Friday, September 28, 2018

Caterpillar Shareholder Suit For Fraudulent Disclosures from Tax Civil and Criminal Investigation Dismissed (9/28/18; 3/20/24)

I have previously written on the Caterpillar kerfuffle.  Search Warrant Executed Against Caterpillar HQ, Apparently Related to Tax (Federal Tax Crimes Blog 3/6/17; 3/8/17), here; and The Whistleblower Behind Caterpillar Tax Commotion (6/2/17), here.  A district court has just dismissed a shareholder claim of securities fraud against Caterpillar for inadequate and misleading disclosures about the search warrant and criminal investigation.  Société Générale Securities Services, GbmH v. Caterpillar, Inc. (N.D. Ill. No. 17 cv 1713), order dated 9/26/18, here.

Several government agencies, including the IRS, obtained and executed a search warrant.  The apparent focus was:
Caterpillar’s creation of a Swiss subsidiary, Caterpillar S.A.R.L. (“CSARL”) in 1999, through which Caterpillar paid an effective tax rate of 4-6% to the Swiss government. Société Générale alleges that CSARL lacked a proper business purpose and thus was not a legitimate tax reduction plan. A former employee filed a whistleblower lawsuit  that was resolved through a settlement. After that lawsuit, however, the IRS, Congress, and other government agencies began investigating Caterpillar’s tax position.
Large dollars are potentially involved, which could substantially affect Caterpillar's financial position and stock price.  In addition, if indeed Caterpillar participated in illegal tax shenanigans, major fines and other financial and reputational consequences could apply.

