Court Weighs Whether a Corporation can Commit Securities Fraud

Can a company be sued for federal securities fraud when the corporate executives who made false statements to the public did not have fraudulent intent? That question will be squarely addressed for the first time by the 2nd Circuit, which heard oral arguments Jan. 30 on the pleading and proof of corporate scienter--the intent to deceive, manipulate or defraud--in a securities fraud class action involving sub-prime loans.

The representative plaintiff, Teamsters Local 445 Freight Division Pension Fund, alleges that Dynex Capital Inc., its subsidiary Merit Securities Corp. and two corporate officers violated the Securities Exchange Act of 1934 by knowingly or recklessly making false or misleading statements to investors during a five-year period about the creditworthiness of $665 million in asset-backed bonds Merit issued in 1999.

The Private Securities Litigation Reform Act of 1995 provides that a plaintiff's complaint can survive a defense motion to dismiss only if it pleads cogent and compelling evidence that suggests a "strong inference that the defendant acted with the required state of mind."

But whose state of mind has drawn conflicting answers in the 2nd Circuit, where some cases proceed if the plaintiffs can raise a strong inference of collective knowledge and intent within the corporation, while others are dismissed if scienter is lacking on the part of the corporate official who made the false statement.

staff Writer

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