The Ninth Circuit Court of Appeals recently dismissed a securities fraud claim for failure to plead individual scienter with sufficient particularity. Glazer Capital Management, LP v. Magistri, No. 06-16899 (9th Cir. Nov. 26, 2008).

The defendant company had announced that it was entering into a merger agreement, but it subsequently announced, before the merger was completed, that it had violated the Foreign Corrupt Practices Act (FCPA) and that the violations might delay the merger. After a drop in the company’s stock price, a shareholder class action suit was filed alleging that the company and certain officer and director defendants falsely represented in the merger agreement that it was “in compliance in all material respects with all laws.”

In an attempt to defeat a motion to dismiss, the plaintiffs urged the court to accept the “collective scienter” theory adopted by several other circuits, under which the knowledge of others at the company can be imputed to the person responsible for the statement in question. While the Court did not categorically reject the theory, it found that it should not be applied in the instant case: “because the merger agreement warranted that the company was in compliance ‘with all laws,’ so long as any employee at the company had knowledge of the violation of any law, scienter could be imputed to the company as a whole. This result would be plainly inconsistent with the pleading requirements of the PSLRA.” (Emphasis in original).

The court then rejected several attempts by plaintiffs to create an inference that the CEO that made the statement in question had the requisite individual scienter:

  • Plaintiffs argued that the “very size and nature” of the business created a “strong inference” that the CEO knew of the violations. The court found that such “general allegations” were not enough to make it “hard to believe” that the CEO was unaware of the violations, particularly considering that the FCPA violations involved a “discrete set of illegal payments” in distant foreign countries.
  • Plaintiffs argued that the CEO’s Sarbanes Oxley certification made representations regarding the company’s disclosure controls that could not have been true, as such controls would have alerted them to the violations. The court followed other circuits in holding that Sarbanes Oxley was not intended by Congress to alter the pleading requirements of the PSLRA in this manner.
  • Plaintiffs argued that, because the company’s merger partner was able to discover the violations “relatively early,” the information must have been readily available. The court found that at most, this created an inference that the CEO should have known of the violations, which is not sufficient to meet the PSLRA requirements.
  • Plaintiffs argued that the CEO’s alleged motives -- to personally profit from the merger -- should create an inference of scienter. The court rejected any strong inference from personal profit motives, noting that “personal profit motive is present in almost every merger.”
  • Finally, plaintiffs argued that scienter could be inferred from the company’s admissions in its settlement agreement with the SEC that it “was aware of the high probability” that its agents had made impermissible payments to government officials. The court found that these general legal statements did not provide “particularized facts” and did not provide any inference that the CEO in particular knew of the violations.

The Court therefore found that Plaintiffs had failed to adequately plead individual scienter and granted defendants’ motion to dismiss.

For a complete copy of the decision, please click here.