Collective Scienter And The PSLRA

Whether a defendant corporation has acted with scienter (i.e., fraudulent intent) is determined by looking “to the state of mind of the individual corporate official or officials who make or issue the statement . . . rather than generally to the collective knowledge of all the corporation’s officers and employees acquired in the course of their employment.” Southland Sec. Corp. v. INSpire Ins. Solutions, Inc., 365 F.3d 353 (5th Cir. 2004). In other words, courts reject a “collective scienter” theory.

Eager to get at corporate wrongdoing, however, some courts have been ignoring this principle. In In re NUI Sec. Litig., 314 F.Supp.2d 388 (D.N.J. 2004), the court found that the plaintiffs had adequately alleged a strong inference of scienter for the corporate defendant because NUI’s associate general counsel (who was not a defendant in the case and made none of the alleged misstatements) 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.

Similarly, in the recent decision in In re Motorola Sec. Litig., 2004 WL 2032769 (N.D. Ill. Sept. 9, 2004), the court held that the plaintiffs had alleged a strong inference that Motorola “through its various officials, sought to mislead the investing public” about its vendor financing to a Turkish company. The direct fraud claims against the individual defendants (the CEO, CFO, and COO of Motorola) were dismissed, however, because the plaintiffs made no allegations that the individual defendants “had specific knowledge of the details concerning Motorola’s loan” and the plaintiffs’ motive allegations were insufficient.

In both cases, the claims against the individual defendants were not fully dismissed. Since the individual defendants controlled NUI and Motorola, and the courts found that a Rule 10b-5 claim was adequately pled against these companies, the Section 20(a) claims against the individual defendants based on control person liability for fraud still remained. By analyzing the scienter of NIU and Motorola separately, the courts, in essence, held that the companies acted with fraudulent intent, but their controlling officers or directors did not. This result both defies common sense (after all, a corporation can only act through its officers and directors) and, given that the individual defendants still have potential Section 20(a) liability, provides an end run around the PSLRA’s requirement that scienter be adequately plead as to each defendant.

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