FILED
NOT FOR PUBLICATION JUN 07 2013
MOLLY C. DWYER, CLERK
UNITED STATES COURT OF APPEALS U .S. C O U R T OF APPE ALS
FOR THE NINTH CIRCUIT
THE HEMMER GROUP, No. 11-56154
Plaintiff - Appellant, D.C. No. 2:08-cv-07844-JHN-
AGR
v.
SOUTHWEST WATER COMPANY; MEMORANDUM *
ANTON C. GARNIER; MARK A.
SWATEK; CHERYL L. CLARY; PETER
J. MOERBEEK,
Defendants - Appellees.
Appeal from the United States District Court
for the Central District of California
Jacqueline H. NGUYEN, District Judge, Presiding
Argued and Submitted April 10, 2013
Pasadena, California
Before: REINHARDT and MURGUIA, Circuit Judges, and LASNIK, District
Judge.**
*
This disposition is not appropriate for publication and is not precedent
except as provided by 9th Cir. R. 36-3.
**
The Honorable Robert S. Lasnik, District Judge for the U.S. District
Court for the Western District of Washington, sitting by designation.
This securities class action stems from SouthWest Water’s announcement
that its financial statements for 2005, 2006, and 2007 could no longer be relied on
and that the company intended to file restated financials for those years. The
company filed restated financials on July 9, 2009. According to the company, the
restatement “correct[ed] errors in the consolidated financial statements.” The
restatement resulted in a massive downward adjustment of operating income. The
adjustment of revenue was not as severe, but was negative for all years. The
complaint alleges that the restatement negatively changed many key financial
numbers. The company also disclosed that it did not “maintain an effective control
environment” due to 15 enumerated “material weaknesses.”
The Second Consolidated Amended Class Action Complaint alleges
violations of: Section 11 of the Securities Act against all Defendants; Section 15 of
the Securities Act against the individual Defendants; Section 10(b) of the
Securities Exchange Act against all Defendants; Section 20(a) of the Securities
Exchange Act against the individual Defendants; and Section 20A of the Securities
Exchange Act against Granier and Moerbeek. Defendants moved to dismiss the
complaint for failure to state a claim under F.R.C.P. 12(b)(6). The district court
granted the motion and dismissed all claims with prejudice.
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The district court had jurisdiction under the Securities Act (15 U.S.C. §§
77k, 77o) and the Securities Exchange Act (15 U.S.C. §§ 78j(b), 78t(a–b), 78t-
1(a)). We have jurisdiction pursuant to 28 U.S.C. § 1291. We review a motion to
dismiss for failure to state a claim under Federal Rule of Civil Procedure 12(b)(6)
de novo. Zucco Partners, LLC v. Digimarc Corp., 552 F.3d 981, 989 (9th Cir.
2009).
I.
To establish a claim under Section 11 of the Securities Act, Plaintiff must
show “(1) that the registration statement contained an omission or
misrepresentation, and (2) that the omission or misrepresentation was material, that
is, it would have misled a reasonable investor about the nature of his or her
investment.” Rubke v. Capitol Bancorp Ltd, 551 F.3d 1156, 1161 (9th Cir. 2009)
(quoting In re Daou Sys., Inc., 411 F.3d 1006, 1027 (9th Cir. 2005)). Section 11 is
a strict liability statute and does not require fraudulent intent. Daou, 411 F.3d at
1027.
Because the Section 11 allegation “sounded in fraud” it is subject to the
heightened pleading requirements of Rule 9. Vess v. Ciba-Geigy Corp. USA, 317
F.3d 1097, 1103–04 (9th Cir. 2003) (Section 11 claims that rely on a “unified
course of fraudulent conduct” are subject to Rule 9(b)).
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The financial statements issued by SouthWest during the class period were,
by SouthWest’s own admission, incorrect. By definition, a restatement corrects
financial data that was false when made. The complaint adequately alleges the
originally reported financial data, the restated financial data, and the difference
between the two. The complaint adequately alleges falsity.
A fact is material if there is “a substantial likelihood that the disclosure of
the omitted fact would have been viewed by the reasonable investor as having
significantly altered the ‘total mix’ of information made available.” Matrixx
Initiatives, Inc. v. Siracusano, 131 S. Ct. 1309, 1318 (2011) (quoting Basic v.
Levinson, 485 U.S. 224, 231–32 (1988)). Materiality should be resolved as a
matter of law in the defendant’s favor “only if the omitted fact is so obviously
unimportant that no reasonable shareholder could have viewed it as significantly
altering the ‘total mix’ of information made available to stockholders.” Zell v.
InterCapital Income Sec., Inc., 675 F.2d 1041, 1045 (9th Cir. 1982) (quoting TSC
Industries, Inc. v. Northway, Inc., 426 U.S. 438, 449 (1976)). The misstatements
alleged in the complaint were material and not obviously unimportant.
