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Eaton Class Action Plaintiffs Argue Court Erred in Dismissing Suit

MAR. 8, 2019

South Carolina Retirement Systems Group Trust et al. v. Eaton Corp. PLC et al.

DATED MAR. 8, 2019
DOCUMENT ATTRIBUTES

South Carolina Retirement Systems Group Trust et al. v. Eaton Corp. PLC et al.

SOUTH CAROLINA RETIREMENT SYSTEMS GROUP TRUST,
Plaintiff-Appellant,
STEAMFITTERS LOCAL 449 PENSION PLAN, individually and on behalf of all others similarly situated, HELENE GABRIELE, Individually and on behalf of all others similarly situated,
Plaintiffs,
v.
EATON CORPORATION PLC, ALEXANDER CUTLER, RICHARD FEARON,
Defendants-Appellees.

IN THE
United States Court of Appeals

FOR THE SECOND CIRCUIT

ON APPEAL FROM THE UNITED STATES DISTRICT COURT
FOR THE SOUTHERN DISTRICT OF NEW YORK

REPLY BRIEF FOR PLAINTIFF-APPELLANT

THOMAS A. DUBBS
LOUIS GOTTLIEB
JEFFREY A. DUBBIN
LABATON SUCHAROW LLP
140 Broadway
New York, New York 10005
(212) 907-0700
Attorneys for Plaintiff-Appellant


TABLE OF CONTENTS

TABLE OF AUTHORITIES

PRELIMINARY STATEMENT

ARGUMENT

I. Materiality Is Plausibly Pled

A. Well-Pled Facts, Unchallenged by Defendants, Show that Their Misstatements Were Material, Their Limited Denials Notwithstanding

1. Analyst Reports Show Defendants' Misstatements Were Material

2. The Fact that Defendants' Misstatements Were Made in Direct Response to Analyst Questions Supports Their Materiality

3. Expert Analyses Show the Omitted Facts Were Material

B. The Market's Reaction to the Corrective Disclosure Establishes Materiality, Defendants' Denials Notwithstanding

1. Eaton's Highly Unusual 8% Stock Drop Strongly Supports Materiality

2. Analyst Backlash Supports Materiality

C. Defendants' Denials Were Not, as a Matter of Law, “Unequivocal”

D. The District Court Erred by Weighing Causation Evidence, Misreading the Record in the Process, Requiring Reversal

E. The Basic Test Does Not Apply

F. The District Court Did Not Apply Basic Correctly

II. The Truth Was Not Already Known During the Class Period

A. Key Facts Remained Undisclosed

B. The Legal Impact Was Also Undisclosed

III. Falsity Is Plausibly Pled with Particularity

A. Statement Nos. 1-10 Were False, Misleading, and/or Created False Impressions

B. Defendants Concede Statement Nos. 3 And 4 Were Affirmatively False

C. All Ten Misstatements Triggered Defendants' Duty to Tell the Whole Truth

IV. A Strong Inference of Scienter Is Pled

A. Defendants Spoke with Knowledge that Their Statements Would Mislead and While Knowing They Were False

1. The Repeated Nature of Defendants' Misstatements Support a Strong Inference of Scienter

2. Defendants' Admissions Sufficiently Plead a Strong Inference of Scienter

B. Defendants Spoke at Least Recklessly

C. Defendants' Insider Trading Also Creates a Strong Inference of Scienter

V. The Class Period Properly Runs from May 21, 2012 through July 28, 2014

A. The Pleaded Class Period Is the Only “Real” Class Period

B. The SAC Relates Back to the Initial Complaint, Mooting the Issue

CONCLUSION

TABLE OF AUTHORITIES

Cases

Amgen Inc. v. Conn. Ret. Plans & Trust Funds, 568 U.S. 455 (2013)

Basic Inc. v. Levinson, 485 U.S. 224 (1988)

In re Bristol Myers Squibb Sec. Litig., 586 F. Supp. 2d 148 (S.D.N.Y. 2008)

Caiola v. Citibank, N.A., New York, 295 F.3d 312 (2d Cir. 2002)

Castellano v. Young & Rubicam, Inc., 257 F.3d 171 (2d Cir. 2001)

Christine Asia Co. v. Ma, 718 F. App'x 20 (2d Cir. 2017)

In re Enzymotec Sec. Litig., 2015 WL 8784065 (D.N.J. Dec. 15, 2015)

Fin. Guar. Ins. Co. v. Putnam Advisory Co., LLC, 783 F.3d 395 (2d Cir. 2015)

Ganino v. Citizens Util. Co., 228 F.3d 154, 167 (2d Cir. 2000)

Gerstle v. Gamble-Skogmo Inc., 478 F.2d 1281 (2d Cir. 1973)

Heliotrope Gen., Inc. v. Ford Motor Co., 189 F.3d 971 (9th Cir. 1999)

Institutional Inv'rs Grp. v. Avaya, Inc., 564 F.3d 242 (3d Cir. 2009)

Kleinman v. Elan Corp., PLC, 706 F.3d 145 (2d Cir. 2013)

Lincoln Prop. Co. v. Roche, 546 U.S. 81 (2005)

Litwin v. Blackstone Grp., LP, 634 F.3d 706 (2d Cir. 2011)

Makor Issues & Rights, Ltd. v. Tellabs Inc., 437 F.3d 588 (7th Cir. 2006), vacated in part on other grounds, 551 U.S. 308 (2007)

Matrixx Initiatives, Inc. v. Siracusano, 563 U.S. 27 (2011)

Meyer v. JinkoSolar Holdings, 761 F.3d 245 (2d Cir. 2014)

New Orleans Emps. Ret. Sys. v. Celestica, Inc., 455 F. App'x 10 (2d Cir. 2011)

Novak v. Kasaks, 216 F.3d 300 (2d Cir. 2000)

Omnicare, Inc. v. Laborers Dist. Council Const. Indus. Pension Fund, 135 S. Ct. 1318 (2015)

In re Oxford Health Plans, Inc. Sec. Litig., 187 F.R.D. 133 (S.D.N.Y. 1999)

In re Progress Energy, 371 F. Supp. 2d 548 (S.D.N.Y. 2005)

Pub. Emps. Ret. Sys. of Miss. v. Amedisys, Inc., 769 F.3d 313 (5th Cir. 2014)

