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In re Eletrobras Securities Litigation

United States District Court, S.D. New York

March 25, 2017




         This is a consolidated securities action purportedly brought on behalf of a class of all purchasers of U.S. exchange-traded securities of Centrais Elétricas Brasileiras S.A. (“Eletrobras” or the “Company”) between August 17, 2010 and June 24, 2015 (the “class period”). The lead plaintiffs, the City of Providence and Dominique Lavoie (the “plaintiffs”) filed a Second Amended Complaint (“SAC”) on February 26, 2016. The plaintiffs asserted violations of Section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b) (the “Exchange Act”), and Rule 10b-5 promulgated thereunder, 17 C.F.R. § 240.10b-5, against Eletrobras and four senior executives of the Company, namely, José Antonio Muniz Lopes (“Lopes”), José da Costa Carvalho Neto (“Carvalho”), Armando Casado de Araújo (“Araújo”), and Valter Luiz Cardeal de Souza (“Cardeal”) (collectively, the “individual defendants”).[1] The plaintiffs also asserted control person liability under Section 20(a) of the Exchange Act, 15 U.S.C. § 78t(a), against the individual defendants.

         The defendants Eletrobras, Lopes, Carvalho, and Araújo now move to dismiss the SAC for failure to state a claim under Federal Rule of Civil Procedure 12(b)(6).


         In deciding a motion to dismiss pursuant to Rule 12(b)(6), the allegations in the complaint are accepted as true, and all reasonable inferences must be drawn in the plaintiffs' favor. McCarthy v. Dun & Bradstreet Corp., 482 F.3d 184, 191 (2d Cir. 2007). The Court's function on a motion to dismiss is “not to weigh the evidence that might be presented at a trial but merely to determine whether the complaint itself is legally sufficient.” Goldman v. Belden, 754 F.2d 1059, 1067 (2d Cir. 1985). A complaint should not be dismissed if the plaintiffs have stated “enough facts to state a claim to relief that is plausible on its face.” Bell Atl. Corp. v. Twombly, 550 U.S. 544, 570 (2007). “A claim has facial plausibility when the plaintiff[s] plead[] factual content that allows the court to draw the reasonable inference that the defendant[s] [are] liable for the misconduct alleged.” Ashcroft v. Iqbal, 556 U.S. 662, 678 (2009). While factual allegations should be construed in the light most favorable to the plaintiffs, “the tenet that a court must accept as true all of the allegations contained in a complaint is inapplicable to legal conclusions.” Id.

         A claim under Section 10(b) of the Securities Exchange Act sounds in fraud and must meet the pleading requirements of Rule 9(b) of the Federal Rules of Civil Procedure and of the Private Securities Litigation Reform Act (“PSLRA”), 15 U.S.C. § 78u- 4(b). Rule 9(b) requires that the complaint “(1) specify the statements that the plaintiff[s] contend[] were fraudulent, (2) identify the speaker, (3) state where and when the statements were made, and (4) explain why the statements were fraudulent.” ATSI Commc'ns, Inc. v. Shaar Fund, Ltd., 493 F.3d 87, 99 (2d Cir. 2007). The PSLRA[2] similarly requires that the complaint “specify each statement alleged to have been misleading [and] the reason or reasons why the statement is misleading, ” and it adds the requirement that “if an allegation regarding the statement or omission is made on information and belief, the complaint shall state with particularity all facts on which that belief is formed.” 15 U.S.C. § 78u-4(b)(1); ATSI, 493 F.3d at 99.

         When presented with a motion to dismiss pursuant to Rule 12(b)(6), the Court may consider documents that are referenced in the complaint, documents that the plaintiffs relied on in bringing suit and that are either in the plaintiffs' possession or that the plaintiffs knew of when bringing suit, or matters of which judicial notice may be taken. See Chambers v. Time Warner, Inc., 282 F.3d 147, 153 (2d Cir. 2002). The Court can take judicial notice of public disclosure documents that must be filed with the SEC and documents that both “bear on the adequacy” of SEC disclosures and are “public disclosure documents required by law.” Kramer v. Time Warner, Inc., 937 F.2d 767, 773-74 (2d Cir. 1991); see also Plumbers & Pipefitters Nat'l Pension Fund v. Orthofix Int'l N.V., 89 F.Supp.3d 602, 607-08 (S.D.N.Y. 2015); Silsby v. Icahn, 17 F.Supp.3d 348, 353-54 (S.D.N.Y. 2014), aff'd sub nom., Lucas v. Icahn, 616 F. App'x 448 (2d Cir. 2015).



