Zales Won’t Face Claims of Securities Fraud

(CN) - The 5th Circuit refused to revive securities fraud claims that the diamond retailer Zales inflated earnings and defrauded investors.

Pipefitters Local No. 636 Defined Benefit Plan had filed the class action against Zale Corp. and executives Mary Burton, Cynthia Gordon and Rodney Carter in 2010.

A federal judge in Texas dismissed the complaint, however, after finding that the allegations did not show a strong inference of fraud.

In an unpublished opinion Friday, a three-judge panel with the New Orleans-based federal appeals court affirmed.

"Because Pipefitters has not raised a strong inference that any of the three individual defendants, or any other Zale official responsible for the allegedly fraudulent financial statements, acted with scienter, the district court's order dismissing Pipefitters' complaint with prejudice is affirmed," the unsigned opinion states.

In their complaint, the investors had tried establish fraud by Zale by relying heavily on SEC allegations against Higgins.

They claimed on appeal that the trial court improperly drew an adverse inference based on the fact that the Securities and Exchange Commission did not file charges against former Zale vice president of marketing Rebecca Higgins.

But this argument did not sway the appellate judges.

"The district court stated only that the SEC's decision not to charge Higgins with fraud 'is consistent with' its finding that Higgins had not intended to commit fraud and did not consider the SEC's charging decision as actual evidence of Higgins' lack of fraudulent intent," the 10-page ruling states. "However, even assuming that the district court did rely on the SEC's charging decision and that was improper, we would affirm the district court's order. Even without considering the SEC's charging decision as evidence of lack of scienter, Pipefitters has not made a strong showing of scienter."

Scienter involves a showing of intent to deceive or an extreme departure from the standard of ordinary care.

The court found no weight behind claims that Zale had erred in its "severely reckless ... decision to blindly insert Higgins' suspicious numbers into Zale's formal accounting without any independent verification."

"We would not generally consider it to be 'severely reckless' for Zale and its officers to rely on a vice president in Zale's marketing depart to provide accurate information and follow company guidelines, and the facts alleged by Pipefitters do not show that it was reckless in this case," the opinion states. "Furthermore, although Pipefitters argues that 'Zale's accounting staff literally faked numbers to match Higgins' internal forecasts,' the actual allegations stated in the SEC complaint ... suggest merely that the accounting department relied upon Higgins' representations as to when advertising costs should be expensed."

In their conclusion, the judges downplayed Zale's admissions that it failed to maintain effective control over certain account reconciliations.

The panel also noted the great emphasis that investors placed on public statements from Zale officers, promising "good expense control," "financial rigor," and a "culture of cost discipline and accountability."

"Pipefitters contends that, because Zale's officers were paying close attention to expenses, surely they noticed that Higgins' reported numbers were causing profits to be overstated and simply ignored this," the opinion states. "However, the statements by Zale officials reasonably suggest that Zale wished to reduce advertising costs and make more efficient use of advertising dollars - not that Zale intended to double-check accounting figures submitted by high-level executives for accuracy."

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