Class Action Complaint Adequately Alleged Section 10(a) Control Person Liability as to All Individual Defendants and Adequately Alleged Section 10(b) Violation Against Company and Three of its Officers, but Failed to Establish Necessary Inference of Scienter as to Two Other Officers Warranting Dismissal of Claim Against Them Only Delaware Federal Court Holds
Nine (9) securities class action lawsuits were filed against MBNA and consolidated in the United States District Court for the District of Delaware. The consolidated class action complaint sought to represent purchasers of MBNA securities and alleged that the company of five of its officers violated Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5. Baker v. MBNA Corp., ___ F.Supp.2d ___, 2007 WL 2009673, *1 (D. Del. July 6, 2007). Defense attorneys moved to dismiss the class action; the federal court dismissed one count as against two of the individual defendants, but otherwise denied the defense motion.
The class action complaint named MBNA and MBNA officers Bruce L. Hammonds, Kenneth A. Vecchione, Richard K. Struthers, Charles C. Krulak, and John R. Cochran, III, and alleged that defendants reported false information concerning its growth in order to artificially inflate the stock price for their personal financial gain. Baker, at *1. The details of the allegedly false statements are discussed in the court’s opinion, see id., at *1-*2. The class action contained two counts only: one for violations of Section 10(b) and Rule 10b-5 against all defendants, and one for violations of Section 20(a) against the individual defendants. Id., at *3. All defendants moved for dismissal of the class action complaint under Rule 12(b)(6) and Rule 9(b), id. In addition to noting its safe harbor provision, the district court summarized the impact of the Private Securities Litigation Reform Act of 1995 (PSLRA) on securities cases at page *4 as follows:
The PSLRA requires plaintiffs to “specify each statement alleged to have been misleading, the reason or reasons why the statement is misleading, and, if an allegation regarding the statement or omission is made on information and belief, the complaint shall state with particularity all facts on which that belief is formed.”… In cases alleging securities fraud claims, such as Rule 10b-5 claims, the PSLRA requires that “the complaint shall, with respect to each act or omission alleged to violate this chapter, state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind.”…
Moreover, the typical analysis under Rule 12(b)(6) has been modified by the PSLRA. “‘[W]hereas under Rule 12(b)(6), we must assume all factual allegations in the complaint are true … under the [PSLRA], we disregard ‘catch-all’ or ‘blanket’ assertions that do not live up to the particularity requirements of the statute.’”… The PSLRA requires a “strong inference” that the defendants acted with the required state of mind and, accordingly, alters the normal operation of inferences under Rule 12(b)(6)…. Failure to meet the PSLRA’s pleading requirements will result in dismissal of the complaint…. (Citations omitted.)
With respect to the Section 10(b) claim in the class action complaint, the PSLRA requires allegations sufficient to give rise to a strong inference of scienter as to each individual defendant. Baker, at *5. As to the company, the district court found that the complaint alleged at least 7 violations of GAAP and listed several “red flags” that should have placed MBNA on notice of problems with its financial statements. The court was careful to stress that it was not prejudging whether the claim would survive a summary judgment motion, only that it could not “rule out, as a matter of law, a strong and reasonable inference of [the defendant’s] scienter.” Id., at *6.
As to the named individuals, the district court recognized that “‘blanket allegations against numerous defendants,’ such as allegations against defendants ‘based on their position, without any attempt to link specific individuals to specific instances of reckless conduct,’ do not meet the requirements of the PSLRA or Rule 9(b).” Baker, at *6. The court found that the allegations that Hammonds and Vecchione signed and certified documents that contained allegedly false or fraudulent statements, in addition to other specific allegations against these individuals, were sufficient to defeat the defense motion, id., at *7. However, the class action complaint contained only two allegations that named explicitly any of the remaining three individuals: that they sold from 9% (Cochran) to 64% (Krulak) of their stock holdings in the company during the relevant time period, and that they, along with many others and simply as part of a “huge distribution list,” regularly received financial information on the company. Id. The court held that Krulak’s sale of two-thirds of his stock was sufficient to create an inference of scienter, but found no such inference as to Cochran or Struthers, id. Accordingly, it denied the motion to dismiss as to Krulak, but granted the motion to dismiss the Section 10(b) claim against Cochran and Struthers. Id.
With respect to the Section 20(a) claim, which imposes joint and several liability for “control persons,” the district court held that the class action complaint survived the motion to dismiss because it alleges that the named individuals were controlling persons in “high level positions” at MBNA. Baker, at *8. The federal court explained that “whether MBNA is actually liable under 10(b) and whether certain defendants are ‘controlling persons’ within the meaning of 20(a) are questions of fact that the court is not willing to resolve at the pleadings stage.” Id. (citations omitted). Accordingly, it denied the motion to dismiss Count Two of the class complaint.
NOTE: The district court discussed also the “safe harbor” provision in the PSLRA, see Baker, at *4, but held that to the extent the allegedly false representations were made in MBNA’s Form 8-K, they were not protected and were thus actionable under the securities laws, id., at *5.