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Pension Trust Fund For Operating Engineers v. Kohl's Corp.

United States Court of Appeals, Seventh Circuit

July 12, 2018

Pension Trust Fund for Operating Engineers, et al., Plaintiffs-Appellants,
Kohl's Corporation, et al., Defendants-Appellees.

          Argued January 16, 2018

          Amended July 16, 2018

          Appeal from the United States District Court for the Eastern District of Wisconsin. No. 13-CV-1159 - J. P. Stadtmueller, Judge.

          Before Wood, Chief Judge, and Rovner and Hamilton, Circuit Judges.

          WOOD, CHIEF JUDGE.

         In September 2011, Kohl's Corporation announced that it was correcting several years of its financial filings because of multiple lease accounting errors. Hard on the heels of that announcement came a putative class action complaint. The plaintiffs, led by the Pension Trust Fund for Operating Engineers, allege that Kohl's and two of its executives defrauded investors by publishing false and misleading information in the lead-up to the corrections. (For ease of exposition, we refer to the putative class as the Pension Fund.) The Pension Fund took the position that one can infer that the defendants knew that these statements were false or recklessly disregarded that possibility at the time they were made, because Kohl's recently had made similar lease accounting errors. Despite those earlier errors, it was pursuing aggressive investments in its leased properties, and at the same time, company insiders sold considerable amounts of stock.

         The district court dismissed the complaint for failure to meet the enhanced pleading requirements for scienter imposed by the Private Securities Litigation Reform Act (PSLRA). The court entered that dismissal with prejudice, declining to give the Pension Fund even one opportunity to amend to cure the defects. The Pension Fund now appeals both the dismissal of the complaint and the district court's decision to enter it with prejudice. Because the first complaint fell short and the Pension Fund has not been able to suggest how an amendment might help, we affirm.


         Kohl's runs over one thousand department stores across the United States. About 65 percent of those stores are leased-a fact that makes lease obligations a significant component of Kohl's financial picture. The treatment of those leases has caused Kohl's accountants and external auditors some trouble in recent years. The company was forced to adjust its accounting practices three times-in 2005, 2010, and 2011-to bring its books in line with generally accepted accounting principles ("GAAP"). The first and third of these corrections were material and required the restatement of several years' worth of financial statements. The second was comparatively minor and required an adjustment to income in one quarter. The Pension Fund asserts that these recurring lease accounting errors show that Kohl's, its CEO Kevin Man-sell, and its CFO Wesley McDonald were at least reckless in overseeing the company's lease accounting practices by the time of the second and third corrections. Specifically, the Pension Fund contends that purchasers of Kohl's stock from February 26, 2009, to September 13, 2011 (the "class period"), were defrauded by knowing or reckless false statements in Kohl's financial reports.

         The Pension Fund advanced two theories of liability in the district court: securities fraud in violation of section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b), and SEC Rule 10b-5, 17 C.F.R. § 240.10b-5, against all defendants, and "controlling person" liability under section 20(a) of the Securities Exchange Act, 15 U.S.C. § 78t(a), against Mansell and McDonald. We can limit our discussion to section 10(b) and Rule 10b-5, because a violation of those provisions is necessary to support a violation of section 20(a). Pugh v. Tribune Co., 521 F.3d 686, 693 (7th Cir. 2008).

         To state a claim under section 10(b), a plaintiff must plead "(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." Id. We can narrow our focus even further, for the scienter element is the only point of dispute between the parties. We review the sufficiency of scienter pleadings de novo. Id. at 692.

         Scienter pleadings in securities fraud class actions must satisfy a heightened standard of plausibility. Through the PSLRA, Congress requires that plaintiffs "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) (emphasis added). For a case under section 10(b), that state of mind is "an intent to deceive, demonstrated by knowledge of the statement's falsity or reckless disregard of a substantial risk that the statement is false." Higginbotham v. Baxter Int'l, Inc., 495 F.3d 753, 756 (7th Cir. 2007).

         The Supreme Court has told us that a complaint gives rise to a strong inference of scienter "only if a reasonable person would deem the inference of scienter cogent and at least as compelling as any opposing inference one could draw from the facts alleged." Tellabs, Inc. v. Makor Issues & Rights, Ltd., 551 U.S. 308, 324 (2007). In making this determination, the allegations in the complaint "are accepted as true and taken collectively." Id. at 326. We must consider the relative probability of whether, taken as a whole, the false statements alleged here were "the result of merely careless mistakes at the management level based on false information fed it from below" or reflect "an intent to deceive or a reckless indifference to whether the statements were misleading." Makor Issues & Rights, Ltd. v. Tellabs Inc., 513 F.3d 702, 709 (7th Cir. 2008). If the latter inference is not at least as compelling as the former, dismissal is appropriate.


         Most of the Pension Fund's complaint recounts the details of the accounting errors and Kohl's financial restatements, but both sides argue that we need not wade too deeply into those details. The Pension Fund insists that because Kohl's repeatedly made lease accounting errors, something is up-where there's smoke, there's fire. But this inference depends on how (dis)similar the errors are. Kohl's counters that technical accounting errors such as these are well below the pay grade of its executives. But leases are a significant part of Kohl's financial picture that cannot be expected to evade executive knowledge altogether. See S. Ferry L P, No. 2 v. Killinger, 542 F.3d 776, 784 (9th Cir. 2008) (concluding that a "core-operations inference" can support scienter after Te l l a b s ). We decline to take either simplistic approach. Tellabs's repeated emphasis on looking at the facts "holistically" tells us that we must do more. 551 ...

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