Rothman v. Gregor, 220 F.3d 81 (2d Cir. 2000)

In re Sanofi-Aventis Sec. Litig., 774 F. Supp. 2d 549 (S.D.N.Y. 2011)

In re Scholastic Corp. Sec. Litig., 252 F.3d 63 (2d Cir. 2001)

Sirota v. Solitron Devices, 673 F.2d 566 (2d Cir. 1982)

Slayton v. Am. Exp. Co., 604 F.3d 758 (2d Cir. 2010)

Stevelman v. Alias Research Inc., 174 F.3d 79 (2d Cir. 1999)

U.S. v. Schiff, 602 F.3d 152 (3d Cir. 2010)

In re Vivendi, S.A. Sec. Litig., 838 F.3d 223 (2d Cir. 2016)

Other Authorities

5C Arnold S. Jacobs, Disclosure and Remedies Under the Securities Laws § 12:77 (2018)

Brief for Defendants-Appellees Stevelman v. Alias Research Inc., 1998 WL 35155442 (2d Cir. Apr. 8, 1998)

Donald P. Board, Tell It to Your Analyst? Inversions, Spin-Offs, and Rule 10b-5, The M&A Tax Report, Vol. 26, No. 5, December 2017

Robert Rothman, Back to the Bog: The IRS's New Policy on Spin-off Rulings Leaves Practitioners With a Sinking Feeling, 30 J. Corp. Tax'n 3 (2003)


PRELIMINARY STATEMENT

During the Class Period, at least sixteen sophisticated analysts wrote about the benefits to investors of Eaton divesting its Vehicle division, particularly through a tax-free spin-off. These analysts repeatedly questioned Defendants regarding not only their interest in such a divestiture, but also regarding Eaton's ability to enter into it. In short, they were focused on whether Eaton had the option to enter into such a transaction.

Through ten false and misleading statements, Defendants said that they had no current or active plans to divest the Vehicle division, though “nothing is a sacred cow.” JA388-89:¶215.1 Defendants' hedged answers intentionally or recklessly misled investors.

In its Order, the district court effectively ignored the questions and reports of the sixteen analysts, detailed in the Second Amended Complaint (“SAC”), which showed that the market was misled. And it ignored that Defendants' hedged denials of current intent sent a clear message to investors that the option to sell the Vehicle division was still on the table.

On July 29, 2914, Defendants finally admitted that it was “not possible to do a tax free spin [off] for five years” (JA369:¶167) and “that it's not simply an issue of will” but actually a “kind of prohibition” (JA368:¶164). And Cutler confessed that Defendants were “well aware of this all along.” JA369:¶¶167-68. On this news, the price of Eaton shares dropped 8.2%, its largest single-day decline in six years. JA317:¶27. Goldman Sachs, J.P. Morgan, and Deutsche Bank immediately downgraded Eaton's stock because of these revelations. JA371-72:¶¶174-77.

ARGUMENT

While this Court may affirm on any ground, it bears notice that Defendants' Brief (“DB”) advances alternative grounds for affirmance more often than it defends the Order below. Tellingly, the errors below catalogued in Plaintiff's Brief (“PB”) go largely unrebutted. The district court failed to accept well-pled allegations of materiality, falsity, and scienter as true — as it must under Tellabs — and should be reversed for that reason alone. Defendants' alternative grounds do not withstand scrutiny.

I. Materiality Is Plausibly Pled

Defendants' statements concealing Eaton's tax constraint were material. The SAC's allegations, which remain largely unchallenged, make that conclusion at least plausible. See Kleinman v. Elan Corp., PLC, 706 F.3d 145, 152 (2d Cir. 2013) (to survive a motion to dismiss “[f]or a violation of Section 10(b) and Rule 10b–5, a plaintiff must plead a plausible claim”).

A. Well-Pled Facts, Unchallenged by Defendants, Show that Their Misstatements Were Material, Their Limited Denials Notwithstanding

1. Analyst Reports Show Defendants' Misstatements Were Material

Defendants do not challenge Plaintiff's allegations that at least sixteen stock analysts unanimously expected that a spin-off of Eaton's Vehicle division was a definite possibility and a valuable option throughout the Class Period, nor do they dispute that analysts serve as a proxy for what was important to investors. PB:26-28. Defendants do not even discuss the myriad cases cited in support of this conclusion. Id. (citing Ganino, Scholastic, CVS Caremark, and NovaGold). And they do not defend the district court's reversible error in “discredit[ing]” these “significant allegations on which Plaintiffs' claims relied.” See Christine Asia Co. v. Ma (“Alibaba”), 718 F. App'x 20, 23 (2d Cir. 2017).

Instead, Defendants, adopting the catchy jargon of the Court below, insist that “the hypothetical tax consequences of a hypothetical spin-off” could not plausibly be material as a matter of law. DB:30-31, 38-41.

Was the possibility of a transaction truly “hypothetical,” as the district court found as “fact” (on a motion to dismiss), and as Defendants repeat? Based on everything Defendants actually said, analysts did not think the possibility was hypothetical. The never-denied possibility of a transaction remained very real to the market until the July 29, 2014 corrective disclosure. See JA368-69:¶166 (analyst demanding to know on July 29, 2014 “why we're kind of learning of a five year limitation now”); JA372:¶177 (Deutsche Bank analyst downgrading Eaton's stock because “the company threw cold water on” a “key element to our previous [Eaton] recommendation” while noting “Eaton had not previously publicly discussed these items”).

Objectively, from the perspective of a reasonable investor throughout the Class Period, there was nothing hypothetical about the possibility of a tax-free spin-off. See In re Vivendi, S.A. Sec. Litig., 838 F.3d 223, 250 (2d Cir. 2016) (“Whether a misrepresentation is material is 'judged according to an objective standard' based on 'the significance of an omitted or misrepresented fact to a reasonable investor.'” (quoting Amgen Inc. v. Conn. Ret. Plans & Trust Funds, 568 U.S. 455, 459 (2013)).

2. The Fact that Defendants' Misstatements Were Made in Direct Response to Analyst Questions Supports Their Materiality

Importantly, the analysts' shared understanding that spin-offs remained a valuable option was not fanciful speculation. Rather, analysts asked Defendants about it specifically and repeatedly, and seven of Defendants' false and misleading statements came as direct responses to such questions. PB:12-16.

