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Reese v. Malone

United States Court of Appeals, Ninth Circuit

February 13, 2014

CLAUDE A. REESE, Plaintiff, and CITY OF EDINBURGH COUNCIL AS ADMINISTERING AUTHORITY OF THE LOTHIAN PENSION FUND; BANKINTER GESTION DE ACTIVOS SGIIC; FRANKFURT TRUST INVESTMENT-GESELLSCHAFT MBH; FRANKFURTER-SERVICE KAPITALANLAGE-GESELLSCHAFT MBH; PIPEFITTERS LOCAL UNION #537 TRUST FUNDS, individually and on behalf of all others similarly situated, Plaintiffs-Appellants,
v.
ROBERT A. MALONE, Defendant, JOHN BROWNE; BP PLC; BP EXPLORATION (ALASKA), INC.; MAUREEN L. JOHNSON; STEVEN MARSHALL, Defendants-Appellees

Argued and Submitted, Seattle, Washington: May 9, 2013.

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Appeal from the United States District Court for the Western District of Washington. D.C. No. 2:08-cv-01008-MJP. Marsha J. Pechman, District Judge, Presiding.

Thomas A. Dubbs (argued), Javier Bleichmar, and Erin H. Rump, Labaton Sucharow LLP, New York, New York; Robert D. Stewart and Timothy Michael Moran, Kipling Law Group PLLC, Seattle, Washington, for Plaintiffs-Appellants.

Richard C. Pepperman II (argued) and Patrick B. Berarducci, Sullivan & Cromwell LLP, New York, New York; Diane L. McGimsey, Sullivan & Cromwell LLP, Los Angeles, California; David C. Lundsgaard, Graham & Dunn PC, Seattle, Washington, for Defendants-Appellees.

Before: Sidney R. Thomas and Jacqueline H. Nguyen, Circuit Judges, and Raymond J. Dearie, District Judge.[*] Opinion by Judge Dearie.

OPINION

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DEARIE, Senior District Judge:

In March of 2006, an oil leak in one of BP's Alaskan pipelines spilled approximately 200,000 gallons of oil onto the Alaskan tundra. Despite BP's public statements suggesting that the spill was an anomaly, a second leak was discovered five months later in a different BP oil transit line in the region. As a result, the company temporarily shut down regional operations.

This class action complaint was filed by BP shareholders, who allege that the company knowingly, or with deliberate recklessness, made false and misleading statements about the condition of the pipelines and BP's pipeline maintenance and leak detection practices prior to and in the wake of the first spill. They seek relief under Sections 10(b), 18(a) and 20(a) of the Securities Exchange Act of 1934, and Rule 10b-5, for investment losses incurred when the second spill and shutdown allegedly caused a four percent decline in BP's share price.

The district court granted defendants' motion to dismiss with prejudice. Although the court found that some of the statements were actionably false or misleading, it dismissed the claims because plaintiffs did not plead facts sufficient to show that the challenged statements gave rise to a strong inference of scienter. We have jurisdiction pursuant to 28 U.S.C. § 1291, and we reverse in part and affirm in part.

I. BACKGROUND

A. The Parties

Plaintiffs-appellants (hereinafter " plaintiffs" ) in this class action are purchasers of BP's common stock and American Depository Receipts (" ADRs" ) between June 30, 2005, and August 4, 2006.[1] Defendants-appellees (hereinafter " defendants" ) in this case are: (1) BP, the largest oil and gas producer in the United States; (2) BP Exploration Alaska (" BPXA" ) (hereinafter " BP-Alaska" ), a Delaware corporation and wholly-owned subsidiary of BP based in Anchorage, Alaska; (3) John Browne, BP's CEO during the class period; and (4) Maureen Johnson, BP-Alaska's Senior Vice President and Greater Prudhoe Bay Performance Unit Leader during the class period.

B. BP's Corrosion Monitoring Practices and the Prudhoe Bay Spills

Prudhoe Bay, the area where the spills took place, is located on the Northern Slope of Alaska and contains more than sixteen miles of oil transit lines (" OTLs" ). BP-Alaska operates " three similar low-stress pipelines" at Prudhoe Bay--the Western Operating Area (" WOA" ), the Eastern Operating Area (" EOA" ), and the Lisburne lines. There are a variety of methods of maintaining pipelines, but the principal process is called " pigging." " Maintenance pigging" consists of inserting a mechanical tool to clean the inside of the pipeline and remove debris and undesirable material. " Smart pigging" is used

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to detect the presence of cracks, corrosion, and pitting within the pipeline. According to media coverage and the company's eventual admissions, BP " pigged" the Prudhoe Bay OTLs infrequently and at a rate that fell significantly below industry standards for this type of pipeline. Instead, BP monitored for internal corrosion using less accurate methods, including an ultrasonic device used to measure the thickness of pipeline wall and " corrosion coupons," small metal plates placed inside the pipeline every ninety days to inspect for corrosion.

