Hertz rental sign/photo by enjosmith/Flickr Hertz rental sign/photo by enjosmith/Flickr

The U.S. Court of Appeals for the Third Circuit has upheld dismissal of a shareholder class action against Hertz Global Holdings stemming from a large-scale accounting debacle.

The company in the fall of 2013 announced that it had grossly overstated revenue and profits for fiscal years 2011 through 2013. The plaintiff-appellants, two labor union pension funds, filed suit in November 2013, claiming the company gave overly rosy assessments of its finances because several investors were planning to sell large blocks of shares.

The appeals court affirmed a U.S. District Court judge’s ruling that the plaintiffs failed to sufficiently demonstrate that three top company executives knew about accounting problems before those problems became public knowledge. The plaintiffs alleged that former Hertz CEO Mark Frissora, former CFO Elyse Douglas and former controller Jatindar Kapur violated securities laws by making materially false and misleading statements about the company’s finances.

The plaintiffs also claimed that Douglas and Kapur sold large amounts of their own Hertz stock holdings in trades that were out of line with their usual trading practices.

Circuit Judges Thomas Ambro, Kent Jordan and Thomas Hardiman on Sept. 20 ruled that the company’s 2014 restatement of accounting results, which reduced 2011-2013 pretax income by $215 million and net income by $132 million, provided “at most, some inference of scienter but not a strong inference” on the part of the three. And Hertz’s accompanying admissions of weakness in internal controls, and an “inappropriate tone at the top,” did not weigh in favor of inferring knowledge of the problems by the executives, the panel said. Finally, resignations of Frissora, Douglas and Kapur soon after the reinstatement do not materially add to an inference of scienter, the panel said.

The decision affirmed a 2015 ruling by U.S. District Judge Madeline Arleo, who dismissed the suit for failure to establish an inference of scienter as required under the Private Securities Litigation Reform Act.

On appeal, the plaintiffs argued that Arleo failed to conduct a proper analysis of scienter under Tellabs v. Makor Issues & Rights, a 2007 U.S. Supreme Court ruling. They claimed Arleo deviated from the Tellabs framework by failing to draw inferences favorable to them, requiring “smoking gun” evidence to adequately plead scienter, and failing to consider the complaint’s allegations holistically.

But Jordan, writing for the panel, said Arleo properly adhered to Tellabs by conducting an analysis of both inferences favorable to the plaintiffs as well as “plausible, nonculpable explanations” for the defendants’ conduct.

“That the District Court disagreed with the Funds’ preferred inferences is not a violation of the Tellabs framework,” Jordan wrote.

Jordan said Arleo didn’t hold the plaintiffs to a “smoking gun” standard, but simply emphasized that the complaint failed to allege a connection between Hertz’s accounting problems, caused by the individual defendants, and an inference that those defendants were aware they caused the problems.

Finally, Jordan said, the court below conducted the holistic analysis of the complaint as required under Tellabs. He said Arleo conducted a proper holistic analysis when she wrote: “The strongest inference of scienter comes from the restatement. However, the restatement is not enough by itself, so Plaintiffs had to tip the inferential scale with the four other categories of allegations. But, as explained, those categories do not strengthen the inference of knowledge or recklessness.”

Seven months after the present case was filed, Hertz was hit with another shareholder suit stemming from the same events. But that case was voluntarily dismissed in August 2014.

Kevin Marino of Marino, Tortorella & Boyle in Chatham, representing Hertz and Douglas, said of the ruling, “We’re very gratified by the Third Circuit’s opinion. Judge Arleo wrote a very thoughtful, carefully considered opinion and we are very pleased that the Third Circuit saw it the same way. There was no evidence whatsoever of any intent to violate the securities laws.”

Douglas Wilens of Robbins Geller Rudman & Dowd in Boca Raton, Florida, and Peter Pearlman of Cohn Lifland Pearlman Hermann & Knopf in Saddle Brook, who represented the plaintiffs, didn’t return calls about the case.

Adam Uniknowsky of Jenner & Block in Washington, D.C., who argued for Hertz before the Third Circuit, also did not return calls.

David Kotler of Dechert in Princeton, representing Frissora, did not return a call, and Gregory Markel of Seyfarth Shaw in New York, representing Kapur, declined to comment and referred a reporter to Hertz headquarters. Hertz did not respond to a request for comment about the case.