Plaintiffs in securities class actions often point to insider trades as evidence that the individual defendants had a pecuniary motive to commit fraud. But if the plaintiffs do not make any allegations related to insider trades, can defendants conversely use SEC filings to show, at the motion to dismiss stage, that there was no suspicious trading (and, accordingly, no pecuniary motive)?
In Zak v. Chelsea Therapeutics Int’l, Ltd., 2015 WL 1137142 (4th Cir. March 16, 2015), the district court took judicial notice of certain SEC filings concerning insider sales and the individual defendants’ stock holdings. It then “concluded that the defendants’ purported failure to sell Chelsea stock during the class period ‘tip[ped] the scales’ of the competing inferences of scienter” in favor of the defendants. The Fourth Circuit held that this analysis was improper. First, the district court should not have considered the SEC filings because they “were not explicitly referenced in, or an integral part of, the plaintiff’s complaint,” which did not contain any allegations related to insider trades. Second, the SEC filings the district court considered did not conclusively establish that none of the individual defendants sold any Chelsea stock during the class period.
Holding: Dismissal vacated.
Addition: One of the panel members dissented from the decision, but stated that he agreed with the majority’s “determination that the district court misused the challenged SEC documents.” Interestingly, the dissent notes that prior to the instant case, the Fourth Circuit had never overturned, in the post-PSLRA era, a district court decision holding that the plaintiffs had failed to plead facts supporting a strong inference of scienter (eight total cases).