Court Dismisses SEC Fraud Claims As to Three of Six Defendants For Failure to Plead Particularized Facts As to Each Dismissed Defendant
This month, a Federal Judge in Massachusetts entered a final judgment of dismissal as to three of six named defendants in the SEC’s two year old action against the former Putnam Fiduciary Trust Company executives. The SEC’s complaint, filed in 2005, alleged violations of the Sections 10(b) and 17(a), among others, based on an claimed scheme to defraud regarding Putnam defined contribution plan client, Cardinal Health, Inc. Specifically, the complaint alleged that the defendants’ misconduct arose out of a one-day delay in investing certain assets of Cardinal, which caused the company’s plan to miss out on about $4 million of market gains. Following the error, the defendants chose not to inform Cardinal. Rather, they took steps to cover up the action by improperly shifting approximately $3 million of costs to the shareholder of other Putnam mutual funds and through various accounting machinations. In the end, according to the complaint, Cardinal’s plan bore approximately $1 million in losses. SEC v. Durgarian, Civil Action No. 05-12618 (D. Mass. Filed Dec. 30, 2005).
In detailing the scheme and the participation of the defendants, the complaint repeatedly detailed the actions of defendants Karnig Durgarian, then Chief of Operations, Donald McCracken, former Head of Global Operations Services, and Ronald Hogan, then vice president in the new business implementation unit. In contrast, defendants Virginia Papa, then Director of Defined Contribution Plan Servicing, Kevin Crain, former head of the plan administration unit and Sandra Childs, previously responsible for overall compliance, are generally described as attending various meetings where the error and cover up were discussed and in which “all” agreed with the adopted course of action. These three defendants did however certify, in connection with audits of the internal controls, that they were unaware of any “uncorrected errors, frauds or illegal acts … .”
In reviewing motions to dismiss by each of the defendants, the court first held that the SEC must comply with the dictates of Rule 9(b), requiring that fraud be pled with particularity, as well as the standard pleading rules. As to Defendants Durgarian, McCracken and Hogan, the court had little trouble finding that the SEC met the requisite pleading standards in view of the detailed allegations regarding the conduct of each.
In contrast, however, the court found the allegations as to defendants Crain, Papa and Ghilds wholly insufficient: “The Court finds that, beyond their attendance at the January, 2001 meeting, the Complaint identifies no explicit acts, taken by defendants Crain, Papa and Childs … in furtherance of the fraudulent scheme. While the Complaint contends generally that all of the defendants listened, discussed and then agreed upon the fraudulent scheme, there are no explicit details outlining specific actions taken by these defendants.” Citing Central Bank of Denver v. First Interstate, 511 U.S. 164 (1994), the court went on to hold that the SEC must “make an explicit allegation of a manipulative act committed by the defendant in furtherance of the scheme … .” In this regard “generalized allegations” as the defendants termed them are insufficient, the court concluded.
The court also rejected the SEC’s argument that the certifications executed by defendants Crain, Papa and Childs were sufficient to establish liability, even at the pleading stage: “The Court agrees with the contention of these defendants that the alleged false certifications bearing their signatures are too attenuated to link them to the fraudulent scheme. The SEC provides no allegation linking the signatures to the fraud other than its general assertion that the defendants attended the meeting.”
Finally, the court rejected the SEC’s claim that Crain, Papa and Childs could be held liable under an aiding and abetting theory. Again, the court pointed to the fact that the SEC had failed to detail specific participation by each of the defendants. Throughout its opinion, the court repeatedly rejected the SEC’s attempt to lump these three defendants together and hold them liable based on generalized allegations. Rather, the court made it clear that to plead a securities fraud complaint, the SEC must allege specific allegations as to each defendant detailing that person’s participation in the scheme to defraud.
The Commission’s November 27, 2007 Litigation Release discussing, among other things, the dismissal of these three defendants, may be found here.