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Brendon v. Allegiant Travel Co.

United States District Court, D. Nevada

September 9, 2019

CHARLES BRENDON[1] and DANIEL CHECKMAN, Individually and on Behalf of All Others Similarly Situated, Plaintiffs



         This is a securities fraud class action lawsuit against Allegiant Travel Company, the owner of Allegiant Air (collectively, Allegiant). The First Amended Complaint (FAC) alleges that Allegiant used second-hand aircraft to fly travelers. Beginning in 2015, Allegiant experienced numerous aircraft maintenance and repair issues with its second-hand aircraft, resulting in cancellations, delays, emergency landings, and aborted takeoffs. During this time, Allegiant and its officers assured investors and the public that the airline and its fleet were safe and reliable. In April 2018, the CBS television network broadcast a story on Allegiant's maintenance and repair issues, and Allegiant's stock price dropped precipitously.

         Plaintiffs Charles Brendon and Daniel Checkman sued Allegiant and its officers (Maurice J. Gallagher, Jr., Scott Sheldon, Steven E. Harfst, and Jude I. Bricker) on behalf of all persons who traded in Allegiant securities between June 8, 2015 and May 9, 2018. The plaintiffs allege that the defendants violated section 10(b) of the Securities Exchange Act of 1934 (the Exchange Act), 15 U.S.C. § 78j(b), and Securities and Exchange Commission (SEC) Rule 10b-5, 17 C.F.R. § 240.10b-5. The plaintiffs also assert control person liability against the individual defendants under section 20(b) of the Exchange Act. The defendants move to dismiss the FAC, challenging falsity, scienter, and loss causation. I grant the motion with respect to some of the allegedly fraudulent statements because the plaintiffs fail to plead falsity or scienter. However, I deny the motion with respect to other statements, and I grant plaintiffs leave to amend.

         I. BACKGROUND

         Allegiant used second-hand aircraft to transport passengers from under-served airports to leisure destinations like Las Vegas.[2] ECF No. 34 at 17. Allegiant was profitable because it served airports with lower fees, faced little competition, and flew second-hand aircraft that cost a fraction of new models. Id. at 17-21. These aircraft required “far greater maintenance than newer planes, ” however, so maintenance expenses were a “material component of Allegiant's operating costs.” Id. at 20. The plaintiffs allege that Allegiant understaffed its maintenance department, hired inexperienced and unqualified maintenance personnel, failed to adequately train its maintenance employees, and had a culture that “compromised maintenance . . . for profits.” Id. at 3, 21-39. In support of their allegations, the plaintiffs include statements from former Allegiant maintenance personnel. Id. at 11-14, 21-39.

         In 2015 and early 2016, local news sources across the country reported “horror stories of Allegiant aircraft experiencing flight delays, emergency landings, aborted takeoffs, and smoke in the cabin, ” which “intensified as Allegiant's maintenance issues seemed to become more prevalent.” Id. at 39. On January 8, 2016, the Tampa Bay Times reported that an Allegiant maintenance employee quit after two weeks because Allegiant had a “worrisome culture, ” failed to follow procedures, and misused FAA rules. Id. at 43. Allegiant denied the allegations, claiming that its maintenance personnel were “highly-trained.” Id. The following day, Allegiant announced Harfst's resignation as the airline's Chief Operating Officer (COO), explaining that “the Company will use this leadership change as an opportunity to refocus on operational needs and areas for improvement.” Id. at 44.

         Later that month, Gallagher (Allegiant's CEO) and Bricker (the new COO), participated in a conference call about Allegiant's fourth quarter 2015 financial results. Id. During the call, an analyst asked about recent “operational challenges” reflected in news stories, Allegiant's plan to correct the challenges, and whether the challenges were overhyped by the media or represented “safety issues.” Id. Bricker responded, in relevant part, “[i]t's a safe operation. Last year, it was a safe operation, and this year as well.” Id. at 45. Gallagher pointed to ongoing union negotiations as a potential reason for the stories, stressed the airline's safety programs, and emphasized that “as [Bricker] said, we are safe.” Id. The plaintiffs allege that Bricker and Gallagher's statements that Allegiant was safe were false or misleading due to Allegiant's maintenance practices. Id. at 54.

