Opinion ID: 785790
Heading Depth: 4
Heading Rank: 1

Heading: Governing Law — Pleading Standards

Text: 30 Section 10(b) 1 of the Exchange Act and Rule 10b-5 2 promulgated thereunder prohibit fraudulent, material misstatements or omissions in connection with the sale or purchase of a security. Morse v. McWhorter, 290 F.3d 795, 798 (6th Cir.2002). In order to state a claim pursuant to Section 10(b) and Rule 10b-5, a plaintiff must allege, in connection with the purchase or sale of securities, the misstatement or omission of a material fact, made with scienter, upon which the plaintiff justifiably relied and which proximately caused the plaintiff's injury. Hoffman v. Comshare, Inc. (In re Comshare, Inc. Secs. Litig.), 183 F.3d 542, 548 (6th Cir.1999). Adding to the Federal Rule of Civil Procedure 9(b) requirement that fraud allegations be stated with particularity, the PSLRA requires that the complaint specify each statement alleged to have been misleading, the reason or reasons why the statement is misleading, and, if an allegation regarding the statement or omission is made on information and belief, the complaint shall state with particularity all facts on which that belief is formed. 15 U.S.C. § 78u-4(b)(1). 31 The appeal before us centers on whether the Complaint adequately pleads the scienter element of a Section 10(b) and Rule 10b-5 claim. In reviewing the district court's decision dismissing the Complaint, we must first examine the meaning of scienter in the securities fraud setting. The Supreme Court has defined scienter as a mental state embracing intent to deceive, manipulate, or defraud. Ernst & Ernst v. Hochfelder, 425 U.S. 185, 193 n. 12, 96 S.Ct. 1375, 1381 n. 12, 47 L.Ed.2d 668 (1976). In securities fraud claims based on statements of present or historical fact — such as the claims Plaintiffs bring in this case — scienter consists of knowledge or recklessness. 3 Helwig v. Vencor, Inc., 251 F.3d 540, 552 (6th Cir.2001) (en banc). Recklessness is defined as highly unreasonable conduct which is an extreme departure from the standards of ordinary care. While the danger need not be known, it must at least be so obvious that any reasonable man would have known of it. Mansbach v. Prescott, Ball & Turben, 598 F.2d 1017, 1025 (6th Cir.1979) (quoted in Miller, 346 F.3d at 672). Recklessness is a mental state apart from negligence and akin to conscious disregard. Comshare, 183 F.3d at 550. See also Id. at 550 n. 7 (As we have observed, federal appellate courts have long held the view that, for the purposes of securities fraud, `recklessness' that is far from negligence and closer to a `lesser form of intent' constitutes scienter.) (quoting Sanders v. John Nuveen & Co., Inc., 554 F.2d 790, 793 (7th Cir.1977)). 32 Next, we examine the special requirements for pleading scienter in federal securities fraud cases such as this. As with all fraud claims, Federal Rule of Civil Procedure 9(b) applies to pleading a defendant's state of mind, allowing that [m]alice, intent, knowledge, and other condition of mind of a person may be averred generally. However, Congress amended the Securities Exchange Act of 1934 through passage of the PSLRA, heightening the standard for pleading scienter in a securities fraud case: 33 In any private action arising under this title in which the plaintiff may recover money damages only on proof that the defendant acted with a particular state of mind, the complaint shall, with respect to each act or omission alleged to violate this title, state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind. 34 15 U.S.C. § 78u-4(b)(2) (emphasis added). The PSLRA provides that if a plaintiff does not meet this requirement, a court may, on any defendant's motion, dismiss the complaint. See 15 U.S.C. § 78u-4(b)(3). As courts have observed, the PSLRA did not change the scienter that a plaintiff must prove to prevail in a securities fraud case but instead changed what a plaintiff must plead in his complaint in order to survive a motion to dismiss. Comshare, 183 F.3d at 548-49 (citation omitted). 35 As the foregoing authorities make clear, a plaintiff may survive a motion to dismiss by pleading with particularity facts giving rise to a strong inference that the defendant acted with knowledge or recklessness. In other words, not only must the complaint make particular factual allegations, but the inference of scienter which those allegations generate must be strong. In Helwig, we provided a definitive explanation of the meaning of a strong inference: 36 Inferences must be reasonable and strong — but not irrefutable. Strong inferences nonetheless involve deductive reasoning; their strength depends on how closely a conclusion of misconduct follows from a plaintiff's proposition of fact. Plaintiffs need not foreclose all other characterizations of fact, as the task of weighing contrary accounts is reserved for the fact finder. Rather, the strong inference requirement means that plaintiffs are entitled only to the most plausible of competing inferences. 37 251 F.3d at 553. The PSLRA does not change the Rule 12(b)(6) maxim that when an allegation is capable of more than one inference, it must be construed in the plaintiff's favor. Id. (Our willingness to draw inferences in favor of the plaintiff remains unchanged by the PSLRA.). However, the strong inference requirement means that a plaintiff is entitled to only the most plausible of competing inferences. Miller, 346 F.3d at 673. 38 We have previously stated that the factors enumerated in the following list, while not exhaustive, are probative of scienter in securities fraud actions: 39 (1) insider trading at a suspicious time or in an unusual amount; (2) divergence between internal reports and external statements on the same subject; (3) closeness in time of an allegedly fraudulent statement or omission and the later disclosure of inconsistent information; (4) evidence of bribery by a top company official; (5) existence of an ancillary lawsuit charging fraud by a company and the company's quick settlement of that suit; (6) disregard of the most current factual information before making statements; (7) disclosure of accounting information in such a way that its negative implications could only be understood by someone with a high degree of sophistication; (8) the personal interest of certain directors in not informing disinterested directors of an impending sale of stock; and (9) the self-interested motivation of defendants in the form of saving their salaries or jobs. 40 Helwig, 251 F.3d at 552 (citing Greebel v. FTP Software, Inc., 194 F.3d 185, 196 (1st Cir.1999)). 41