Multiple courts recognize that when a false or misleading statement is made in direct response to an analyst's inquiry, its materiality is more plausible. E.g.Makor Issues & Rights, Ltd. v. Tellabs Inc., 437 F.3d 588, 597 (7th Cir. 2006), vacated in part on other grounds, 551 U.S. 308 (2007); In re Sanofi-Aventis Sec. Litig., 774 F. Supp. 2d 549, 568-69 (S.D.N.Y. 2011). Defendants made no response to this argument (PB:29-30), nor do they defend the district court's decision discrediting well-pled allegations of materiality (PB:31, 34-39, 41-44). This was reversible error. See Alibaba, 718 F. App'x at 23.

3. Expert Analyses Show the Omitted Facts Were Material

Defendants' brief makes no mention of the SAC's allegations that two experts measured Eaton's option to spin-off its Vehicles business tax-free and concluded the option was worth billions of dollars during the Class Period, based on then-available information. PB:30-32. Nor do Defendants respond to the experts' analysis that a taxable divestment would have reduced Eaton's value by billions of dollars, making any sale or spin-off economically unworkable. Moreover, at least one analyst report incorporated the value of this option into its recommendations to buy Eaton stock. PB:31. The district court ignored these allegations, which supported materiality. Unrebutted, they strongly support the conclusion that the SAC “alleged facts plausibly suggesting that reasonable investors would have viewed” the truth “as material.” See Matrixx Initiatives, Inc. v. Siracusano, 563 U.S. 27, 31 (2011).

B. The Market's Reaction to the Corrective Disclosure Establishes Materiality, Defendants' Denials Notwithstanding

1. Eaton's Highly Unusual 8% Stock Drop Strongly Supports Materiality

Defendants do not, and cannot, contest that a “'precipitous decrease in share price'” after “'disclos[ing] the truth'” supports materiality, as this Court has held. PB:34 (quoting New Orleans Emps. Ret. Sys. v. Celestica, Inc., 455 F. App'x 10, 16 (2d Cir. 2011)); see also U.S. v. Schiff, 602 F.3d 152, 172 (3d Cir. 2010) (“'[T]he materiality of disclosed information may be measured post hoc by looking to the movement, in the period immediately following disclos[ure], of the price of the firm's stock.'”) (quoting Oran v. Stafford, 226 F.3d 275, 282-83 (3d Cir. 2000) (Alito, J.)). Nor do they contest that Eaton's share price declined precipitously on July 29, 2014 — 8.2%, its largest drop in six years (JA370-71:¶¶172-73) — because of Defendants' revelations that day. PB:33-34. This allegation strongly supports materiality.

2. Analyst Backlash Supports Materiality

Defendants do not contest that “'sharp criticism from industry analysts after'” a corrective disclosure “further indicates the weight given to [the omitted] information,” i.e., its materiality. PB:32-33 (quoting In re Scholastic Corp. Sec. Litig., 252 F.3d 63, 76 (2d Cir. 2001)). Nor do they dispute that “numerous analysts reacted critically to Defendants' July 29, 2014 disclosures” in the reports that ensued, including immediate downgrades from Goldman Sachs, J.P. Morgan, and Deutsche Bank. Id.

Defendants ask this Court to focus on the questions analysts asked during the July 29, 2014 conference call. DB:11-12, 39 n.10 (noting analysts did not ask follow-up questions about the tax revelation until the twenty-fifth question). It is a new argument never made before in this litigation, and with good reason: it's meaningless. Defendants chose which analysts could ask questions on that call, and in what order. See JA106. And there are many reasons why an analyst may refrain from criticizing Defendants during the call. Significantly, all three of the analysts who immediately downgraded Eaton's stock because of the spin-off revelation that day (Goldman Sachs, J.P. Morgan, and Deutsche Bank) were on the call and saved their criticisms for their reports. JA107-08, JA110-11. Moreover, the fact that even one analyst directly criticized Defendants about the spin-off news during the call (JA368-69:¶166) speaks volumes. See Scholastic, 252 F.3d at 76 (“sharp criticism from industry analysts after [the corrective disclosure] further indicates” materiality).

In any event, Defendants' new argument ignores the parade of negative commentary about the news from at least eight analysts within a day of the call. See PB:32-33. These allegations (JA371-74:¶¶174-185) strongly support materiality.

C. Defendants' Denials Were Not, as a Matter of Law, “Unequivocal”

Contrary to Defendants' arguments, their denials about divestment plans were hedged, time-limited, and incomplete insofar as Defendants were always careful to leave open the possibility of spin-offs, thereby misleading analysts and investors. PB:17-18. Defendants disagree, saying they “repeatedly” and “actively disavowed any interest in the transaction in question.” DB:39-40. However, this factual dispute is “inappropriate for resolution on a motion to dismiss,” Fin. Guar. Ins. Co. v. Putnam Advisory Co., LLC, 783 F.3d 395, 405 (2d Cir. 2015), and runs afoul of the requirement to “assum[e] the complaint's allegations to be true.” Matrixx, 563 U.S. at 28.

On their face, the denials were at least equivocal. Both briefs cite the denials at length. Plaintiff submits that its unedited quotation of four of the denials at issue (PB:12-14) and lengthy discussion of these, plus a fifth denial (PB:17 & n.8), shows the Court their incompleteness. In contrast, Defendants employ eight ellipses and thirteen alterations using brackets to describe their denials. DB:7-11 (omitting hedging language, e.g., “at this point” from February 5, 2013 denial). Further, Plaintiff highlights precisely the hedged parts (e.g., denial of having “active” plans or discussions for spin-offs “at this point” or “right now”) that made each denial materially less than the truth that Eaton had no option to divest its Vehicles division for five years. PB:17. These hedges mattered because “a denial can only neutralize a misrepresentation if it 'tracks the substance of the alleged misrepresentation.'” See PB:39 (quoting Caiola v. Citibank, N.A., New York, 295 F.3d 312, 330 (2d Cir. 2002).

