Flaherty & Crumrine Preferred Income Fund, Inc. v. TXU Corp.
2009 WL 930055, 2009 U.S. App. LEXIS 7133, 565 F.3d 200 (2009)
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Rule of Law:
Under the Private Securities Litigation Reform Act (PSLRA), a securities fraud claim will be dismissed if the plaintiff's allegations, viewed holistically, do not give rise to a 'strong inference' of scienter that is 'cogent and compelling,' rather than merely reasonable or permissible, especially when a plausible, non-culpable explanation for the defendant's conduct exists.
Facts:
- In a May 2004 press release, TXU Corp. stated it did not anticipate increasing its stock dividend until 2006, when certain financial benchmarks were reached, but noted its Board could consider other factors.
- On September 15, 2004, TXU announced a self-tender offer to repurchase certain convertible securities, including those owned by Flaherty & Crumrine (F&C) and Stan Haiduk. The offer materials stated that management was 'evaluating' the dividend policy but could not predict the outcome or timing.
- On September 28, 2004, TXU's CEO, C. John Wilder, gave a presentation that reiterated the dividend policy was 'under review.'
- On October 12, 2004, one day before the tender offer expired, TXU management provided a detailed financial plan concerning a potential dividend increase to credit rating agencies for their evaluation.
- On October 13, 2004, the tender offer expired, with F&C and Haiduk having sold a substantial portion of their securities back to TXU.
- On October 22, 2004, nine days after the offer closed, TXU's Board of Directors approved a 350% dividend increase and a 400% increase in its stock repurchase program.
- On October 25, 2004, TXU publicly announced the dividend and repurchase increases, causing the value of its common stock and related securities to increase by nearly 20%.
Procedural Posture:
- Flaherty & Crumrine and Stan Haiduk filed a class action complaint against TXU Corp. and John Wilder in the U.S. District Court for the Northern District of Texas, alleging federal securities fraud.
- The defendants filed a motion to dismiss, which the district court granted.
- The plaintiffs appealed to the U.S. Court of Appeals for the Fifth Circuit.
- While the appeal was pending, the U.S. Supreme Court decided Tellabs, Inc. v. Makor Issues & Rights, Ltd., which clarified the pleading standard for scienter.
- The Fifth Circuit vacated the district court's judgment and remanded the case for reconsideration in light of Tellabs.
- On remand, the plaintiffs filed a second amended complaint, adding state common law fraud claims.
- The defendants again filed a motion to dismiss, which the district court granted for failure to plead a 'strong inference of scienter' under the Tellabs standard.
- The plaintiffs then filed the present appeal to the Fifth Circuit.
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Issue:
Do allegations that a company announced a significant dividend increase shortly after a tender offer closed create a 'strong inference of scienter' sufficient to survive a motion to dismiss under the PSLRA, when the company's prior statements described its dividend policy as being 'under review'?
Opinions:
Majority - Judge Benavides
No. Allegations that a company announced a significant dividend increase shortly after a tender offer closed do not create a 'strong inference of scienter' when the company's prior statements were cautiously worded and a plausible, non-fraudulent explanation for the timing exists. To satisfy the PSLRA's heightened pleading standard as clarified in Tellabs, an inference of fraudulent intent must be 'cogent and compelling,' not merely plausible. Here, the suspicious timing of the announcement, while providing some basis for an inference of fraud, is not sufficient on its own. The court must weigh the inference of scienter against plausible opposing inferences. TXU's statements that its dividend policy was 'under review' were vague but accurate, as the final decision had not been made and was contingent on factors like feedback from credit rating agencies, which was not received until after the tender offer closed. The inference that TXU was truthfully stating its policy was under review and awaiting final information is a plausible, non-culpable explanation that weakens the plaintiffs' claim. Therefore, the inference of fraud is merely 'permissible,' not the 'cogent and compelling' strong inference required to proceed with a securities fraud claim.
Analysis:
This decision exemplifies the significant hurdle plaintiffs face in pleading scienter after the Supreme Court's ruling in Tellabs. The court's holistic analysis, which requires weighing culpable inferences against plausible non-culpable ones, makes it difficult to survive a motion to dismiss based on suspicious timing alone. The ruling reinforces that corporations may use cautious, non-committal language like 'under review' to describe potential future actions without incurring securities fraud liability, so long as the final decision has not yet been made. This case serves as a strong precedent for defendants arguing that even highly suggestive circumstances do not meet the 'cogent and compelling' standard if an alternative, innocent explanation is plausible.
