Securities Litigation

The US Sixth Circuit last week narrowed its standard for adequately pleading scienter in PSLRA cases using a collective-knowledge theory to impute knowledge to a corporate defendant from among various employees. In Omnicare, the Court limited collective-knowledge scienter by imposing the helpful, but unremarkable, requirement that such a pleading demonstrate a reasonably close connection between the collectively-held-knowledge and the issuance of the misstatement (or decision not to correct a prior omission). In re Omnicare, Inc. Securities Litigation, No. 13-5597 (6^th Cir. Oct. 10, 2014)(a Rule 10b-5 putative class-action following an internal-audit VP's termination and unsuccessful qui tam action for alleged Medicare/Medicaid fraud). The odd case involved allegedly fraudulent statements of "belief" and procedurally-backwards judicial-notice issues. Using Collective-Knowledge to Plead Corporate Scienter In its 2005 City of Monroe decision, the Sixth Circuit attributed an EVP's knowledge of safety failures to a corporate defendant, writing the "knowledge of a a corporate officer or agent acting within the scope of his authority is attributable to the corporation." City of Monroe Emps. Ret. Sys. v. Bridgestone Corp., 399 F. 3d 651, 688-90 (6^th Cir.), cert. denied, 546 U.S. 936 (2005). Calling Circuit precedent on Rule 10b-5 class-action pleading standards "somewhat hazy and muddled," the Court recognized the need to narrow its recognition of the collective-knowledge theory of scienter: "If the scienter of any agent can be imputed to the corporation, then it is possible that company could be liable for a statement made regarding a product so long as a low-level employee, perhaps in another country, knew something to the contrary." Omnicare at 23. The Court surveyed outstanding precedent: - The 5^th and 11^th Circuits' narrow view imputing knowledge to the corporation from a statement's maker under traditional respondeat superior, see Southland Sec. Corp. v. Inspire Ins. Solutions, Inc., 365 F. 3d 353, 366 (5^th Cir. 2004); Phillips v. Scientific-Atlanta, Inc., 374 F. 3d 1015, 1018-19 (11^th Cir. 2004). - The 6^th and 10^th Circuits' acceptance of collective-knowledge theories, see City of Monroe, 399 F. 3d at 688-90 (adequately alleged misrepresentations against corporation with non-speaking CEO's alleged knowledge of falsity); Adams v. Kinder-Morgan, Inc., 340 F. 3d 1083, 1106 (10^th Cir. 2003). - The 2^nd, 7^th, and 9^th Circuits' dicta acknowledging the theory, but not applying it, see Teamsters Local 445 Freight Div. Pension Fund v. Dynex Capital Inc., 531 F. 3d 190, 196 (2^nd Cir. 2008)(needn't name individual; dicta, because complaint didn't demonstrate information was misleading); Makor Issues & Rights, Ltd. v. Tellabs, Inc., 513 F. 3d 702, 710 (7^th Cir. 2008)( dicta, because CEO allegedly knowingly misrepresented material facts with intent to defraud); Glazer Captial Mgt., LP v. Magistri, 549 F. 3d 736, 744 (9^th Cir. 2008)(refusing to reject collective knowledge theory; also dicta). The Court re-stated the Circuit's view of the doctrine: The state(s) of mind of any of the following are probative for purposes of determining whether a misrepresentation made by a corporation was made by it with the requisite scienter under Section 10(b): . . . a. The individual agent who uttered or issued the misrepresentation; b. Any individual agent who authorized, requested, commanded, furnished information for, prepared (including suggesting or contributing language …), reviewed, or approved the statement … before its ... issuance; c. Any high managerial agent or member of the board of directors who ratified, recklessly disregarded, or tolerated the misrepresentation . . . . Omnicare at 24, citing P. Abril & A. Olazábal, The Locus of Corporate Scienter, ­2006 Colum. Bus. L. Rev. 81, at 135 (2006). The Omnicare Court applied that standard to the Tellabs requirements, affirming dismissal because the complaint lacked sufficiently particular allegations to demonstrate a strong inference of scienter at least as compelling as other inferences. The Complaint failed to do enough to "connect up" results of three internal compliance audits (varyingly negative) with upper-management's public statements of "belief" (positive) in the corporation's overall Medicaid/Medicare compliance. Because the challenged statement itself was one of belief ("soft"), Plaintiffs faced the "higher bar" of demonstrating (subjective) knowing falsity when made, without the benefit of an objectively ("hard") false statement. Omnicare at 16. The Opinion offers a too-formulaic "hard" and "soft" information typology as it works through Plaintiffs' claims that Omnicare's executives could not have genuinely believed in the firm's compliance in the face of the audits. Omnicare at 15-17. The Opinion begs more confusion, by over-stating that a "different analytical framework" and "different rules apply when the misrepresentation or omission concerns hard, as opposed to soft, information." Omnicare at 15. The Court got the result right, but over-extended in its desire to clarify the Circuit's "recipe" for pleading under the PSLRA. Instead, the same rules, standards and analysis apply, but simply demand greater pleading and proof when a Plaintiff sets out to allege and prove that a speaker could not possibly have believed his statement of opinion. A Judicial-Notice "Hail Mary." Plaintiffs didn't do themselves any favors in this case: "The actors and allegations in the Complaint are many and muddled." Omnicare at 3. Then they "forfeited" the District Court's denial of their "awkward request to amend," but asked the Sixth Circuit to take judicial notice of additional facts on appeal. The Court noted the well-established rule that it can take judicial notice of the existence and content (for its fact, not truth) of: (a) documents incorporated by reference, quoted, or extensively relied upon in the Complaint, or (b) public-record documents refuting the allegations. Omnicare at 11-13. The Court rebuked Plaintiffs' attempts to save their action by appealing to the content of audit-committee charters, corporate-integrity agreements (both filed with the SEC) and filings from a related, unsuccessful qui tam action. "After all, judicial notice is not an alternative avenue for amending the complaint after a district court dismisses the suit of failure to state a claim." Omnicare at 9. The Court granted Defendants' request, taking judicial notice of the rest of SEC filings selectively quoted in the Complaint. The Opinion, In re Omnicare, Inc. Securities Litigation, No. 13-5597 (6^th Cir. Oct. 10, 2014), is here. Thomas K. Potter, III (tpotter@burr.com) is a partner in the Securities Litigation Practice Group at Burr & Forman, LLP. Managing Partner of the Nashville office, Tom is licensed in Tennessee, Texas and Louisiana. He has over 28 years' experience representing financial institutions in litigation, regulatory and compliance matters. © 2014 by Thomas K. Potter, III (all rights reserved)