Friday, September 4, 2015

An “Unremarkable” Securities Law Decision from the Sixth Court Of Appeals

An “Unremarkable” Securities Law Decision from the Sixth Court Of Appeals

      Only occasionally do cases applying the federal securities law come before the Sixth Circuit Court of Appeals. Therefore, any decision they render in the field is noteworthy simply for that fact. That said, substantively, and here utilizing the description of another commentator, a recent decision from the Sixth Circuit Court of Appeals affirming the dismissal of certain allegations of securities fraud is of itself “unremarkable.” Bondali v. Yum! Brands, Inc., No. 15-5064, CCH Fed. Sec. Rptr. ¶ 98603 (6th Cir. Aug. 20, 2015).
      Yum! Brands, through its KFC (f/k/a Kentucky Fried Chicken) restaurants, has a significant presence in China. The Chinese market is of course well known for issues of food safety. When reports surfaced to the effect that KFC restaurants for selling chicken that had been possibly adulterated with drug and antibiotic residues, sales weakened and the price of Yum! Brands stock fell. Bondali brought a securities class action against Yum! Brands and certain of its executives asserting that disclosures made with respect to food safety were misleading.  Those allegations were rejected by the trial court, and that rejection was in turn affirmed by the Sixth Circuit Court of Appeals.

       Ultimately, the securities fraud suit failed for a pair of reasons, either of which, of itself, would have been sufficient to justify dismissal. First, the plaintiff failed to identify any actionable misstatements by the company. Second, the plaintiffs failed to demonstrate the necessary degree of “scienter” (i.e., recklessness). Both are necessary as part of a successful claim for securities fraud.
      In the Complaint, the plaintiff’s pointed to a number of statements, alleging they are misrepresentations or were incomplete as to the food safety standards and protocols utilized in China as well as a failure to completely disclose the risks that arise from food safety issues. Rather than being misstatements, both the trial court and the Court of Appeals found that the descriptions of the protocols and procedures utilized by Yum! were accurate. No claim for securities violation could be based upon the assertion that the protocols and procedures could be different, broader, etc.
It is also difficult to see how Yum misled investors by describing its food quality and safety standards as “strict.”  The fact of the matter is Yum had multiple protocols in place to promote food quality and safety, including spot checks, supplier evaluations, and an auditing system.  Describing those protocols as “strict” was reasonably grounded in objective fact and, thus, is not “disproven” just because Yum could have strengthened its standards and protocols.  By pointing out the structural weaknesses of Yum’s standards and protocols, all the plaintiffs have done is shown that whether Yum’s standards and protocols could be described as “strict” is a question subject to reasonable debate. Slip op., at 9-10.
In addition, it was held that statements set forth in internal procedure manuals were not representations upon which a claim for securities fraud could be based.
      As to the required element of scienter, both courts found that the plaintiffs have failed to demonstrate that the corporate officers of Yum! knew or should have known that the statements being made were misleading.

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