Opinion ID: 161559
Heading Depth: 4
Heading Rank: 1

Heading: Pleading intentional fraud or recklessness

Text: 60 Intentional misconduct is easily identified since it encompasses deliberate illegal behavior. See Novak v. Kasaks, 216 F.3d 300, 308 (2d Cir. 2000), cert. denied, 531 U.S. 1012 (2000). Recklessness is much harder to define adequately. See Novak, 216 F.3d at 308. In Anixter, we stated both that recklessness satisfies the scienter requirement for a primary violation of 10(b) and that recklessness is defined as conduct that is an extreme departure from the standards of ordinary care, and which presents a danger of misleading buyers or sellers that is either known to the defendant or is so obvious that the actor must have been aware of it. 77 F.3d at 1232 (quotation marks omitted); see also San Juan County, 965 F.2d at 883; Hackbart v. Holmes, 675 F.2d 1114, 1117 (10th Cir. 1982). 61 Courts have been cautious about imposing liability for securities fraud based on reckless conduct, however. See Novak, at 309 ([W]e have identified several important limitations on the scope of liability for securities fraud based on reckless conduct.). Plaintiffs should not be allowed to proceed with allegations of fraud by hindsight, for example, because corporate officials should be liable for failing to reveal only those material facts reasonably available to them. See id. Thus, allegations that defendants should have anticipated future events and made certain disclosures earlier than they actually did do not suffice to make out a claim of securities fraud. Id. We explained our rejection of the fraud by hindsight method of pleading in securities fraud cases in Grossman, 120 F.3d at 1124, in which we stated: 62 What makes many securities fraud cases more complicated is that often there is no reason to assume that what is true at the moment plaintiff discovers it was also true at the moment of the alleged misrepresentation, and that therefore simply because the alleged misrepresentation conflicts with the current state of facts, the charged statement must have been false. Securities fraud cases often involve some more or less catastrophic event occurring between the time the complained-of statement was made and the time a more sobering truth is revealed (precipitating a drop in stock price). . . . In the face of such intervening events, a plaintiff must set forth, as part of the circumstances constituting fraud, an explanation as to why the disputed statement was untrue or misleading when made. 63 Id. (emphasis in original) (quoting In re GlenFed Sec. Litig., 42 F.3d 1541, 1548-49 (9th Cir. 1994) (en banc)). 64 Further, allegations that the defendant possessed knowledge of facts that are later determined by a court to have been material, without more, is not sufficient to demonstrate that the defendant intentionally withheld those facts from, or recklessly disregarded the importance of those facts to, a company's shareholders in order to deceive, manipulate, or defraud. As the Seventh Circuit explained in Schlifke v. Seafirst Corp., 866 F.2d 935 (7th Cir. 1989): 65 The plaintiffs submit that the Bank's actual knowledge of the facts withheld amply establishes the necessary degree of scienter; however, this argument misconstrues the relevant inquiry. The question is not merely whether the Bank had knowledge of the undisclosed facts; rather, it is the danger of misleading buyers that must be actually known or so obvious that any reasonable man would be legally bound as knowing. 66 Id. at 946 (emphasis in original). This reading of the statute and Rule comports with the Supreme Court's definition of scienter, i.e., intent to deceive, manipulate, or defraud and knowing or intentional misconduct. Thus, to establish scienter in a securities fraud case alleging non-disclosure of potentially material facts, the plaintiff must demonstrate: (1) the defendant knew of the potentially material fact, and (2) the defendant knew that failure to reveal the potentially material fact would likely mislead investors. The requirement of knowledge in this context may be satisfied under a recklessness standard by the defendant's knowledge of a fact that was so obviously material that the defendant must have been aware both of its materiality and that its non-disclosure would likely mislead investors. 67 Finally, allegations of GAAP violations or accounting irregularities, standing alone, are insufficient to state a securities fraud claim. Novak, 216 F.3d at 309. Only where such allegations are coupled with evidence that the violations or irregularities were the result of the defendant's fraudulent intent to mislead investors may they be sufficient to state a claim. 68