A federal district court denied defendants’ motion to dismiss plaintiff’s securities fraud class action, which asserted claims under Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5. Plaintiff alleged, among other things, that defendants knew or recklessly disregarded the fact that there were multiple accounting errors in the defendant-issuers financial statements and weaknesses in its internal controls. Defendants, the corporate issuer and its two top executives, moved to dismiss on the ground that, among other things, the complaint failed to adequately allege scienter.
In denying defendants’ motion, the Court held that a plaintiff alleging fraud in a Section 10(b) action must plead facts rendering an inference of scienter at least as likely as any plausible opposing inference. Plaintiff argued that its allegations of (i) the sheer amount of the restatement, (ii) defendants’ use of the allegedly inflated stock to support their push for massive growth through acquisitions, and (iii) defendants’ “false rationalization” for the restatements (i.e., that the interpretation of accounting had changed when, in fact, they had not) sufficiently alleged scienter.
After noting the absence of any “smoking gun” evidence of scienter, including any allegations based on information from confidential witnesses or evidence of insider trading, the Court sustained the scienter allegations, ruling that “while it is plausible that defendants truly did not know that they were using inappropriate accounting methods and had a good faith basis to blindly pursue its ambitious acquisition strategy, it is equally plausible that defendants took great care not to ‘know’ that the stock was artificially inflated and that there were reasons to slow the [growth strategy] down.” (In Re PainCare Holdings Securities Litigation, 2008 WL 348781 (M.D. Fla. Feb. 7, 2008)) (emphasis in original).