Two recent Fourth Circuit decisions applied the Supreme Court’s Tellabs standard and affirmed dismissals of securities actions where plaintiffs failed to allege facts giving rise to an inference of scienter, or wrongful intent.
In Public Employees’ Ret. Ass’n of Colorado v. Deloitte & Touche, LLP, the court affirmed dismissal of a securities class action brought against Deloitte & Touche, arising from accounting fraud by Royal Ahold, whose financial statements Deloitte had audited. Nov. 07-1704 (4th Cir. Jan. 5, 2009). Plaintiffs argued that Deloitte knew or recklessly disregarded knowledge of the accounting fraud. The court concluded, however, that the strongest inference from the complaint’s allegations was that Royal Ahold had deceived Deloitte by purposely withholding information. The court stated that while Deloitte could have conducted a more thorough audit, the scienter standard “requires more than a misapplication of accounting principles” and plaintiffs were required to show that Deloitte was complicit in fraud or recklessly disregarded readily apparent malfeasance.
Similarly, in Cozzarelli v. Inspire Pharm., Inc., the Court rejected a securities class action for failure to allege facts supporting a strong inference of scienter. No. 07-1851 (4th Cir. Dec. 12, 2008). Plaintiffs alleged that Inspire Pharmaceuticals and its directors omitted material information from statements about the likelihood of success on a new drug’s clinical trial. The defendants argued that the company had a legitimate business purpose in omitting the information: protecting proprietary information from its competitors. Siding with the defendants, the court stated that, while the statements in question may have contained general, imprecise, or even negligent language, the statements failed to raise a strong inference of wrongful intent. The court stated that “a decision to seek a competitive advantage, whether wise or not, is quite different from an intent to deceive.” Indeed, the court noted that the defendants had expressly stated they would not discuss specifics about the clinical trial for “competitive reasons.”
These decisions are further evidence that, at least in the Fourth Circuit, the Tellabs standard may have some teeth.
McGuireWoods has extensive experience defending companies involved in class action securities litigation. If you have questions, please contact us.