Indeed, market commentary proved that Defendants' denials were insufficient to neutralize the fraud. Plaintiff quoted five analysts and business writers acknowledging the equivocal aspects of Defendants' denials. PB:35-37.2

Taking these allegations as true, it is more than plausible that Defendants' equivocal denials did not neutralize the materiality of what they concealed. See Matrixx, 563 U.S. at 31 (pleading standard for materiality is plausibility). In fact, the M&A Tax Report independently concluded that Defendants' denials were not a “binding commitment” and left open the possibility of spin-offs “if conditions changed.”3 See JA:467, Donald P. Board, Tell It to Your Analyst? Inversions, Spin-Offs, and Rule 10b-5, The M&A Tax Report, Vol. 26, No. 5, December 2017, http://www.woodllp.com/Publications/Articles/pdf/Tell_It.pdf.

D. The District Court Erred by Weighing Causation Evidence, Misreading the Record in the Process, Requiring Reversal

The district court found “reason to discount” the SAC's allegation that Defendants' admissions caused Eaton's stock drop on July 29, 2014. SPA22. Finding facts and weighing evidence about alternative causes for the drop (an affirmative defense), the district court misread the record — an error Defendants do not even try to defend. DB:39. The opinion below looked outside the SAC for “other negative news” that day, mistook one analyst's personal reduction in “earnings per share estimates” for the Company's official guidance, and then erroneously treated another item discussed (Eaton's lower profit margins in segments) as news, even though it had been announced three months prior. See PB:41-42. In reality, no reduction in earnings per share guidance even happened.4 PB:42. Defendants' brief mixes up these two issues and defends neither. DB:39 n.10 (arguing that “the revised earnings guidance” (which did not occur) was not “old news”). This factual morass is precisely why district courts should not entertain arguments made for the first time in reply briefs, let alone do its own financial research to incorporate into its opinion, much less engage in factual disputes on a motion to dismiss at all. See Putnam, 783 F.3d at 405 (“[A] factual dispute [ ] is inappropriate for resolution on a motion to dismiss.”).

The district court's weighing of evidence based on a faulty reading of the record regarding causation was its sole “reason to discount” Plaintiff's argument that the July 29, 2014 stock drop supported the materiality of Defendants' admissions that day (see SPA22), in disregard of Celestica, 455 F. App'x at 16. This error, too, requires reversal.

E. The Basic Test Does Not Apply

The SAC's well-pled allegations, taken as true, “plausibly suggest[ ] that reasonable investors would have viewed” the omitted information “as material” (see Matrixx, 563 U.S. at 31) regardless of another test for the materiality of contingent or speculative information outlined in Basic Inc. v. Levinson, 485 U.S. 224, 238 (1988).

Under Basic, if an omission concerns “contingent or speculative information or events,” then its materiality depends on balancing “both the indicated probability . . . and the anticipated magnitude” thereof. Basic, 485 U.S. at 238. For the unchallenged reasons in Plaintiff's opening brief (PB:45-46), including that management was “very certain” about Eaton's spin-off constraint (JA369:¶167 (Fearon's admission)), the omitted information about this constraint was neither contingent nor speculative.

Put simply, the onerous tax limitation was an existing fact. Basic is, thus, irrelevant. From management's perspective, there was nothing contingent or speculative about the Merger, its tax consequences, or the potential for a spin-off over the next five years — it was just undisclosed. Thus, the argument that Basic's test does not apply here is not “a roadmap for circumventing Basic in virtually every case,” as Defendants claim. DB:40. It is a roadmap for not applying Basic where non-contingent, non-speculative information or events are at issue. SPA16.

F. The District Court Did Not Apply Basic Correctly

Even assuming arguendo the Basic test is applicable here, this Court's precedent is clear that even “a relatively improbable event of sufficient magnitude could potentially be material.” Castellano v. Young & Rubicam, Inc., 257 F.3d 171, 185 (2d Cir. 2001).5 The magnitude of the undisclosed information (a taxable sale of the Vehicle division, compared to a tax-free spin-off of that division) was measured by experts to be approximately $3.5 billion. JA311:¶11. Among other allegations of its importance, Eaton's true tax situation translated to an impact on the Company's “total market value” of “10.6%” to “16.7%.” PB:47. Defendants make no response about the magnitude of the undisclosed information,6 nor did the district court consider the “magnitude” prong, even as both stressed the Basic test's applicability. Even if Basic were to apply, this misapplication requires reversal.

* * *

In sum, Defendants' misstatements were not so obviously immaterial that the matter can be determined on a motion to dismiss. This Court reached a similar holding in Gerstle v. Gamble-Skogmo Inc., 478 F.2d 1281 (2d Cir. 1973) (Friendly, C.J.). Gerstle held there was a material difference between 'would' and 'could' even with the “higher standard” of Section 14 (compared to Section 10(b)). Id. at 1302-03 (proxy statement that company “intended to continue the outdoor advertising business” — what it would do — was materially misleading where its “true intention [was] to seek to dispose of all the remaining outdoor advertising plants as soon as possible, and . . . that it could do this on favorable terms”).

II. The Truth Was Not Already Known During the Class Period

Defendants contend they had no duty to disclose “a generally applicable tax provision that applies to all corporations,” or “the tax laws,” or “what tax implications the company had concluded would flow from” the “firm-specific information” that “Eaton fully disclosed.” DB:33-38. This invokes the truth-on-the-market defense,7 which “is intensely fact-specific and is rarely an appropriate basis for dismissing a § 10(b) complaint.” Ganino v. Citizens Utils. Co., 228 F.3d 154, 167 (2d Cir. 2000). Whether Eaton disclosed enough “company-specific” information for investors to decipher the undisclosed tax limitation has not been established — particularly here, where every stock analyst (including Goldman Sachs, J.P. Morgan, and Deutsche Bank) did not know that supposed truth. PB:27.

A. Key Facts Remained Undisclosed

Defendants have not explained why any investor should have known that Section 355 of the Tax Code would be triggered here. Sophisticated stock analysts could not figure it out from the facts available during the Class Period, and investors still do not know what part of Section 355 triggered the spin-off limitation.

