Must Have Known

In Berson v. Applied Signal Tech., Inc., 527 F.3d 982 (9th Cir. 2008), the company allegedly misled investors into believing it was likely to perform contracted work. According to the plaintiffs, however, the work had actually ceased pursuant to “stop-work” orders and was not likely to be resumed. On appeal, the U.S. Court of Appeals for the Ninth Circuit reversed the dismissal of the case. A couple of interesting holdings in the decision:

(1) Scienter – The plaintiffs did not allege particular facts indicating that the individual defendants knew about the stop-work orders. Instead, they argued that Applied Signal’s CEO and CFO must have known about the stop-work orders because of the devastating effect of the orders on the corporation’s revenue. The court agreed and found that the stop-work orders “were prominent enough that it would be ‘absurd to suggest’ that top management was unaware of them.” The decision continues a recent appellate trend of finding “must have known” allegations sufficient in situations where the underlying events are deemed to be highly important to the corporation.

(2) Loss Causation – The Supreme Court’s Dura decision left open the question of whether loss causation is subject to a heightened pleading standard. A number of courts have held that notice pleading pursuant to F.R.C.P. 8(a)(2) is sufficient (see, e.g.Greater Penn. Carpenters Pension Fund v. Whitehall Jewellers, Inc., 2005 WL 1563206 (N.D. Ill. June 30, 2005)), while a few others have required pleading with particularity pursuant to F.R.C.P. 9(b) (see, e.g.In re The First Union Corp. Sec. Litig., 2006 WL 163616 (W.D.N.C. Jan. 20, 2006)). The Applied Signal court noted that this is still an open question in the Ninth Circuit, but declined to decide it because the loss causation allegations in the case met the more stringent standard.

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