When a registered public company has a significant event that could affect its share price, it has to make appropriate public announcements.  Obviously, a previously undisclosed criminal investigation with a search warrant is a major event requiring some disclosures.  Caterpillar made announcements which, according to the opinion, the plaintiff alleged were actionably inadequate by downplaying the potential financial effect of the investigations, particularly the potential for significant tax, penalties and interest.  The Court summarized and categorized the claims as follows:
(1) General statements that Caterpillar’s consolidated financial statements are prepared in accordance with generally accepted accounting principles (“GAAP”). These statements appear in nearly identical form in Caterpillar’s Form 10-K (2013-2017) and Form 10-Q for each quarter of 2013 and 2014. 
(2) Statements disclosing the IRS examination of tax returns from 2007 to 2009 in Form 10-K (2013 and 2014) and Form 10-Q (each quarter of 2014). The forms further state: “In the opinion of management, the ultimate disposition of these matters will not have a material adverse effect on our consolidated financial position, liquidity or results of operations.” In 2014, Caterpillar included the additional statement that this opinion included “the impact of a loss carry-back to 2005.”  
(3) Lagacy’s testimony before the Senate Subcommittee and corresponding press release in advance of that testimony in which she referred to Caterpillar’s legal compliance with tax laws, that CSARL is not a shell corporation, and that Caterpillar remains convinced that its restructuring complied with the tax code. 
(4) Caterpillar’s Form 10-K, 2015-2016 (all quarters) and 2017 (first quarter) disclosed the grand jury subpoena from January 8, 2015, stating: “The Company is cooperating with this investigation. The Company is unable to predict the outcome or reasonably estimate any potential loss; however, we currently believe that this matter will not have a material adverse effect on the Company’s consolidated results of operations, financial position or liquidity.” Caterpillar further states: “we believe that taxing authorities could challenge certain positions[,]” and reported that “[o]n January 30, 2015, we received a Revenue Agent’s Report (RAR) from the Internal Revenue Service (IRS) indicating the end of the field examination of our U.S. tax returns for 2007 to 2009 including the impact of a loss carryback to 2005. The RAR proposed tax increases and penalties for these years of approximately $1 billion primarily related to two significant areas that we intend to vigorously contest through the IRS Appeals process…. Based on the information currently available, we do not anticipate a significant increase or decrease to our recognized tax benefits for these matters within the next 12 months. We currently believe the ultimate disposition of these matters will not have a material adverse effect on our consolidated financial position, liquidity or results of operations. We expect the IRS field examination of our U.S. tax returns for 2010 to 2012 to begin in 2015. In our non-U.S. jurisdictions, tax years are typically subject to examination for three to eight
I won't get into the details of the Court's treatment of the securities and fraud claims because they relate to law other than the focus of this blog -- federal tax crimes.  But, federal tax crimes enthusiasts might be interested in the following excerpts (which at least I found interesting):
What Société Générale is really asking is that Caterpillar be required to admit liability for uncharged, unadjudicated claims while the investigation into its tax position was ongoing. That sort of confession of guilt is not required. See Anderson v. Abbott Labs., 140 F. Supp. 2d 894, 906 (N.D. Ill.), aff'd sub nom. Gallagher v. Abbott Labs., 269 F.3d 806 (7th Cir. 2001) (“SEC rules do not create a duty to confess contested charges.”); Ballan v. Wilfred American Edu. Corp., 720 F.Supp. 241, 249 (E.D.N.Y.1989) (“[T]he SEC's proxy disclosure rules do not require a company's management to confess guilt to uncharged crimes, or ‘to accuse itself of antisocial or illegal policies.’ ... There is no reason why a different rule should apply under § 10(b).”) (citations omitted)). 
* * * * 
Citing the grand jury subpoena and execution of search warrants, Société Générale essentially argues that Caterpillar should have admitted a securities or tax law violation while the investigations were ongoing and the failure to do so was both a material omission and a misstatement. This Court finds such a position untenable. If every investigation or executed search warrant was evidence of wrongdoing then what purpose do hearings and trials have. As previously stated, securities laws generally do not impose such a duty upon publicly traded corporations to confess to uncharged, unadjudicated claims of wrongdoing. See Anderson v. Abbott Labs., 140 F. Supp. 2d 894, 906 (N.D. Ill.), aff'd sub nom. Gallagher v. Abbott Labs., 269 F.3d 806 (7th Cir. 2001) (“SEC rules do not create a duty to confess contested charges.”); see also Mogell v. Calhoun, No. 15 CV 1239, 2016 WL 3369233, at *5 (C.D.Ill. Mar. 15, 2016) (Mihm, J.) (finding that the plaintiff failed to show further disclosures were required by Caterpillar’s Board of Directors). 
Société Générale further claims that Caterpillar’s statements, regarding its compliance with the tax laws and its cooperation with the investigation, were false based on a report from an accounting professor, Dr. Robinson, that was prepared for the Senate Subcommittee hearings and was excerpted in the New York Times on March 7, 2017. Société Générale also points to a Wall Street Journal (“WSJ”) article from July 3, 2017. Newspaper and media may be credible sources bolstering plaintiff’s claim, “if the newspaper article includes numerous factual particulars and is based on an independent investigative effort[.]” In re McKesson HBOC, Inc. Sec. Litig., 126 F. Supp. 2d 1248, 1272 (N.D. Cal. 2000). The articles on which Société Générale relies do not support an inference that Caterpillar’s statements regarding its tax position were false, especially where Caterpillar qualified those statements by acknowledging that it could not predict the outcome. The excerpts from Dr. Robinson’s report are stated as opinion, “I believe that the company’s noncompliance with these rules was deliberate and primarily with the intention of a higher share price.” Similarly, the WSJ reported, “[f]ederal investigators believe Caterpillar, Inc. failed to submit numerous required export findings with the government in recent years.” Neither these reports nor the retirement or resignation of two senior executives suggests that Caterpillar did not believe that it complied with tax laws and was cooperating with the investigation. 
* * * * 
The 2009 lawsuit was an employment discrimination suit claiming retaliation by a former employee for raising concerns over the CSARL tax position that settled and was never adjudicated on the merits. Caterpillar contested that case as it has the IRS investigation. That Caterpillar consistently maintained its belief that it complied with tax laws, cooperated with the government, determined to appeal any adverse findings is not undermined by any or all of the allegations. Caterpillar did not present an overly sunny outlook, but specifically disclosed the investigations. Indeed, Caterpillar’s continued statements that it continued to belief its tax position complied with the law, the company specifically tempered those statements with ones acknowledging that the taxing authorities could challenge their position and that the ultimate outcome is not predictable. These facts suggest that it was at least as likely that Caterpillar believed its advisors and accountants that their position complied with the law. This position was perhaps negligent but Société Générale has not supplied sufficient facts to demonstrate that it was fraudulent or even reckless. “Perhaps the executives had a motive to pretend nothing was amiss (though even that does not seem beyond dispute, as they might equally have wanted the most accurate financial picture possible), but a generalized motive common to all corporate executives is not enough to establish scienter.” Kohl’s, 895 F.3d 939-40. Further, there is no meaningful dispute that significant time has passed since the agencies completed their investigations and no charges have been filed.
I don't know the current status of the tax or any other investigations.  If readers know and think it material for readers of this blog, please advise either by comment or email to me at

Note: I made minor text changes (wording, grammatical) on 3/20/24 @ 10am, incident to preparing an update blog entry. See Based in Part on NYT Article, Senators Request Information from AG Garland about Possible Political Intervention in Caterpillar Tax Investigation(s) (3/20/24), here.

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