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Third Circuit Affirms Dismissal Of Putative Class Action Against Telecommunications Company For Failure To Allege Scienter
08/10/2021On August 5, 2021, the United States Court of Appeals for the Third Circuit, in a non-precedential opinion, affirmed the dismissal of a putative class action against a multinational telecommunications company (the “Company”) and certain of its officers and directors for violations of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5. PAMCAH-UA Local 675 Pension Fund v. BT Group PLC, No. 20-2016 (3d Cir. 2021). Plaintiffs alleged that the Company made false and misleading statements about its financial performance as a result of a complex, decade-long accounting fraud that occurred at its Italian subsidiary (the “Subsidiary”). The Third Circuit affirmed dismissal on the grounds that the stronger inference from the factual allegations in the complaint as to the Company’s executives was a lack of scienter and, even if scienter was sufficiently alleged as to executives at the Subsidiary, that could not be imputed to the Company.
The lawsuit—and plaintiffs’ allegations—stem from the Company’s disclosure in 2017 that it overstated profits by $700 million as a result of an accounting fraud that occurred at the Subsidiary for nearly ten years. Plaintiffs alleged that defendants were knowledgeable—or reckless in their ignorance of—fraudulent practices at the Subsidiary. Plaintiffs further attempted to impute the mental states of individual executives to the Company under the corporate scienter doctrine. The district court dismissed the complaint, holding that the scienter allegations were lacking. Specifically, the district court held that, even though the Third Circuit had “neither . . . accepted nor rejected the doctrine of corporate scienter in securities fraud actions,” the complaint’s allegations in any event did not “move the needle towards the extraordinary circumstances required to show corporate scienter.”
In affirming dismissal, the Third Circuit expressly did not address the issue of whether the mental states of individual executives could be imputed to the Company, holding that plaintiffs failed to sufficiently allege scienter by any individual executive, much less the type of allegations required to impute scienter to the Company. First, the Court addressed plaintiffs’ argument that the complaint sufficiently alleged scienter for the Chairman of the Company’s Audit Committee through allegations that: (i) the Audit Committee had concerns about the Subsidiary, (ii) the Committee was monitoring controls and risk management at the Subsidiary, and (iii) Subsidiary employees had informed the Company executives regarding accounting irregularities, all during the same period that the Company reported improved controls at the Subsidiary. While the Court acknowledged that the allegations supported an inference of scienter, it held that the complaint’s allegations “also support[ed] the inference that the [Company] intended to detect and prevent fraud.” For example, the Court cited to allegations that the Audit Committee requested reviews and monitoring of the Subsidiary and that the Company voluntarily disclosed historical accounting errors of the Subsidiary. Accordingly, while some of the allegations supported an inference that the Chairman of the Audit Committee acted with scienter, “those allegations [were] comparatively weaker than the contrary inference that he did not.”
Next, the Court addressed plaintiffs’ argument that they sufficiently alleged scienter for certain individual executives of the Subsidiary and of another one of the Company’s line of businesses, and that their mental states could be imputed to the Company. First, as to the executives in a different line of business, plaintiffs attempted to allege scienter through: (i) news articles that the executives were being investigated and subsequently charged for complicity in false accounting at the Subsidiary; (ii) communications that purported to show that the executives set unrealistically high financial targets; and (iii) news reports that the Subsidiary shared all economic and financial transactions with the two executives. According to the Court, these allegations did not provide sufficient detail. Second, the Court rejected the argument that the scienter of the Subsidiary’s executives should be imputed to the Company, noting that “parent companies are not, merely by dint of ownership, liable for acts of their subsidiaries.” Thus, even if the Third Circuit accepted the corporate scienter doctrine—a question the Court expressly did not address—plaintiffs would still be required to allege that the Company participated in the Subsidiary’s fraud, such as through a cover-up, which plaintiffs did not do.
