Dalton Petrie v. Electronic Game Card, Inc.
761 F.3d 959
9th Cir.2014Background
- Investors sued former CEO Lee Cole and CFO Linden Boyne (and other control-person defendants) under §10(b) and §20(a), alleging securities fraud based on consolidated financial statements that relied on a purported Subsidiary and a Gibraltar bank account.
- The Company’s auditor withdrew audit opinions for FY 2006–2008 after detecting irregularities regarding a bank account said to be held by the Subsidiary; the Company later disclosed that revenues may have been materially overstated.
- Investors obtained documents from the auditor by third-party subpoena on June 23, 2011, under a district-court discovery schedule issued after an earlier motion rulings; some subpoena responses arrived August 22, 2011.
- Cole notified plaintiffs on August 8–9, 2011 of his intent to move for judgment on the pleadings (which defendants contend triggered an automatic PSLRA discovery stay); plaintiffs filed the Third Amended Complaint (TAC) in November 2011, incorporating auditor materials.
- The district court struck TAC allegations and exhibits derived from the auditor materials as violating the PSLRA stay and dismissed the TAC with prejudice for failure to plead falsity and scienter; the Ninth Circuit reversed and remanded.
Issues
| Issue | Plaintiff's Argument | Defendant's Argument | Held |
|---|---|---|---|
| Whether TAC portions based on auditor materials violated the PSLRA discovery stay | Plaintiffs subpoenaed auditor before any stay; using late-arriving third-party responses is permissible | Use of discovery received after a stay is barred; plaintiffs violated the statutory stay | Court held plaintiffs did not violate the PSLRA: subpoena was issued when no stay existed and using responses received later was permissible |
| Whether district court properly struck portions of the TAC under Rule 12(f) for materials allegedly obtained in violation of PSLRA | Stricken auditor materials were relevant and material to falsity and scienter allegations | Materials should be excluded as product of stay violation, warranting striking | Court reversed striking: Rule 12(f) abuse of discretion where materials were properly obtained and material to claims |
| Whether TAC sufficiently pleaded falsity (under PSLRA) against Cole and Boyne | TAC (with auditor exhibits) alleges forged confirmations, fabricated minutes, false consolidation of subsidiary, and non-existent Gibraltar account | Defendants argued plaintiffs lacked particularized factual allegations and relied on improperly obtained discovery | Court held TAC adequately pleaded falsity when auditor materials considered |
| Whether TAC pleaded a strong inference of scienter against Cole and Boyne | Allegations of document forgery, concealment of the 2002 Agreement, and creation/use of false bank confirmations support intent or deliberate recklessness | Defendants argued nondisclosure and conduct explained by non-fraudulent reasons; no strong inference of scienter | Court held allegations, taken holistically with auditor exhibits, raise a strong inference of scienter sufficient to satisfy PSLRA/Tellabs standard |
Key Cases Cited
- SG Cowen Sec. Corp. v. U.S. Dist. Court for N. Dist. of Cal., 189 F.3d 909 (9th Cir. 1999) (PSLRA stay aims to prevent discovery abuses and coercive costs)
- Tellabs, Inc. v. Makor Issues & Rights, Ltd., 551 U.S. 308 (U.S. 2007) (plaintiff must plead a strong inference of scienter that is at least as compelling as nonfraudulent inferences)
- Metzler Inv. GMBH v. Corinthian Colls., Inc., 540 F.3d 1049 (9th Cir. 2008) (pleading elements and PSLRA particularity reviewed de novo)
- In re Daou Sys., Inc., 411 F.3d 1006 (9th Cir. 2005) (scienter requires intentional or deliberately reckless false statements)
- In re VeriFone Holdings, Inc. Sec. Litig., 704 F.3d 694 (9th Cir. 2012) (scienter standard: dangerousness of misrepresentation must be actually known or obvious)
- S.E.C. v. Todd, 642 F.3d 1207 (9th Cir. 2011) (materiality standard: omitted fact that would have significantly altered the total mix of information)
- Matrixx Initiatives, Inc. v. Siracusano, 563 U.S. 27 (U.S. 2011) (complaint must be reviewed holistically when assessing adequacy of allegations)