In its Tellabs decision, the U.S. Supreme Court held that a court must assess a plaintiff’s scienter (i.e., fraudulent intent) allegations “holistically” in determining whether the plaintiff has met the requisite “strong inference” pleading standard. The 10b-5 Daily noted at the time of the Tellabs decision that this holding “would appear to alter the evaluation of scienter in the Second Circuit and Third Circuit, both of which have held that a court can examine allegations of motive or knowledge/recklessness separately.” The Second Circuit has failed to address this inconsistency, however, leading to decisions that are arguably at odds with binding precedent.
In In re Gentiva Sec. Litig., 2013 WL 5291297 (E.D.N.Y. Sept. 19, 2013), the court addressed allegations that the company violated Medicare rules and artificially inflated the Medicare payments it received. In its first motion to dismiss decision, the court found that the plaintiffs had failed to adequately plead either motive and opportunity to commit fraud or sufficient circumstantial evidence of conscious misbehavior.
As to the amended complaint, the court again concluded that there were insufficient allegations to establish that the “Individual Defendants knew or had access to information showing that Gentiva was pressuring its staff to provide as many therapy visits as possible to receive extra Medicare payments without consideration of patients’ needs.” On the issue of motive, however, the court found that two of the individual defendants had exercised stock options and sold a significant amount of shares during the class period. It also found that corporate scienter could be “inferred from the ‘suspicious’ insider stock sales.” Accordingly, the court denied the motion to dismiss “to the extent the Plaintiff seeks to establish scienter of the Defendants Malone, Potapchuk, and Gentiva based on a theory of ‘motive and opportunity.'”
What does it mean to “holistically” examine the complaint’s scienter allegations if they are divided into two categories? The court offers no explanation, but the responsibility ultimately lies with the Second Circuit, which needs to address this question.
Holding: Motion to dismiss denied, with the court curiously stating the plaintiff would “not be permitted to present . . . at trial” a theory of scienter based on circumstantial evidence of misbehavior or recklessness.