In any event, the Merger's impact on Eaton's spin-off ability was the type of “complex” information “understandable only through expert analysis [that] may not be readily digestible by the marketplace.” Pub. Emps. Ret. Sys. of Miss., v. Amedisys, Inc., 769 F.3d 313, 323 (5th Cir. 2014). Defendants feign simplicity in the application of I.R.C. Section 355 to the Merger. DB:7. But “[t]he rules of Section 355 are sufficiently complex that they have been compared to the legendary Serbonian Bog, which is said to have been so impenetrable that it swallowed up entire armies.” Robert Rothman, Back to the Bog: The IRS's New Policy on Spin-off Rulings Leaves Practitioners With a Sinking Feeling, 30 J. Corp. Tax'n 3, 3 n.2 (2003). Indeed, Defendants' claim of factual simplicity is defeated by their own admissions that Eaton discovered its tax limitation after “not a simple analysis” (JA369:¶167), involving reasons too “complex” to explain (JA369-70:¶170), requiring “several outside advisors” (JA369:¶167). As Fearon admitted, the tax limitation was “[b]ecause of the legal steps we had to do to complete the transaction” — yet neither these steps nor their impact were known to investors. JA369:¶167.

B. The Legal Impact Was Also Undisclosed

This Court has rejected an almost identical argument, holding that even if underlying facts were public, “the key information that plaintiffs assert should have been disclosed” was the “potential future impact” of those facts on the company, which “was certainly not public knowledge.” Litwin v. Blackstone Grp., LP, 634 F.3d 706, 718-19 (2d Cir. 2011).8

Here, even though tax laws and some facts about the Merger were publicly available, Eaton concealed their “potential future impact” on spin-offs. See id.

This information was not publicly known; Defendants have not cited anything suggesting that any analyst or investor even suspected it. See In re Bristol Myers Squibb Sec. Litig., 586 F. Supp. 2d 148, 161 (S.D.N.Y. 2008) (denying defense where “analysts were unaware of the impact”); In re Enzymotec Sec. Litig., 2015 WL 8784065, at *15-16 (D.N.J. Dec. 15, 2015) (defendants “would have to show that the market understood the regulations' implications, which is a fact question not properly addressed at this stage”). As one analyst confirmed after Eaton's disclosures, “Eaton had not previously publicly discussed these items.” JA372:¶177.9

III. Falsity Is Plausibly Pled with Particularity

All analysts following Eaton formed a materially false understanding of Eaton's spinoff ability. It is more than plausible that Defendants' statements caused that false understanding, satisfying the pleading standard.

A. Statement Nos. 1-10 Were False, Misleading, and/or Created False Impressions

The false and misleading nature of Defendants' statements has already been detailed. PB:11-18, 49-53. They misled because the denials were studiously incomplete. E.g., JA383-84:¶204 (Misstatement No. 6: “Yes, there is nothing structural in our deal structure or any of our covenants that, it prevents us from making changes in our portfolio[.] [T]hat is not our plan at this point”). Defendants make only two arguments concerning falsity.

First, they argue that Misstatement No. 8 “was true” and not misleading based on their interpretation of what everybody meant. DB:27-28 (claiming “the question was not about whether there were any constraints imposed by the 'tax structure'” but “whether there were constraints on 'things you might do strategically”). The analyst's question speaks for itself, asking if “[a]nything about the way the tax structure has formed over time would constrain things you might do strategically, whether that were a larger-scale divestiture or anything else?” Cutler replied, “No.” He added an irrelevant fact that did not answer the analyst's question (“We've got great flexibility in terms of how we are able to move cash around the world”), but then he responded to the question more pointedly: “I would say no on that one.”10 JA386-87:¶209. Cutler's meaning was plain, and it was false because the Company's post-Merger's structure did “constrain” Eaton's ability to do a larger-scale divestiture, such as a spin-off, for five years. See also JA369:¶167 (Fearon's admission that the tax constraint was “[b]ecause of the legal steps we had to do to complete the transaction for Cooper”).

Second, Defendants argue that all seven alleged “half-truths” were actually “the complete truth.” DB:28-30 (statements not misleading because they reflected “management's business judgment” doubting “the strategic wisdom of a spin-off” for reasons other than “a different (tax-based) rationale”). If these were the complete truth, Defendants fail to explain (a) why Cutler felt he had to eventually “clarify that we are not able to do a tax free spin of any business for five years post the acquisition date of the Cooper transaction” on July 29, 2014 (JA105), or (b) why Eaton's share price declined precipitously after this admission.11 It is settled that “literal accuracy is not enough,” lest courts “punch a hole in the statute for half-truths.” Omnicare, Inc. v. Laborers Dist. Council Const. Indus. Pension Fund, 135 S. Ct. 1318 (2015).

B. Defendants Concede Statement Nos. 3 And 4 Were Affirmatively False

Defendants do not address the literal falsity of Eaton's two Proxy statements, which affirmatively stated they did “not omit anything” material, but did. These statements were “untrue outright.” Vivendi, 838 F.3d at 239.

C. All Ten Misstatements Triggered Defendants' Duty to Tell the Whole Truth

This Court recognizes that “once a company speaks on an issue or topic, there is a duty to tell the whole truth,” because otherwise, a partial answer misleads. Meyer v. JinkoSolar Holdings, 761 F.3d 245, 250 (2d Cir. 2014).

It is undisputed that subjects of divesting its Vehicle business (Misstatement Nos. 1, 2, 5, 6, 7, 9), “tax consequences” of the Merger (Nos. 3, 4), and Eaton's constraints on divesting (Nos. 5, 6, 8, 10) came up repeatedly. Defendants simply dismiss these subjects as “so broad as to be useless.” DB:32-34.12

First, they propose that tax consequences of reincorporating in Ireland discussed in the proxies (Nos. 3 & 4) create a duty to disclose only “taxes that the restructured company actually expected to pay.” DB:32-33. These were not tax bills or financial statements, but proxies promising they “do[ ] not omit anything” important while conveying to investors Eaton's official “conclu[sion] that incorporating in Ireland would provide” various enumerated “financial benefits . . . without negative tax effects.” JA381-82:¶¶198-99. No one required Defendants to go so far in their Proxies, but “upon choosing to speak, one must speak truthfully about material issues.” Caiola, 295 F.3d at 331; see also Meyer, 761 F.3d at 250 & n.3 (where “prospectus . . . put the issue in play,” the company had “a duty to tell the whole truth”).

