In this earlier post, the recent Fifth Circuit decision in (Southland Sec. Corp. v. INSpire Ins. Solutions, Inc., No. 02-1055 (5th Cir. March 31, 2004)) was noted for holding that the group pleading doctrine for alleging a company’s public statements (such as press releases or regulatory filing statements) as a basis for fraud against corporate officers does not withstand the Private Securities Litigation Reform Act of 1995 (PSLRA)’s specificity requirements.
However, other federal courts have not been as demanding as the Fifth Circuit in requiring specific allegations of fraud against defendants. In the recent decision of In re NUI Sec. Litig., 2004 WL 895846 (D.N.J. April 23, 2004, the court found that the plaintiffs had adequately pled a sufficiently strong inference of scienter to sustain Rule 10b-5 claims against the corporate defendant (NUI) based on allegations that a stock-for-stock acquisition of another company gave NUI a motive to inflate the price of its stock and that NUI’s associate general counsel (who is not a defendant in the case) knew of NUI’s fraudulent conduct. As to NUI’s CEO and CFO (both of whom are defendants in the case), the court concluded that the plaintiffs’ allegations regarding their motive to commit fraud and knowledge of the fraudulent conduct were insufficient to sustain the Rule 10b-5 claims against them.
But wait. The CEO and CFO are not off the hook. Inasmuch as they controlled NUI and the court found that a Rule 10b-5 claim was adequately pled against NUI, the Section 20(a) claims against the CEO and CFO based on control person liability can continue. Ouch!
This decision — as with last year’s decision in In re Interpublic Securities Litigation, 2003 WL 21250682, (S.D.N.Y. May 29, 2003) — are eroding the PSLRA’s requirement that plaintiffs specifically plead scienter as to each defendant in the lawsuit. Normally, courts reject “collective scienter” theories — that is, in determining whether a corporate defendant acted with scienter, courts examine the specific state of mind of the individual corporate official who made or approved the corporate statement rather than the collective knowledge of all the corporation’s officers and employees. However, in the In re NUI Sec. Litig. decision, the court clearly imputed the knowledge of the associate general counsel to the corporate defendant for scienter purposes despite the fact that the associate general counsel was not alleged to have made or issued the false statements.
This is a trend worth keeping an eye on. Hat tip to the 10b-5 Daily for the link to the NUI decision.