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Ind. Pub. Ret. Sys. v. SAIC, Inc.

United States Court of Appeals, Second Circuit

March 29, 2016

INDIANA PUBLIC RETIREMENT SYSTEM, Indiana State Teachers' Retirement Fund, Indiana Public Employees' Retirement Fund, Plaintiffs-Appellants, City of Westland Police and Fire Retirement System, on Behalf of Itself and All Others Similarly Situated, Locals 302 and 612 of the International Union of Operating Engineers-Employers Construction Industry Retirement Fund, on Behalf of Themselves and All Others Similarly Situated, IBEW Local Union No. 58 Annuity Fund and the Electrical Workers Pension Trust Fund of IBEW Local Union No. 58, Plaintiffs,
v.
SAIC, INC., Mark W. Sopp, Walter P. Havenstein, Defendants-Appellees, Gerard Denault, Kenneth C. Dahlberg, Deborah H. Alderson, Defendants

         Argued October 6, 2015

Page 86

[Copyrighted Material Omitted]

Page 87

         Plaintiffs-appellants Indiana Public Retirement System, on behalf of themselves and a class of other similarly situated investors, appeal from an order of the District Court (Batts, J.) denying their motions to vacate the judgment and to amend their complaint. Plaintiffs brought a securities fraud suit pursuant to Section 10(b), 15 U.S.C. § 78j(b), and Section 20(a), 15 U.S.C. § 78t(a), of the Securities Exchange Act of 1934 against SAIC, Inc., Walter P. Havenstein, Mark W. Sopp, and others, alleging material misstatements and omissions in SAIC's public filings regarding its exposure to liability for employee fraud in connection with SAIC's contract work for New York City's CityTime project. Because amendment of Plaintiffs' FAS 5 and Item 303 claims based on SAIC's March 2011 Form 10-K would not be futile, we VACATE the order denying the postjudgment motion with respect to those claims and REMAND for further proceedings consistent with this opinion. We AFFIRM the decision of the District Court with respect to Plaintiffs' other claims.

         DOUGLAS WILENS, Robbins Geller, Rudman & Dowd LLP, Boca Raton, FL; Samuel H. Rudman, Joseph Russello, Sean T. Masson, Robbins Geller, Rudman & Dowd LLP, Melville, NY, for Plaintiffs-Appellants.

         ANDREW S. TULUMELLO (Jason J. Mendro, on the brief), Gibson, Dunn & Crutcher LLP, Washington, DC; Eric Robert Delinsky, Zuckerman Spaeder LLP, Washington, DC for Defendants-Appellees SAIC, Inc. and Mark W. Sopp.

         Mark Filip, P.C., Vikas Didwania, Kirkland & Ellis LLP, Chicago, IL; Beth A. Williams, Emily P. Hughes, Kirkland & Ellis LLP, Washington, DC for Defendant-Appellee Walter P. Havenstein.

         Before: LYNCH, LOHIER, and CARNEY, Circuit Judges.

          OPINION

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          LOHIER, Circuit Judge.

         The Indiana Public Retirement System, the Indiana State Teachers' Retirement Fund, and the Indiana State Public Employees' Retirement Fund, on behalf of themselves and a class of other similarly situated investors (" Plaintiffs" ), appeal from an order of the United States District Court for the Southern District of New York (Batts, J.) denying their motions to vacate the judgment and to amend their complaint. Plaintiffs sued SAIC, Inc.; [1] Walter P. Havenstein, its Chief Executive Officer; Mark W. Sopp, its Chief Financial Officer; and others (collectively, " Defendants" ) for securities fraud in violation of Section 10(b) of the Securities Exchange Act of 1934 (the " Exchange Act" ), 15 U.S.C. § 78j(b), Section 20(a) of the Exchange Act, 15 U.S.C. § 78t(a), and Securities and Exchange Commission (" SEC" ) Rule 10b-5, 17 C.F.R. § 240.10b-5. Their lawsuit arose from a series of alleged material misstatements and omissions in SAIC's public filings regarding its exposure to liability for employee fraud in connection with SAIC's contract work for New York City's CityTime project. On appeal, we address principally four issues arising from Plaintiffs' motion to file a Proposed Second Amended Complaint (" PSAC" ): (1) SAIC's alleged failure to comply with Generally Accepted Accounting Principles (" GAAP" ) by failing to disclose appropriate loss contingencies associated with the CityTime project, in violation of Financial Accounting Standard No. 5 (" FAS 5" ); (2) SAIC's alleged failure to disclose a known trend or uncertainty reasonably expected to have a material impact on its financial condition, in violation of Item 303 of SEC Regulation S--K, 17 C.F.R. § 229.303(a)(3)(ii) (" Item 303" ); [2] (3) SAIC's scienter; and (4) among other remaining issues, SAIC's allegedly misleading statements regarding its commitment to ethics and integrity contained in its 2011 Annual Report to shareholders.

