On February 22, 2007, Bernstein Liebhard LLP (BL) filed an amicus curiae (friend of the court) brief to the United States Court of Appeals for the Second Circuit in In re Dynex Capital Securities Litigation. BL submitted the brief on behalf of four states and three public pension funds: Mississippi, New Jersey, New Mexico, Rhode Island, the Iowa Public Employees’ Retirement System, the Pennsylvania Public School Employees’ Retirement System, and the Pennsylvania State Employees’ Retirement System.
Combined, the amici states and public pension funds manage an aggregate $255 billion invested in public markets, and are among the largest public and private money managers in the United States. They manage the retirement plans for more than 2.2 million active and retired public servants.
The Dynex appeal concerns the attribution of the scienter (intent) element of a securities fraud action to a corporate entity, and whether scienter can be attributed based on the actions of the corporation as a whole, or whether corporate scienter is limited to the scienter of the corporation’s highest level officers and authorized public speakers.
A corporation can be liable for securities fraud, distinct from the liability of its officers. In most cases, however, the corporation is liable because the false public statements are attributable to the corporation, such as its press releases and SEC filings, and the plaintiff shows that one of the persons involved in the drafting of these public statements, typically the corporation’s highest management, harbored the requisite intent to commit fraud. The intent of that manager is then imputed to the corporation. The Dynex case addresses whether the corporation may also be liable for the intent of its lower level officers and agents, and whether the corporation itself can have a separate intent to commit fraud, evidenced by an ongoing pattern of reckless actions, even if no specific intent is attributed to a single employee.
Although it may be rare for a corporation to commit fraud without the involvement of its senior officers, the issue is nonetheless important. If corporate liability is only coextensive with the liability of its senior officers, those officers will have an incentive to wall themselves off from information about the conduct of their subordinates. Additionally, the issue is an important one procedurally. Given the heightened pleading requirements of the Private Securities Litigation Reform Act of 1995, it is often difficult at the pleading stage to identify which officers were involved in the fraud, let alone show that they acted recklessly. When auditors are named as defendants, plaintiffs rarely, if ever, know the names of the particular audit partners who certified the financial statements. If intent can be attributed on the basis of the actions of all employees, either individually or as a group, plaintiffs need not, at the outset of a case, try to identify specific corporate principals so long as they have adequate evidence of company-wide misconduct.
The issue is particularly timely given the SEC’s recent pronouncement that it intends to seek ways to shield auditors from liability for flawed certifications. Although it is already quite difficult to plead a successful complaint against an auditor, it will become immeasurably more so if the Second Circuit eliminates the concept of corporate scienter. Coupled with the SEC’s proposal, an adverse Second Circuit decision could render auditors virtually unaccountable for reckless certifications.
To avoid this result, and with the hope of securing an unambiguous endorsement of the collective scienter doctrine from the Second Circuit, BL filed its amicus brief on February 22, 2007.