CHICAGO (CN) - Paving the way for sanctions, the 7th Circuit rejected claims that Boeing inflated its share price by misrepresenting the plane's readiness for a maiden flight.
In April 2009, Boeing's soon-to-be-released Dreamliner failed a wing stress test. Less than two weeks later, the company announced that "all structural tests required on the static airframe prior to First Flight are complete," with "positive" results.
Boeing CEO James McNerney publicly stated that the Dreamliner was on track for a June 30, 2009, maiden flight.
The plane failed another stress test in mid-May, but Boeing did not announce the First Flight's cancelation until one week beforehand. Boeing simultaneously announced that the cancelation would cause an indefinite delay in the delivery of Dreamliners, including those that had been pre-ordered.
Boeing's share price dropped 10 percent in the two days following the announcements.
Attorneys at Robbins Geller Rudman & Dowd filed a class action representing investors who had purchased the company's stock during the period between the failed test and Boeing's cancelation announcement.
The complaint charged Boeing and two of its executives with securities fraud for falsely claiming that the plane could be ready to fly.
U.S. District Judge Ruben Castillo dismissed the complaint without prejudice, however, after finding no "strong inference" that Boeing knowingly made false statements.
In amended complaint, the investors relied heavily on their investigator's interview with engineer Bishnujee Singh whom they described as a "Boeing senior structural analyst engineer." Attorneys for the class claimed that Singh had worked on the April stress test and had access to files showing that Boeing executives knew of the plane's failure.
Further investigation revealed, however, that Singh did not work for Boeing. He actually worked for a subcontractor testing a different model of the Dreamliner than what the suit involved, and he denied having access to Boeing's internal files. Singh had never met with plaintiffs' attorneys before the second amended complaint was filed.
Judge Castillo again dismissed the suit, this time with prejudice. On appeal, a three-judge panel of the 7th Circuit sided squarely with Boeing.
To prevail, the investors must do more than demonstrate that Boeing executives knew of the failed tests, according to the ruling. They must also have known that the test spelled certain doom for the First Flight but continued to lie publicly.
"No prediction - even a prediction that the sun will rise tomorrow - has a 100 percent probability of being correct," Judge Richard Posner wrote for the court. "The future is shrouded in uncertainty. If a mistaken prediction is deemed a fraud, there will be few predictions, including ones that are well grounded, as no one wants to be held hostage to an unknown failure."
"There is no duty of total corporate transparency - no rule that every hitch or glitch, every pratfall, in a company's operations must be disclosed in 'real time,' forming a running commentary, a bearing of the corporate innards, day and night," Posner added.
Because purchasers of the Dreamliner were able to cancel their orders, it is unlikely that Boeing timed its announcement so as to deceive clients and investors, the court found.
"A more plausible inference that that of fraud is that the defendants, unsure whether they could fix the problem by the end of June, were reluctant to tell the world 'we have a problem and maybe it will cause us to delay the First Flight and maybe not, but we're working on the problem and we hope we can fix it in time to prevent any significant delay, but we can't be sure so stay tuned,'" Posner wrote.
Finding the complaint properly dismissed, the court noted that sanctions may be in order since the attorneys at Robbins Geller Rudman & Dowd failed to meet the burden that the Private Securities Litigation Reform Act of 1995 carries for federal securities fraud plaintiffs.
"The plaintiffs' lawyers had made confident assurances in their complaints about a confidential source - their only barrier to dismissal of their suit - even though none of the lawyers had spoken to the source and their investigator had acknowledged that she couldn't verify what (according to her) he had told her," Posner wrote (parentheses in original).
Though the investigator said she had expressed qualms about Singh, attorneys for the plaintiffs included him in the amended complaint without investigating, according to the ruling.
"Their failure to inquire further puts one in mind of ostrich tactics - of failing to inquire for fear that the inquiry might reveal stronger evidence of their scienter regarding the authenticity of the confidential source than the flimsy evidence of scienter they were able to marshal against Boeing," Posner wrote.
Noting that the firm has reportedly engaged in similar conduct in three other cases, the court remanded the case for Castillo to determine appropriate sanctions.
"The District Court is in a better position than the court of appeals to calculate the dollar amount of sanctions," Posner wrote. "It also may have additional insights into the accused lawyers' conduct, by virtue of having spent more time on the litigation than the appellate court."
The Dreamliner's maiden flight did not take place until December 2009. The plane faced additional setbacks in January 2013 when the Federal Aviation Administration ordered all U.S.-based airlines to ground their Boeing 787s pending investigation and design modifications. Incidents of electrical overheating and fires had forced multiple emergency landings worldwide.
Boeing reported in February that the National Transportation Safety Board "has identified the origin of the event as having been within the battery."
"We continue to provide support to the investigative groups as they work to further understand these events and as we work to prevent such incidents in the future," Boeing said on its website. "The safety of passengers and crew members who fly aboard Boeing airplanes is our highest priority."
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