(Article from Securities Law Alert, June 2016)
For more information, please visit the Securities Law Alert Resource Center
On May 24, 2016, the Sixth Circuit affirmed dismissal of a securities fraud action against General Cable Corporation for failure to allege scienter. Doshi v. General Cable, 2016 WL 2991006 (6th Cir. 2016) (Cook, J.). The Sixth Circuit found that a senior corporate executive’s alleged knowledge of certain theft and accounting errors could be imputed to the corporation. However, the Sixth Circuit held the executive’s state of mind could not be imputed to the corporation for scienter purposes because the defendant did not make any public misstatements.
Background
Plaintiffs brought suit in the Eastern District of Kentucky alleging that General Cable Corporation and two of its executives had “acted at least recklessly in issuing or approving General Cable’s . . . public financial statements,” which were allegedly “materially false” because of accounting errors and an alleged theft scheme in the company’s Brazilian operations. The district court dismissed plaintiffs’ claims for failure to allege scienter. Plaintiffs appealed.
Sixth Circuit Declines to Impute to the Corporation the State of Mind of a Senior Executive Who Made No Public Misstatements
Plaintiffs alleged that Mathias Sandoval, the General Cable executive responsible for the company’s Brazilian operations, submitted allegedly misleading financial data to General Cable, which the company then incorporated into its financial disclosures. Plaintiffs contended that Sandoval’s state of mind could be imputed to General Cable for scienter purposes.
The Sixth Circuit found plaintiffs “sufficiently allege[d]” that Sandoval “knew of theft and inventory accounting errors in Brazil in January but failed to report those problems to General Cable until September 2012.” However, the court held that even if Sandoval had “acted recklessly in transmitting [his division’s] financial data to General Cable, only his knowledge of theft and accounting errors―not his state of mind―impute[d] to General Cable.” The court reasoned that under its prior decision in In re Omnicare Securities Litigation, 769 F.3d 455 (6th Cir. 2014), “a corporate executive’s or employee’s state of mind” may only be imputed “to a corporate defendant when such a person makes a public misstatement.” But here, plaintiffs did not allege any “public misstatement by Sandoval from which to impute his recklessness directly to General Cable.” Rather, plaintiffs alleged only that “Sandoval submitted [his division’s] financial data to General Cable, not that he drafted, reviewed, or approved General Cable’s erroneous public financial statements.”
Based on these allegations, the Sixth Circuit imputed to General Cable “Sandoval’s knowledge of theft and accounting errors in Brazil,” but not his scienter. The court explained that under Sixth Circuit precedent, it was then required to apply the factors set forth in Helwig v. Vencor, 251 F.3d 540 (6th Cir. 2001)[1] “to analyze whether all the facts alleged [gave] rise to a strong inference that General Cable [had] acted with the necessary scienter.”
Applying the Helwig Factors, Sixth Circuit Finds Plaintiffs’ Allegations Insufficient to Plead Corporate Scienter
The Sixth Circuit applied the Helwig factors and considered the allegations of the complaint holistically to determine whether plaintiffs adequately pled General Cable’s scienter. The court found “[t]wo Helwig factors support[ed] inferring scienter: (1) divergence between internal reports and external statements on financial data; and (2) disregard for the most current factual information before making public financial statements.”
However, the Sixth Circuit determined that “[t]he disparity between Sandoval’s knowledge and what General Cable publicly misstated . . . reduce[d] the force behind these factors.” The court explained that “Sandoval knew about theft and inventory accounting errors in [his division’s] Brazilian operations” but “General Cable misstated its firm-wide financial data of which [Sandoval’s] data composed only a part.”
In light of “Sandoval’s knowledge and the magnitude of [General Cable’s] financial misstatements,” the Sixth Circuit found it possible to “infer that General Cable [had] acted recklessly by issuing its public financial statements from January 2012 to September 2012.” But the court stated that “a countervailing inference remain[ed] stronger: a theft scheme racked General Cable’s operations in Brazil where local managers overrode accounting procedures, which, when coupled with the legitimate freedom afforded [Sandoval’s division] to report its financial data, led General cable to issue materially false public financial statements.” The Sixth Circuit held plaintiffs’ “allegations therefore fail[ed] to create a strong inference that General Cable acted with scienter.”
[1] In Helwig, the Sixth Circuit enumerated a non-exhaustive list of nine factors courts must consider when evaluating a complaint’s scienter allegations.