Second, Defendants indicate that the remaining “subjects of divesting its Vehicle business and constraints on divestitures by Eaton generally” could be false only if statements that “misled investors by saying one thing and holding back another” were actionable. DB:33. But the Supreme Court has held that it is actionable: speakers “must as well desist from misleading investors by saying one thing and holding back another.” Omnicare, 135 S. Ct. at 1331; see also Vivendi, 838 F.3d at 240 (reiterating this Circuit's “rule against half-truths, or statements that are misleading by omission”).

Thus, Defendants' proposal that they would have needed to “sp[eak] to the economic feasibility of a potential spin-off” (DB:33) to have any duty to disclose the truth is wrong. The proposed statement would have been literally false, but it is black letter law that securities laws prohibit more. Vivendi, 838 F.3d at 240; Meyer, 761 F.3d at 250 (“The literal truth of an isolated statement is insufficient. . . .”). The “subject” giving rise to a duty to speak completely cannot be defined so narrowly as Defendants would like.

IV. A Strong Inference of Scienter Is Pled

“When the allegations are accepted as true and taken collectively,” scienter is pled where “a reasonable person [would] deem the inference of scienter at least as strong as any opposing inference.” Tellabs, 551 U.S. at 326.

A. Defendants Spoke with Knowledge that Their Statements Would Mislead and While Knowing They Were False

Defendants never responded to the argument that the repeated nature of their misstatements, while knowing the misleading effect each prior statement had, suffices to plead scienter. See PB:57-58. Therefore, they concede it. Vivendi, 838 F.3d at 249 (“Vivendi does not clearly make such an argument . . . in its opening brief. Thus, the argument is waived.”). And they are incorrect in arguing that their admitted knowledge of facts undermining the alleged misstatements is not enough. See DB:49-50. Each provides a strong inference of scienter.

1. The Repeated Nature of Defendants' Misstatements Support a Strong Inference of Scienter

At least sixteen analysts and business writers shared the same false understanding that Eaton's option to spin-off a key segment after the Merger was both possible and valuable, and conveyed this to Defendants often. Because Defendants spoke on the subject at least ten times, the most compelling inference is that they knew their statements (including recurrences of the same type of limited denials) would mislead, and continue misleading. PB:57. This argument goes largely unrebutted.13

The hedged denials do not diminish this strong inference of scienter because those statements withheld the full truth and further cultivated investors' false impressions. If Defendants wanted to mislead analysts, they would have made exactly the statements they made.

The long-lasting nature of the analysts' false understanding, combined with Defendants' repeated misstatements and omissions, constitutes “the most powerful evidence of scienter.” Institutional Inv'rs Grp. v. Avaya, Inc., 564 F.3d 242, 269-70 (3d Cir. 2009). Defendants do not cite, much less distinguish, Avaya. Nor do they contest that the repeated nature of their misstatements supports a strong inference of scienter. See generally DB:47-50.

Defendants only ask that this Court not to use “post hoc criticism” in “hindsight” to support scienter, e.g., that Defendants “could have been more convincing to analysts” or come clean “sooner.” DB:3, 49. But analysts made clear throughout the Class Period, with reports and direct questions to Defendants, that they had the wrong understanding about Eaton's option to divest its Vehicle division, so there is nothing “post-hoc” about the fact that they were repeatedly misled.14 The stronger inference is that Defendants knew that repeating the same hedged denials for more than two years would only strengthen — not cure — analysts and investors' false impression.

2. Defendants' Admissions Sufficiently Plead a Strong Inference of Scienter

Defendants' knowledge of the omitted facts while speaking, alone, pleads a strong inference of scienter. “[A]ctual knowledge of the misstatement, irrespective of intent, satisfies the scienter standard.” 5C Arnold S. Jacobs, Disclosure and Remedies Under the Securities Laws §12:77 (2018).

Defendants' insistence that “the question is not whether Defendants 'knew about' the tax limitations” but rather “whether Defendants intentionally (or with gross recklessness) misled investors” (DB:49-50) is decidedly wrong. Scienter is not mens rea; civil liability does not require a specific intent to defraud. In this Circuit, a strong inference of scienter is pled where “defendants . . . were aware of undisclosed facts tending to seriously undermine the accuracy of the statement.” Slayton v. Am. Exp. Co., 604 F.3d 758, 775 (2d Cir. 2010).

Here, Defendants knew “all along” the information that undermined their statements. They knew that something did “constrain things [Eaton] might do strategically, whether that were a larger-scale divestiture or anything else,” despite answering “No.” JA386-87:¶209. They knew the Merger proxies did “omit anything likely to affect the import of ” their information — particularly after the final proxy touted that reincorporating in Ireland would be “without negative tax effects.” JA378:¶193, JA381:¶¶198-99. They knew “all along” that it would be “not possible to do a tax free spin for five years,” and any attempt “actually would be taxed higher than just an asset sale,” yet cultivated investors' false impressions that spinoffs remained an option. JA369-70:¶¶167-170.

Regardless of what they hoped to accomplish by withholding this information, Defendants' “knowledge of facts” they materially omitted means they spoke with scienter. See Novak v. Kasaks, 216 F.3d 300, 311-12 (2d Cir. 2000) (strong inference of scienter pled where “defendants knew at all relevant times that the Company had serious inventory problems that they sought to disguise”); 5C Jacobs §12:77 (“A defendant's actions constitute knowing conduct if he knows the truth concerning the misrepresented facts or is aware of the omitted data when the violation takes place. . . .”).15

The fact that Plaintiff's allegations of Defendants' knowledge comes through the Defendants' own admissions makes the inference of scienter even stronger. Indeed, this Court has found defendants' admissions of knowledge sufficient to establish scienter even at trial. See Sirota v. Solitron Devices, 673 F.2d 566, 570, 573 (2d Cir. 1982) (affirming “post-verdict assessment that there was sufficient evidence of scienter” when making misstatements about inventory where “defendants admitted such overstatements of inventory” showing their “actual knowledge”). Defendants attempt to distinguish Sirota without success. DB:50 (asking that Sirota be limited to cases where “defendants admitted that they had affirmatively mispresented” facts).

Here, at the pleading stage, the bar is lower: a complaint survives if the pleading sets forth a cogent set of allegations that Defendants “knew facts . . . suggesting that their public statements were not accurate.” Novak, 216 F.3d at 311. Cutler and Fearon admitted their actual knowledge, and the district court committed reversible error ignoring those admissions in evaluating scienter.