On March 2, 2006, an oil spill was discovered in the WOA pipeline. Estimates suggest the leak went undetected for at least five days, spilling approximately 4,800 barrels of oil (about 200,000 gallons) onto the Alaskan tundra. Subsequent investigation found that the leak was the result of a quarter-inch wide hole in a pipeline caused by internal corrosion. The second spill was discovered five months later on August 5 and 6, 2006. This leak occurred in a different corroded pipeline in the EOA, on the opposite side of Prudhoe Bay, spilling another twenty-five barrels of oil (about 1,000 gallons). Following the second spill, BP temporarily shut down the Prudhoe Bay oil field, which accounts for more than eight percent of total U.S. oil production.

The complaint alleges that BP had ample notice of, and disregarded, corrosion monitoring deficiencies at Prudhoe Bay. In 2001, the Alaska Department of Environmental Conservation hired Coffman Engineers, Inc. (" Coffman" ) to evaluate a report BP submitted on its corrosion prevention efforts. Coffman raised many questions about BP-Alaska's pigging practices and ultimately concluded that " the reporting style makes it difficult to develop a qualitative understanding of the basis for [BP's] corrosion strategy." [2] Plaintiffs also claim that BP's Board of Directors was warned about the severe corrosion problems at Prudhoe Bay in 2004, when Chuck Hamel, an advocate for BP workers in Alaska, voiced concerns about corrosion and environmental threats at Prudhoe Bay. The warnings are documented in a letter from Hamel to Walter Massey, the chairman of the environmental committee of BP's non-executive board of directors, advising Massey of " serious corrosion" and predicting a " major catastrophic event." [3]

C. Government Intervention

The first spill on March 2, 2006, received significant publicity and sparked immediate government intervention. It quickly came to light that BP had not tested the integrity of the WOA with a smart pig since 1998.

On March 15, 2006, the U.S. Department of Transportation Pipeline and Hazardous Materials Safety Administration (" PHMSA" ) issued a Corrective Action Order (" CAO" ) to BP-Alaska, addressed to defendant Maureen Johnson, Greater Prudhoe Bay Performance Unit Leader. The CAO preliminary findings identified six additional " anomalies" of internal corrosion, including one area with ninety percent corrosion and only 0.04 inches of wall remaining. It also noted the similarities between the three Prudhoe Bay Lines:

The PBWOA [WOA line] is one of three similar low-stress pipelines operated by Respondent that feed into PS-1. . . All

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three pipelines were constructed around the same time, operate in similar environmental conditions, transport the same quality crude oil that contributed to the cause of the internal corrosion in PBWOA, and are operated and maintained in a similar manner by Respondent.

The order concluded that " continued operation of [BP's] WOA, EOA and Lisburne hazardous liquid pipelines without corrective measures would be hazardous to life, property and the environment." It mandated several specific corrective actions, including the requirement that BP inspect all three lines with smart pigs within certain deadlines.

Under the terms of the Corrective Action Order, BP had three months to smart pig the EOA line by June 15, 2006. It failed to do so. The FS2-FS1 segment of the EOA line was not inspected until July 22, 2006, more than a month after the deadline. The delayed results showed significant corrosion, including sixteen different corroded areas with wall loss exceeding seventy percent, including two spots with greater than eighty percent loss. One hundred eighty-seven tested areas showed wall loss of close to fifty percent. As a result, BP decided to bypass certain parts of the pipelines instead of fixing them.

The second leak, this time in the EOA transit line, was discovered on August 5 and 6, 2006. In response, the Pipeline and Hazardous Materials Safety Administration issued Amendment No. 2 to the Corrective Action Order on August 10, 2006, adding more stringent directives and corrective actions including periodic reporting requirements and tight deadlines.

