June 3, 2004

The Perfect Storm Redux

Are two opinions a trend? Last year, The 10b-5 Daily posted about the denial of the motion to dismiss in the Interpublic Group securities litigation in the S.D.N.Y. The court's opinion in that case was based on the following controversial legal propositions: (1) Section 20(a) claims have no scienter pleading requirement; (2) corporate acquisitions for stock can be a motive for securities fraud; and (3) companies can be personified for scienter purposes (i.e., a finding of fraudulent intent). In a holding that was described here as "the perfect storm that happens when these three strands of questionable law come together," the Interpublic court found that even though the plaintiffs had failed to establish a strong inference of scienter for any of Interpublic's officers, the case could proceed against Interpublic and its officers based on the company's alleged motive to commit fraud and control person liability.

A year later, another court has issued a very similar decision. In In re NUI Sec. Litig., 2004 WL 895846 (D.N.J. April 23, 2004), the court found that the plaintiffs had adequately alleged a strong inference of scienter for the corporate defendant based on two sets of facts applicable to different parts of the class period. First, NUI's stock-for-stock acquisition of another company allegedly gave it a motive to inflate the price of its stock. Second, NUI's associate general counsel (who is not a defendant in the case) was alleged to have actual knowledge of the company's fraudulent conduct. As to the individual defendants (the CEO and CFO of NUI), however, the court held that there were insufficient allegations concerning their motive to commit fraud and knowledge of the alleged fraudulent conduct. Just as in Interpublic, the Rule 10b-5 claims were allowed to continue against NUI, but were dismissed against the individual defendants. The individual defendants were not, however, free to go. Since they controlled NUI and the court had found that a Rule 10b-5 claim was adequately pled against NUI, the Section 20(a) claims against the individual defendants based on control person liability still remain.

The NUI decision, like the Interpublic decision, would appear to eviscerate the PSLRA's requirement that scienter be adequately plead as to each defendant (see the post on the Interpublic decision for a fuller discussion). Moreover, the NUI court adds a fourth strand of questionable law to the mix. As recently discussed at length in the Fifth Circuit's decision in Southland Sec. Corp. v. INSpire Ins. Solutions, Inc., 365 F.3d 353 (5th Cir. 2004) (see this post on the decision's group pleading holding), in determining whether a corporate defendant has acted with scienter, a court generally looks "to the state of mind of the individual corporate official or official who make or issue the statement (or order or approve it or its making or issuance, or who furnish information or language for inclusions therein, or the like) rather than generally to the collective knowledge of all the corporation's officers and employees acquired in the course of their employment." In other words, courts generally reject a "collective scienter" theory - for example, where a plaintiff attempts to impute the knowledge of the associate general counsel, who is not alleged to have made or issued any statements, to the corporation for scienter purposes. The perfect storm keeps going.

Holding: Motion to dismiss granted in part (as to a separate alleged fraudulent scheme and certain statements), and denied in part.

Posted by Lyle Roberts at June 3, 2004 10:55 PM | TrackBack
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