Pleading Scienter In The Ninth Circuit: The Collective Pleading Doctrine, SOX Certifications, and DOJ/SEC Settlement Documents
The Ninth Circuit Court of Appeals ruled on three significant issues regarding pleading a strong inference of scienter under the PSLRA in Glazer Capital Management, LP v. Sergio Magistri, No. CV -04-02181 (9th Cir. Nov. 26, 2008). The first issue focused on the use of the collective scienter approach to pleading individual scienter. The second focused on the use of SOX certifications as an indicia of scienter. The third concerned the use of allegations from DOJ and SEC consent settlements.
In Magistri, the Circuit Court affirmed the dismissal of a securities fraud class action brought by institutional investors against InVision Technologies, a small publicly traded manufacturer and seller of explosive detection systems, and two of its officers. The complaint was based on representations made in an acquisition agreement under which InVision would be acquired by General Electric.
At the time the deal was announced, InVision issued a press release and filed a copy of the merger agreement with the SEC. In that agreement, InVision represented that its books and records were in compliance with the applicable provisions of the Exchange Act and that neither the company, nor to its knowledge, any officer or director had violated Section 30A of that Act, the anti-bribery provisions.
Subsequently, a second press release was issued noting that in fact there may be violations of the FCPA. The stock price of the company dropped significantly following that press release. Eventually, the company self reported FCPA violations to the Department of Justice and the SEC. Charges with the former were resolved with a non-prosecution agreement. With the latter, the company consented to the entry of a cease and desist order in an administrative proceeding.
The complaint dismissed by the district court tracked the allegations in the SEC administrative proceeding. It also named as an individual defendant one of the officers who executed the merger agreement.
After concluding that plaintiffs had adequately pled falsity as required by the PSLRA the Court turned to the question of scienter. First, the court considered whether plaintiff is required to plead scienter as to the individual defendant or could rely on a “collective scienter” theory. According to the Court, the circuits are split as to whether a collective approach is sufficient to comply with the particularity requirements of the PSLRA. The Second and Seventh Circuits have approved this approach under certain circumstances. The Fifth and Eleventh Circuits however, have not.
After distinguishing one of its earlier decisions which seemed to foreclose this approach, the Court “concluded that ‘corporate scienter relies heavily on the awareness of the directors and officers,’ and that on the facts of this case, ‘we see no way that [the defendant] could show that the corporation, but not any individual [director or officer], had the requisite intent to defraud.'” (citations omitted). While the Court agreed in certain circumstances this approach may be sufficient, it rejected its application here.
The Court then turned to specific arguments raised by plaintiff to establish the requisite strong inference of scienter. One key argument was based on the SOX certification executed by the individual defendant. The other was keyed to the SEC consent decree.
As to the SOX certification, the Court noted it had not examined the interplay between the certification and the PSLRA pleading requirements. Both the Eleventh and Fifth Circuits have previously rejected this approach. The Ninth Circuit followed these two circuits, concluding that there was no evidence that Congress intended to alter the pleading requirements of the PSLRA with the SOX certification requirements. Accordingly, the “‘Sarbanes-Oxley certification is only probative of scienter if the person signing the certification was severely reckless in certifying the accuracy of the financial statements.'” (citations omitted).
Finally, the court rejected the claim that the settlement agreements with DOJ and the SEC are sufficient to create a strong inference of scienter. While the company took responsibility for the violations in the settlement documents, the general statements and largely legal conclusions, rather than particularized facts, were insufficient to meet the particularity requirements of the PSLRA. Accordingly, the district court properly dismissed the complaint.