In a putative securities fraud class action brought by shareholders against the company and its former CEO and CFO, defendants moved to dismiss on the grounds that, inter alia, plaintiffs failed to adequately plead scienter. After applying the Tellabs standard, i.e., scienter element is met by alleging facts that give rise to an inference of scienter that is at least as likely as any opposing inference, the Court denied the motion, finding that the scienter of the CEO and CFO were sufficiently pled and that their acts were attributable to the company under agency law principles.
With respect to the former CEO, the Court held that the following allegations, among others, gave rise to a strong inference of scienter: (i) the company,with the CEO’s knowledge, made statements and omissions with reckless, if not knowing, disregard for the truth; (ii) the company admitted that it had engaged in a backdating scheme of its stock options, which required it to restate its financials; (iii) the CEO was forced to resign; and (iv) the CEO repeatedly made false Sarbanes-Oxley certifications attesting to the adequacy of the company’s internal controls, despite his knowledge of their flaws—including his undetected improper pledge of company stock as collateral for his margin account, which the Court found created an incentive for him to conceal problems at the company in order to avoid a stock price decline that could trigger a margin call.
Similarly, with respect to the former CFO, the Court ruled that plaintiffs had adequately pled her scienter through allegations that her conduct was “highly unreasonable” and “an extreme departure from the standards of ordinary care” with respect to dangers that were either known to her or so obvious that she must have been aware of them. As examples, the Court cited plaintiffs’ allegations that the CFO repeatedly made Sarbanes-Oxley certifications even though she knew or was reckless in not knowing that the company’s financial statements (i) were false and camouflaged 25 instances of options backdating, and (ii) were based upon faulty internal control processes. (Hall v. The Children’s Place Retail Stores, Inc., 2008 WL 2791526 (S.D.N.Y. July 18, 2008))