         The next month, Allegiant issued its 10-K annual report for 2015. Id. at 51. Gallagher and Sheldon (Allegiant's CFO) signed the report, which stated that “[w]e believe our aircraft are, and will continue to be, mechanically reliable.” Id. at 51-52. The form also included a section on aircraft maintenance. Id. In relevant part, this section of the 10-K stated that Allegiant's “technicians . . . have appropriate experience, ” Allegiant “provide[d] them with comprehensive training[, ]” and that Allegiant could hire “sufficient qualified alternative providers of maintenance services . . . to satisfy . . . maintenance needs.” Id. Allegiant repeated this statement in its 2016 and 2017 10-Ks. Id. at 55, 57-58. The plaintiffs allege that these statements were false or misleading due to Allegiant's maintenance practices. Id. at 54, 56-58.

         Gallagher sent letters to Allegiant's shareholders in 2016 and 2017. Id. at 53-56. In those letters, he assured investors that Allegiant placed its “focus on safety and reliability, ” had a “proven, seasoned model, ” and that safety was its “core fundamental.” Id. Similarly, Allegiant's Code of Ethics stated that the company was required to: (i) remain “honest, fair and accountable in all business dealings”; (ii) “provide safe working conditions” to employees; (iii) “be a responsible and responsive corporate citizen in a moral, ethical and beneficial manner” to society and the local community; and (iv) “pursue growth and earnings objectives while adhering to ethical standards.” Id. at 53. The plaintiffs allege that these statements were false or misleading due to Allegiant's maintenance practices. Id. at 54, 56-57.

         In 2017, the CBS television network submitted Freedom of Information Act (FOIA) requests to the Federal Aviation Administration (FAA) for Allegiant's maintenance records. Id. at 59. The FAA released the records over Allegiant's objection. Id. at 60. On April 13, 2018, CBS announced that it would air a report criticizing Allegiant's safety and maintenance record on 60 Minutes that weekend. Id. Allegiant shares fell 8.59% on “unusually heavy volume.” Id. at 7, 60. The CBS report claimed that “(i) Allegiant aircraft had a high number of serious mechanical incidents from mid-2015 through October 2017; (ii) Allegiant lack[ed] the infrastructure and personnel to adequately maintain their aircraft; (iii) Allegiant discouraged employees from reporting safety and maintenance issues; and (iv) Allegiant had a poor safety culture.” Id. Following the broadcast on April 15, 2018, Allegiant shares fell more than 3% on “unusually heavy volume.” Id. at 8, 69. On May 9, 2018, the U.S. Department of Transportation (DOT) announced that it would audit FAA oversight of Allegiant's maintenance practices. Id. Allegiant shares fell over 2% on the news. Id. at 70.

         Allegiant did not pay Gallagher a salary during the relevant time period. ECF No. 53-5 at 5.[3] Instead, 82.4% of Gallagher's 2015 total compensation was comprised of a nearly $3 million cash bonus tied to Allegiant's operating margin. Id.; ECF No. 34 at 4. The 2015 bonus was “far above [Gallagher's] usual payout” as Allegiant's profits increased from $87 million to $220 million. ECF No. 34 at 4.

         Gallagher also traded in Allegiant stock throughout the plaintiffs' proposed class period. On March 9, 2016, Gallagher sold $47, 774, 700 of Allegiant stock. Id. at 59. In January 2018, Allegiant “announced that Gallagher had set up a 10b5-1 stock trading plan, which it became aware [of] as of December 30, 2017.” Id. Between December 28, 2017 and January 17, 2018, Gallagher sold $33, 232, 408.01 of Allegiant shares through the plan. Id. Gallagher then exercised stock options to sell an additional $2, 066, 137.15 in Allegiant stock on March 6, 2018. Id.


         Section 10(b) of the Exchange Act prohibits the use of “any manipulative or deceptive device or contrivance” related to the purchase or sale of securities when the use violates the regulations promulgated by the SEC. 15 U.S.C. § 78j(b). Under SEC Rule 10b-5, it is unlawful for any person “[t]o make any untrue statement of fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading.” 17 C.F.R. § 240.10b-5(b). “To recover damages for violations of section 10(b) and Rule 10b-5, a plaintiff must prove (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; (4) reliance upon the misrepresentation or omission; (5) economic loss; and (6) loss causation.” In re Quality Sys., Inc. Sec. Litig., 865 F.3d 1130, 1140 (9th Cir. 2017).

         At the pleading stage, a complaint alleging violations of Section 10(b) of the Exchange Act and SEC Rule 10b-5 must meet both the heightened pleading requirements for fraud claims under Federal Rule of Civil Procedure 9(b) and the “exacting pleading requirements of the Private Securities Litigation Reform Act” (PSLRA), 15 U.S.C. § 78u-4(b)(2)(A). Id. Rule 9(b) requires that the complaint “state with particularity the circumstances constituting fraud.” Fed.R.Civ.P. 9(b). The PSLRA requires that the complaint “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).

