(Article from Securities Law Alert, January 2015)
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In a January 16, 2015 decision , the Tenth Circuit affirmed dismissal of a securities fraud action against Gold Resource Corporation for failure to meet the heightened scienter pleading standards of the PSLRA. In re Gold Resource Corp. Sec. Litig., 2015 WL 221614 (10th Cir. 2015) (Seymour, J.). The Tenth Circuit held that plaintiffs’ allegations of GAAP violations, standing alone, were insufficient to plead scienter. The court further ruled that plaintiffs could not meet the PSLRA’s scienter pleading requirements merely by alleging that defendants “must have known” of the alleged fraud or financial discrepancy at issue.
Tenth Circuit Deems Allegations of GAAP Violations Insufficient to Plead Scienter Absent Particularized Facts Showing Fraudulent Intent
The Tenth Circuit first addressed plaintiffs’ attempt to plead scienter by pointing to an alleged GAAP violation concerning “the material overstatement of revenues.” The Tenth Circuit explained that “allegations of GAAP violations, standing alone, are insufficient to state a securities fraud claim.” Rather, such allegations may only “be sufficient to state a claim” where they are “coupled with evidence that the violations or irregularities were the result of the defendant’s fraudulent intent to mislead investors.”
The Tenth Circuit found that the allegations of GAAP violations against Gold Resource Corporation did not “come on top of … [any] other particularized facts showing fraudulent intent” and were therefore inadequate to plead scienter. Gold Resource, 2015 WL 221614.
Tenth Circuit Finds Plaintiffs Cannot Meet the PSLRA’s Scienter Pleading Requirements Merely by Asserting That Defendants “Must Have Known” of the Alleged Financial Misstatements
The Tenth Circuit rejected plaintiffs’ assertion that defendants “‘must have known’ of the alleged revenue misstatements at the time they occurred” in view of “the small size of the one-product company” and the fact that “the accounting misstatements amounted to more than sixteen percent of net income for the first quarter of 2012.” The Tenth Circuit found that plaintiffs’ “view of the situation fail[ed] to take account of other plausible inferences” as required under the Supreme Court’s decision in Tellabs, Inc. v. Makor Issues & Rights, Ltd., 551 U.S. 308 (2007).
The alleged revenue misstatements stemmed in large part from a pricing discrepancy involving one of the company’s two customers. Applying the Tellabs standard, the Tenth Circuit deemed it plausible that lower-level employees at Gold Resource Corporation might have delayed informing senior executives of this pricing discrepancy if they thought the “figures were wrong.” Gold Resource, 2015 WL 221614. The Tenth Circuit observed that “a prudent executive would want to investigate and confirm a claimed discrepancy before disclosing it publicly.”
In reaching this conclusion, the Tenth Circuit found persuasive the Seventh Circuit’s reasoning in Higginbotham v. Baxter International, Inc., 495 F.3d 753 (7th Cir. 2007). There, the Seventh Circuit upheld dismissal of a securities fraud action where an executive learned of fraud at one of the company’s subsidiaries in May of 2004 but did not publicly disclose the fraud until July 2004. The Seventh Circuit found that “sometime during May 2004, [the executive] learned enough to lead a reasonable person to conduct an investigation.” However, the Seventh Circuit emphasized that “[k]nowing enough to launch an investigation … is a very great distance from convincing proof of intent to deceive.”
The Tenth Circuit determined that “[t]he same [analysis] is true in this case.” Gold Resource, 2015 WL 221614. In the case at hand, the Tenth Circuit found that “[d]efendants had every reason not to disclose the [alleged pricing discrepancy] before the dispute was investigated and settled.” The Tenth Circuit was “not persuaded [that] a reasonable person would deem an inference of scienter more cogent or compelling than an opposing inference of nonfraudulent intent with respect to the misrepresentations” at issue, and therefore affirmed dismissal of the complaint.
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