The Second Circuit has offered investors another chance to bring claims against a company that was the subject of criminal charges and returned more than $500 million to New York City after massive employee fraud at the company was discovered. Investors alleged that the company’s public filings included misstatements and omissions about the alleged criminal activity and violated Item 303 of Regulation S-K (Indiana Public Retirement System v. SAIC, Inc., March 29, 2016, Lohier, R.).
Allegations against SAIC. The Indiana Public Retirement System, the Indiana State Teachers’ Retirement Fund and the Indiana State Public Employees’ Retirement Fund sued SAIC, Inc. in connection with a series of alleged material misstatements and omissions in SAIC’s public filings regarding its exposure to liability for employee fraud arising out of SAIC’s contract work for New York City’s CityTime project.
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.
Eventually, SAIC’s deputy program manager hired a subcontractor to provide staffing services on the project, which gave rise to an elaborate kickback scheme in which the subcontractor made payments to the deputy program manager for each hour a consultant worked on the CityTime project.
SAIC billed New York approximately $635 million for CityTime through May 2011, which was well over the $63 million the city had initially budgeted for the contract.
By late 2010, the scheme began to unravel and the firm hired an outside law firm to conduct an investigation while New York Mayor Michael Bloomberg announced he was reevaluating SAICs role in the project and reviewing whether to seek recovery of the city’s payment to SAIC in connection with the project.
SEC filings. SAICs Form 10-K filed on March 25, 2011, did not disclose SAIC’s potential liability related to the CityTime project, even though by May 2011 several individuals had been criminally charged with defrauding the city.
In a Form 8-K filed on June 2, 2011, SAIC finally disclosed that the U.S. Attorney’s office was conducting a criminal investigation, and that SAIC had billed a total of $635 million, with $40 million in outstanding receivables. The filing also disclosed that the deputy project manager had been arrested and that SAIC had offered to refund the city the $2.5 million that was billed as part of the kickback scheme. In addition, the filing disclosed that Mayor Bloomberg had indicated that the city intended to pursue recovery of costs associated with the program and the city’s investigations.
On June 3, 2011, SAIC filed a Form 10-Q that repeated the representations made in the 8-K about the project. On July 1, 2011, SAIC filed a second 8-K that included a letter from the mayor formally demanding that SAIC reimburse the city for approximately $600 million.
In March 2012, SAIC entered into a deferred prosecution agreement in which SAIC agreed to reimburse the city approximately $500.4 million and to forfeit $40 million in unpaid receivables.
Investors’ complaint dismissed. The investors’ complaint alleged that SAIC’s March and June 2011 SEC filings failed to disclose SAIC’s potential liability arising out of the CityTime fraud or known trends or uncertainties associated with the fraud, as required by Item 303 of Regulation S-K.
After the district court granted SAICs motion to dismiss the Item 303 claim, the investors proposed an amended complaint, including allegations that SAIC was aware of the government’s criminal investigation and had actually agreed to advance legal fees in connection with the investigation and any criminal proceeding that emerged.
On January 30, 2014, the district court granted SAIC’s motion to dismiss the Item 303 claims and the court immediately entered judgment dismissing the remaining claims with prejudice. The court denied the investors’ motion to vacate or obtain relief from judgment and file an amended complaint, concluding that any amendment reflected in the amended complaint would be futile.
Item 303. The amended complaint alleged that SAIC violated Item 303 by failing to disclose that SAIC had overbilled the city hundreds of millions of dollars on CityTime over a multi-year period and that SAIC’s overbilling practices subjected it to numerous undisclosed risks, including monetary risks and reputational risks, particularly because government agencies were SAICs primary customer and any harm to its reputation and or relationships with such agencies would adversely affect its current business as well as its future revenues and growth prospects.
In ruling on the investors’ appeal, the Second Circuit for the first time specifically held that the plain language of Item 303 “requires the registrants’ actual knowledge” of the relevant trend or uncertainty. “We therefore hold that Item 303 requires the registrant to disclose only those trends, events or uncertainties that it actually knows of when it files the relevant report with the SEC. It is not enough that it should have known of the existing trend, event or uncertainty.”
Here, the amended complaint supported a strong inference that SAIC “actually knew about the CityTime fraud before filing its Form 10-K on March 25, 2011, and that it could be implicated in the fraud and required to repay the city the revenue generated by the contract.
Moreover, the Second Circuit held that the amended complaint plausibly alleged that as a result of the fraud, both the city and New York State rejected pending contract awards to SAIC valued at more than $150 million. Exposure of the fraud also jeopardized SAIC’s existing or future relationship with other governmental entities that accounted for a significant amount of its revenue.
Under the alleged circumstances, the court said, SAIC was required under Item 303 to disclose the manner in which the then-known trend, event, or uncertainty might reasonably be expected to materially impact SAIC’s future revenues.
The Second Circuit vacated the district court’s order denying the investors’ motion and remanded the matter for further proceedings.
The case is No. 14-4140.
Attorneys: Douglas S. Wilens (Robbins Geller Rudman & Dowd LLP) for Indiana Public Retirement System, Indiana State Teachers' Retirement Fund, and Indiana Public Employees' Retirement Fund. Jason J. Mendro (Gibson Dunn & Crutcher LLP) for SAIC, Inc.
Companies: Indiana Public Retirement System; Indiana State Teachers' Retirement Fund; Indiana Public Employees' Retirement Fund; SAIC, Inc.; City of Westland Police and Fire Retirement System; Locals 302 and 612 of the International Union of Operating Engineers Employers Construction Industry Retirement Fund; IBEW Local Union No. 58 Annuity Fund; The Electrical Workers Pension Trust Fund of IBEW Local Union No. 58
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