Opinion ID: 774794
Heading Depth: 3
Heading Rank: 2

Heading: Circumstantial Evidence of Conscious Misbehavior or Recklessness

Text: 50 Having concluded that Kalnit failed to allege scienter adequately by demonstrating motive and opportunity to defraud, we next turn to whether Kalnit's allegations demonstrate strong circumstantial evidence of defendants' conscious misbehavior or recklessness. Shields, 25 F.3d at 1128. Where motive is not apparent, it is still possible to plead scienter by identifying circumstances indicating conscious behavior by the defendant, though the strength of the circumstantial allegations must be correspondingly greater. Beck v. Mfrs. Hanover Trust Co., 820 F.2d 46, 50 (2d Cir. 1987) (citations omitted), overruled on other grounds by United States v. Indelicato, 865 F.2d 1370 (2d Cir. 1989) (en banc). 51 To survive dismissal under the conscious misbehavior theory, the appellants must show that they alleged reckless conduct by the appellees, which is at the least, conduct which is highly unreasonable and which represents an extreme departure from the standards of ordinary care to the extent that the danger was either known to the defendant or so obvious that the defendant must have been aware of it. 52 Honeyman v. Hoyt (In Re Carter-Wallace, Inc. Secs. Litig.), 220 F.3d 36, 39 (2d Cir. 2000) (citation omitted). Although this is a highly fact-based inquiry, generalities can be drawn. 53 [S]ecurities fraud claims typically have sufficed to state a claim based on recklessness when they have specifically alleged defendants' knowledge of facts or access to information contradicting their public statements. Under such circumstances, defendants knew or, more importantly, should have known that they were misrepresenting material facts related to the corporation. 54 Novak, 216 F.3d at 308. 55 Plaintiff argues that defendants' knowledge of, but failure to disclose, the Hostetter release suffices to show conscious misbehavior or recklessness. He cites to our decision in Novak, 216 F.3d at 311-12, for support. In that case, shareholders claimed that defendants had knowingly and intentionally... overstated [AnnTaylor, Inc.'s] financial condition by accounting for inventory that they knew to be obsolete and nearly worthless at inflated values and by deliberately failing to adhere to the Company's publicly stated markdown policy. Novak, 216 F.3d at 304. We concluded that plaintiffs' scienter allegation was adequate, emphasizing that plaintiffs alleged also that the defendants had, after discussion, made a conscious decision not to mark down inventory specifically because of the effect on AnnTaylor Stores Corporation. Id. at 311-12. In making this decision, defendants knowingly sanctioned procedures that violated the Company's own markdown policy, as stated in the Company's public filings... [and] caused those filings to be materially misleading in that the disclosed policy no longer reflected actual practice. Id. at 311. 56 Plaintiff also relies on our decision in Rothman, 220 F.3d at 90-91. In Rothman, we found allegations that defendant had, for a full year, failed to expense royalty advances for poorly selling products when the defendant knew (because of quarterly assessments) that these products were selling poorly to be sufficient recklessness allegations. The Rothman plaintiffs had pointed to defendants' pleadings in other lawsuits which sought to recover royalty payments as evidence of defendants' knowledge that these products were not selling. Id. at 91. We noted that the large size of the eventual write-off taken by defendants renders less credible the proposition that... [defendant] believed it likely that it could recover those royalty advances. Id. at 92. 57 The nondisclosure allegations here do not rise to the level of recklessness as did those in Novak or Rothman. In those cases, the defendants' duty to disclose the concealed information was not seriously disputed. Both cases involved a corporation's financial statements and its publicly known accounting policies. Thus, that the Novak or Rothman defendants were reckless (or consciously misbehaving) in not disclosing their inventory losses was more clear and this failure to disclose amounted to, at the least, reckless behavior. As the district court here pointed out, the duty to disclose the Hostetter letter was not so clear, especially given that the public was aware that MediaOne could accept a superior proposal within forty-five days. Kalnit I, 85 F. Supp. 2d at 245. Therefore, defendants' recklessness cannot be inferred from the failure to disclose. Further, because plaintiff has failed to demonstrate that defendants had a motive to defraud the shareholders, he must produce a stronger inference of recklessness. Beck, 820 F.2d at 50. This he has not done. 58 Plaintiff cites two district court cases involving merger negotiations as support. The first, Buxbaum v. Deutsche Bank, A.G., 2000 U.S. Dist. LEXIS 5838, at  (S.D.N.Y. March 7, 2000), involved public statements by a chairman of the acquiring bank denying the existence of takeover discussions, where less than a month later, defendants announced a merger. In the interim, the price of the target bank's stock was depressed. Plaintiffs, shareholders who had sold the target bank's stock following defendants' statement, alleged that the merger talks had been going on prior to the public interview and claimed that the statement denying these discussions was false when made. Id. at -. The court found that plaintiffs sufficiently alleged scienter, noting that the facts alleged clearly suggest that takeover talks were well under way..., that [defendant] was personally involved in those talks, and that he falsely and knowingly denied the existence of those talks. Id. at . 59 The second case, In re MCI Worldcom, Inc. Securities Litigation, 93 F. Supp. 2d 276 (E.D.N.Y. 2000), involved similar facts. Sellers of the target corporation's shares who sold during the three day period between the date of a misleading statement by defendants (asserting that its registration of an internet domain name matching the name of the target company was not an indication of an intention to acquire the company) and the date of the merger announcement, brought suit alleging securities fraud. Id. at 279-80. The court found that the plaintiffs' allegations sufficed to plead conscious misbehavior or recklessness, noting that the statement in controversy had also affirmatively misrepresented that the domain name registration was the product of one employee acting alone, but plaintiffs offered a New York Times article indicating that the company itself registered the domain. Id. at 285. 60 These cases are distinguishable from this case. First, both Buxbaum and MCI involve affirmative misstatements, not merely a failure to disclose merger discussions. There can be no question that a corporation's public statements must be truthful. Here, however, plaintiff's claim lies in non-disclosure. Because, as discussed earlier, this case does not present facts indicating a clear duty to disclose, plaintiff's scienter allegations do not provide strong evidence of conscious misbehavior or recklessness. Also, both Buxbaum and MCI involve misstatements about merger discussions that were ongoing, where the allegations here concern MediaOne's failure to disclose its waiver of a then three year old standstill provision. The recklessness of this behavior is not apparent from the facts alleged by plaintiff. We therefore conclude that plaintiff's allegations are inadequate to demonstrate strong circumstantial evidence of defendants' conscious misbehavior or recklessness. 61 Plaintiff has failed to allege scienter adequately, through either method. Accordingly, plaintiff's complaint fails to assert a securities fraud claim properly.