The core operations theory, as developed in the Ninth Circuit, holds that it may be possible to infer a strong inference of scienter in situations where the nature of the alleged fraud “is of such prominence that it would be ‘absurd’ to suggest that the management was without knowledge of the matter.” The theory has come under criticism from other courts and there are relatively few reported decisions where it has been successfully invoked.
In Patel v. Axesstel, Inc., 2015 WL 631525 (S.D. Cal. Feb. 13, 2015), however, the court found the alleged facts supported the application of the core operations theory. As the court summarized the situation: “it would be absurd to think that the CEO and CFO of a company with just thirty-five employees, or whom only ten are involved in sales, general or administration, would be unaware of the lack of written agreements or definitive payment terms with the five new customers in Africa that represented the company’s first sales of a significant new product that constituted between twenty and forty percent of Axesstel’s overall revenue.” Moreover, the individual defendants made “numerous statements . . . indicating that they were directly involved in sales and knew the details of Axesstel’s dealings with its African customers.” Accordingly, the court held that the plaintiffs had adequately plead a strong inference of scienter.
Holding: Motion to dismiss denied.
Quote of note: “[The individual defendants’] roles in Axesstel are magnified by the exceedingly small size of the company. Axesstel is not to be confused with Apple. The individual defendants here are not officers in a large company who may be removed from the details of a specific business line or remote business activity.”