Opinion ID: 1448459
Heading Depth: 3
Heading Rank: 1

Heading: The Element of Scienter

Text: To state a claim on which relief can be granted under § 10(b) and Rule 10b-5, a plaintiff must plead, inter alia, that in connection with the purchase or sale of securities, the defendant made a false representation as to a material fact, or omitted material information, and acted with scienter. See, e.g., Tellabs, Inc. v. Makor Issues & Rights, Ltd., 551 U.S. 308, 318, 321, 127 S.Ct. 2499, 168 L.Ed.2d 179 (2007); Chill v. General Electric Co., 101 F.3d 263, 265 (2d Cir.1996) ( Chill ); In re Time Warner Inc. Securities Litigation, 9 F.3d 259, 264 (2d Cir.1993), cert. denied, 511 U.S. 1017, 114 S.Ct. 1397, 128 L.Ed.2d 70 (1994). The Supreme Court has defined scienter as `a mental state embracing intent to deceive, manipulate, or defraud.' Tellabs, 551 U.S. at 319, 127 S.Ct. 2499 (quoting Ernst & Ernst v. Hochfelder, 425 U.S. 185, 194 n. 12, 96 S.Ct. 1375, 47 L.Ed.2d 668 (1976)). Prior to the enactment of the PSLRA, this Court had held that in order to plead an intent to deceive, the complaint must allege facts giving rise to a strong inference of fraudulent intent, Acito v. IMCERA Group, Inc., 47 F.3d 47, 52 (2d Cir. 1995); see, e.g., Shields v. Citytrust Bancorp, Inc., 25 F.3d 1124, 1128 (2d Cir. 1994); In re Time Warner Inc. Securities Litigation, 9 F.3d at 268, and that such an inference could be drawn from allegations of facts showing that the defendant had both motive and opportunity to commit fraud, see, e.g., Acito v. IMCERA Group, Inc., 47 F.3d at 52; Shields v. Citytrust Bancorp, Inc., 25 F.3d at 1128. Motive, we observed, could be shown by pointing to the concrete benefits that could be realized from one or more of the allegedly misleading statements or nondisclosures; opportunity could be shown by alleging the means used and the likely prospect of achieving concrete benefits by the means alleged. Id. at 1130. This test is generally met when corporate insiders [a]re alleged to have misrepresented to the public material facts about the corporation's performance or prospects in order to keep the stock price artificially high while they sold their own shares at a profit. Novak, 216 F.3d at 308. But in attempting to show that a defendant had fraudulent intent, it is not sufficient to allege goals that are possessed by virtually all corporate insiders, such as the desire to maintain a high credit rating for the corporation or otherwise sustain the appearance of corporate profitability or the success of an investment, or the desire to maintain a high stock price in order to increase executive compensation. Id.; see, e.g., San Leandro Emergency Medical Group Profit Sharing Plan v. Philip Morris Cos., 75 F.3d 801, 814 (2d Cir.1996); Chill, 101 F.3d at 268; Acito v. IMCERA Group, Inc., 47 F.3d at 54. This Court has also long held that the scienter element can be satisfied by a strong showing of reckless disregard for the truth. See, e.g., Lanza v. Drexel & Co., 479 F.2d 1277, 1301 (2d Cir.1973) (en banc); Rolf v. Blyth, Eastman Dillon & Co., 570 F.2d 38, 47 (2d Cir.) ( Rolf ), cert. denied, 439 U.S. 1039, 99 S.Ct. 642, 58 L.Ed.2d 698 (1978); SEC v. McNulty, 137 F.3d 732, 741 (2d Cir.), cert, denied, 525 U.S. 931, 119 S.Ct. 340, 142 L.Ed.2d 281 (1998); Novak, 216 F.3d at 306, 308; ATSI Communications, Inc. v. Shaar Fund Ltd., 493 F.3d 87, 99 n. 3 (2d Cir.2007). See also Tellabs, 551 U.S. at 319 n. 3, 127 S.Ct. 2499 (Every Court of Appeals that has considered the issue has held that a plaintiff may meet the scienter requirement for civil liability under § 10(b) and Rule 10b-5 by showing that the defendant acted [either] intentionally or recklessly; the Supreme Court itself has not yet decided whether [a showing of] reckless behavior is sufficient.). By reckless disregard for the truth, we mean conscious recklessness  i.e., a state of mind approximating actual intent, and not merely a heightened form of negligence,  Novak, 216 F.3d at 312 (internal quotation marks omitted) (emphases ours). In elaborating as to what may constitute recklessness in the context of a private securities fraud action, we have referred to conduct that `at the least ... 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, ' In re Carter-Wallace, Inc. Securities Litigation, 220 F.3d 36, 39 (2d Cir.2000) (quoting Rolf, 570 F.2d at 47 (emphasis ours)); or to evidence that the defendants failed to review or check information that they had a duty to monitor, or ignored obvious signs of fraud, and hence should have known that they were misrepresenting material facts, Novak, 216 F.3d at 308 (emphases added). An egregious refusal to see the obvious, or to investigate the doubtful, may in some cases give rise to an inference of ... recklessness. Chill, 101 F.3d at 269 (internal quotation marks omitted) (emphases added); see, e.g., SEC v. McNulty, 137 F.3d at 741 (defendant corporate officer who prepared and proceeded to file documents with the SEC containing statements whose veracity he himself had questioned, had had an obvious duty to verify the suspicious information). In passing the PSLRA, Congress adopted a substantive `standard modeled upon the pleading standard of the Second Circuit,' Novak, 216 F.3d at 311 (quoting legislative history), insofar as we had applied a strong inference test ( see Part II.B.2. below), although it did not adopt our motive-and-opportunity gloss for the pleading of intent or our alternative standard of recklessness, see Novak, 216 F.3d at 311. Thus, we reasoned that, under the PSLRA, litigants and courts need not and should not employ or rely on magic words such as `motive and opportunity' with respect to intent; but that, in accordance with our prior cases, a strong inference of the requisite state of mind may arise where the complaint sufficiently alleges that the defendants: (1) benefitted in a concrete and personal way from the purported fraud ...; (2) engaged in deliberately illegal behavior...; (3) knew facts or had access to information suggesting that their public statements were not accurate ...; or (4) failed to check information they had a duty to monitor.... Id.; see also id. at 307-09. In Novak, we also noted that there are limits to the scope of liability for failure adequately to monitor the allegedly fraudulent behavior of others. Id. at 309. In Chill, for example, we held that the allegation that a parent company had failed to interpret its subsidiary's unprecedented and dramatically increasing profitability in a particular form of trading as a sign of problems, and thus had failed to investigate further, did not adequately plead recklessness amounting to scienter. See 101 F.3d at 269-70. In Decker v. Massey-Ferguson, Ltd., 681 F.2d 111, 120-21 (2d Cir.1982), we held that the allegation of a non-fiduciary accountant's failure to identify problems in a company's internal controls and accounting practices was not sufficient. For recklessness on the part of a non-fiduciary accountant [to] satisfy Ernst & Ernst 's requirement of scienter, it must approximate an actual intent to aid in the fraud being perpetrated by the audited company. Id.