Sixth Circuit Clarifies Standard For Pleading 'Collective Knowledge' Scienter In Securities Fraud Cases

A recently issued decision from the Sixth Circuit adopts a modified "collective knowledge" theory for determining corporate scienter and clarifies the standard for pleading corporate scienter in a securities fraud action. The decision pares back the Circuit's more expansive position in an earlier decision that permitted knowledge of all of the corporation's officers and employees to be imputed to the corporation. The decision also highlights for senior executives of public corporations the importance of internal review and oversight of public statements.

The On October 10, 2014, in Ansfield v. Omnicare, Inc., No. 13-5597 ("Omnicare"), a three-judge panel for the U.S. Court of Appeals for the Sixth Circuit clarified the standard in securities fraud suits for alleging the necessary element of "scienter," or the mental state embracing intent to deceive, manipulate or defraud, with respect to corporate defendants. In Omnicare, the plaintiffs alleged that a corporation and several corporate officers, employees and agents had committed securities fraud by making various material misrepresentations and omissions in public and in SEC filings regarding the corporation's compliance with Medicare and Medicaid regulations. In several years of the corporation's SEC filings, the corporation had stated that it believed it was complying in all material respects with federal, state and local law, and further that its billing practices materially complied with applicable state and federal requirements. However, plaintiffs alleged that the corporation had conducted three internal audits that showed that the corporation's billing and records practices were not in compliance with Medicare and Medicaid regulations, rendering those statements fraudulent.

The panel noted that a securities fraud suit must plead facts to show the following six elements: (1) a material misrepresentation or omission by the defendant, (2) scienter, (3) a connection between the misrepresentation or omission and the purchase or sale of a security, (4) reliance upon the misrepresentation or omission, (5) economic loss and (6) loss causation. The panel ruled that there are different standards for a misrepresentation that concerns "hard information" than for one concerning "soft information." A misrepresentation regarding historical or factual and objectively verifiable information (hard information) is actionable if a plaintiff pleads facts to show the statement was objectively false and...