In In re Ceridian Corp. Sec. Litig., __ F.3d ___, No. 07-2707, 2008 WL 4163782 (8th Cir. Sept. 11, 2008), plaintiffs filed a securities class action complaint accusing the company and certain of its officers of “a massive accounting scheme to inflate Ceridian’s financial results and its stock price by exploiting a weak or corrupt system of internal controls to commit numerous violations of Generally Accepted Accounting Principles (GAAP).” Id. at *2. Plaintiffs based their claims for violations of Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 on the fact that Ceridian had issued five announcements over the course of two years that it would be restating its financial statements. Id. The restatements were based on “dozens, if not hundreds, of accounting errors – errors of many different types committed by many different employees over many different years.” Id. at *3.
The Eighth Circuit upheld the dismissal of the complaint based on the plaintiffs’ failure to plead scienter in conformity with the Private Securities Litigation Reform Act (the “Reform Act”) and the Supreme Court’s decision in Tellabs, Inc. v. Makor Issues & Rights, Ltd., 127 S. Ct. 2499 (2007). Id. at *1. The court focused on the directive from Tellabs that the plaintiffs’ allegations of scienter must give rise to a strong inference of scienter that is “at least as compelling as any opposing inference of nonfraudulent intent.” Id. at *2 (citations omitted and emphasis in original). As explained below, the court rejected most of plaintiffs’ scienter allegations because the plausible (non-fraudulent) opposing inference was simply more compelling than any inference of scienter. See id. at *3-*6.
Plaintiffs’ primary contention was that the sheer number of GAAP violations gave rise to a strong inference of scienter. Id. at *3. The court rejected this argument, holding that the number of purported GAAP violations actually militates against an inference of scienter because, with dozens of employees involved in hundreds of unrelated accounting errors, “it seems almost inconceivable that there could have been any unifying intent behind the errors, much less an intent to defraud.” Id. at *6. More compelling was the opposing inference of non-fraudulent intent that these alleged accounting errors “were mistakes by accounting personnel undetected because of faulty accounting controls.” Id. at *3. At best, plaintiffs’ allegations supported the inference that the defendants should have known about the accounting errors, but that inference would support a claim of negligence only, not of fraud. Id. at *6.
The court also rejected plaintiffs’ other allegations of scienter, concluding that the opposing inference of non-fraudulent intent was more compelling. Id. at *4-*6. Plaintiffs, for example, claimed that the Sarbanes-Oxley Act certifications, wherein the defendant officers declared that they had designed and evaluated the company’s internal accounting controls, supported a strong inference of scienter. Id. at *5. Plaintiffs, however, did not allege any specific facts showing that any of the defendant officers knew the internal controls were deficient at the time the certifications were made. Accordingly, any inference of scienter gave way to the more plausible “opposing inferences of inadvertent mistake or mere negligence.” Id. Plaintiffs also claimed that an ongoing SEC investigation, the forced departures of two of the defendant officers, and the firing of fourteen employees for GAAP violations required an inference of scienter. Id. at *6. Again, the court found more compelling the following inference of non-fraudulent intent – namely, “that the SEC investigation uncovered no evidence of fraud, and that the accounting personnel and corporate officers responsible for the accounting function were fired or forced to depart for incompetence, not fraud.” Id.