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Susan M. Greenwood | Bloomberg Law
The U.S. District Court for the Northern District of Florida dismissed with prejudice a securities fraud class action against real estate developer St. Joe Company (St. Joe) and certain of its former officers (collectively, Defendants). The Court held that plaintiffs failed to plead loss causation, a material misstatement, or scienter for their claims under Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder.
Industry Crisis or Accounting Fraud?
As the Court explained, St. Joe, a former timber and paper company, expanded into real estate development and now deals in (1) residential real estate, (2) commercial real estate, (3) rural property, and (4) forestry. When the real estate market crashed, St. Joe faced significant revenue losses as home sales "plummeted," forcing the company to halt development of new properties and lay-off two-thirds of its workforce. According to plaintiffs, Defendants did not take appropriate impairment charges for the true value of development projects affected by the real estate market crash. Instead, Defendants allegedly overstated St. Joe's earnings and asset values in violation of Securities and Exchange Commission (SEC) regulations and U.S. generally accepted accounting principles (GAAP).
Loss Causation and Future Events
Plaintiffs alleged that Defendants' purported accounting fraud first came to light through an investor presentation by David Einhorn. Einhorn, a St. Joe investor holding a short position, conducted his own research before concluding that the company's properties could not "'meet or exceed their carrying value.'" He further castigated St. Joe for failing to take necessary impairment charges. Following Einhorn's presentation, St. Joe's stock price fell by 20 percent. Nevertheless, the Court held that Einhorn's presentation did not support loss causation. "Information that is already publically available cannot be a corrective disclosure," the Court said. Einhorn's presentation, it continued, expressly stated that the information came from "'publically available sources.'" Under the fraud on the market theory, "'all publically available information about a security is reflected in the market price of the security.'" Accordingly, plaintiffs could not establish loss causation based on Einhorn's presentation of information already absorbed by the market. Expert analysis of public information can be considered new if, the Court explained, the analysis goes "beyond a mere re-characterization of previously disclosed facts" to "'identify, reveal or correct any prior misstatement, omission, or improper accounting practice by Defendants'" (emphasis added by Court). Parsing the language of Einhorn's presentation, however, the Court determined that it "indicates future action that St. Joe needed to take and does not indicate an impermissible practice." Even disseminations of Einhorn's presentation by the media "interpreted Mr. Einhorn's predictions as being that St. Joe would need to take some future action of impairment." Thus, the Court concluded that Einhorn's analysis did not implicate Defendants' past accounting practices. Similarly, plaintiffs' reliance on announcements of SEC investigations did not support loss causation. Noting a "split of authority concerning whether a regulatory investigation qualifies as a corrective disclosure," the Court followed the reasoning of the Northern District of California that "SEC investigation announcements are 'indicators of risk because they reveal the potential existence of future corrective information.'" The risk of future accounting problems, the Court held, does not reveal past impropriety. The Court acknowledged that St. Joe's stock price declined following Einhorn's presentation and the announcements of SEC investigations, but concluded that the stock drop "can be just as easily attributed to predictions of future impairments, as they could be to what Plaintiffs contend are improper past impairments."
GAAP Violations as Misstatements
While "[v]iolations of the GAAP may constitute false or misleading statements of material fact," the Court noted that "'GAAP is not [a] lucid encyclopedic set of pre-existing rules.'" Given conflicting treatments for accounting issues, as well as "'an elaborate hierarchy of GAAP sources to determine which treatment to follow," a plaintiff must allege more than the failure to take an impairment. Instead, the Court explained, "'the Complaint must provide detail as to why an impairment was required under then-existing accounting rules.'" Plaintiffs set forth eight factors that Defendants allegedly ignored, which pointed to the need for additional impairments of St. Joe's real estate assets. However, plaintiffs did not provide "concrete evidence in support of their assertions." As the Court explained, Defendants fully disclosed St. Joe's methodology for assessing impairments and market condition risks. Rather than contend that Defendants ignored their stated methodology or hid adverse facts, plaintiffs took issue with Defendants' opinions. However, "the absence of a detailed alternative impairment analysis suggests that the correct impairments were not 'so apparent.'" Defendants' judgment as to impairments may have been wrong in hindsight, but the Court could not find an actionable misstatement.
GAAP and Scienter
The alleged failure to follow GAAP, without more, does not raise an inference of scienter. Also, inaccurate accounting figures may be caused by differing conclusions by accountants, "'negligence, oversight, or simple mismanagement.'" None of these reasons, the Court said, support intentional misconduct or severe recklessness. Plaintiffs alleged that Defendants knew the average sale prices of St. Joe's properties and, therefore, should have known that they materially overstated the value of unsold properties. The Court disagreed, finding that Defendants' "knowledge of average sales prices does not speak to the veracity of their professional opinions about future prices." Plaintiffs' allegations about Defendants' motives also received limited consideration by the Court because Defendants' purported desire for increased compensation, debt covenants, and successful stock offerings are "generalized factors [that] go only so far in establishing a guilty mind." DisclaimerThis document and any discussions set forth herein are for informational purposes only, and should not be construed as legal advice, which has to be addressed to particular facts and circumstances involved in any given situation. Review or use of the document and any discussions does not create an attorney-client relationship with the author or publisher. To the extent that this document may contain suggested provisions, they will require modification to suit a particular transaction, jurisdiction or situation. Please consult with an attorney with the appropriate level of experience if you have any questions. Any tax information contained in the document or discussions is not intended to be used, and cannot be used, for purposes of avoiding penalties imposed under the United States Internal Revenue Code. Any opinions expressed are those of the author. The Bureau of National Affairs, Inc. and its affiliated entities do not take responsibility for the content in this document or discussions and do not make any representation or warranty as to their completeness or accuracy.©2014 The Bureau of National Affairs, Inc. All rights reserved. Bloomberg Law Reports ® is a registered trademark and service mark of The Bureau of National Affairs, Inc.
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