Allegations of “improper accounting requiring a restatement does not, by
itself, establish materiality.” United States v. Reyes, 660 F.3d 454, 470 (9th Cir.
2011). A plaintiff must “show with particularly how the [accounting irregularities]
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affected the company’s financial statements and whether they were material in
light of the company’s overall financial position.” Daou, 411 F.3d at 1018. A
restatement can “be used as evidence” to support such a showing. Reyes, 660 F.3d
at 470.
The complaint pleads materiality with sufficient particularity. The
complaint describes “massive” changes in financial data including downward
revisions in Net Income from 2004 to 2007 to between 33% and 100% of
previously recorded income. The complaint reproduces a chart from SouthWest’s
2008 10-K that identifies the Operating Income, Income from Continuing
Operations, Income from Discontinued Operations, and Net Income as originally
stated, the amount it was restated by, and the restated amount for 2004 to 2007.
These allegations, especially when combined with the fact that the SouthWest
restated its financials, are sufficient to plead materiality.
We REVERSE the dismissal of the Section 11 claims.
II.
To prevail on a claim for fraudulent misrepresentation under Section 10(b)
of the Securities Exchange Act of 1934, Plaintiff must allege: “(1) a material
misrepresentation or omission by the defendant; (2) scienter; (3) a connection
between the misrepresentation or omission and the purchase or sale of a security;
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(4) reliance upon the misrepresentation or omission; (5) economic loss; and (6)
loss causation.” Stoneridge Inv. Partners, LLC v. Scientific-Atlanta, 552 U.S. 148,
157 (2008).
Plaintiff must establish that the misrepresentations were made with “a
mental state embracing intent to deceive, manipulate, or defraud.” Matrixx, 131 S.
Ct. at 1323. It is sufficient to demonstrate that the defendant acted with “deliberate
recklessness.” S.E.C. v. Platforms Wireless Intern. Corp., 617 F.3d 1072, 1093
(9th Cir. 2010); Hollinger v. Titan Capital Corp., 914 F.2d 1564, 1568–69 (9th
Cir. 1990) (en banc); see also Tellabs, Inc. v. Makor Issues & Rights, Ltd., 551
U.S. 308, 319 n.3 (2007) (noting that all courts of appeals have found recklessness
sufficient).
The Private Securities Litigation Reform Act (“PSLRA”) imposes a special
pleading regime over the substantive law of scienter and the complaint must “state
with particularity facts giving rise to a strong inference that the defendant acted
with the required state of mind.” 15 U.S.C. § 78u–4(b)(2)(A). A complaint
survives a motion to dismiss “only if a reasonable person would deem the
inference of scienter cogent and at least as compelling as any opposing inference
one could draw from the facts alleged.” Tellabs, 551 U.S. at 324.
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The complaint here does not survive because the more likely inference from
the facts alleged is that SouthWest was at most negligent in its failure to maintain
proper accounting internal controls. Most of the facts alleged in the complaint are
consistent with both the fraudulent and non-fraudulent inference. But the facts
that: (1) the company disclosed potential problems in its accounting system during
the class period; (2) the Confidential Witness testified that the company was
making efforts to improve its accounting system; and (3) the accounting errors
originated from distinct geographic regions, are consistent only with the non-
fraudulent inference. The inference of scienter is therefore not as compelling as
the inference of negligence.
We AFFIRM the dismissal of the Section 10(b) claims.
III.
The Section 20(a) and Section 20A claims require a violation of Section
10(b). Because we affirm the dismissal of the Section 10(b) claims, we also affirm
the dismissal of the Section 20(a) and 20A claims.
The complaint does, however, state a claim for violation of Section 11, and
therefore if Defendants “exercised actual power or control over the primary
violator,” they are liable for a violation of Section 15 of the Securities Act. Howard
v. Everex Systems, Inc., 228 F.3d 1057, 1065 (9th Cir. 2000). At the pleading
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stage, Plaintiffs must only show authority to exercise such power, rather than
actual exercise of such power. Id. Here, the complaint sufficiently alleges that the
executives were control persons based on their role in the company. Specifically,
the complaint alleges that Defendants signed registration statements containing the
false financial statements. Howard, 228 F.3d at 1066 (denying motion of
executive that signed financial statements); Paracor Fin., Inc. v. Gen. Elec. Capital
Corp., 96 F.3d 1151, 1161 (9th Cir. 1996) (denying summary judgment motion of
CEO that signed allegedly false statements). We therefore reverse the dismissal of
the Section 15 claims.
AFFIRMED IN PART, REVERSED IN PART, and REMANDED.
Each party shall bear their own costs on appeal.
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