Both the Senate and the House of Representatives launched investigations regarding the spills.[4] On September 7, 2006, several BP executives were called to testify about the shutdown of Prudhoe Bay at a hearing before the House Subcommittee on Oversight and Investigations. During the hearing, Richard C. Woolam, leader of the Corrosion Inspection and Chemicals Group at BP-Alaska for many years before the spills, was asked when he became aware of the " pipeline integrity problems" at Prudhoe Bay, " including concerns about accelerated localized corrosion, microbial corrosion and [the fact] that the failure to send maintenance pigs or smart pigs down the transmission lines was placing those pipelines at high risk of failure." Mr. Woolam invoked the Fifth Amendment and refused to answer. Several parties testified that BP's maintenance practices deviated from industry standards. PHMSA Administrator Thomas J. Barrett stated, " Given the multiple risk factors for corrosion in the Prudhoe Bay environment and the low velocities on these lines, it is mystifying that BP did not run cleaning pigs regularly on these transit lines. Most pipeline operators demonstrate a higher standard of care than this regardless of whether they are federally regulated or not." Kevin Hostler, President and CEO of Alyeska Pipeline Service, a pipeline design, building, and maintenance company in Alaska, testified that pigging is particularly important for low-stress lines and should be part of a routine maintenance program.

In October of 2007, BP-Alaska pled guilty to a misdemeanor violation of the Clean Water Act, 33 U.S.C. § § 1319(c)(1), 1321(b)(3), for the negligent discharge of a harmful quantity of oil to a water of the United States, and agreed to pay a $20

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million fine in settlement of federal and state criminal violations. In the plea agreement, BP admitted that it was aware of the corrosion in the WOA pipelines in 2005. BP also conceded knowledge of the company's " insufficient inspection data" on the EOA line and awareness of sediment buildup in those pipelines prior to both spills. With respect to the company's corrosion monitoring practices, BP also knew that the WOA line had not been pigged since 1998, eight years before the leak, and that the EOA line had not been pigged since 1990, sixteen years before the leak.

On March 31, 2009, both the Department of Justice (" DOJ" ) and the State of Alaska filed separate civil lawsuits. The DOJ's civil complaint was for violations of the Clean Water Act, the Clean Air Act, and Federal Pipelines Safety Laws. On July 20, 2011, BP-Alaska entered into a consent decree to settle the claims, agreeing to pay $25 million in civil penalties and make $60 million in improvements to its pipelines in Alaska.

The State of Alaska's civil suit addressed BP-Alaska's alleged violations of state laws mandating compliance with a State-approved oil discharge prevention and contingency plan (" the Plan" ) and requirements for operating and maintaining a leak detection system. The State's complaint alleged that BP-Alaska " failed to adequately monitor corrosion rates [and] failed to adjust corrosion inhibitor levels in the OTLs" pursuant to the Plan. State of Alaska Compl. ¶ ¶ 142-45. With respect to BP's failure to adequately monitor corrosion rates, the State's complaint relied on BP-Alaska's October 2007 Guilty Plea to allege that BP " knew that it had insufficient inspection data on the EOA OTL." Id. ¶ ¶ 41, 50. The State also pointed to BP-Alaska's EOA Incident Investigation Report, which concluded that the number of ultrasonic thickness measurements collected by BP " were not sufficient to accurately represent the true condition of the line." Id. ¶ 62.

D. Procedural History

Plaintiffs filed the complaint[5] in 2008, alleging that defendants made false and misleading statements in violation of Sections 10(b), 18(a) and 20(a), and Rule 10b-5 of the Securities Exchange Act of 1934. The United States District Court for the Western District of Washington[6] granted in part and denied in part defendants' motion to dismiss, finding only one of the twenty-five statements to be actionable. That one statement was contained in quarterly filings with the SEC, made in connection with BP-Alaska's obligations to its shareholders, in which the company represented that it would operate Prudhoe Bay pursuant to the " Prudent Operator Standard." Ruling on interlocutory appeal, a panel of this Court reversed, concluding that " [BP-Alaska's] contractual promise to act as a prudent operator did not expressly or implicitly assert that [BP-Alaska] was in full compliance with its obligations thereunder . . . ." Reese v. BP Exploration (Alaska) Inc., 643 F.3d 681, 693 (9th Cir. 2011). The Court did not reach the issue of scienter.

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Plaintiffs' First and Second Amended Complaints add significant facts that came to light during the investigations and lawsuits arising out of the spills. They focus on five types of false or misleading statements: (i) a press statement made by Johnson regarding the most recent inspection data indicating that corrosion was occurring at a low and manageable rate; (ii) two press statements by Johnson suggesting that the March spill was anomalous and distinguishing the WOA OTL conditions with those of the other Prudhoe Bay pipelines; (iii) a statement by CEO Browne at an April 2006 press conference stating that the first spill occurred " in spite of the fact that [BP has] both world class corrosion monitoring and leak detection systems" ; (iv) a statement in BP's 2005 Annual Report stating that management believed BP was in ...


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