Bondali v. Yum! Brands, Inc.: Section 10(b) Claims Require More Than an Overall Impression

In Bondali v. Yum! Brands, Inc., No. 15–5064, 2015 WL 4940374 (6th Cir. 2015), the United States Court of Appeals for the Sixth Circuit affirmed the district court’s holding, dismissing Arun Bondali’s (collectively, “Plaintiffs”) class action complaint against Yum! Brands, Inc. (“Yum”) and three Yum senior officers, CEO David C. Novak, Richard T. Carucci, and Jing-Shyh Su (collectively, “Defendants”).  The court determined the district court correctly dismissed the complaint for failure to plead with particularity under Section 10(b) and Section 20(a) of the Securities Exchange of 1934 as well as Rule 10b-5.

According to the allegations, Yum owned Kentucky Fried Chicken (“KFC”) and had a significant presence in China. Between 2010 and 2011, Yum received test results from an independent laboratory showing batches of chicken from a supplier tested positive for drug and antibiotic residues.  Subsequently, Yum disqualified the relevant suppliers but did not disclose the results or the disqualifications nor that one other supplier had tested negatively.  Only after the media began raising issues with respect to drug or antibiotic residues in chickens did Yum “publicly acknowledged any issues”.  In Feb. 2013, Yum stated that, as a result of the “negative same-store sales” and the need to “recover consumer confidence,” the company no longer expected to “achieve” earnings per share growth in 2013.

Plaintiffs brought an action for securities fraud alleging that the Defendants made false or misleading statements and acted with scienter by failing to disclose adverse results and system failures to the public, eventually resulting in a 17% drop in stock prices.  Yum moved to dismiss all claims, and the district court granted the motion, finding Plaintiffs failed to allege both actionable misstatements and scienter.

Under Section 10(b) and Rule 10(b)(5), a plaintiff must prove: (1) material misrepresentation or omission by a defendant; (2) scienter; 3) in connection with the purchase or sale of security; (4) reliance upon the misrepresentation or omission; (5) economic loss; and (6) loss causation.

Plaintiffs appealed, alleging that during the Class Period, Yum made ten materially false or misleading statements.  The court divided Yum’s statements into four categories: (1) cautionary statements or risk disclosures (statements on the investment risk that food safety issues posed; (2) statements touting standards and protocols; (3) responses to negative publicity; and (4) statements on softer sales (statements relating to “lowered same-store sales projections”).

First, statements regarding food standards and safety protocols, the court determined Yum’s were not misleading.  The court found that Yum’s statements regarding its “strict” standards and protocols were reasonably grounded in objective fact.  Thus, the court determined it was “not reasonable” to interpret Yum’s statements as a “guarantee” that its suppliers would always abide by these standards.  The court also agreed that statements providing assurance that unsafe products would be “immediately . . . pulled from distribution” because they appeared in a Code of Conduct and were “aspirational.” (“Nevertheless, Yum's statement is not actionable because it was a statement of aspiration made in Yum's corporate Code of Conduct rather than rather an assertion of objective fact made in a public filing or press release. As the district court properly explained, a code of conduct is not a guarantee that a corporation will adhere to everything set forth in its code of conduct. Instead, a code of conduct is a declaration of corporate aspirations.”). 

Second, the court found Plaintiffs failed to show how Yum’s responses to negative publicity were false and misleading.  Yum took the actions mentioned in the statements to manage suppliers by engaging in spot checks and eliminating “inferior” suppliers.  To the extent that Plaintiffs allegations went to the efficiency of the process, the court noted efficiency was an issue of corporate mismanagement, not investor deception.

With respect to allegations relating to food safety, Plaintiff asserted that Yum portrayed the issue as a food safety as a future rather than a materialized risk.  The court first reasoned that cautionary disclosures were inherently prospective and did not “infer anything regarding the current state of a corporation's compliance, safety, or other operations... ”  The court further reasoned that Plaintiffs did not allege facts to show the food safety issues “were so sever” that they would have “resulted in financial loss for Yum.”  As for the other allegations of falsity, the court stated that “the remaining statements can be cast aside with little fanfare.”  The court also declined to examine the “overall impression created by Yum’s statements” concluding that courts “do not forego a statement-by-statement analysis of objective falsity in favor of analyzing the overall impression made by a set of statements.”

Lastly, the court held Plaintiffs failed to sufficiently allege a “strong inference” of scienter.  The court determined that allegations of “motive” were not enough to establish scienter.  Nor did the allegations sufficiently tie the individual defendants to the test results “by alleging that senior officers were regularly notified of test results or that Yingtai and Liuhe supplied such a substantial proportion of KFC China's chickens that senior officers would have had to be aware of any issues with such major suppliers.”    

Accordingly, the court affirmed the lower court’s dismissal of the suit.

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