On April 26, 2021, Judge Sara L. Ellis of the Northern District of Illinois granted a motion to dismiss a putative securities class action asserting claims under Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 (the “Exchange Act”) against a financial services provider (the “Company”) and two of its executives.  Heavy & General Laborers’ Local 472 & 172 Pension and Annuity Funds v. Fifth Third Bancorp, et. al., No. 20-C-2176 (N.D. Ill. Apr. 26, 2021).  Plaintiff, on behalf of herself and a putative class of investors who allegedly purchased and sold securities of the Company during the putative class period, alleged that defendants made materially misleading statements regarding the Company’s business practices that were the subject of a federal investigation.  The Court granted defendants’ motion to dismiss the consolidated complaint without prejudice, holding that plaintiff failed to adequately plead scienter.  

According to the complaint, defendants made material misstatements when they failed to disclose a Consumer Financial Protection Bureau’s (“CFPB”) investigation into the Company’s alleged improper business practice of issuing unauthorized credit cards for consumers.  The CFPB investigation focused on whether the Company used predatory consumer practices and opened unauthorized accounts between 2017 and 2019.  Specifically, plaintiff alleged that defendants made materially false or misleading statements across five categories during the putative class period:  (1) statements regarding financial disclosures; (2) statements relating to risk management practices; (3) statements in the Company’s code of business conduct; (4) statements about its business practices; and (5) statements concerning its compensation plan.  

As an initial matter, the Court dispensed with defendants’ assertion that plaintiff’s consolidated complaint was a “puzzle pleading,” that “improperly place[s] the burden on the Court to sort out the alleged misrepresentations and then match them with the corresponding adverse facts,” which, according to defendants, fell short of the heightened pleading standard of the PSLRA.  Defendants claimed that rather than pleading specific facts, plaintiff’s complaint “merely paste[d] repetitive and lengthy quotes” from the Company’s regulatory filings and earnings” and used “boilerplate allegations.”  Rejecting this assertion, the Court found that it was able to identify the alleged false statements giving rise to the claims at issue and the factual allegations underlying them, and noted the defendants’ extensive briefing demonstrated that they too could identify the alleged false statements.   

Turning to its analysis of the Exchange Act claims, the Court only addressed the issue of scienter, finding that plaintiff’s allegations did not support a strong inference of scienter under the PSLRA’s heightened pleading standard.  The Court considered scienter with respect to multiple theories advanced by plaintiff and rejected each in turn.   

First, the Court rejected plaintiff’s allegation that defendants “knew the omitted facts undermining their alleged misstatements” in their financial disclosures made during the putative class period.  With respect to the alleged receipt of the CFPB Civil Investigative Demand (“CID”) prior to the putative class period, and receipt of five additional demands during the putative class period, the Court held that “the allegations concerning the CIDS demonstrate at this stage [that one of the individual defendants] knew of the investigation, not necessarily of the problem itself.”  Further, the Court found that the complaint lacked any factual allegation that the individual defendants were or should have been aware of the alleged fraud, noting that their attendance at investor meetings and signing of statements filed with SEC did not sufficiently allege scienter.   

Second, the Court rejected plaintiff’s argument that the individual defendants acted with scienter because they made alleged statements regarding the Company’s “robust risk management and compliance practices” and that pursuant to those practices, the alleged fraud concerning improper sales practices would have been known by them.  Finding that plaintiff failed to allege specific facts showing that defendants were aware of the alleged “deficiencies” in the Company’s compliance program, the Court determined that “the existence of inadequate compliance practices alone” does not show that defendants “acted with the intent to deceive.”   

Third, the Court found that, beyond establishing statements made by defendants in CFPB’s ongoing litigation against the Company, plaintiff failed to allege specific facts in that litigation that “suggest [defendants] had personal knowledge of any problematic practices at the time when they made the statements at issue.”  Although “[g]overnment investigations can help to reinforce allegations of scienter,” the Court noted that “such an inference,” without any additional facts, “strikes the Court as improperly inferring fraud by hindsight,” and that it is “inappropriate to infer scienter from conclusory statements made in another litigation.”   

Fourth, the Court rejected plaintiff’s theory that scienter could be inferred from the individual defendants’ motive to increase their compensation.  The complaint alleged that the individual defendants were motivated to conceal the alleged ongoing problems with unauthorized accounts and the resulting investigation by the CFPB to increase their incentive-based compensation, which was significantly higher than their base compensation.  But the Court found that allegations regarding an executive’s financial motive “are too common among corporations and their officers to be considered evidence of scienter,” and that if Courts were to infer scienter from such motive, “most corporate executives would be subject to such allegations, and the heightened pleading requirements for these claims would be meaningless.”  The Court also found that the complaint’s allegations concerning the individual defendants’ alleged stock sales during the putative class period also failed to allege scienter.  Specifically, the Court found that “the general desire to keep stock prices high to make the company appear profitable” does not suffice to allow a strong inference of scienter and “could just as well demonstrate [their] motivation ‘of running a successful corporation.’”  Finally, even though the complaint alleged that one of the individual defendants sold 26% of his stock during the putative class period, the Court found that the complaint failed to tie the timing of the alleged sales to any specific alleged misleading or false statement.    

Having dismissed the Section 10(b) claims, the Court similarly dismissed plaintiff’s control-person liability claims under Section 20(a), finding no predicate violation of the Exchange Act under which such claims could be established.