On 10 October 2014, in In re Omnicare, the federal appellate court based in Ohio announced a new standard for pleading that a corporation had the requisite level of intent for securities fraud under Section 10(b) of the Exchange Act. Another case involving Omnicare is pending before the United States Supreme Court concerning whether a speaker's state of mind is relevant under a different securities law that does not generally require intent. This case, however, dealt with Section 10(b), which requires a plaintiff to show scienter (i.e., intent). In setting out a new standard for pleading corporate scienter, the court acknowledged a divergence among the federal appellate courts around the country on this issue.
The plaintiff claimed that Omnicare, a health care company, made material misstatements and omissions by affirming legal compliance even though internal audits revealed problems with its billing practices. The court's decision turned on whether the plaintiff had sufficiently pleaded that the corporation knew that these statements were false. The court first explained that some appellate courts around the country hold, under the respondeat superior theory of corporate intent, that a corporation's state of mind can be shown only through the knowledge of the individuals involved in making the statement at issue, but not through the "collective knowledge of all of the corporation's officers and employees." But other appellate courts have suggested that, at least in certain situations, collective scienter may be inferred based on the significance of the misstatements at issue.
The court here explained that a middle ground is necessary. Focusing on only the individuals involved in making the statements at issue risks encouraging corporations to shield key individuals from learning relevant information. On the other hand, a pure collective-knowledge approach could unfairly hold a company liable even if the only person with knowledge is a low-level employee far removed from the statements at issue. The court thus attempted to strike a balance between these approaches by holding that the state of mind of individuals connected to a misrepresentation, as well as of sufficiently senior employees or directors who at least tolerated or recklessly disregarded the misrepresentation, are all relevant to, but not determinative of, the corporation's intent. Applying this standard, the court held that while the auditor's knowledge could be imputed to the corporation, that was still not sufficient because the totality of the circumstances did not support the inference that the corporation "acted to defraud the public."
The test enunciated in In re Omnicare is very fact-dependent. In addition, the court's decision here leaves substantial uncertainty as to what a plaintiff must plead to show corporate scienter under Section 10(b), both within this court's jurisdiction and throughout the country. As a result, the applicable standard for corporate scienter could depend on the jurisdiction where the case is litigated.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