B. Defendants Spoke at Least Recklessly

Recklessness is pled where the “danger” of misleading investors “was either known to the defendant or so obvious that the defendant must have been aware of it.” Rothman v. Gregor, 220 F.3d 81, 90 (2d Cir. 2000). Here, Cutler and Fearon received numerous, repeated questions from analysts and investors throughout the Class Period — including seven of the ten misstatements at issue (PB:12-15) — showing Defendants at least should have known the market's false understanding. JA327:¶58 (“The question regarding a possible spin[-off] of Auto & Truck has come up in many investor events.”). Because Cutler and Fearon responded to these questions the same way they always had, without disclosing what they knew, “defendants acted in ways that could be found to be reckless.” Scholastic, 252 F.3d at 77 (“[T]he most egregious allegations [of recklessness] involve Scholastic's response to inquiries from Merrill Lynch.”).

C. Defendants' Insider Trading Also Creates a Strong Inference of Scienter

Defendants propose potentially benign explanations for their insider sales (DB:43-46) but do not rebut that Cutler and Fearon's $40.4 million of insider sales were “concrete” personal benefits from fraudulently inflated share prices during the Class Period. Scholastic, 252 F.3d at 74; Tellabs, 551 U.S. at 325 (“personal financial gain may weigh heavily in favor of [ ] scienter”). Much about these sales is still suspicious, and the extraneous facts Defendants introduce are not exculpatory.

This Court has consistently held that “the amount of profit from the sales, the portion of stockholdings sold, [and] the change in volume of insider sales” are all relevant to whether stock sales are suspicious. Scholastic, 252 F.3d at 74-76. Cutler's $17.45 million in profits (4.85 times his total 2012-2014 salaries) and Fearon's $5.038 million in profits (2.41 times his total 2012-14 salaries) represent significant profits under this approach. JA392:¶222, JA392:¶225.

Cutler: In February 2013, Cutler sold 31.5% of his stockholdings and another 30.5% in March 2014.16 JA127-38. These sales were unusually large. In re Oxford Health Plans, Inc. Sec. Litig., 187 F.R.D. 133, 139-40 n.1 (S.D.N.Y. 1999) (11% and 17% support scienter).

Cutler's pre-Class Period sales, while large, do not diminish the suspiciousness of his Class Period trading because they occurred during a scandal. PB:60. Defendants disagree, pointing out that the securities case related to that scandal was dismissed, and the sales occurred “eight months before” news of that scandal broke. DB:45 n.11. But insider trades always occur before the news breaks. And the fact that the case was later dismissed has no bearing on the suspicious nature of Cutler's sales beforehand.

Defendants point to post-Class Period sales (DB:44-45) to distract from Culter's suspicious Class Period sales. But it makes no sense to consider post-Class Period sales because it would allow defendants to simply sell stock after-the-fact to avoid liability. PB:61.

Fearon: Defendants concede that Fearon's insider sales doubled compared to his pre-Class Period sales. DB:46. They also became unusually large during the Class Period. In May 2013, Fearon sold 19.3% of his stockholdings and another 17% in November 2013. JA142-47. See Oxford, 187 F.R.D. at 139-40 n.1.

Defendants distract using Fearon's post-Class Period sales (DB:45-46), which are not exculpatory. Indeed, Fearon sold over half of these post-Class Period shares (85,195) after investors filed this suit. See Dkt. Below, Hammel Decl. in Supp. Mot. Dismiss, ECF No. 54, Exs. 38-39.

Last, Defendants argue that Fearon's holdings increased during the Class Period. But they leave out that this increase occurred entirely from exercising stock options or restricted stock units on highly favorable terms. See id. Exs. 30-36. The fact that he increased his holdings at below-market prices does not undermine the inference of scienter.

* * *

Defendants knew that, throughout the Class Period, investors believed that a tax-free spin-off was a valuable option. Defendants never propose a stronger inference as to why Cutler and Fearon repeated their misleading statements for eighteen months while knowing that the Merger made a tax-free spin-off impossible and any taxable sale of the Vehicle division unworkable. The strongest inference is that they spoke with scienter.

V. The Class Period Properly Runs from May 21, 2012 through July 28, 2014

A. The Pleaded Class Period Is the Only “Real” Class Period

Defendants misinterpret the Class Period covered by the SAC. Quoting less than half of the Class definition, they state that the Class is “limited to those who purchased shares between November 13, 2013 and July 28, 2014.” DB:53.

The actual Class is defined as “all persons and entities that, during the period from May 21, 2012 through July 28, 2014, inclusive (the 'Class Period'), purchased the publicly traded common stock of Eaton and/or exchange-traded options on such common stock, so long as they” also “purchased at least one share or option from November 13, 2013 through July 28, 2014, inclusive (the 'Original Class Period').” JA306:¶1. As pled, persons and entities who purchased stock before November 13, 2013 may still assert claims and recover for those purchases (so long as they also purchased after November 13, 2013). It is nonsensical for Defendants to insist that the “true” Class Period begins on November 13, 2013.17 “[P]laintiff is the master of the complaint and has the option of naming only those parties the plaintiff chooses to sue, subject only to the rules of joinder of necessary parties.” Lincoln Prop. Co. v. Roche, 546 U.S. 81, 91 (2005).18

B. The SAC Relates Back to the Initial Complaint, Mooting the Issue

In any event, Defendants do not dispute the district court's correct ruling that the SAC related back to the initially-filed complaint. DB:56.

Nor could they. “Under Rule 15, the central inquiry is whether adequate notice of the matters raised in the amended pleading has been given to the opposing party within the statute of limitations by the general fact situation alleged in the original pleading.” Slayton, 460 F.3d at 228. This remains the only relevant inquiry (Stevelman v. Alias Research Inc., 174 F.3d 79, 86-87 (2d Cir. 1999)), even if an amended complaint alleges “a largely different set of alleged misstatements” or expands the Class period “over seven months.” Brief for Defendants-Appellees, Stevelman, 1998 WL 35155442 (2d Cir. Apr. 8, 1998).