         The defendants argue that the FAC should be dismissed because the plaintiffs failed to adequately allege material misrepresentation, scienter, and loss causation.

         A. Material Misrepresentation

         The defendants argue that the plaintiffs failed to plead an actionable false statement because: (1) under In re Merck & Co. Securities Litigation, 432 F.3d 261 (3d Cir. 2005), an actionable false statement cannot be based upon previously disclosed public information, and (2) the alleged misrepresentations consist of inactionable puffery or mismanagement claims. The plaintiffs respond that defendants improperly rely on a fact-intensive affirmative defense to support dismissal and that their alleged misstatements are actionable.

         1. Merck

         In Merck, the Third Circuit held that a Wall Street Journal article analyzing Merck's opaquely disclosed accounting practices could not form the basis of a false statement because the efficient market hypothesis suggests the market would have already incorporated the information into Merck's share price. 432 F.3d at 270-71. Similarly, the truth-on-the-market defense excuses a “failure to disclose material information . . . where that information has been made credibly available to the market by other sources.” In re Apple Computer Securities Litigation, 886 F.2d 1109, 1115 (9th Cir. 1989). However, “any material information which insiders fail to disclose must be transmitted to the public with a degree of intensity and credibility sufficient to effectively counter-balance any misleading impression created by the insiders' one-sided representations.” Id. at 1116. Accordingly, “the truth-on-the-market defense is intensely fact-specific, so courts rarely dismiss a complaint on this basis.” In re Amgen Inc. Sec. Litig., 544 F.Supp.2d 1009, 1025 (C.D. Cal. 2008).

         The defendants argue that the facts underlying the 60 Minutes report had already been reported by local news sources, thus requiring dismissal under Merck. Even assuming that Merck is the law in the Ninth Circuit, however, the plaintiffs allege a key fact distinguishing this case from Merck: the CBS broadcast reported undisclosed Allegiant maintenance records obtained by the FOIA request. To the extent that the defendants raise a truth-on-the market defense, the plaintiffs plead facts showing that the local news reports that emerged before the 60 Minutes report were not comprehensive or credible enough to counterbalance Allegiant's alleged misrepresentations. I therefore deny the defendants' motion to dismiss on this ground.

         2. False or Misleading Statements

         The plaintiffs must “specify each statement alleged to have been misleading, [and] the reason or reasons why the statement is misleading” to adequately plead material misrepresentation. 15 U.S.C. § 78u-4(b)(1). “A litany of alleged false statements, unaccompanied by the pleading of specific facts indicating why those statements were false, does not meet this standard.” Metzler Inv. GMBH v. Corinthian Colleges, Inc., 540 F.3d 1049, 1070 (9th Cir. 2008).

         With respect to opinion statements, “when a plaintiff relies on a theory of material misrepresentation, the plaintiff must allege both that the speaker did not hold the belief she professed and that the belief is objectively untrue.” City of Dearborn Heights Act 345 Police & Fire Ret. Sys. v. Align Tech., Inc., 856 F.3d 605, 615-16 (9th Cir. 2017) (quotation omitted). “[W]hen a plaintiff relies on a theory that a statement of fact contained within an opinion statement is materially misleading, the plaintiff must allege that the supporting fact [the speaker] supplied [is] untrue.” Id. (quotation omitted) (alterations in original).

         However, a “mildly optimistic, subjective assessment hardly amounts to a securities violation, ” so I must distinguish material misrepresentations from “puffery.” Oregon Pub. Employees Ret. Fund v. Apollo Grp. Inc., 774 F.3d 598, 606 (9th Cir. 2014). “Statements by a company that are capable of objective verification are not puffery and can constitute material misrepresentations.” Id. (quotation omitted). And, “general statements of optimism, when taken in context, may form a basis for a securities fraud claim when those statements address specific aspects of a company's operation that the speaker knows to be performing poorly.” In re Quality Sys., 865 F.3d at 1143 (quotation omitted). “For example, reassuring investors that ‘everything [was] going fine' with FDA approval when the company knew FDA approval would never come was materially misleading.” Id. (quoting Warshaw v. Xoma Corp., 74 F.3d 955, 959 (9th Cir. 1996)).

         Additionally, Section 10(b) is not a cause of action for corporate mismanagement. Santa Fe Indus., Inc. v. Green, 430 U.S. 462, 479 (1977). But the plaintiffs can plead a cognizable claim if they allege both corporate mismanagement and false or misleading public statements. See Reese v. Malone, 747 F.3d 557, 581 ...

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