In Glazer Capital Management, LP v. Magistri, 2008 WL 5003306 (9th Cir. Nov. 26, 2008), the United States Court of Appeals for the Ninth Circuit held that when pleading scienter as to a corporate defendant, the Private Securities Litigation Reform Act of 1995 (the “Reform Act”) “requires [plaintiff] to plead scienter with respect to those individuals who actually made the false statements.” This ruling clarifies that in all but the most unusual cases, a plaintiff in this Circuit may not rely upon notions of “collective scienter” — that is, the idea that a corporation’s state of mind for purposes of pleading securities fraud can be inferred from the collective knowledge of the totality of its employees, instead of the knowledge of a particular officer or director — to state a claim for securities fraud against a corporate defendant. In addition, Glazer reaffirms longstanding Ninth Circuit authority holding that, when alleging scienter as to an individual defendant, the Reform Act requires plaintiff to “plead, in great detail, facts that constitute strong circumstantial evidence of deliberately reckless or conscious misconduct” on the part of the defendant.
Plaintiff in Glazer alleged that the defendant corporation, InVision Technology Inc. (“InVision”), made false statements in a merger agreement attached to a Form 10-K filed by InVision with the Securities and Exchange Commission (“SEC”). The merger agreement was signed by InVision’s Chief Executive Officer (“CEO”) and Chief Operating Officer (“COO”). Several months after filing, InVision announced that it had commenced an internal investigation into allegations that certain of its employees had violated the Foreign Corrupt Practices Act (“FCPA”) by bribing government officials in Asia. InVision further announced that it had reported these activities to the SEC and the Department of Justice (“DOJ”), and that the conduct was likely to delay its merger. Plaintiff brought suit shortly thereafter, alleging that InVision, its CEO and its Chief Financial Officer (“CFO”) falsely represented in its filing with the SEC that the company was in compliance with all material laws, that it properly accounted for all payments in its books and records and that it was not in violation of the anti-bribery provisions of the Securities Exchange Act of 1934. The district court granted defendants’ motion to dismiss without leave to amend on the grounds that, inter alia, plaintiff had failed to plead facts giving rise to a strong inference of scienter in accordance with the Reform Act’s heightened pleading requirements.
The Ninth Circuit affirmed. It held that the district court did not err by dismissing claims against InVision because plaintiff failed “to plead scienter with respect to those individuals who actually made the false statements.” In so holding, the Ninth Circuit expressly foreclosed application of collective scienter to claims arising out of a corporation’s blanket representation in an SEC filing that it complies with applicable laws and standards of accounting. The court explained:
If the doctrine of collective scienter excuses Glazer from pleading individual scienter with respect to these legal warranties, then it is difficult to imagine what statements would not qualify for an exception to individualized scienter pleadings. In fact, because the [SEC filing] warranted that the company was in compliance “with all laws,” then under the collective scienter theory urged by Glazer, so long as any employee at InVision 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 [Reform Act].
The court further held that the district court did not abuse its discretion by refusing to allow plaintiff to file a third amended complaint adding allegations of knowledge on the part of the company’s former senior vice president of sales and marketing, who was alleged to have orchestrated the misconduct in Asia, because “the fact that Glazer could have shown that a different executive knew about the FCPA violations would do nothing to resuscitate Glazer’s claims.”
The Ninth Circuit also held that the district court did not err in holding that plaintiff failed to plead scienter as to InVision’s CEO (one of the officers alleged to have signed the inaccurate statement). Plaintiff argued that it was not required to plead the CEO’s scienter with particularity because the nature of the violation was “so central” to company’s business that the “core operations inference” applied. The Ninth Circuit rejected this argument, reasoning that because the conduct at issue involved surreptitious, illegal payments made by sales agents in Asia, who were purportedly operating under the direction of the company’s vice president of sales, “it would not be ‘absurd to suggest’ that [the CEO] was unaware of the details.” The Ninth Circuit similarly rejected plaintiff’s attempt to plead scienter based on the fact that the acquiring corporation uncovered the misconduct as part of its due diligence. At most, the court held, this discovery indicated that the CEO “should have known of the violations.” “This not sufficient to meet the stringent scienter pleading requirements of the [Reform Act].” The court also rejected plaintiff’s attempts to plead scienter based on the financial benefits the CEO would receive as a result of the merger and on the fact that he signed SOX certifications, holding that neither allegation was sufficient, “without more,” to raise a strong inference of scienter. Finally, the court rejected plaintiff’s attempt to plead scienter based on the company’s admissions that it “was aware of the high probability that its foreign sales agents or distributors paid or offered to pay something of value to government officials in order to obtain or retain business.” The court explained, “[a]s discussed earlier, the mere fact that someone at InVision had knowledge of the illegal transactions is not sufficient to satisfy the scienter pleading requirements of the [Reform Act] . . . .”
