Shah Rahman v. Kid Brands, Inc.
2013 U.S. App. LEXIS 23084
3rd Cir.2013Background
- Plaintiff Shah Rahman filed a securities class action against Kid Brands, Inc. and three officers, alleging false/misleading statements and omissions about customs violations and other operational problems that inflated stock price during Mar 26, 2010–Aug 16, 2011.
- Kid Brands imports infant products; a U.S. Customs "Focused Assessment" (Dec 2010) led Kid Brands to hire Skadden for an internal investigation; public disclosure of LaJobi violations occurred on Mar 15, 2011, causing a stock drop.
- Additional disclosures in Aug 2011 disclosed customs issues at other subsidiaries and estimated >$10 million in liabilities, causing further share-price declines.
- Rahman relied on six confidential witnesses (former employees) to plead that Kid Brands and certain officers knew of or recklessly disregarded ongoing mislabeling/relayeling of country-of-origin labels to evade duties.
- The District Court dismissed the second amended complaint (SAC) with prejudice for failure to plead scienter under the PSLRA; the Third Circuit affirmed, holding the SAC did not allege facts giving rise to a "strong inference" of scienter.
Issues
| Issue | Plaintiff's Argument | Defendant's Argument | Held |
|---|---|---|---|
| Whether the SAC adequately alleged materially false or misleading statements or omissions under Rule 10b-5 | Rahman: Kid Brands concealed the Focused Assessment and misstatements about customs compliance and financial condition that were material | Kid Brands: disclosures and timing were reasonable; some statements were not materially false and the company investigated before disclosure | Court: Some statements could be material, but materiality alone insufficient; focus turned to scienter and dismissal affirmed on scienter grounds |
| Whether the SAC pleaded scienter with particularity under the PSLRA (strong inference of intent to deceive) | Rahman: Confidential witnesses and operational facts show knowledge or reckless indifference by corporate officers | Kid Brands: CW allegations are vague, untimely, lack reliable basis, and do not show motive or specific knowledge by officers | Court: CW statements discounted as insufficiently particular; no motive or cogent facts; holistically inference of scienter not as strong as nonfraudulent explanations |
| Whether corporate/collective scienter or core-operations inference supports liability | Rahman: Company-wide violations and executive involvement permit imputing scienter to the corporation and officers | Kid Brands: Hiring outside counsel and disclosing results undercuts any inference of a cover-up; $10M liabilities do not implicate core operations of a large company | Court: Declined to adopt or reject corporate scienter doctrine here but found alleged facts do not support it or a core-operations inference |
| Whether controlling-person liability under Section 20(a) survives absent Section 10(b) violation | Rahman: Officers controlled the company and thus are liable | Kid Brands: Section 20(a) is derivative of 10(b); no primary liability alleged | Court: Dismissed 20(a) claim because no viable Section 10(b) claim remained |
Key Cases Cited
- Tellabs, Inc. v. Makor Issues & Rights, Ltd., 551 U.S. 308 (establishes PSLRA "strong inference" scienter standard)
- Institutional Investors Grp. v. Avaya, Inc., 564 F.3d 242 (Third Circuit on PSLRA pleading, confidential witness evaluation, and core-operations inference)
- Belmont v. MB Inv. Partners, Inc., 708 F.3d 470 (recklessness definition in securities context)
- Ernst & Ernst v. Hochfelder, 425 U.S. 185 (definition of scienter as intent to deceive, manipulate, or defraud)
- California Pub. Emps. Ret. Sys. v. Chubb Corp., 394 F.3d 126 (use of confidential witnesses and Novak standard)
- In re Merck & Co., Inc. Securities Litig., 432 F.3d 261 (post- and pre-class period facts can corroborate falsity)
- City of Monroe Emps. Ret. Sys. v. Bridgestone Corp., 399 F.3d 651 (corporate scienter and cover-up allegations supporting inference)
- Metzler Inv. GmbH v. Corinthian Colleges, Inc., 540 F.3d 1049 (management awareness alone insufficient for scienter without specific allegations)
- Teamsters Local 445 Freight Div. Pension Fund v. Dynex Capital Inc., 531 F.3d 190 (discussion of collective scienter and pleading standards)