Plaintiffs filed a class action lawsuit alleging that HydroFlo, a company that invests in a portfolio of private companies, and certain of its officers and directors, violated sections 10(b) and 20(a) of the Securities Exchange Act of 1934 by issuing a series of press releases which inaccurately reported information concerning one of HydroFlo’s largest portfolio companies.

Defendant Traveller, a Director of HydroFlo, moved to dismiss the section 20(a) claim asserted against him. Traveller argued that in addition to pleading (i) a predicate violation of Section 10(b), and (ii) that the defendant had control over the primary violator, plaintiffs were also required to allege facts demonstrating his “culpable participation” in the predicate act in order to state a claim for control person liability. Traveller further argued that the heightened pleading requirements under the PSLRA (including its state of mind pleading requirements) apply to section 20(a) claims.

While recognizing that a split of authority exists regarding whether the alleged control person’s “culpable participation” must be pled and the applicable pleading burden, the court sided with the majority view, ruling (i) that the plain language of Section 20(a) assigns secondary liability upon a demonstration of a primary violation, without prescribing culpability as a prima facie element of the claim, and (ii) because Section 20(a) does not require that the control person act with scienter, the plaintiff need not comply with PSLRA’s heightened pleading standards. The Court held that, under the applicable standards, the Plaintiffs had sufficiently pled their section 20(a) claim and, accordingly, denied defendant’s motion to dismiss. (Huttenstine et al. v. Mast et al., 2006 WL 3771096 (E.D.N.C. December 21, 2006))

Scienter Pleading Requirement Under PSLRA Satisfied As to Two Defendants

Plaintiff investors filed a class action lawsuit against company in which they invested and its senior corporate officers, alleging violations of section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5. Plaintiffs alleged that defendants caused the company’s stock price to be artificially inflated by, among other things, materially overstating income by failing to recognize known liabilities, concealing a decline in demand for its products, and deceiving investors about its excessive inventory and accounts receivable. Defendants moved to dismiss the Second Consolidated Amended Complaint solely on the basis that it did not allege sufficient facts that each defendant knew or recklessly disregarded that statements were false or misleading when made.

After noting PSLRA’s requirement that both falsity and scienter be pled with particularity and that the facts alleged must give rise to a strong inference of scienter, the Court examined whether such allegations had been made against any of the individual defendants. The Court found the allegations lacking as to all but two, noting that many of the allegations were made against the defendants as a group and that such allegations were “too nebulous” to support the requisite strong inference of scienter against any particular defendant.

As to the two individual defendants that were not dismissed, the Court ruled that allegations that they deliberately decided not to report a substantial deferred compensation award payable to one of the two defendants in order to artificially and materially inflate the Company’s income and stock price despite their knowledge at the time that the omission was false and misleading satisfied PSLRA’s heightened pleading standard. (Navarre Corporation Securities Litigation, 2006 WL 3759750 (D.Minn. December 21, 2006))