3rd Circuit Upholds Dismissal of Securities Fraud Class Action Against AD Duty Evading Importer
The 3rd Circuit U.S. Court of Appeals upheld the dismissal of a securities fraud class action lawsuit related to an importer’s evasion of antidumping duties. Shah Rahman had argued that Kid Brands misled investors when it failed to immediately disclose that it was subject to a CBP focused assessment, and that its subsidiaries had mislabeled its products to disguise their origin and evade AD duties on wooden bedroom furniture from China. The company’s stock price tumbled from $9.24 to $2.97 per share as the news emerged over a five month span. The New Jersey U.S. District Court dismissed the case in October 2012, because Raman didn’t prove that executives at Kid Brands intended to deceive investors. On appeal, the 3rd Circuit wasn’t convinced by the testimony of six confidential witnesses, and upheld the dismissal.
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Rahman’s class action complaint argued Kid Brands should have told investors of its AD duty evasion issues as early as December 2010, when CBP notified Kid Brands that it was conducting a focused assessment of the company’s import practices and procedures. At that time, Kid Brands hired an outside law firm to investigate its compliance with import laws and regulations. But Kid Brands didn’t tell investors of the focused assessment and the investigation until March 2011, when it put out a press release that estimated it would have to pay $7 million in fines to resolve charges that its subsidiary LaJobi mislabeled merchandise to avoid AD duties. As a result, Kid Brands’ stock fell from $9.24 to $6.91 on that date.
The full scale of Kid Brands’ import compliance problems didn’t become apparent to investors until August 2011, when Kid Brands disclosed to the Securities and Exchange Commission AD duty evasion by two other subsidiaries, CoCaLo and Kids Line, and estimated liabilities of $10 million in fines and charges associated with the violations. The company’s stock fell to $2.97 per share over the following week.
Under the Private Securities Litigation Reform Act, class action lawsuits for securities fraud have to prove that a company made misleading statements, and that the company acted with intent to deceive, manipulate, or defraud. The New Jersey District Court said the company’s initial delay in informing investors that it was the subject of a CBP focused assessment was not misleading, because the company reasonably wanted to investigate before disclosing any compliance problems. On the other hand, the delay until August 2011 for Kids Brands to explain the full extent of its compliance issues was misleading to investors. But in any case, the district court said Rahman didn’t show that corporate officers at Kids Brands knew of their subsidiaries’ duty evasion scheme, and dismissed the case because of a lack of intent.
On appeal, the 3rd Circuit upheld the dismissal of the case for lack of intent to defraud by Kids Brands’ corporate officers. Departing from the district court ruling, the appeals court said Kids Brands’ failure to immediately disclose the CBP focused assessment and internal investigation may have been misleading, because the company arguably could have released the information on a tentative basis before March 2011. Nonetheless, the appeals court agreed that Rahman failed to prove that Kids Brands’ corporate officers acted with intent. Rahman relied on six confidential witnesses -- all former employees of Kids Brands and its subsidiaries -- to prove involvement by Kids Brands corporate officers. But the six witnesses made only vague and circumstantial claims regarding oversight by Kids Brands’ corporate officers of the AD duty evasion scheme, the appeals court found.
(Shah Rahman v. Kids Brands, Inc., 3rd Circuit No. 12-4257, dated 11/15/13)