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Doshi v. General Cable Corp.

United States District Court, E.D. Kentucky, Northern Division, Covington

January 27, 2015

SATISH DOSHI, Individually And on behalf of all other Persons similarly situated and CITY OF LIVONIA EMPLOYEES' RETIREMENT SYSTEM, Individually And on behalf of all others Similarly situated Plaintiffs,



Lead Plaintiff City of Livonia Employees' Retirement System brings this action on behalf of a class of persons and entities that purchased General Cable Corporation common stock between November 3, 2010, and October 14, 2013, inclusive (the "Class Period"). Plaintiffs allege that Defendant General Cable Corporation and two of its senior executives, individual Defendants Gregory B. Kenny and Brian J. Robinson, [1] engaged in a fraudulent scheme to inflate artificially General Cable's stock price in violation of § 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b), and Rule 10b-5, 17 C.F.R. § 240.10b-5. Plaintiffs further allege that Kenny and Robinson are liable as "controlling persons" of General Cable, pursuant to § 20(a) of the Securities Exchange Act of 1934, 15 U.S.C. §78(t)(a). As evidence of fraud, Plaintiffs point to General Cable's need to restate, on two occasions, previously issued financial data to correct material errors. These restatements - announced in 2012 and 2013[2] - resulted in significant declines in General Cable's stock price.

This putative class action is before the Court on the defendants' motion to dismiss (Doc. 98). Defendants argue that Plaintiffs have failed to state a claim upon which relief may be granted, asserting that Plaintiffs have not adequately pled scienter. The Court heard oral argument on Wednesday, January 7, 2015, and thereafter took the motion under advisement. After further study, the Court now issues the following Memorandum Opinion and Order.


A. Parties and Summary of Allegations

General Cable is a publicly traded company that manufactures cable and wire for industrial uses around the world. Based in Highland Heights, Kentucky, the company's operations, management, and financial reporting are divided into three geographic segments: North America; Europe and Mediterranean; and Rest of World ("ROW").

Plaintiffs' allegations focus on accounting errors principally affecting the ROW division - specifically, operations in Brazil. General Cable established the ROW division in October 2007 after it acquired Phelps Dodge International Corp. ("Phelps Dodge") as a privately held subsidiary. Phelps Dodge, which served markets in developing economies, was acquired to allow General Cable to expand its international operations. General Cable placed Phelps Dodge and the entire ROW division under the supervision of Mathias Sandoval, who had been Phelps Dodge's CEO and President.

Plaintiffs assert that the Defendants failed to integrate Phelps Dodge into General Cable's internal management and financial reporting control systems, allowing "a multitude of material accounting irregularities to occur." Doc. 97, Complaint, ¶ 6. Further, Plaintiffs allege that the Defendants affirmatively shielded the ROW division from "meaningful financial supervision, " id., instead instructing corporate finance staffers not to interfere with ROW as it appeared to be a successful operation. Id. ¶ 5.

Allegedly as a result of this lax supervision, General Cable failed to detect not only the accounting errors but also a complex inventory theft scheme in the ROW division's Brazilian operation that resulted in the loss of millions of dollars' worth of raw materials and finished goods. Plaintiffs assert that ROW division executives learned of the theft and other errors in January 2012 but did not notify General Cable's corporate headquarters until September 2012.

B. Restatement of Financial Information - 2012 and 2013

On October 29, 2012, General Cable announced that financial statements filed between 2007 and second quarter 2012 contained material accounting errors and should not be relied upon. The company further announced that it would be restating fourteen financial statements covering 2009 through Second Quarter 2012.

Then, on October 10, 2013, General Cable announced that it needed to restate the corrected financial statements, as well as three other publicly filed reports, to correct material errors related to (1) improperly recognized revenue on Brazilian "bill-and-hold" sales; (2) Value Added Tax (VAT) assets related to the missing Brazilian inventory; and (3) other accounting irregularities unrelated to Brazil. General Cable explained that it discovered these errors while remedying the errors that necessitated the first restatement.

Plaintiffs allege that the restatements are evidence that General Cable's financial statements for the fiscal quarters and years 2008 through First Quarter 2013 and related earnings releases were materially false and misleading, in violation of Generally Accepted Accounting Principles (GAAP). More specifically, Plaintiffs allege that Defendants violated GAAP by:

(1) inflating operating income, net income, and earnings per share by improperly recognizing bill-and-hold sales;
(2) understating cost of sales expenses and overstating operating income, net income, earnings per share, and inventory balances by improperly accounting for inventory and the related VAT assets in General Cable's Brazilian subsidiary;
(3) understating cost of sales expense and overstating inventory, property, plant & equipment assets, and comprehensive income by recording erroneous foreign currency adjustments in or related to its Canadian and Mexican subsidiaries; and
(4) improperly accounting for other transactions by understating expense accounts while overstating related asset accounts by improperly delaying the reporting of expenses or other charges.

Following the issuance of the Restatements, General Cable made significant changes in the ROW division, including adjustments to inventory-related processes and security in Brazil. Moreover, the ROW CEO and CFO resigned and numerous other managers in Brazil were terminated from employment. Kenny and Robinson assumed leadership responsibilities for the ROW division. Finally, General Cable took steps to better integrate ROW division financial reporting and communication. Doc. 97-2, Year 2012 Form 10-K/A, at 7-8.

C. Facts Supporting Scienter

In the Corrected Consolidated Complaint ("Complaint") (Doc. 97), Plaintiffs also pleaded facts related to scienter, as they are required to do.

Plaintiffs assert that Kenny and Robinson knew or recklessly disregarded that adverse facts had not been disclosed to, and were being concealed from, the investing public. Specifically, Plaintiffs allege that Kenny and Robinson, through their positions as senior executive officers of General Cable, had direct access to confidential and proprietary information and an opportunity to commit fraud by way of their control of the contents of General Cable's public reports, filings, and press releases, and their participation in the company's management and operations. Doc. 97, Complaint, ¶¶ 20-22. Plaintiffs also contend that Kenny and Robinson had motive to commit fraud because stock options and bonuses tied to stock price and earnings comprised significant portions of their compensation during the years covered by the restatements. Id. ¶¶ 129-30.

Plaintiffs also emphasize the nature and scope of the restatements, noting that General Cable was required to restate its financial information twice, that the restatements covered a lengthy period and numerous filings, that the required adjustments were material, and that errors were beneficial to General Cable's bottom line. Id. ¶¶ 35, 39, 47, 49, 53. Further, Plaintiffs allege that the time between the initial disclosure of the errors and General Cable's issuance of restatements was longer than average for public companies. Id. ¶ 50.

Plaintiffs also allege that General Cable's internal controls were ineffective and insufficient, despite Kenny and Robinson signing Sarbanes-Oxley certifications attesting to the controls' adequacy. Id. ¶¶ 51-52, 54-56, 58. Plaintiffs aver that Kenny and Robinson were bound by the company's Code of Ethics, which required them to follow internal controls to ensure accurate financial reporting. Id. ¶ 114. Plaintiffs allege that a proper evaluation of the company's internal controls would have alerted (or did alert) Defendants to the deficiencies leading to the restatements. Id. ¶¶ 60-61.

Next, Plaintiffs allege that Kenny and Robinson provided lax oversight of the ROW group, allowing accounting problems to persist. Specifically, they assert that Kenny and Robinson failed to insist upon open communications between ROW upper management and the corporate controller. Id. ¶¶ 64-65. Moreover, they allege that Defendants failed to require the ROW division to fully explain its financial data to corporate finance leaders, instead instructing the ...

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