         The following facts alleged in the SAC are accepted as true for purposes of the defendants' motion to dismiss.

         Eletrobras is a state-run energy corporation organized under the laws of Brazil that generates about 35% of Brazil's total electricity. SAC ¶¶ 27, 41. The Brazilian government has generally owned a majority of the Company's common shares, giving them the right to appoint seven of the up to ten members of the board of directors. Id. Since at least 2002, Eletrobras has sponsored American Depository Shares (“ADSs”) representing Eletrobras's common and preferred equity and has listed them on the New York Stock Exchange (“NYSE”). SAC ¶ 29.

         The individual defendants are current and former officers of Eletrobras. Lopes was a government-appointed member of Eletrobras's board of directors from the start of the class period through February 25, 2011, and the board-selected Chief Executive Officer (“CEO”) during that period. SAC ¶ 30. Carvalho replaced Lopes in both roles on February 25, 2011. SAC ¶ 31. Araújo served as the Chief Financial Officer (“CFO”) and the Head of Investor Relations throughout the class period. SAC ¶ 32. Cardeal served as Eletrobras's Chief Generation Officer throughout the class period. SAC ¶ 33.

         In June 2010, Eletrobras updated and amended its “Code of Ethics: Ethical Principles and Conduct Commitments” (“Code of Ethics”) and declared that it would be adhered to by all Eletrobras companies and all Eletrobras employees. SAC ¶¶ 79-80. The Code of Ethics was signed by the President of every Eletrobras affiliate company, and emphasized that Eletrobras would “repudiat[e] any manner of fraud and corruption, ” as well as “comply[] with Brazilian laws and with the legislation of countries in which Eletrobras Companies operate.” SAC ¶ 82. The Code of Ethics further pledged “[t]o make corporate decisions based on the principles of ethics, transparency, integrity, loyalty, impersonality, legality and efficiency” and “[t]o refuse and denounce any form or attempt of corruption, bribery, kickback and ‘backscratching'.” SAC ¶ 84. The Company's 2010 annual report asserted that the Code of Ethics was binding on all Eletrobras employees, and, according to the plaintiffs, the Code of Ethics was effective throughout the class period. SAC ¶ 80-81.

         Both Carvalho and Araújo signed Eletrobras's annual reports on Form 20-F for fiscal years 2009 through 2013, and also signed Sarbanes Oxley (“SOX”) certifications included in each of the annual reports. SAC ¶¶ 31-32. In each annual report from 2010 through 2013, the Company admitted that there were material weaknesses in the design of its internal controls related to financial reporting. SAC ¶¶ 111-19. The 2010 annual report also included certifications from Carvalho and Araújo stating that they were responsible for establishing, maintaining, and designing disclosure controls. SAC ¶ 114. In its 2011 annual report, the Company disclosed that eight previously disclosed material weaknesses in internal controls were recurrent, and added that it did not adequately design and maintain controls “with respect to accounting for property, plant and equipment, specifically, to ensure the completeness, accuracy and validation of these acquisitions.” SAC ¶ 120. The 2012 annual report further disclosed that the Company “did not adequately design and maintain effective controls with respect to the impairment calculation of assets.” SAC ¶ 125. Each annual report from 2010 through 2013 also acknowledged that, despite the issues with internal controls, the financial statements were fairly presented in all material respects. See SAC ¶¶ 113, 122, 127, 132.

         The plaintiffs allege that Eletrobras significantly increased the use of Special Purpose Entities (“SPEs”) to conduct its business throughout the class period. See SAC ¶ 46-48. In 2013, the Company's internal audit unit conducted a special audit that showed an overall need to improve control processes over SPEs, specifically identifying that Eletrobras needed to develop, formalize and adopt a code of ethics with respect to SPEs, that shareholder agreements with SPEs did not contain provisions giving Eletrobras unrestricted access to technical and operational information in its SPEs, and that Eletrobras failed to require SPE partners to provide anticorruption statements attesting to no knowledge of unlawful business activities. SAC ¶ 248-49. These concerns were reiterated in a December 12, 2014 internal audit report that was allegedly circulated to Eletrobras's board of directors, including Carvalho; the report concluded that with respect to SPEs, “corporate management is a black hole and that the company lacks controls to approve their accounts.” SAC ¶ 249.

