Circuits Split On When To Impute Employees’ Knowledge To Corporation For Section 10(b) Claims

One of the most significant challenges facing plaintiffs in pleading a violation of Section 10(b) of the Securities Exchange Act of 1934 is sufficiently alleging that the defendant company possessed scienter, or an "intent to deceive." Because a corporation can only act through its employees, the challenge is to determine which employees' alleged state of mind should be imputed to the company.

On October 10, 2014, the Sixth Circuit considered that question in In re Omnicare Sec. Litig., No. 13-5597, 2014 WL 5066826 (6th Cir. Oct. 10, 2014). Omnicare involved a Section 10(b) shareholder class action against Omnicare, Inc., a pharmaceutical manufacturer, alleging that Omnicare's financial statements and other public disclosures contained misstatements regarding the company's compliance with Medicare and Medicaid regulations. In particular, plaintiffs alleged that although Omnicare's internal audit group discovered that certain company facilities had submitted false reimbursement claims, Omnicare failed to disclose the fraud and, in publicly-filed documents signed by the CEO and CFO, asserted that Omnicare's "billing practices materially comply with applicable state and federal requirements."

The district court dismissed plaintiffs' claims on the ground, among others, that the compliance-related statements at issue were "soft information" and plaintiffs therefore were required to demonstrate that Omnicare had "actual knowledge" that the statements were false. While Sixth Circuit precedent permitted a plaintiff to impute a corporate employee's knowledge to his employer, the district court found that the complaint failed to allege that Omnicare (even by imputation) had actual knowledge that its compliance-related statements were false.

On appeal, the Sixth Circuit considered whether the knowledge of certain employees (internal audit and compliance personnel who were aware of the false reimbursement claims) could be imputed to Omnicare. The Court recognized that there was significant disagreement among the Circuits on this issue. The Fifth Circuit, for example, has rejected such a theory of "collective scienter," whereby a plaintiff can prove intent to deceive on the part of a corporation without actually connecting that intent to a specific individual. Rather, the Fifth Circuit looks "to the state of mind of the individual corporate official or officials who make or issue the statement." Southland Sec. Corp. v. Inspire Ins. Solutions, Inc., 365...