Wednesday, August 19, 2015

Complaint Over Nondisclosure of Pledged Shares Falls Short

By Anne Sherry, J.D.

The PSLRA ensnared a complaint alleging that the former CEO of ZAGG, Inc.’s failure to disclose that he had pledged his shares rose to the level of fraud. The Tenth Circuit affirmed the district court’s dismissal of the suit, holding that the plaintiffs did not meet the PSLRA’s heightened pleading requirement of alleging intent to defraud with particularity (In re ZAGG, Inc. Securities Litigation, August 18, 2015, Tymkovich, T.).

Background. According to the complaint, prior to the class period, Robert Pedersen—the co-founder of the electronics accessories company, and its CEO and chairman at the time—pledged almost half of his ZAGG shares on margin as collateral. ZAGG did not disclose Pedersen's pledged shares as it was required to do under Regulation S-K. In December 2011, and twice more in August 2012, margin calls forced Pedersen to sell his shares. In late August 2012, ZAGG announced Pedersen's resignation, which was attributed to the margin calls.

The complaint, filed in the district of Utah, alleged that Pedersen and several other ZAGG officers and directors deceived the investing public and artificially inflated and maintained ZAGG's stock price, which caused the plaintiffs to purchase ZAGG stock at artificially inflated prices. Specifically, the plaintiffs alleged that the defendants failed to disclose Pedersen's pledges and that ZAGG had a secret succession plan for replacing Pedersen.

Dismissal. The district court found that the plaintiffs’ allegations established that Pedersen knew of the pledged shares but failed to give rise to an inference that he intended to deceive investors or recklessly disregarded a risk of misleading investors. Reviewing the dismissal de novo, the appeals court agreed. Contrary to the plaintiffs’ arguments, the defendants’ statements on ZAGG’s filings were not inconsistent. Furthermore, neither Pedersen’s position nor the failure to comply with a regulatory requirement was, by itself, enough to raise a strong inference of scienter, and the only particularized fact alleged in support of the claim that Pedersen understood the risk of his pledging was a statement made months after the alleged omissions occurred.

Even giving the plaintiffs the benefit of the doubt that the complaint raised some inference of scienter, it was not “at least as compelling as any opposing inference one could draw from the facts alleged.” The defendants put forward the plausible inference that Pedersen did not know of the Regulation S-K requirement and believed he appropriately disclosed the margin account following each margin call. A reasonable person would not deem the inference of scienter to be at least as strong as the nonculpable inference set forth by the defendants, the court concluded.

The case is No. 14-4026.