Whether a plaintiff can establish the scienter 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 is getting increased attention in the courts. The author of The 10b-5 Daily wrote a New York Law Journal column (with a colleague) on collective scienter earlier this year.
The main case discussed in that column was decided by the Second Circuit last week. In Teamsters Local 445 Freight Division Pension Fund v. Dynex Capital, Inc., 2008 WL 2521676 (2nd Cir. June 26, 2008), the court drew a distinction between the pleading and proving of corporate scienter. Although to prove corporate liability “a plaintiff must prove that an agent of the corporation committed a culpable act with the requisite scienter, and that the act (and accompanying mental state) are attributable to the corporation,” the court found that at the pleading stage a plaintiff is only required to create a strong inference that “someone whose intent could be imputed to the corporation acted with the requisite scienter.” This pleading burden can be met “with regard to a corporate defendant without doing so with regard to a specific individual defendant.” The court went on to hold, however, that the generic allegations of knowledge and motive in the complaint failed to meet this standard.
Practitioners, especially in the defense bar, are likely to find the decision disappointing. First, the court did not address what type of factual allegations would be sufficient to find the existence of a strong inference of corporate scienter (in the absence of sufficient factual allegations concerning an individual defendant). The only hint is a quote from the Seventh Circuit’s decision in Tellabs II discussing a hypothetical in which “General Motors announced that it had sold one million SUVs in 2006, and the actual number was zero.” Although General Motors now knows one situation to avoid, that fact pattern offers limited guidance for the lower courts. Second, the court provided no legal basis for its announced pleading standard (other than the citation to Tellabs II) and did not address the growing circuit split on this issue.
Disclosure: The author of The 10b-5 Daily submitted an amicus brief in the Dynex Capital case on behalf of the Washington Legal Foundation.