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Wyche v. Advanced Drainage Systems, Inc.

United States District Court, S.D. New York

March 10, 2017

CHRISTOPHER WYCHE, individually and on behalf of all others similarly situated, Plaintiff,


          KATHERINE POLK FAILLA, United States District Judge.

         Lead Plaintiff Christopher Wyche (“Plaintiff”) brings this class action lawsuit on behalf of purchasers (the “Class”) of securities issued by Advanced Drainage Systems, Inc. (“ADS” or the “Company”) during the period from July 25, 2014, through March 29, 2016, inclusive (the “Class Period”). Plaintiff alleges that ADS, Joseph A. Chlapaty (“Chlapaty”), and Mark B. Sturgeon (“Sturgeon, ” with Chlapaty, the “Individual Defendants, ” and with Chlapaty and ADS, “Defendants”) violated Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 (the “Exchange Act”), 15 U.S.C. §§ 78j(b) and 78t(a), and Rule 10b-5 promulgated thereunder, 17 C.F.R. § 240.10b-5, in financial statements issued in conjunction with the Company's Initial Public Offering (“IPO”) and during the months thereafter. Defendants have moved to dismiss Plaintiff's Amended Complaint (the “Complaint”) pursuant to Federal Rules of Civil Procedure 9(b) and 12(b)(6) for failure to state a claim.

         There is no shortage of statements identified in the Complaint as to which Plaintiff cries fraud. There is, however, a noticeable shortage of well-pleaded allegations of scienter, and likely also loss causation. Accordingly, and for the reasons outlined below, Defendants' motion to dismiss is granted.


         A. Factual Background

         Plaintiff alleges that Defendants perpetrated a fraud in connection with ADS's July 24, 2014 IPO in order to inflate artificially the price of ADS's common stock. Before explaining why these allegations fail, the Court situates them in context.

         1. The Parties

         Plaintiff is an individual who purchased eight shares of ADS common stock on March 23, 2015, for a price of $28.96 per share. (Compl., Ex. A, Dkt. #43).

         ADS is a “leading manufacturer of high performance thermoplastic corrugated pipe, providing a comprehensive suite of water management products and superior drainage solutions for use in the construction and infrastructure marketplace.” (Compl. ¶ 22).[2] Its “product line includes corrugated high density polyethylene (or HDPE) pipe, polypropylene (or PP) pipe[, ] and related water management products.” (Id.). ADS is a Delaware corporation that maintains its principal executive offices in Hilliard, Ohio; its common stock trades on the New York Stock Exchange under the ticker symbol “WMS.” (Id. at ¶ 17).

         Chlapaty served as the Company's President and Chief Executive Officer throughout the Class Period. (Compl. ¶ 18). He first joined ADS in 1980, and rose to serve “as Chairman of the ADS board of directors since 2008, a director since 1988, President since 1994[, ] and Chief Executive Officer since 2004.” (Id.). Sturgeon was the Company's Executive Vice President, Chief Financial Officer, Secretary[, ] and Treasurer. (Id. at ¶ 19). He joined ADS in 1981 to serve as a Corporate Cost and Budget Manager and Market Planning Manager; by 1994, he had been elevated to the position of Executive Vice President and Chief Financial Officer. (Id.). Each Individual Defendant “signed all relevant filings with the [SEC], certifying the Company's post-IPO financial statements and the material accuracy of its financial condition and results of operations as ADS's principal executive officer.” (Id. at ¶¶ 18-19).

         2. The Initial Public Offering

         “Prior to July 24, 2014, ADS was a private company with equity ownership divided among management (24.17%), and several investors including ASP ADS Investco, LLC (‘ASP') (57.42%) and the University of Notre Dame du Lac (‘Notre Dame') (10.10%).” (Compl. ¶ 26).[3] On July 24, 2014, “[b]y means of a Registration Statement on Form S-1 and a Prospectus ([the] ‘Offering Documents'), [which] Defendant ADS filed with the Securities Exchange Commission ... ADS issued stock in its initial public offering ([the] ‘IPO') for the first time.” (Id. at ¶ 3). “In the IPO, ASP sold 7, 894, 737 shares while Notre Dame sold 1, 315, 789 shares and the Company sold 5, 289, 474 shares for proceeds of $118, 105, 266[;] $19, 684, 203[;] and $79, 130, 531 respectively, after underwriting discounts and commissions.” (Id. at ¶ 26).[4]

         A primary purpose of the IPO was to generate proceeds with which the Company could repay its debt. (Compl. ¶ 38). In connection with the IPO, the Company disclosed that its debt obligations included

a credit agreement with PNC bank that consisted of a $325 million revolving credit facility and bank term loans in an aggregate original principal amount of $100 million. In addition[, ] the Company had issued Senior Notes through a private shelf offering with Prudential Investment Management, Inc., enabling the Company to issue to Prudential notes in the aggregate principal amount of $100 million[, ]

         all of which had been issued as of the IPO. (Id. at ¶ 35). These debts were subject to certain restrictive covenants. (Id. at ¶ 37). The Company indicated that its intention with regard to the IPO proceeds was to repay at least $72.8 million of its indebtedness under the revolving portion of its credit facility. (Id. at ¶ 38).

