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In re Carbo Ceramics, Inc. Stock and Options Securities Litigation

United States District Court, Second Circuit

June 26, 2013

In re CARBO CERAMICS, INC. STOCK AND OPTIONS SECURITIES LITIGATION. This Document Relates to: ALL ACTIONS.

OPINION AND ORDER

LOUIS L. STANTON, District Judge.

In this consolidated securities class action, plaintiffs, investors in common stock and options contracts of Carbo Ceramics, Inc. ("Carbo") who purchased or sold those securities between October 27, 2011 and January 26, 2012, assert claims against defendants Carbo, Gary Kolstad, and Ernesto Bautista for violations of section 10(b) of the Securities Exchange Act of 1934 (the "Exchange Act") and rule 10b-5 thereunder, and against individual defendants under section 20(a) of the Exchange Act as "control persons" of Carbo.

The elements of a claim under section 10(b) and rule 10b-5 are that the defendants "(1) made misstatements or omissions of material fact; (2) with scienter; (3) in connection with the purchase or sale of securities; (4) upon which plaintiffs relied; and (5) that plaintiffs' reliance was the proximate cause of their injury." Lentell v. Merrill Lynch & Co. , 396 F.3d 161, 172 (2d Cir. 2005) (internal quotation marks omitted).

Plaintiffs allege that defendants made materially misleading statements about the impact on Carbo of a shift in the hydraulic fracking industry's focus from the extraction of natural gas to liquid oil.

Defendants move under Fed.R.Civ.P. 12(b) (6), 9(b), and the Private Securities Litigation Reform Act ("PSLRA") of 1995, 15 U.S.C. 78u-4(b) (3) (A) (2006), to dismiss the amended consolidated complaint.

The Complaint's Allegations

Carbo's Logistical Problems

Carbo is a manufacturer and supplier of ceramic proppant, a product used in hydraulic fracking.[1] Gary Kolstad is Carbo's chief executive officer, and Ernesto Bautista is Carbo's chief financial officer.

Carbo has six production plants located in the United States and abroad, and transports proppant by rail to distribution facilities it maintains across North America. Proppant is then distributed by truck to customer well sites from such facilities. Carbo is paid after delivery to customer well sites.

For several years before 2011, heightened demand for natural gas led to increased drilling for natural gas, and the resulting demand for proppant in areas with a propensity to produce natural gas. By early to mid-2011, the market had shifted, and natural gas prices fell far below oil prices. Consequently, many exploration and production companies shifted their focus to areas with a greater propensity for liquid oil production ("liquid-rich plays"). Carbo's proppant sales declined in natural gas fields, and there was a corresponding increase in demand for proppant in liquid-rich plays.

Areas that produce natural gas and liquid oil are located in different parts of the United States; in order to take advantage of the demand for its product in liquid-rich plays, Carbo needed to reconfigure its distribution structure to transport and distribute its proppant to liquid-rich areas.

Carbo experienced a number of logistical problems in distributing proppant to those liquid-rich areas. First, there was a shortage of railroad cars, and Carbo's railcar fleet was inadequate to transport sufficient proppant to liquid-rich areas. Second, Carbo lacked adequate storage capacity in liquid-rich areas, and resorted to using railcars for storage, which further reduced the availability of its railcar fleet. Third, because the rail infrastructure was less developed in liquid-rich areas, the industry's migration to those areas caused significant railway congestion and service failures.

As a result of those issues, Carbo was unable to transport sufficient proppant to liquid-rich areas to fully realize the demand for its product, and its sales declined.

The Alleged Fraud

On October 27, 2011, the beginning of the class period, Carbo issued a press release announcing its financial results for the previous quarter. Mr. Kolstad commented, in writing, on that announcement, stating:

We are pleased that CARBO set a number of financial and operational records during the quarter. The exceptional third quarter results continued to highlight the importance that our clients place on high conductivity proppant, especially in the North American liquid-rich resource plays such as the Bakken, Colony Granite Wash, Eagle Ford, and Permian.
The demand by E&P operators[2] for our high quality, high conductivity ceramic proppant continues to grow, as evidenced by the company's record ceramic proppant sales volume for the quarter. The benefit E&P operators see, as measured by increased production and higher estimated ultimate recovery (EURe), continues to enhance their economic returns. We continue to work with our clients to optimize their fracs and maximize their profit through Economic Conductivity® analysis. Regarding our commitment to capacity growth, we were excited to commence production ahead of schedule at the company's newest 250 million lb. production line at our Toomsboro, Georgia plant.

Compl. ┬ 55. Mr. Kolstad also wrote that:

We exited the third quarter with positive momentum. As a result, we expect proppant sales volumes to remain healthy, tempered by typical fourth quarter seasonality. Although broader economic issues remain fluid and commodity prices continue to fluctuate, we remain optimistic with respect to proppant demand in 2012. Noteworthy is the continued migration of North American upstream investment toward liquid-rich resource plays, ...

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