Whether a plaintiff can establish the scienter (i.e., fraudulent intent) of a defendant corporation based on the collective knowledge of the corporation's employees (commonly referred to as the "collective scienter" theory), is a topic that has been simmering in the courts for a number of years. When The 10b-5 Daily last checked in on the status of the issue back in 2004, the Sixth Circuit had issued an opinion in the Bridgestone securities litigation that appeared to apply a collective scienter theory. Although the opinion did not specifically discuss the issue, the court's holding clearly was incompatible with the Fifth and Ninth Circuits' previous rulings that a defendant corporation only can be deemed to have acted with scienter if the individual officer making the alleged false statement acted with scienter.
Fast forward a couple of years and the collective scienter theory is gaining traction in certain district courts. There are two distinct versions of the theory being applied.
Under the weaker version, it is sufficient for a plaintiff to establish that a management-level employee of the corporation acted with fraudulent intent, even if that employee is not a defendant and did not make any alleged false statement. Two recent decisions from the D. of Mass. and the S.D.N.Y. have adopted this version. In re Sonus Networks, Inc. Sec. Litig., 2006 WL 1308165 (D. Mass. May 10, 2006) (scienter of former controller attributable to corporation); In re Marsh & McLennan Companies, Inc. Sec. Litig., 2006 WL 2057194 (S.D.N.Y. July 20, 2006) (scienter of "particular management-level employees identified in the Complaint" attributable to corporation).
Under the stronger version, a plaintiff can establish that the corporation acted with fraudulent intent without any reference to a particular employee. Not only has this version been adopted by a court in the S.D.N.Y., but that court has certified the issue for interlocutory appeal to the Second Circuit. In re Dynex Capital, Inc. Sec. Litig., 2006 WL 1517580 (S.D.N.Y. June 2, 2006) (finding that relevant prior decisions from Second Circuit do not clearly decide issue).
So stay tuned. The Second Circuit will have the opportunity to decide a question that The 10b-5 Daily posited years ago: if an officer makes the statement and a janitor knows the statement is false, has the corporation acted with fraudulent intent? If the answer is "yes," there will be an open circuit split on corporate scienter.Posted by Lyle Roberts at August 22, 2006 2:52 PM | TrackBack