The 10b-5 Daily

The U.S. Court of Appeals for the First Circuit has previously held that the Tellabs decision lowered the pleading standard for scienter in its court. While that determination did not lead to a reversal of the dismissal in the ACA Financial case, the same cannot be said of a new First Circuit decision issued this week.

In Mississippi Public Employees’ Retirement System v. Boston Scientific Corp., 2008 WL 1735390 (1st Cir. April 16, 2008), the court specifically noted that its application of Tellabs lead it to conclude that the district court, which “did not have the benefit” of the Supreme Court’s opinion, had erroneously dismissed the complaint based on a failure to adequately plead scienter. The court based its holding on allegations suggesting that Boston Scientific may have known of the relevant manufacturing problem during the class period, the closeness in time between alleged misstatements by the company and an announced product recall, and stock sales by the individual defendants.

On the issue of insider trading, the court addressed the defendants’ argument that many of the alleged insider stock sales were effectuated pursuant to Rule 10b5-1 trading plans and therefore could not have supplied a motive to engage in fraud. The court concluded, however, that there was insufficient evidence about the nature of the plans to credit this argument. (The author of The 10b-5 Daily has co-written an article on the potential use of Rule 10b5-1 trading plans in defending against securities class actions, including the importance of public disclosure of the nature of the plans. In addition, a discussion of other relevant cases can be found here.)

Quote of note: “It was the defendants’ choice to move to dismiss the case on the pleadings without presenting evidence. As a result, there is no evidence of when the [Rule 10b5-1] trading plans went into effect, that such trading plans removed entirely from defendants’ discretion the question of when sales would occur, or that they were unable to amend these trading plans.”

The Seventh Circuit is determined to be the market leader in interpreting U.S. Supreme Court securities litigation opinions. Following up on its application of Tellabs, last week it issued the first appellate decision utilizing the Stoneridge decision.

In Pugh v. Tribune Co., 2008 WL 867739 (7th Cir. April 2, 2008), the court considered the issue of “scheme liability” in the context of a corporate insider’s activities (as opposed to the actions of a third party). One of the individual defendants was a Tribune vice-president, as well as the director of circulation for a subsidiary. In his capacity as an officer of the subsidiary, the individual defendant allegedly signed false circulation audits that inflated the paid circulation figures for two publications. The plaintiffs argued that it was “‘forseeable’ that this scheme [to defraud the advertisers] would result in improper revenue which, in turn, would be reflected in Tribune’s published financial statements.”

The Seventh Circuit found that these allegations were insufficient. As in Stoneridge, the individual defendant “participated in a fraudulent scheme but had no role in preparing or disseminating Tribune’s financial statements or press releases.” Moreover, there was no allegation that Tribune investors had been informed of the false circulation audits. Accordingly, the plaintiffs failed to establish “the requisite proximate relation” between the advertiser fraud and the harm to Tribune’s investors.

Interestingly, the Seventh Circuit also addressed the issue of whether the scienter of this individual defendant could be imputed to Tribune on a respondeat superior theory. The court concluded that it could not because: (a) the individual defendant had no primary liability; (b) the misconduct of an employee of a subsidiary is not normally attributable to the corporate parent; and (c) the advertiser fraud was not undertaken to benefit Tribune. (For a discussion of the lower court’s decision on corporate scienter, see this post.)

Holding: Dismissal affirmed.