Analysis of the corporate mens rea is, by definition, contrived and one with which federal courts have struggled. Unlike instances where an individual is charged with securities fraud, determining the “thinking” or “knowledge” of an artificial entity, sometimes comprised of thousands of disparate employees throughout the world, is a difficult theoretical undertaking. Until last Friday, corporate scienter generally was assessed by reference to one of two established approaches: traditional respondeat superior, where the company stands in the shoes of the relevant actors; or collective knowledge, where a company is charged with the knowledge of any of its agents, even those who may not have committed the offending conduct.

In a groundbreaking decision issued last week in In re Omnicare Securities Litigation, the Sixth Circuit took a novel approach to examine corporate scienter in recognition that neither of the established approaches is ideal or serve to effectuate the purpose of securities fraud laws. This new hybrid approach may have applicability beyond the context of civil securities fraud litigation, where the Private Securities Litigation Reform Act (PSLRA) creates heightened pleading standards, designed to limit frivolous securities lawsuits.

In Omnicare, a PSLRA case, class action plaintiffs alleged that the corporate defendant, a pharmaceutical care company, made false statements about the company’s billing practices. Reviewing the district court’s dismissal of the case for failure to state a claim, a three-judge panel of the Sixth Circuit examined whether the plaintiffs sufficiently had alleged the requisite scienter on behalf of the pharmaceutical care company.

The Court detailed the current landscape of the law regarding corporate knowledge of wrongdoing, including its own Circuit’s prior pronouncements. The Fifth and Eleventh Circuits adhere to the traditional theory ofrespondeat superior, looking to the state of mind of the specific individual corporate officer alleged to have committed the wrongdoing. The Second, Seventh and Ninth Circuits have held that courts may infer corporate scienter without being able to name the individuals who engaged in the alleged fraud. Under this alternative theory of collective knowledge, even where no one agent can be identified as having knowledge of the alleged misrepresentation, the circumstances alleged by a plaintiff may create a strong inference that corporate agents were sufficiently knowledgeable about the alleged fraud to meet the scienter requirement for a securities fraud action. For its part, the Sixth Circuit previously had ruled that the knowledge of a corporate agent could be imputed to the corporation even though that officer did not issue the false or misleading statement.

As recognized by the Sixth Circuit panel in Omnicare, in recent years, however, courts and commentators have debated the merits of both approaches and “[m]ost agree that neither – when taken to the extreme – is ideal though there is no consensus about how to calibrate the middle ground.” A suitable middle ground would ensure that corporations do not avoid liability where culture or implicit encouragement of fraudulent behavior exists without an identifiable culprit or, on the other hand, sustain broad exposure for activities known only to be potentially fraudulent by isolated, low-level employees. According to the panel in Omnicare, neither result reflects Congressional intent in enacting the securities fraud laws.

In Omnicare, the three-judge panel avoided overruling what it identified as that Circuit’s rule that a corporation can be liable for the knowledge of a corporate agent, choosing instead to offer clarification of the Circuit’s position by delineating the type of corporate agents whose state of mind is relevant in determining whether corporate scienter exists. The panel opined that for purposes of determining whether a misrepresentation made on behalf of a corporation was made with the requisite scienter, the relevant individual state(s) of mind to consider are: 1) the individual agent who uttered or issued the misrepresentation; 2) any individual agent who authorized, requested, commanded, furnished information for, prepared, or approved the statement in which the misrepresentation was made before its utterance or issuance; and 3) any high managerial agent or member of the board of directors who ratified, recklessly disregarded, or tolerated the misrepresentations after its utterance or issuance.

The Court in Omnicare concluded that this approach both prevented corporations from evading liability through tacit encouragement and willful ignorance, as they potentially could under a strict respondeat superior approach, and protected corporations from liability when one individual unknowingly makes a false statement that another individual, unrelated to the preparation or issuance of the original statement, knew to be false or misleading.

The Sixth Circuit is to be commended for thinking outside the box to try to fashion a hybrid solution to an appropriate standard for corporate mens rea. Although whether other circuits follow the Sixth Circuit’s lead remains to be seen, the possibility exists that the new decision will have an impact beyond civil securities fraud lawsuits and be considered relevant in the context of corporate criminal prosecutions and regulatory enforcement proceedings where such progressive thinking may be warranted.