The Sixth Circuit recently held that lead plaintiffs— former shareholders of auto parts manufacturer Dana Corporation (“Dana”)—adequately pleaded scienter with respect to their claims under Section 10(b) of the Securities Exchange Act of 1934 (the “Exchange Act”). Frank v. Dana Corp., No. 09-4233, 2011 WL 2020717 (6th Cir. May 25, 2011). Frank v. Dana Corp. involved a class action securities fraud lawsuit against the former CEO and CFO (“Defendants”) of Dana. The plaintiff class (“Plaintiffs”) alleged that, prior to Dana’s bankruptcy, Defendants falsely portrayed Dana as fi nancially healthy. In September 2005, Defendants announced reduced earnings projections, triggering a downward spiral that included restated earnings, plummeting stock prices and, ultimately, bankruptcy on March 3, 2006.1

To state a claim for securities fraud under Section 10(b) of the Exchange Act, a plaintiff must allege, among other things, that a misstatement or omission of material fact was made with scienter.2 Under the Private Securities Litigation Reform Act, a securities fraud plaintiff “must [1] provide specifi c facts in support of the allegations of fraud, as well as [2] provide support for allegations of the required state of mind.” Frank v. Dana Corp., 525 F. Supp. 2d 922, 927 (N.D. Ohio 2007).

In Tellabs, Inc. v. Major Issues & Rights, Ltd., the Supreme Court established a three-step analysis for determining the adequacy of a 10(b) claim. A court must (1) accept all the plaintiff’s factual allegations as true; (2) consider the complaint, documents incorporated by reference, and matters of which the court has taken judicial notice in their entirety; and (3) take into account plausible opposing inferences when determining whether a strong inference of scienter exists. 551 U.S. 308, 322–24 (2007). Frank v. Dana Corp., Part IV concerns the second and third steps.

In support of their securities fraud claim, Plaintiffs asserted eight specifi c allegations from which an inference of scienter could be drawn: (1) Defendants received internal reports showing fi nancial distress, yet they continued to make positive statements about Dana’s fi nancial well-being; (2) Defendants vouched for Dana’s accounting systems which, in reality, were functioning improperly; (3) Defendants’ allegedly false statements caused large losses; (4) Defendants’ positive statements were quickly followed by Dana’s announcements to the contrary and subsequent downfall; (5) Defendants had motivation to make Dana appear healthy; (6) the CFO Defendant retired within months of the discovery of accounting errors; (7) Defendants signed Dana’s Sarbanes-Oxley certifi cations accompanying the false fi nancial fi lings; and (8) the SEC conducted an investigation into Dana’s accounting practices.

In 2007, the United States District Court for the Northern District of Ohio dismissed Plaintiffs’ class action claim, fi nding that, on balance, Plaintiffs failed to plead facts suffi cient to create an inference of scienter that was more plausible and powerful than competing inferences. On appeal, the Sixth Circuit Court of Appeals, citing Tellabs, held that the proper standard was not whether the inference of scienter was more plausible than competing inferences, but rather whether it was at least as compelling as any opposing inference. Frank v. Dana Corp., 547 F.3d 564, 571 (6th Cir. 2008). The Sixth Circuit remanded the case to the Northern District in light of its holding. On rehearing of Defendants’ motion to dismiss, the Northern District again granted the motion, noting that Plaintiffs failed to allege specifi c facts showing that Defendants actually knew of the alleged indicia of Dana’s fi nancial health. The District Court noted, for example, that the complaint did not specify “when the reports were prepared, when [Defendants] received them, whether they actually reviewed them, and how the information contained in these reports varied from Dana’s public statements.” Frank v. Dana Corp., 649 F. Supp. 2d 729, 738 (N.D. Ohio 2009).

Plaintiffs again appealed to the Sixth Circuit, which reversed the dismissal. In reversing the dismissal, the Sixth Circuit cited a 2011 Supreme Court case, Matrixx Initiatives, Inc. v. Siracusano, for the proposition that the inference-of-scienter inquiry was to be done “holistically” and noting that “reviewing each allegation individually . . . risks losing the forest for the trees.” Frank, 2011 WL 2020717, at *5. The court determined that the inference of scienter created by Plaintiffs’ allegations was at least as compelling as the inference that failed accounting systems were to blame, as proposed by Defendants. In reaching its conclusion, the court focused on the struggles of some of Dana’s key product lines, the rising cost of steel, and the bonuses that Defendants stood to earn, fi nding it “diffi cult to grasp that [Defendants] really had no idea that Dana was on the road to bankruptcy.” Id.

Signifi cance

By combining the lower inferential standard established in Tellabs—that the inference of scienter need be only at least as compelling as opposing inferences—with a “holistic” analysis of a plaintiff’s allegations, it can be argued that the Sixth Circuit signifi cantly weakened the heightened pleading standard required in securities fraud cases. This lower standard appears to allow plaintiffs to survive a motion to dismiss by forming an amalgamation of otherwise individually factually insuffi cient allegations.