On February 25, 2020, the United States Court of Appeals for the Tenth Circuit affirmed the dismissal of a putative class action asserting claims under Section 10(b) of the Securities Exchange Act of 1934 against a money-transfer services company and certain of its former executives. Smallen v. W. Union Co.,—F.3d—, 2020 WL 893826 (10th Cir. 2020). Plaintiff alleged that the company made misrepresentations in SEC filings and public statements concerning its compliance with anti-money laundering and anti-fraud laws. The lower court determined that plaintiff failed to adequately allege scienter. Id. at *1. The Tenth Circuit affirmed, holding that, although the complaint “may give rise to some plausible inference of culpability,” it fell short of the heightened standard imposed by the Private Securities Litigation Reform Act (“PSLRA”). Id.
First, the Court rejected plaintiff’s argument that various red flags alerted the individual defendants to regulatory compliance violations. Id. at *5. For example, plaintiff alleged that the company received a large number of customer complaints concerning more than $630 million in allegedly fraudulent transactions, which had occurred over a 12 year period. The Court noted, however, that the value of allegedly fraudulent payments was less than 1% of the company’s total payments over the relevant period and, further, that plaintiff failed to plead particularized facts connecting the individual executives to the customer complaints or to the other purported red flags—allegations that the company’s agents in several countries were involved in fraudulent transfers and that several third-party agents were arrested. Id. In addition, the Court rejected plaintiff’s argument that scienter could be inferred because the executives attended Board and committee meetings where compliance programs may have been discussed, as “mere attendance” at such meetings did not “contribute to an inference of scienter.” Id. More specifically, the Court held that discussions of related topics, such as controls and areas of particular regulatory enforcement, could not be equated with knowledge of ongoing compliance issues. Id. The Court also rejected plaintiff’s allegations that defendants knew or should have known of the alleged non-compliance as a result of ongoing government investigations and information that the company provided to government regulators in the course of those investigations. Id. at *6.
The Court held that plaintiff had failed to adequately allege scienter as to any defendant because plaintiff failed to make specific, factual allegations supporting any defendant’s knowledge. Id. at *6-7. Even as to the company’s former CEO, who, a confidential witness alleged, was routinely briefed as to compliance-related matters, the Court nevertheless held that it could not infer scienter “based only on a defendant’s position in a company or involvement with a particular project.” Id. at *6.
In addition, the Court disregarded plaintiff’s allegations based on a deferred prosecution agreement entered into after the alleged misrepresentations at issue, which the Court held were an impermissible attempt to plead “fraud by hindsight.” Id. at *7. Although plaintiff argued that scienter should be inferred because certain executives allegedly sold company stock at artificially high prices, the Court explained that while “suspicious insider stock trading is evidence of motive and weighs in favor of inferring fraudulent intent, the amount of profit realized through executive stock sales, standing alone, is insufficient to support an inference of scienter.” Id. at *8. Because plaintiff failed to identify suspicious transactions, and also failed to provide context for these transactions that would explain the type of financial gain at issue, the Court rejected this argument. Id.
Having dismissed the allegations against the individual defendants, the Court also rejected the argument that the company itself could be held liable based on the scienter of lower level employees. Id. at *10. Joining the Fifth and Seventh Circuits, the Court concluded that it was necessary to look to the state of mind of the individuals who made or issued the relevant statement, or who ordered or approved it or its making or issuance, or who furnished information or language for inclusion therein—rather than other employees or agents. Id. Looking at the relevant executives who made the statements in question, the Court concluded that plaintiff failed to allege that any of those individuals acted with scienter, because plaintiff failed to allege that any of them consciously disregarded company failures regarding compliance matters or any legal violations. Id. at *11.
Separately, the Court declined to resolve whether the theory of “corporate scienter” was viable in the Tenth Circuit without identifying a specific individual, but noted that the facts alleged in the complaint were “a far cry” from the dramatic and obvious alleged misstatements in which other courts had recognized the corporate scienter doctrine. Id. at *11-12.