Excavators and Pavers Pension Fund v. Diodes Inc.: Insufficient pleading under the PSLRA

In Excavators and Pavers Pension Trust Fund v. Diodes Inc., No. 14-41141, 2016 BL 9217 (5th Cir. Jan. 13, 2016), the United States Court of Appeals for the Fifth Circuit affirmed the lower court’s decision granting Diodes, Inc.’s (“Diodes”), its CEO Keh-Shew Lu’s (“Lu”), and its CFO Richard White’s (“White”) (collectively, “Defendants”) motion to dismiss the securities fraud class action. The 5th Circuit held Excavators and Pavers Pension Trust Fund’s (“Plaintiff”) claims did not support an inference of scienter under the Private Securities Litigation Reform Act’s (“PSLRA”) heightened pleading requirements.

According to Plaintiff’s allegations, on February 9, 2011, Lu announced Diodes’s revenue would stagnate or drop 5% because its Shanghai production facility experienced labor shortages, which adversely affected manufacturing output. On May 10, 2011, White stated at an industry conference that Diodes had noticed the labor problem, which would affect manufacturing output, around Chinese New Year, and that Diodes intended to hire new workers to replace non-returning workers; however, typical training lasted six to eight weeks. Following White’s announcement, Diodes’s stock price dropped. On June 9, 2011, Diodes again lowered its revenue prediction because labor recovery was slower than expected, and Diodes’s stock price fell again.

Plaintiff’s complaint alleged violations of Sections 10(b) and 20(a) of Securities Exchange Act of 1934. Plaintiff claimed: (1) Defendants must have known or were severely reckless in not knowing Diodes’s internal labor policies would exacerbate labor problems; (2) Defendants made early shipment orders to customers in an attempt to conceal the severity and duration of the labor shortage; and (3) Lu’s stock sales at this time supported a strong inference of scienter. Defendants moved to dismiss Plaintiff’s complaint for failure to state a claim. 

A complaint will survive a motion to dismiss under the PSLRA if the allegations specify: (1) each misleading statement; (2) the reasons why the statement is misleading; and (3) the facts, stated with particularity, which give rise to a strong inference of scienter. Under PSLRA’s heightened standard, a complaint’s cogent and compelling allegations are enough for a court to infer scienter—an intent to deceive or defraud. The complaint’s allegations must do more than create just a reasonable or permissible inference.

The court held the Plaintiff’s allegations were not cogent or compelling enough to conclude that a strong inference of scienter existed. Specifically, the court ruled the allegations failed to show sufficient facts indicating Defendants had actual knowledge the labor shortage was principally caused by Diodes’s workplace policies; rather, its management never denied the existence of labor shortages and accurately predicted the impact on Diodes’s financial results. Additionally, the court held that shipping orders ahead of schedule would enhance the labor shortage problem, rather than conceal the problem as Plaintiff argued, because shipping orders early would deplete inventory and cause Diodes’s inability to fill orders to quickly become apparent. Finally, the court held Lu’s significant stock sales alone did not support a strong inference of scienter; rather, nonculpable inferences drawn from Lu’s stock sales were more compelling than Plaintiff’s culpable inferences.

Accordingly, the court of appeals affirmed the decision to grant Defendants’ motion to dismiss because the complaint failed to satisfy the PSLRA’s heightened pleading requirement.

The primary materials for this case may be found on the DU Corporate Governance Website.