A complaint that includes damaging statements from a confidential witness who used to carpool with the company’s CEO and CFO seems like it should survive a motion to dismiss, but it may depend on how the plaintiffs frame the allegations. In In re Maxwell Technologies, Inc. Sec. Litig., 2014 WL 1796694 (S.D. Cal. May 5, 2014), the plaintiffs alleged that the company and its senior officers had engaged in a scheme to fraudulently recognize revenue. The court’s decision addressed a couple of interesting pleading issues.
(1) Corporate scienter – The requirements for corporate scienter continue to be an open question in the Ninth Circuit. The court found while a corporation can be held responsible for the actions of its executives, corporate scienter cannot be “based only upon the scienter of a non-defendant who did not make or certify the statements at issue.” Accordingly, the plaintiffs needed to demonstrate that one of the named defendants (the CEO and CFO) had acted with scienter.
(2) Confidential witnesses – The plaintiffs based their scienter allegations largely on statements from confidential witnesses. These witnesses included a senior director for global sales and marketing who (a) was fired for having a role in the revenue recognition issues, and (b) used to carpool with the CEO and CFO and reportedly heard them talking about taking certain actions necessary to “make the numbers.” The court, however, took issue with how the confidential witness statements were plead, noting that it was often difficult to determine what the witnesses had actually said as opposed to the plaintiffs’ characterizations of those statements. With respect to the carpooling senior director, the statements “certainly indicate that CW4 may have heard or seen something from which this Court could infer scienter . . . but many of the statements about the role of [the CEO and CFO] are conclusory and without foundation.”
Holding: Dismissed without prejudice based on the failure to sufficiently allege scienter.
The 10b-5 Daily 