In Teamsters Local 445 Freight Division Pension Fund v. Dynex Capital Inc., 2008 WL 2521676 (2d Cir. June 26, 2008), the United States Court of Appeals for the Second Circuit held that in order to state a claim for securities fraud against a corporate defendant, plaintiffs may not rely upon the theory of “collective scienter,” but instead must plead a strong inference of scienter by the individual “who was responsible for the [allegedly false or misleading] statements made” by or on behalf of the corporation. This decision aligns Second Circuit law with the law of the Ninth Circuit (see, e.g., In re International Rectifier Corp. Sec. Litig., 2008 U.S. Dist. LEXIS 44872 (C.D. Cal. May 23, 2008)), and sets an additional obstacle for plaintiffs to state a securities fraud claim against a corporation. 

At issue in Dynex was a series of statements issued by the defendant, Dynex Capital (“Dynex”), in connection with its lending practices. Plaintiffs named Dynex, its subsidiary Merit, and two of Dynex’s officers, alleging that the defendants were liable for fraud because certain officers and directors at both the parent and the subsidiary (1) had access to records and failed to review documents that could have revealed the fraud and (2) were motivated to “sustain the appearance of profitability” at Dynex. The district court held that, while these allegations were insufficient as to the individual defendants, they were adequate to plead a claim against the corporate defendants based on the doctrine of “collective scienter,” that is, the theory that a plaintiff can plead fraud by pointing to a corporation’s “collective” knowledge and intent and not the information possessed by any particular corporate officer or director. Recognizing a split of authority on the issue, however, the district court took the unusual step of certifying the issue for interlocutory appeal to permit the Second Circuit to resolve the issue.

The Second Circuit reversed. Rejecting “collective scienter” as a permissible means of pleading knowledge and intent under the Private Securities Litigation Reform Act of 1995, the court held that “[w]hen the defendant is a corporate entity . . . the pleaded facts must create a strong inference that someonewhose intent could be imputed to a corporation acted with the requisite scienter.” The court explained that while this might not preclude a plaintiff from pleading scienter as to a corporation based on the conduct of certain officers and directors not named in the complaint, it would require a plaintiff to plead specific facts raising a strong inference that the officer or director who acted with the requisite scienter was not only “someone whose scienter is imputable to the corporate defendants” but also “someone who was responsible for the statements made.” This additional requirement represents an expansion of the rule followed by many other circuits, in which courts have rejected collective scienter while still permitting scienter to be alleged based on the knowledge of any identified officer or director, though it appears to correspond generally with the rule adopted by courts in the Ninth Circuit.

Dynex cites no authority in support of its requirement that plaintiffs must plead knowledge as to the person responsible for making the challenged statement, but it likely paraphrased this rule from a 2004 decision from the Southern District of New York, Kinsey v. Cendant Corporation, 2004 U.S. Dist. LEXIS 23059, at *13 (S.D.N.Y. Nov. 16, 2004), which the Dynex district court cited in its decision certifying the matter for interlocutory appeal. In Kinsey, the court quoted a case from the Northern District of California, In re Apple Computer, Inc., 243 F. Supp. 2d 1012, 1023 (N.D. Cal. 2002), which held that “[i]t is not enough to establish fraud on the part of a corporation that one corporate officer makes a false statement that another officer knows to be false. A defendant corporation is deemed to have the requisite scienter only if the individual . . . making the statement has the requisite level of scienter.”

Dynex’s apparent reliance upon Kinsey and, by extension, Apple underlines the similarity between the standards adopted by the Second and Ninth Circuits. The Ninth Circuit rejected collective scienter over a decade ago in Nordstrom, Inc. v. Chubb & Son, Inc., 54 F.3d 1424, 1435 (9th Cir. 1995), but it has yet to consider whether plaintiffs are required to plead knowledge as to the speaker. Every subsequent Ninth Circuit district court case to have considered this issue, though, has followed Apple and held that Nordstrom requires plaintiffs to allege scienter as to the person charged with making the disputed statement. With its decision in Dynex, the Second Circuit appears to join the Ninth not only in rejecting collective scienter but, also, in requiring that plaintiffs allege knowledge as to the person responsible for making the challenged statement in order to state a claim against the corporate defendant. This rule presents another hurdle for plaintiffs to clear in order to proceed with a securities fraud case against a corporation.