         We conclude that the District Court improperly denied Plaintiffs' postjudgment motion to amend their FAS 5 and Item 303 claims based on SAIC's March 2011 Form 10-K. We therefore vacate the District Court's order denying the motion with respect to those claims and remand for further proceedings consistent with this opinion. We affirm the judgment of the District Court with respect to Plaintiffs' remaining claims.

         BACKGROUND

         We accept as true the facts alleged in the PSAC because Plaintiffs appeal from the denial of leave to amend on the ground of futility. See In re Advanced Battery Techs., Inc., 781 F.3d 638, 641-42 (2d Cir. 2015).

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          1. Facts

         SAIC provided defense, intelligence, homeland security, logistics, and other services primarily to government agencies. In 2000 SAIC became the prime government contractor on a project with New York City to develop and implement an automated timekeeping program known as CityTime for employees of various City agencies. SAIC anticipated that the project, if successful, would attract business from municipalities across the United States with similar timekeeping requirements and would lead to contracts unrelated to timekeeping in the City. As a result, SAIC kept a close eye on the project's progress.

         In 2002 SAIC hired Gerard Denault as Deputy Program Manager in charge of the CityTime project. In 2003 Denault enlisted Technodyne, a small, relatively unknown company, to provide staffing services on the project, but the relationship soon gave rise to an elaborate kickback scheme in which Technodyne illegally paid Denault and Carl Bell (SAIC's Chief Systems Engineer) for each hour a Technodyne consultant or subcontractor worked on CityTime. The scheme encouraged Denault and Bell to hire more Technodyne workers than the project required and to inflate billable hours and hourly rates.

         Although SAIC initially suffered large losses under the CityTime contract, the contract became profitable in 2006 after Denault negotiated an amendment to the contract that transferred the risk of any cost overruns to the City. As a result of the amendment and the cost overruns associated with the kickback scheme, SAIC billed the City approximately $635 million for CityTime through May 2011, well over the $63 million that the City initially budgeted for the contract.

         By late 2010, when the scheme began to unravel, SAIC had removed Denault from the CityTime project, placed him on administrative leave, and hired an outside law firm to conduct an internal investigation of possible fraud with the help of SAIC's internal auditors, who were tasked with reviewing Denault's timekeeping practices. At the same time, then-Mayor Michael Bloomberg announced that he was reevaluating SAIC's role in the CityTime project and reviewing whether to seek recovery of the City's payments to SAIC in connection with that project. On March 9, 2011, SAIC's audit team reported the results of its findings regarding Denault's improper timekeeping practices to SAIC.

         Notwithstanding the audit team's findings, SAIC's Form 10-K, filed on March 25, 2011, and certified by Sopp and Havenstein, did not disclose SAIC's potential liability related to the CityTime project. To the contrary, in a separate Annual Report to shareholders that same month, SAIC touted its commitment to high standards of " ethical performance and integrity." Joint App'x 252. By the end of May 2011, though, Denault, Bell, the Technodyne principals, and others were charged in a federal criminal complaint with defrauding the City.[3] The charges, together with the results of the internal investigation from March 2011, prompted SAIC to fire Denault in May 2011 and offer to repay the City the amount he had billed after the 2006 amendment of the CityTime contract--a total of $2.5 million.

         Thereafter, in a Form 8-K filed with the SEC on June 2, 2011, SAIC finally disclosed

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that the United States Attorney's Office for the Southern District of New York (the " Government" ) and the New York City Department of Investigation (" DOI" ) were conducting a joint criminal investigation into the CityTime contract. The 8-K further disclosed that SAIC had billed a total of $635 million for the CityTime project, that it had $40 million in outstanding receivables, that Denault had been arrested for fraud, and that SAIC had offered to refund the City the $2.5 million that Denault billed as part of the kickback scheme with Technodyne. Finally, the 8-K explained that Mayor Bloomberg had

indicated that the City intends to pursue the recovery of costs associated with the CityTime program that the City's investigation reveals were improperly charged to the City. The City has not filed any claim against the Company or otherwise requested reimbursement or return of payments previously made to the Company and the Company has not recorded any liabilities relating to this contract other than the approximately $2.5 million it offered to refund. However, there is a reasonable possibility of additional exposure to loss that is not currently estimable if there is an adverse outcome. An adverse outcome of any of these investigations may result in non-payment of amounts owed to the Company, a demand for reimbursement of other amounts previously received by the Company under the contract, ...

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