         In March 2014, a Brazilian criminal money laundering investigation known as “Operation Car Wash” uncovered evidence of a bribery scheme related to the state-run oil company, Petróleo Brasileiro S.A. (“Petrobras”). SAC ¶ 7. On October 24, 2014, a Brazilian newspaper reported that the investigation had expanded to include Eletrobras. SAC ¶ 271. On October 27, 2014, the value of Eletrobras ADSs fell 11.95%, and the following day, Eletrobras filed a Form 6-K with the SEC and issued a press release stating that all Eletrobras companies “respect the principles set out in its [sic] Code of Ethics, ” and that Eletrobras's corporate governance rules follow the laws of Brazil and the United States and “are observed by Eletrobras companies in its [sic] operations, including through the Special Purpose Entities. . . .” SAC ¶¶ 103, 271.

         On November 20, 2014, after media reports indicated that documents relating to an Eletrobras project were discovered in the office of a money-launderer at the center of the Petrobras bribery scandal, then-CEO Carvalho stated that “[w]e have a governance system, management, and internal control[s] that are very strong, and we are always looking to improve them.” SAC ¶ 104.

         On February 10, 2015, Eletrobras issued a 6-K, signed by Araújo, denying news reports claiming that the Company's auditor was requiring that Eletrobras include certain provisions related to corruption measures in the Company's financial statements, and stating that “the Company, through its internal controls and compliance program, did not identify the existence of any episode of fraud and corruption in its projects.” SAC ¶ 106. That day, Eletrobras ADSs declined nearly 7%. SAC ¶ 275.

         Beginning on February 28, 2015 and during the first two weeks in March 2015, reports surfaced that construction contracts for Angra 3 -- a thermonuclear reactor operated by wholly owned Eletrobras subsidiary Eletrobras Thermonuclear S.A. (“Eletronuclear”) -- may have been tainted by bribery and corruption as part of a scheme allegedly organized and executed in part by Chief Generation Officer Cardeal. SAC ¶¶ 12, 44B[3]. Between February 28, 2015 and March 12, 2015, the value of Eletrobras ADSs declined by over 19%. SAC ¶ 278.

         On April 29, 2015, in response to more news reports about potential bribery and corruption with the Angra 3 project, Eletrobras also filed a Form 6-K, signed by Araújo, “reiterating to its investors the Company's commitment to transparency and ethic[al] conduct in its business.” SAC ¶ 108.

         The Company delayed the filing of its 2014 Form 20-F annual report, missing the initial April 30, 2015 prescription date, the extended deadline of May 15, 2015, and a third deadline of November 18, 2015. SAC ¶ 19. On June 10, 2015, Eletrobras disclosed in an SEC filing that it had hired an international law firm to conduct an internal investigation related to the allegations stemming from Operation Car Wash. SAC ¶ 284. The investigation focused primarily on nine different projects that Eletrobras was involved in either directly through its subsidiaries or indirectly through investments in SPEs: (1) the “Angra 3” thermonuclear reactor; (2) the “Belo Monte” hydroelectric dam; (3) the “Jirau” hydroelectric plant; (4) the “Santo Antonio” hydroelectric plant; (5) the “Teles Pires” hydroelectric plant (6) the “São Manoel” hydroelectric plant; (7) the “Mauá 3” thermoelectric plant; (8) the “Tumarín” hydroelectric plant; and (9) the “Simplício” hydroelectric plant. SAC ¶ 8, 9, 15, 17.

         On October 11, 2016, Eletrobras eventually filed its Form 20-F 2014 and 2015 annual reports. See Campbell Decl., ECF. No 61, Ex. K, (2014 Annual Report); Ex. L (2015 Annual Report). The reports begin with an “explanatory note” describing the results of the Company's “independent internal investigation” that assessed “violations of the U.S. Foreign Corruption Practice Act (FCPA), the Brazilian Anticorruption Law and the Eletrobras' code of ethics.” Campbell Decl. Ex. K at 1, Ex. L at 1. It disclosed that a former officer of Eletronuclear was sentenced to 43 years in prison for passive bribery, money laundering, obstruction of justice, tax evasion, and participation in a criminal organization, and that other former officers had been formally charged with corruption, money laundering, and obstruction of justice. See id. Eletrobras also disclosed that “[s]ince the start of the investigation, the Company replaced its entire Board of Directors, hired a new CEO and a Compliance Officer, and created an independent Compliance Department to help coordinate compliance across subsidiaries.” Id.

