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(Article from Securities Law Alert, June 2020)

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On May 27, 2020, the Second Circuit affirmed the denial of leave to amend a securities fraud complaint alleging that a corporation made misstatements concerning the quality of its surgical gowns. Jackson v. Abernathy, 960 F.3d 94 (2d Cir. 2020) (per curiam). Although the proposed amended complaint alleged that “three employees knew of problems with the [surgical] gown,” the complaint did not specify “what role those employees played in crafting or reviewing the challenged statements.” The court concluded that it could not impute the employees’ knowledge to the corporation.

The Second Circuit explained that “[w]here a defendant is a corporation,” a plaintiff must “plead[ ] facts that give rise to a strong inference that someone whose intent could be imputed to the corporation acted with the requisite scienter.” The court noted that “[a]scribing a state of mind to a corporate entity is a difficult and sometimes confusing task,” particularly because “the hierarchical and differentiated corporate structure often muddies the distinction between a deliberate fraud and an unfortunate (yet unintentional) error caused by mere mismanagement.” The court observed that “the most straightforward way to raise a strong inference of corporate scienter is to impute it from an individual defendant who made the challenged misstatement.” The court recognized that “[t]he scienter of the other officers or directors who were involved in the dissemination of the fraud may also be imputed to the corporation, even if they themselves were not the actual speaker.” And “[i]n exceedingly rare instances, a statement may be so dramatic that collective corporate scienter may be inferred.”

In the case before it, the court found the proposed amended complaint “sets forth no such allegations.” The court noted that the three employees with alleged knowledge of problems with the surgical gown “did not themselves possess scienter, as the steps they took to raise concern about the [surgical] gown’s testing failures belie any inference of fraudulent intent.” The court explained that “while particularized allegations that senior officers ignored those employees’ warnings could demonstrate that those officers acted fraudulently,” the complaint “fails to make that showing” as it “offers only general allegations of warnings made to unidentified senior executives.” Because the proposed amended complaint “provides no connective tissue between [the three] employees [with alleged knowledge] and the alleged misstatements,” the court determined that it could “only guess” whether it would “be fair to charge the Corporate Defendants with their knowledge.” The court concluded that granting leave to amend would be futile.