Fred Davoli v. Costco, 20-35821

Background

Plaintiff Fred Davoli appealed the district court's dismissal with prejudice of his Second Consolidated Amended Complaint under Rule 12(b)(6), alleging securities fraud based on Costco’s June 2018 Form 10‑Q.
Davoli alleged Costco misstated that its internal control over financial reporting was effective and claimed scienter through statements and conduct of senior officers (CEO Craig Jelinek, CFO Richard Galanti) and certain IT personnel (including CIO Paul Moulton).
Allegations relied heavily on statements from confidential witnesses who purportedly had knowledge of internal control weaknesses and IT issues.
The district court found the complaint failed to plead the requisite scienter (deliberate recklessness or willful blindness) under the PSLRA and Tellabs standard and dismissed Section 10(b)/Rule 10b‑5(b) claims.
The court also rejected that Sarbanes‑Oxley certifications by Jelinek and Galanti independently established scienter, and it dismissed Section 20(a) control‑person claims because no primary violation was adequately pleaded.
The Ninth Circuit affirmed, concluding the alleged inferences of scienter were weaker than the innocent inference that Costco only learned of control failures during a later, more rigorous review before the October 2018 Form 10‑K.

Issues

Issue	Plaintiff's Argument	Defendant's Argument	Held
Whether Davoli adequately pleaded scienter for Costco under §10(b)/Rule 10b‑5(b) based on senior officers' knowledge	Alleged confidential witnesses and ‘‘red flags’’ show officers knew controls were ineffective when June 2018 10‑Q was signed	Officers lacked actual knowledge; allegations are not particularized and support an innocent inference	Dismissed — scienter not adequately pleaded; inferences insufficient under PSLRA/Tellabs
Whether Jelinek and Galanti’s Sarbanes‑Oxley certifications raise a strong inference of deliberate recklessness	Certifications plus alleged facts show they knowingly misrepresented internal control effectiveness	Certifications alone don’t add substantial scienter; no particularized facts they knew controls failed	Dismissed — certifications do not, by themselves, establish deliberate recklessness
Whether CIO/IT employees’ alleged knowledge can supply scienter imputed to Costco	IT personnel knew control flaws and were involved enough that their scienter is imputed to the corporation	Witness allegations fail to show IT personnel knew of failures in June 2018 or were sufficiently involved in the 10‑Q	Dismissed — allegations about IT personnel are not particularized enough; imputed scienter fails
Whether Section 20(a) control‑person claims survive absent a primary §10(b) violation	Control persons liable because of alleged control and participation in misstatements	No primary §10(b) violation adequately pleaded, so no control‑person liability	Dismissed — Section 20(a) claims fail without a primary violation

Key Cases Cited

In re NVIDIA Corp. Sec. Litig., 768 F.3d 1046 (9th Cir. 2014) (standard of review and scienter pleading under PSLRA)
In re ChinaCast Educ. Corp. Sec. Litig., 809 F.3d 471 (9th Cir. 2015) (imputing controlling officer scienter to corporation)
Prodanova v. H.C. Wainwright & Co., LLC, 993 F.3d 1097 (9th Cir. 2021) (requirements for pleading scienter from personnel alleged to have contributed to statements)
Zucco Partners, LLC v. Digimarc Corp., 552 F.3d 981 (9th Cir. 2009) (Sarbanes‑Oxley certifications generally add little to scienter analysis absent particularized facts)
Tellabs, Inc. v. Makor Issues & Rts., Ltd., 551 U.S. 308 (2007) (requirement that pleaded inferences of scienter be at least as compelling as innocent inferences)
In re Oracle Corp. Sec. Litig., 627 F.3d 376 (9th Cir. 2010) (discussion of ‘‘red flags’’ and willful blindness as a species of deliberate recklessness)
Ernst & Ernst v. Hochfelder, 425 U.S. 185 (1976) (scienter requirement for §10(b) liability)
Hollinger v. Titan Capital Corp., 914 F.2d 1564 (9th Cir. 1990) (en banc) (standards on scienter and culpable mental state)