         The explanatory note also disclosed the results of the internal investigation, stating that for some of Eletrobras's power generation projects, there was “overpricing related to bribery and bid-rigging (a form of fraud in which a commercial contract is promised to one party even though for the sake of appearance several other parties also present a bid. This practice is illegal in most countries) activities deemed to be of an illicit nature in some contracts, since 2008.” Campbell Decl. Ex. K at 2, Ex. L at 2. It went on to note that “[t]he Independent Investigation discovered bribes used to fund improper payments to political parties, elected officials or other public officials, individual contractor personnel, former personnel of subsidiaries or SPEs of Eletrobras and other individuals involved in bid-rigging.” Id.

         Because the Company could not identify the exact timing of these improper payments, Eletrobras determined that the amount of Property Plant and Equipment (“PP&E”) improperly capitalized because of overpricing due to illicit bribes or bid-rigging prior to December 31, 2014 would be written off and expensed in the 2014 annual report, while any improperly capitalized amounts for contracts entered into between December 31, 2014 and December 31, 2015 would be written off and expensed in the 2015 annual report. Campbell Decl. Ex. K at 2-3, Ex. L at 2-3.

         As a result, the Company recognized a loss totaling R$[4]195.1 million in 2014 and R$ 16.0 million in 2015. Campbell Decl. Ex. K at 3, Ex. L at 3. The R$ 195.1 million expensed in 2014 represented illicit payments of R$ 129.8 million for the Angra 3 thermonuclear reactor project, R$ 62.7 million for the Mauá 3 thermoelectric plant project, and R$ 2.6 million in illicit payments made for the Simplício hydroelectric plant. Campbell Decl. Ex. L at F-78; SAC ¶¶ 70, 74. The R$ 16.0 million expensed in 2015 represented illicit payments of R$ 11.5 million made for the Angra 3 project, and R$ 4.5 million for the Mauá 3 project. Campbell Decl. Ex. L at F-78. Eletrobras also recognized a R$ 91.5 million loss in 2014 due to illicit payments for its equity method investments in certain SPEs not controlled by the Company, but did not specify which SPE projects were impacted by payments related to bribery or bid-rigging. Id.


         The plaintiffs assert three claims. In Count One, the plaintiffs allege violations of Section 10(b) of the Exchange Act and Rule 10b-5 against Eletrobras, Lopes, Carvalho, and Araújo based on alleged misrepresentations and omissions. In Count Two, the plaintiffs allege violations of Section 10(b) of the Exchange Act and Rule 10b-5(a) and (c) against all defendants based on alleged “scheme liability.” In Count Three, the plaintiffs allege control person liability in violation of Section 20(a) of the Exchange Act against Lopes, Carvalho, Araújo, and Cardeal.

         Eletrobras, Lopes, Carvalho, and Araújo now move to dismiss the plaintiffs' claims.


         The defendants argue that the named plaintiffs, purchasers of Eletrobras ADSs during the class period, lack standing to bring claims on behalf of purchasers of Eletrobras bonds. “[I]n a putative class action, a plaintiff has class standing if he plausibly alleges (1) that he personally has suffered some actual . . . injury as a result of the putatively illegal conduct of the defendant, and (2) that such conduct implicates the same set of concerns as the conduct alleged to have caused injury to other members of the putative class by the same defendants.” NECA-IBEW Health & Welfare Fund v. Goldman Sachs & Co., 693 F.3d 145, 162 (2d Cir. 2012) (citation and quotation marks omitted); see also In re Winstar Commc'ns Sec. Litig., 290 F.R.D. 437, 452 (S.D.N.Y. 2013) (concluding that an alleged misstatement in a Form 10-K's unqualified audit letter “implicate[d] the same set of concerns for all investors in [the defendant's] securities, including stocks and bonds, because of their common concern for the company's financial health”).

         As purchasers of Eletrobras's ADSs during the class period, the named plaintiffs have plausibly pleaded that they suffered some actual injury as a result of the allegedly material misrepresentations in Eletrobras's annual reports, press releases, and public statements in a way that “was broadcast at the same time to all members of the public, prospective shareholders and prospective bondholders alike.” Winstar, 290 F.R.D. at 452.

         The defendants argue that class standing on behalf of bondholders should be denied because there are fundamental differences between the characteristics of ADSs and bonds. While the accompanying levels of risk between ADSs and bonds do differ, the Second Circuit Court of Appeals has made clear that “varying levels of payment priority [do not] raise such a fundamentally different set of concerns as to defeat class standing.” NECA, 693 F.3d at 164 (citation and quotation marks omitted).[5] ...

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