Thursday, January 15, 2009

Securities: Ninth Circuit Takes Restrictive View of Collective Scienter Theory

The United States Court of Appeals for the Ninth Circuit in the Invision Technologies, Inc., Securities Litigation matter determined that the plaintiff class had failed to adequately allege scienter and refused under the facts of the case to apply the doctrine of "collective scienter."

The litigation arose in connection with a proposed merger between Invision Technologies and General Electric. On the eve of the merger in July 2004 Invision issued a press release casting doubt on the merger due to the discovery of possible violations of the Foreign Corrupt Practices Act. The announcement resulted in an immediate and substantial drop in the share price of Invision stock. The company ultimately settled with the U.S. Department of Justice and the Securities and Exchange Commission, and the merger closed.

Plaintiffs filed a class action suit alleging fraud based on statements made by Invision in its merger documents with GE. The plaintiffs alleged false statements in the merger documents as the basis for the fraud.

The issue confronting the court was whether the plaintiffs had sufficiently alleged scienter by the corporation. The Private Securities Litigation Reform Act requires plaintiffs to plead with specificity the acts giving rise to a strong inference that the defendant acted with culpable knowledge. A general allegation of motive and opportunity or recklessness is insufficient.

The court held that the plaintiffs had to demonstrate knowledge by the Invision official named in the complaint. The Ninth Circuit rejected the use of collective scienter as adequate pleading. (Pleading "collective scienter" involves allegations raising the inference of knowledge as to a corporate defendant without raising such allegations as to an individual defendant within the corporation.) While the court did not go so far as to reject the theory of collective scienter outright in the circuit, it held that the theory would not meet legal requirements in the current case.

The court determined that the allegations of falsity were sufficiently focused on a single individual to require that the complaint adequately allege scienter on the part of that person. The court held that the complaint had failed to do so and affirmed the district court's dismissal.

It is important to note that the Second and Seventh Circuits have adopted the "collective scienter" theory while the Fifth and Eleventh Circuits appear to have rejected it completely.

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