The decision in Glazer is significant for two reasons. First, Glazer represents the first time that the Ninth Circuit has revisited its standard for pleading corporate scienter since its holding over a decade earlier in Nordstrom, Inc. v. Chubb & Son, Inc., 54 F. 3d 1424 (9th Cir. 1995). In Nordstrom, the Ninth Circuit held that “there is no case law supporting an independent ‘collective scienter’ theory.” Nordstrom, however, was an insurance case that discussed corporate scienter only briefly. Left to interpret Nordstrom without further guidance, a majority of district courts in the Circuit subsequently concluded:
The Ninth Circuit has rejected the concept of “collective scienter.” It is not enough to establish fraud on the part of a corporation that one corporate officer makes false statement that another officer knows to be false. A defendant corporation is deemed to have the requisite scienter for fraud only if the individual corporate officer making the statement has the requisite level of scienter . . . .
In re Apple Computer, Inc., 243 F. Supp. 2d 1012, 1023 (N.D. Cal. 2002); accord, e.g., In re Int’l Rectifier Corp. Sec. Litig., 2008 U.S. Dist. LEXIS 44872 (C.D. Cal. May 23, 2008).
In Glazer, the Ninth Circuit confirmed that Apple and its progeny, for the most part, got it right. The court (albeit in dicta) observed that to the extent Apple categorically rejected “collective scienter” in all cases, the decision “appears to have overstated our holding in Nordstrom” because “it [is] possible there could be circumstances in which a company’s public statements were so important and so dramatically false that they would create a strong inference that at least some corporate officials knew of the falsity upon publication.” The Ninth Circuit emphasized, however, that it would not speculate about whether it would overturn Apple and permit collective scienter were it to be confronted with such an extreme case. As the court explained, “[t]hat issue is not before us.” When considering the facts that were before the court — allegations that InVision filed with the SEC documents representing that it complied with all applicable laws and accounting standards — the Ninth Circuit followed the analysis in Apple, holding that because plaintiff failed to plead scienter as to the individual corporate officers charged with signing the SEC filing, plaintiff failed to plead scienter as to the defendant corporation.
Glazer also is notable for its reaffirmation of Ninth Circuit authority predating the Supreme Court’s recent decision in Tellabs, Inc. v. Makor Issues & Rights, Ltd., 127 S. Ct. 2499 (2007) (see blog article). In Tellabs, the Supreme Court held that, in order state a claim for securities fraud, the inference of scienter plaintiffs urge “must be more than merely plausible or reasonable — it must be cogent and at least as compelling as any opposing inference of nonfraudulent intent.” Earlier this term in South Ferry LP, No. 2 v. Killinger, 542 F.3d 776 (9th Cir. 2008) (see blog article), another panel of the Ninth Circuit suggested in dicta that Tellabs may have supplanted earlier Ninth Circuit decisions, including In re Silicon Graphics Inc. Securities Litigation, 183 F.3d 970, 979 (9th Cir 1999), which require plaintiffs to plead with particularity all circumstances constituting fraud, in favor of a holistic standard that considers only whether plaintiffs have pled an inference of fraud that is at least as compelling as any nonculpable inference suggested by the complaint. This dicta from South Ferry contrasts sharply with the Ninth Circuit’s decision in Metzler Inv. GMBH v. Corinthian Colleges, Inc., 540 F.3d 1049 (9th Cir. 2008) (see blog article), in which the court confirmed the continued validity of “the Ninth Circuit’s pre-Tellabs decisions interpreting the [Reform Act’s] scienter requirement.” With its decision in Glazer, the Ninth Circuit again holds that, when pleading scienter, a plaintiff must comply with both the holistic analysis articulated in Tellabs and the specificity requirements expressed in Silicon Graphics.