. While the request was made “in haphazard fashion,” the Circuit Court construed the request as “a proper motion to amend.” Id., at *8 Nonetheless, the motion was properly denied because amendment would not have cured the deficiencies in the complaint, id., at *9. Accordingly, the Fifth Circuit affirmed the district court order dismissing the class action complaint. Id.

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