Here, the SAC covers the same “general fact situation alleged in the original pleading,” as the opinion below rightly held (SPA:13-14), and Defendants do not dispute it. Accordingly, its longer Class Period relates back. Therefore, the SAC does not quote a single “statement[ ] outside the Class Period,” much less “rely” on one. DB:57.

The general rule that a defendant “'is liable only for those statements made during the class period'” is irrelevant here. DB:51-57 (citing Kowal v. Int'l Bus. Machs. Corp., 163 F.3d 102, 107 (2d Cir. 1998)). Defendants should have realized this when arguing: “Since at least some of the allegedly false statements in the amended complaint occurred within the class period identified in Stevelman's original complaint, Kowal did not help resolve that question.” DB:56.Here, too, one of the allegedly false statements in the SAC occurred within the class period identified in the original complaint: Statement No. 10. SPA:14-15. Therefore, Kowal is no more applicable to this case than it was to Stevelman. If it applied, it would render relation back a nullity. That is not the law.

CONCLUSION

The District Court's Order dismissing the SAC should be reversed.

DATED: March 8, 2019

Respectfully submitted,

Thomas A. Dubbs

LABATON SUCHAROW LLP
Louis Gottlieb
Jeffrey A. Dubbin
140 Broadway, 34th Floor
New York, NY 10005
Telephone: 212/907-0700
Facsimile: 212/818-0477

Attorneys for Plaintiff-Appellant South Carolina Retirement Systems Group Trust

FOOTNOTES

1Unless otherwise stated, all emphasis is added and internal citations, quotations, and alterations are omitted.

2The district court misread these five sources in finding that “nearly all” commentators believed the denials were “unequivocal” (SPA19-20), committing reversible error. Tellingly, Defendants do not defend this improper factual finding below.

3In a footnote, Defendants' brief attacks the credibility of this author as an “attorney in private practice” without irony. In fact, he is a highly respected corporate tax attorney and former law professor who clerked for Judge Friendly on this Court. JA:461. Further, he was writing for a corporate audience, with no coordination from Plaintiff, Plaintiff's counsel, or anyone related to this case. Tellingly, Defendants do not address the substance of his observations.

4The very transcript Defendants cite made clear that Eaton met and exceeded its earnings per share guidance: “[W]e expected that our operating earnings per share would be in the $1.10 to $1.12 range and we're pleased this morning they came in right in the middle of that range . . . $1.11,” which was “above the original guidance that we gave when we began this quarter.” JA102. Defendants cannot seriously contend that this positive news caused Eaton's share price to decline 8% instead of Eaton's corrective disclosure that day.

5Thus, Defendants' insistence that “Basic indicates that where a company is exceedingly unlikely to take a given action, information about that action will generally not be material” (DB:40) has thus already been rejected by this Court.

6Perhaps Defendants intend to imply that magnitude is irrelevant where the probability of a divestiture is “zero.” DB:39. The argument amounts to a concession that half of the Basic test does not apply, which really means that the test itself does not apply.

7Defendants put this argument under the “duty to disclose” banner, but it really pertains to “refuting an alleged misrepresentation's materiality.” Amgen, 568 U.S. at 481.

8Thus, Defendants' reliance on an out-of-Circuit and older district court decision (DB:7, 34-36) falls short. Further, neither Heliotrope nor In re Progress Energy involved situations where undisclosed, company-specific facts unexpectedly skewed how known tax laws would impact the companies. See Heliotrope Gen., Inc. v. Ford Motor Co., 189 F.3d 971, 980 (9th Cir. 1999) (dismissing in part because “the market was aware of the mounting costs associated with the tax strategy”); In re Progress Energy, 371 F. Supp. 2d 548, 552 (S.D.N.Y. 2005) (proxy materials clearly disclosed applicability of tax provision to a transaction).

9Defendants argue that Eaton need not have recited the words of Section 355. DB:34-35. Plaintiff agrees. It was the concealed impact of that complex section, as a result of undisclosed company-specific facts, which made Defendants' statements materially false and misleading.

10Notwithstanding the fact that Plaintiff gave the entire quote (JA386-87:¶209), Defendants repeat a claim that Plaintiff has “sliced and diced the quotation” and “twist[ed] Cutler's words.” Their basis is a statement by the district court from a prior opinion not at issue. See DB:27 (quoting JA259, not the opinion below); DB:29 (same response to what Defendants say was “selectively edited”).

11To muddy the waters, Defendants add that Eaton sold aerospace assets during the Class Period, “[c]onfirming Eaton remained free to make portfolio moves.” DB:30 n.6. They do not say how substantial the taxes were on this small transaction, nor compare it to a spin-off of the multibillion-dollar (100-year-old) Vehicle segment with a presumably low tax basis that made its taxable sale economically prohibitive. JA310:¶9, JA333-36:¶¶74-85; see also PB:8 n.5.

12Defendants also insist that they had to disclose only facts, not the tax law itself, and both were well-known. DB:34-38. This truth-on-the-market defense is addressed, supra.

13The closest Defendants come to addressing this point is with the following misdirection: “if Defendants had wanted to mislead analysts and encourage speculation about the possibility of divestment, they would hardly have . . . emphasized Eaton's lack of interest in a spin-off,” or issued their press release and other denials. DB:48.

14Indeed, as this Court observed in Ganino and Scholastic, analyst perceptions are a reliable proxy for reasonable investors (PB:26-28), hence if all analysts were misled, so were reasonable investors.

15Accordingly, Defendants' argument that they “never 'admitted' anything” (DB:50) fails. Nor do they attempt to distinguish Yourish, where the Ninth Circuit stated that an “I knew it all along” admission would support scienter. PB:55 (quoting Yourish). They similarly ignore the cited cases (see id.) where district courts have held admissions of knowledge sufficient for scienter. E.g., id. (quoting Arbitron).

16Defendants propose Cutler's sales could have been because he was retiring. DB:45. But Cutler retired in May 2016 — two to three years later. If anything, Cutler's retirement inflated his post-Class-Period sales that Defendants use as a comparator.

17The SAC defined the Class this way to avoid adding new putative class members, whom the Court held would be deemed “new parties” triggering Rule 15(c)(1)(C)'s “mistake” requirement for relation back. JA243-49.

18It is worth noting that Defendants use this longer Class Period when making their insider trading arguments. See DB:43-46.

END FOOTNOTES

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