         3. The Revelation of the Accounting Errors

         On June 30, 2015, ADS filed a Form 12b-25 with the SEC to notify its investors that it would be unable to file its Form 10-K for the fiscal year that ended March 31, 2015, within the prescribed time period. (Compl. ¶¶ 153, 166). The Company indicated that it was “finalizing its inventory costing analysis, ” and that the Audit Committee of the Company's Board of Directors was engaged in an ongoing “review of the Company's journal entry control processes.” (Id.). The Company estimated its filing delay would be no more than 15 days. (Id.).

         However, on July 15, 2015, in a Form 8-K and accompanying press release, the Company announced that its internal review had expanded, and would take longer than previously disclosed. (Compl. ¶¶ 156, 167). In particular, the Company indicated that its review of “year-end inventory costing analysis and the related impact on the Company's fiscal year 2015 financial statements” was still ongoing, but that the internal review had been broadened to include a review of the Company's “accounting treatment for its transportation and equipment leasing program.” (Id.). This broadened review was anticipated to result in “a reduction of year-end inventory values for fiscal year 2015 as compared to previously reported amounts, and a related increase in cost of sales, ” counterbalanced in part by “a positive impact on cost of sales in fiscal year 2016.” (Id.).

         On August 12, 2015, the SEC's Division of Enforcement notified the Company that it would be conducting an informal inquiry into the Company and requesting the Company's production of documents. (Compl. ¶ 158). Shortly thereafter, on August 17, 2015, the Company released a second Form 8-K and press release in which it advised investors that “its previously issued financial statements and other financial data, including its May 12, 2015 earnings release, should no longer be relied upon, and that it would restate prior period financial statements and related financial information as filed with the SEC ... as soon as practicable.” (Id. at ¶¶ 159-60, 169). The restated financial information was expected to include “the annual periods ended March 31, 2010, 2011, 2012, 2013[, ] and 2014 as set forth in the Company's Registration Statements on Form S-1, as well as the quarterly periods ended June 30, September 30, and December 31, 2013 and 2014, as set forth in the Company's Quarterly Reports on Form 10-Q.” (Id. at ¶ 160). The majority of adjustments to be made in the restatements was expected to “fall within three areas: lease adjustments, inventory adjustments, and other adjustments.” (Id.).

         In the midst of these announcements, it was also announced on November 9, 2015, that Sturgeon, the Company's CFO, “had notified the Company of his intent to retire.” (Compl. ¶ 171). He was replaced by Scott A. Cottril. (Id.).

         By February 2, 2016, the Company still had not filed its Form 10-K for the 2015 fiscal year. (Compl. ¶ 173). Again, it announced a delay, which it explained was “due in part to certain accounting errors that management recently identified with respect to the Company's Mexican joint venture affiliate that extend beyond the scope of the inventory and leasing errors previously disclosed.” (Id.). The Company hoped to file the report by the end of that month, though it admitted that there could “be no assurance that the process will be completed by that time.” (Id.). And indeed, it was not. February came and went, and only on March 28, 2016, did the Company announce it would finish its restatement and file the outstanding reports after the market closed the following day. (Id. at ¶ 175).

         The 2015 Form 10-K was filed on March 29, 2016. (Compl. ¶ 177). “The Company restated its financial results for the years 2011 through 2014 and for the first three quarters of fiscal 2015 as well as providing actual audited financial statements for fiscal 2015.” (Id.). The Company further disclosed that its self-investigation had begun in June 2015, when “the Audit Committee of the ADS's Board of Directors authorized two investigative reviews by its independent counsel and a third-party forensic consulting firm.” (Id. at ¶ 178). The Audit Committee believed this was necessary because “certain members of the Company's finance staff responded affirmatively to questions presented to them by the independent registered public accounting firm in accordance with Public Company Accounting Oversight Board Interim Auditing Standard AU 316, Consideration of Fraud in a Financial Statement Audit (commonly referred to as [the] ‘SAS 99').” (Id.). And “[w]hile the investigation found no evidence of fraud, [the Audit Committee] determined that the concerns reflected in the responses to the SAS 99 questions were well founded and resulted in restatement of prior period financial statements.” (Id.). The self-investigation did not conclude until March 2016. (Id.). The 2015 Form 10-K detailed the Company's findings at length, describing the material weaknesses the Company had identified. (Id.).

         B. Procedural Background

         This lawsuit was brought originally on July 29, 2015. (Dkt. #1, 9). On September 28, 2015, then-Class Member Wyche moved the Court for an order appointing him as Lead Plaintiff in this case and approving his selected counsel as Lead Counsel. (Dkt. #17-18). This motion was granted on January 11, 2016. (Dkt. #25).

         On April 28, 2016, Plaintiff filed the Complaint. (Dkt. #42). Defendants requested leave to file a motion to dismiss the Complaint, which request Plaintiff opposed. (Dkt. #49-50). The Court discussed the contemplated motion with the parties at a Pre-Motion Conference on June 9, 2016, and Plaintiff was afforded an opportunity to amend his Complaint. (Dkt. #56). Plaintiff declined, electing to stand on the Complaint, and the Court set a briefing schedule. (Dkt. #52, 56).

