ALASKA ELECTRICAL PENSION FUND, Lead Plaintiff, Plaintiff-Appellant
FLOTEK INDUSTRIES, INCORPORATED; JOHN W. CHISHOLM; H. RICHARD WALTON; ROBERT M. SCHMITZ, Defendants - Appellees
from the United States District Court for the Southern
District of Texas
DENNIS, CLEMENT, and ENGELHARDT, Circuit Judges.
L. ENNIS, CIRCUIT JUDGE.
appeal arises out of a putative class action filed on behalf
of purchasers of Flotek Industries, Inc. common stock.
Plaintiffs allege that defendants, Flotek and three of its
officers, exaggerated the usefulness of its products. They
allege misrepresentations relating to a proprietary software
Flotek developed to help market these products. The district
court dismissed the complaint, holding that plaintiffs had
failed to plead facts giving rise to a strong inference of
fraudulent scienter. We AFFIRM.
filed this putative securities class action on behalf of
investors who purchased Flotek common stock between October
23, 2014, and November 9, 2015. Defendants are Flotek
Industries, Inc. and three of its officers: Chief Executive
Officer (CEO) and President John W. Chisholm and Chief
Financial Officers H. Richard Walton and Robert M. Schmitz.
Flotek sells oilfield products called "Complex
nano-Fluid technologies" (CnF), which are supposed to
improve the productivity of oil and gas wells. According to
the complaint, CnF is Flotek's "hallmark"
product, and "[b]y the beginning of the Class Period,
the Energy Chemistry Technologies segment [of Flotek]
represented over 50% of the Company's revenue due to
sales of its CnF products." This lawsuit concerns
representations made about a software application Flotek
developed to help market CnF to exploration and production
companies. The software, called "FracMax," analyzes
and presents data concerning hydraulically fractured wells to
allow comparison of the productivity of oil and gas wells
that use CnF with those that do not.
introduced FracMax to investors at a June 2014 investor
conference. Over the next sixteen months, "[D]efendants
attended at least 21 conferences, including Flotek's
earning conference calls, analyst-hosted conferences and
[c]ompany-hosted investor conferences, where they focused on
and praised FracMax and its ability to conclusively validate
the efficacy and economic benefits of Flotek's CnF
products." Defendants promoted FracMax as an integral
component of Flotek's sales strategy and as "key to
'materially broaden[ing] the reach of Flotek's
marketing efforts' for its CnF products."
"[D]efendants reported that the FracMax database
included production data from 80, 000 wells across key U.S.
basins and that based on this data, Flotek's sales force
could demonstrate to potential customers that the use of
Flotek CnF chemistries added at least an estimated $8 billion
in aggregate value for operators when compared to those
operators that had not adopted Flotek's CnF
products." In a 2015 press release, Chisholm,
Flotek's President and CEO, stated, "Our FracMax
software technology provides conclusive evidence that our
[CnF] suite of completion chemistries provides compelling
economic benefits to production companies." Flotek also
represented in a quarterly earnings press release that sales
of CnFs increased substantially because of FracMax.
their complaint largely refers to Defendants generically,
Plaintiffs' references to specific representations, to
the extent they specify, primarily relate to statements made
by Chisholm, who at various times emphasized FracMax's
empirical validity. During several conference calls with
investors, Chisholm explained that FracMax used publicly
available data that companies self-reported to state agencies
to compare production from wells that used CnF and wells that
did not, suggesting this made FracMax's output more
reliable. In September 2015, Chisholm gave a presentation at
an investor conference in which he explained that FracMax
used data reported to the Texas Railroad Commission, a state
agency, and he suggested that the data was "back
check[ed] and validate[d]." In his PowerPoint
presentation, Chisholm presented an "About FracMax"
slide stating that the data was "sourced from
operator-provided completion data." This slide further
stated that the data was "un-adjusted, providing for
comparison and analysis of operators' self-reported data
sets." Chisholm also presented images of the FracMax
interface in order to compare the productivity of four Texas
wells, one that used CnF and three that did not, again
emphasizing the difference in production levels.
November 9, 2015, online financial publication Bronte Capital
released a blog post (the Bronte Report) contending that the
data in Chisholm's presentation was wrong and suggesting
that the data had been intentionally altered to make CnF look
significantly more effective. Specifically, the Bronte Report
alleged that, as compared with the numbers reported by the
Texas Railroad Commission, "Flotek had reduced the
production data for the [three] non-CnF wells by 40% to 50% .
. ., while leaving the production data for the CnF well
unchanged." After release of the Bronte Report, Flotek
next day, Flotek issued a press release conceding that Bronte
Capital's analysis was correct,  and ascribing the error to
data provided by a third party, Drillinginfo, that
"caused FracMax to identify the three non-CnF wells as
contained in units with multiple wells (as opposed to single
well units), which required FracMax to incorrectly apply an
allocation algorithm to the production for the non-CnF
wells." According to Flotek, because Texas reports oil
and gas production by lease, rather than by well, FracMax
used an algorithm to apportion production within
multiple-well lease units, leading to unwarranted adjustments
of the non-CnF wells discussed at the September conference.
Flotek also held a conference call, during which
"Chisholm admitted that the Company's internal
controls 'did not catch'" the errors, and
"that the Company had no internal controls in place to
check the accuracy of the third-party data from
Drillinginfo." He explained that they did not
cross-reference the third-party data against the underlying
state-agency data and that the company "had, several
months ago, evolved to a different allocation program"
that would provide greater accuracy.
to Plaintiffs, a report issued by Iberia Capital Partners
that same day "stated that the four wells presented at
the September 11, 2015 investor conference were designated by
Drillinginfo as being single well leases, not multiple
leases, therefore the Texas Railroad Commission data for
those wells did not require adjustment," and Flotek
shares fell further as a result. Contrary to its earlier
statements following the Bronte Report, Flotek then reported
that an internal investigation concluded that the error
originated in the software, not the data set, as Chisholm had
stated earlier, and "most likely resulted from the
accidental inclusion of test code by the third-party software
developer . . . . who was hired to write code for
filed this lawsuit, alleging violations of Section 10(b) of
the Securities Exchange Act, 15 U.S.C. § 78j(b);
Securities and Exchange Commission Rule 10b-5, 17 C.F.R.
§ 240.10b-5; and control person liability for the
individual defendants under Section 20(a) of the Securities
Exchange Act, 15 U.S.C. § 78t. Defendants filed a motion
to dismiss the complaint for failure to state a claim. The
district court dismissed the complaint, concluding that
Plaintiffs had failed to sufficiently plead scienter.
Plaintiffs timely appealed.
court reviews the sufficiency of a complaint de novo.
Ind. Elec. Workers' Pension Tr. Fund IBEW v. Shaw
Grp., Inc., 537 F.3d 527, 533 (5th Cir. 2008).
Plaintiffs' "well-pleaded facts are to be accepted
as true and viewed in the light most favorable to
[them]." Daugherty v. Convergent Outsourcing,
Inc., 836 F.3d 507, 510 (5th Cir. 2016).
"[C]onclusory allegations, unwarranted deductions, or
legal conclusions" are not "well-pleaded
facts" for purposes of evaluating a complaint.
Southland Sec. Corp. v. INSpire Ins. Sols. Inc., 365
F.3d 353, 361 (5th Cir. 2004). Where fraud is alleged,
Federal "Rule [of Civil Procedure] 9(b) creates a
heightened pleading requirement that 'the circumstances
constituting fraud or mistake shall be stated with
particularity.'" U.S. ex rel. Rafizadeh v.
Cont'l Common, Inc., 553 F.3d 869, 872 (5th Cir.