The Sixth Circuit recently decided a case wherein the Court purports to have clarified the rule for determining whether a complaint satisfies the pleading requirements of corporate knowledge in securities fraud cases. See In re: Omnicare, Inc. Securities Litigation, No. 13-5597 (6th Cir. October 10, 2014). In 2007, the Supreme Court interpreted the higher standard created by Congress in 15 U.S.C. § 78u-4(b)(2) for securities cases, creating a three-part test for lower courts to apply in assessing the sufficiency of the pleadings. See Tellabs, Inc. v. Makor Issues & Rights, Ltd., 551 U.S. 308, 322-23 (2007).
As the Sixth Circuit stated it, the question is, “must the person misrepresenting a material fact in the name of the corporation have also done so with scienter, or is it enough that some person in the corporate structure had the requisite state of mind?” If the latter, how high up the corporate structure must the person with scienter be: CEO, CFO, or is a lower-level accountant enough? Several courts, including the Fifth, Eleventh, and Seventh Circuit Courts of Appeal, have crafted more specific rules within the Supreme Court’s guidelines, but with wide variations.
The issue, sometimes referred to as “collective scienter,” was split even before the Supreme Court entered the fray. In 2004, the Fifth and Eleventh Circuits utilized a narrow view allowing scienter to be imputed to the corporation only under respondeat superior theories. In those circuits, the corporation can only be imputed the knowledge where the officer with the knowledge also was the person making or approving the statement that is alleged to be fraudulent. A year later, the Sixth Circuit allowed an officer’s knowledge to be imputed to the corporation regardless of whether the officer made any allegedly fraudulent statement – if any officer knew the statements were fraudulent, regardless of whether they played any part in making or approving those statements, the corporation was deemed to have the required scienter.
Shortly thereafter, the Second, Seventh, and Ninth Circuits chose a slightly different tack than the earlier courts. The Seventh allowed a “strong inference of corporate scienter” even where the Plaintiffs did not name any individuals who “concocted and disseminated the fraud.” Makor Issues & Rights, Ltd. V. Tellabs Inc., 513 F.3d 702, 710 (7th Cir. 2008). The Second Circuit created a similar rule because it did not believe Congress intended “that in no case can corporate scienter be pleaded in the absence of successfully pleading scienter as to an expressly named officer.” Teamsters Local 445 Freight Div. Pension Fund v. Dynex Capital Inc., 531 F.3d 190, 196 (2d Cir. 2008).
The Ninth Circuit justified the rule because “there could be circumstances in which a company’s public statements were so important and so dramatically false that they would create a strong inference that at least some corporate officials knew of the falsity upon publication.” Glazer Capital Mgmt., LP v. Magistri, 549 F.3d 736, 744 (9th Cir. 2008) (emphasis in original).
In this most recent case, the Sixth Circuit recognized that its original rule could very easily lead to corporate liability well beyond what congress intended. Going forward, the Sixth Circuit laid out a specific list of person(s) whose state of mind would be probative in determining corporate scienter, adopting a portion of the test in Patricia S. Abril & Ann Morales Olazábal’s The Locus of Corporate Scienter. 2006 Colum. Bus. L. Rev. 81, 113–14 (2006). Specifically, the Court “clarified” its earlier rule and held that the state of mind of the following persons are probative on the issue of corporate scienter:
In practice, at least in this case, the Sixth Circuit narrowed the rule even further, requiring the Plaintiff to demonstrate in the complaint allegations that the corporation “or an Individual Defendant filed the Form 10-K statements, knowing they were false, with the intent to defraud the public, or that they knowingly failed to correct them with the same intent.” The Court required the Plaintiff to tie the Individual Defendants to the Form 10-K statements and fit those individuals into a category described above before imputing knowledge to the corporation, which the Plaintiffs failed to do satisfactorily. While the change seems to be nearly identical to the Second, Seventh, and Ninth, the Sixth Circuit recognizes that the old rule is still controlling, but argues that the In re: Omnicare decision fits within that framework.
In the future, Plaintiffs and their counsel should be aware of these newly clarified requirements. Ideally, as always, the complaint should specifically tie identified individuals at the corporation to the creation of a fraudulent Form 10-K and to the approval for dissemination of that 10-K with facts beyond “information and belief.” If a complaint successfully demonstrates these two factors, the case for imputing knowledge to the corporation is strongest in any jurisdiction.
If you need more information of the matters described above, contact Rebecca Gilliland, a lawyer in our firm’s Consumer Fraud Section, at 800-898-2034 or Rebecca.Gilliland@beasleyallen.com.
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