The Ninth Circuit recently affirmed the dismissal of a securities class action asserting claims under Section 10(b) of the Securities Exchange Act of 1934 because the plaintiff failed to plead a strong inference of “scienter” or fraudulent intent with respect to any of the alleged misstatements. Glazer Capital Management, L.P. v. Magistri, --- F.3d ---, 2008 WL 5003306 (9th Cir. Nov. 26, 2008). The issue in Glazer was whether the plaintiff had to plead scienter as to one of the individual officer defendants in order to state a claim against the corporate defendant or whether the plaintiff could rely on a “collective scienter” theory, which would hold the company as a whole responsible for the alleged misstatements contained in an exhibit to its Form 10-K. Id. at *5. The Ninth Circuit held that, under the facts of the case, the plaintiff could not proceed against the company where it had failed to plead scienter as to at least one of the individual defendants. Id. at *6, *11.
Glazer involved a proposed merger between InVision Technologies, Inc. and General Electric. Shortly after this merger was announced and the merger agreement was attached to InVision’s Form 10-K, InVision issued a press release announcing that it had uncovered possible violations by the company of the Foreign Corrupt Practices Act of 1997 (FCPA), 15 U.S.C. § 17dd-1. Id. at *1. Having conducted an internal investigation, InVision voluntarily reported these possible violations to the Securities and Exchange Commission (SEC) and the Department of Justice (DOJ). Id. InVision warned in the press release that the existence of these possible violations might delay or prevent consummation of the previously announced merger. In the wake of this announcement, the company’s stock price dropped significantly and the plaintiff filed suit alleging violations of Section 10(b) based on alleged misstatements in the representations and warranties section of the merger agreement, such as the company’s statement that it was in compliance with all federal laws and specifically that it was unaware of any violations of FCPA. Id. at *1-*2. The lower court had previously dismissed these claims for failure to plead falsity of the alleged misstatements or scienter.
The decision by the Court of Appeals in Glazer focused on the scienter requirement and the court began its analysis by noting that the Ninth Circuit had not previously adopted a theory of collective scienter nor spoken conclusively on whether such a theory was possible. Id. at *6. The court, however, declined to address this question, stating that the facts of the present case did not implicate the issue. Id. The court appeared to be concerned that, if it found an exception existed in this case for pleading individualized scienter, it would have created an exception that would swallow the rule. Id. (noting that “[i]f the doctrine of collective scienter excuses [plaintiff] from pleading individual scienter with respect to these legal warranties, then it is difficult to imagine what statements would not qualify for an exception to individualized scienter pleadings.”) (emphasis in original). Instead, given the nature of these claims, plaintiff was required under the Private Securities Litigation Reform Act “to plead scienter with respect to those individuals who actually made the false statements in the merger agreement” – i.e., the two individual defendants who signed the merger agreement. Id. Thus, the plaintiff “must ‘plead, in great detail, facts that constitute strong circumstantial evidence of deliberately reckless or conscious misconduct” on the part of these individuals. Id. at *7. The court noted that the plaintiff had attempted to plead scienter only as to one of these individuals, InVision’s CEO. Id.
The court determined that the plaintiff had, however, pled no facts that directly demonstrated the CEO possessed the requisite scienter when he made the representations contained in the merger agreement. Id. Although the SEC and the DOJ ultimately concluded that certain illegal payments were approved by one of the company’s regional sales managers and a senior vice president of sales and marketing, the plaintiff had pled no facts to demonstrate that the CEO was personally aware of the illegal payments or that he was actively involved in the details of the company’s sales at issue. Id. Plaintiff described InVision as a small company that sold a small number of devices to a limited number of customers, with an important aspect of its business being its overseas sales. Plaintiffs argued that the size and nature of the business was sufficient to infer scienter on the CEO’s behalf. Id. The court rejected this argument, concluding that “the surreptitious nature of the transactions [at issue] creates an equally strong inference that the payments would have deliberately been kept secret – even within the company.” Id. at *8.
The court similarly rejected plaintiff’s contention that scienter could be pled as to the CEO based on the fact that he had signed a Sarbanes-Oxley certification also attached to the Form 10-K. Id. The Ninth Circuit agreed with the reasoning of the Eleventh and Fifth Circuits that Congress had expressed no intent to alter the pleading requirements of the Reform Act through the passage of Sarbanes-Oxley and, thus, a “‘certification is only probative of scienter if the person signing the certification was severely reckless in certifying the accuracy of the financial statements.’” Id. at *9 (citing Garfield v. NDC Health Corp., 466 F.3d 1255, 1266 (11th Cir. 2006)). Because the plaintiff had pled no facts to that effect, the Sarbanes-Oxley certification was not sufficient, without more, to raise a strong inference of scienter. Id. To rule otherwise would mean that “scienter would be established in every case where there was an accounting error or auditing mistake made by a publicly traded company, thereby eviscerating the pleading requirements for scienter set forth in the [Reform Act].” Id. (internal citation omitted).
The court also rejected the plaintiff’s argument that the CEO’s personal profit motive was sufficient to create a strong inference of scienter. Id. at *10. The court joined other Circuits in recognizing that personal financial incentives are present in almost every merger transaction and, if sufficient standing alone, would subject the directors of almost every company effectuating a merger or acquisition to a securities fraud lawsuit. Id.
The plaintiff’s arguments based on the settlement agreements between InVision and the DOJ and SEC faired no better. Id. at *10. The admissions in these agreements “were largely legal conclusions, rather than particularized facts [creating] a strong inference of scienter” and “nothing in either settlement agreement … support[s] the conclusion that [the CEO] had actual knowledge of the violations.” Id. These agreements did reflect the fact that InVision admitted it “was aware of the high probability” that illegal foreign payments had been made to benefit InVision’s business and that InVision did not properly account for any such payments. Id. However, “the mere fact that someone at InVision had knowledge of the illegal transactions” does not meet the scienter pleading requirements, given the facts here. Id.
For these and other reasons, the Ninth Circuit affirmed the dismissal of all claims against the individual defendants and the corporate defendant.