The Collection Problem: How the Circuit Split on Pleading Standards in Securities Fraud Claims Undermines Federal Regulatory Goals

Authors

Lucas Immer

Document Type

Note

Abstract

(Excerpt)

The Great Depression is generally recognized as the greatest economic calamity in United States history. One of the Great Depression’s many causes was reckless financial speculation driven in part by financial fraud. In response to the crisis, Congress passed the 1934 Securities Exchange Act (“the Exchange Act”), which courts have long held creates a private right of action for plaintiffs who experience an economic loss due to reliance on a material misstatement surrounding the purchase or sale of a security. A prima facie claim for securities fraud under the Exchange Act requires a showing of scienter, defined as “a mental state embracing intent to deceive, manipulate, or defraud.” Securities fraud claims under the Exchange Act provide an important remedy for investors who suffer losses due to fraudulent misstatements related to securities, and they serve a central regulatory function of ensuring accurate disclosure of information in financial markets. However, they have also provided fertile ground for frivolous lawsuits that lack merit and are intended solely to coerce defendants into settling to avoid costly discovery.

In response to a proliferation of frivolous claims, Congress enacted the Private Securities Litigation Reform Act (“PSLRA”) in 1995. Among other changes, the PSLRA elevated the pleading standards for the scienter element of securities fraud claims, requiring plaintiffs to plead facts giving rise to a “strong inference” of scienter to survive a motion to dismiss. The need to plead specific facts around this state-of-mind requirement presents an interpretive puzzle when dealing with corporate defendants because corporations lack their own discrete minds and “think” only through their employees, officers, and agents. Different approaches to interpreting the PSLRA’s heightened pleading standards have created a circuit split around the degree of factual specificity required to plead scienter on the part of a corporate defendant, wherein certain courts consider the knowledge and states of mind of various corporate employees or agents in the aggregate when assessing the corporation’s state of mind, while others reject this type of aggregation. This Note will survey and evaluate the doctrinal roots of the competing approaches. Ultimately, it will argue for an extension of the Sixth Circuit’s approach, which allows courts to consider the states of mind of key decisionmakers in the aggregate in order to raise the required inference of scienter by the corporation.