         Defendants filed their joint Motion to Dismiss the Amended Class Action Complaint for Violations of the Federal Securities Laws on August 8, 2016. (Dkt. #59-61). Plaintiff filed his Opposition to Defendants' Motion on September 22, 2016 (Dkt. #62), and Defendants filed their Reply on October 24, 2016 (Dkt. #63).


         A. Applicable Law

         1. Motions to Dismiss Under Federal Rule of Civil Procedure 12(b)(6)

         When considering a motion to dismiss under Rule 12(b)(6), a court should “draw all reasonable inferences in [the plaintiff's] favor, assume all well-pleaded factual allegations to be true, and determine whether they plausibly give rise to an entitlement to relief.” Faber v. Metro. Life Ins. Co., 648 F.3d 98, 104 (2d Cir. 2011) (internal quotation marks and citation omitted) (quoting Selevan v. N.Y. Thruway Auth., 584 F.3d 82, 88 (2d Cir. 2009)). Thus, “[t]o survive a motion to dismiss, a complaint must contain sufficient factual matter, accepted as true, to ‘state a claim to relief that is plausible on its face.'” Ashcroft v. Iqbal, 556 U.S. 662, 678 (2009) (quoting Bell Atl. Corp. v. Twombly, 550 U.S. 544, 570 (2007)). In this regard, a complaint is deemed to include any written instrument attached to it as an exhibit or any statements or documents incorporated in it by reference. See, e.g., Hart v. FCI Lender Servs., Inc., 797 F.3d 219, 221 (2d Cir. 2015) (citing Fed.R.Civ.P. 10(c) (“A statement in a pleading may be adopted by reference elsewhere in the same pleading or in any other pleading or motion. A copy of a written instrument that is an exhibit to a pleading is a part of the pleading for all purposes.”)).

         “While Twombly does not require heightened fact pleading of specifics, it does require enough facts to ‘[nudge a plaintiff's] claims across the line from conceivable to plausible.'” In re Elevator Antitrust Litig., 502 F.3d 47, 50 (2d Cir. 2007) (per curiam) (quoting Twombly, 550 U.S. at 570). “Where a complaint pleads facts that are ‘merely consistent with' a defendant's liability, it ‘stops short of the line between possibility and plausibility of entitlement to relief.'” Iqbal, 556 U.S. at 678 (quoting Twombly, 550 U.S. at 557). Moreover, “the tenet that a court must accept as true all of the allegations contained in a complaint is inapplicable to legal conclusions. Threadbare recitals of the elements of a cause of action, supported by mere conclusory statements, do not suffice.” Id.

         2. The Relevant Securities Laws

         Under Section 10(b) of the Exchange Act, it is

unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce or of the mails, or of any facility of any national securities exchange ... [t]o use or employ, in connection with the purchase or sale of any security registered on a national securities exchange or any security not so registered, or any securities-based swap agreement any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the Commission may prescribe as necessary or appropriate in the public interest or for the protection of investors.

15 U.S.C. § 78j. Rule 10b-5, promulgated by the SEC under Section 10(b), further provides that a person may not

employ any device, scheme, or artifice to defraud[;] ... make any untrue statement of a material fact or ... omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading[;] or ... engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person[;] in connection with the purchase or sale of any security.

17 C.F.R. § 240.10b-5. “Although Section 10(b) does not expressly provide for a private right of action, courts have long recognized an implied private right of action under Section 10(b) and Rule 10b-5.” In re Longtop Fin. Techs. Ltd. Sec. Litig., 939 F.Supp.2d 360, 376 (S.D.N.Y. 2013) (citing Superintendent of Ins. of State of N.Y. v. Bankers Life & Cas. Co., 404 U.S. 6, 13 n.9 (1971) (“It is now established that a private right of action is implied under [Section] 10(b).”)).

         To succeed on a Section 10(b) and Rule 10b-5 claim, a plaintiff must prove “[i] a material misrepresentation or omission by the defendant; [ii] scienter; [iii] a connection between the misrepresentation or omission and the purchase or sale of a security; [iv] reliance upon the misrepresentation or omission; [v] economic loss; and [vi] loss causation.'” GAMCO Inv'rs, Inc. v. Vivendi Universal, S.A., 838 F.3d 214, 217 (2d Cir. 2016) (quoting Halliburton Co. v. Erica P. John Fund, Inc., - U.S. -, 134 S.Ct. 2398, 2407 (2014)).

         Section 20(a) establishes that “[e]very person who, directly or indirectly, controls any person liable under [the Exchange Act and its implementing regulations] shall also be liable jointly and severally with and to the same extent as such controlled person to any person to whom such controlled person is liable.” 15 U.S.C. § 78t(a). To state a Section 20(a) claim, a plaintiff must show [i] “a primary violation by the controlled person”; [ii] “control of the primary violator by the defendant”; and [iii] that the controlling person “was, in some ...

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