710 F. App'x 471
2d Cir.2017Background
- Christopher Wyche sued Advanced Drainage Systems, Inc. (ADS) and two executives (Joseph Chlapaty and Mark Sturgeon) under Section 10(b)/Rule 10b-5 and derivative Section 20(a) claims, alleging fraudulent accounting and misstatements.
- Wyche alleged defendants manipulated GAAP accounting (inventory costs; lease classification) to avoid breaching debt covenants and to inflate reported performance.
- He asserted motive from (a) avoiding covenant default, (b) executive bonuses tied to preliminary results, and (c) Sturgeon’s stock sales in May 2015.
- The District Court dismissed for failure to plead scienter with the particularity required by Rule 9(b) and the PSLRA; Wyche appealed.
- On appeal, the Second Circuit reviewed whether Wyche adequately pleaded a strong inference of scienter for individual defendants and ADS, and whether the Section 20(a) derivative claim survived absent a primary violation.
Issues
| Issue | Plaintiff's Argument | Defendant's Argument | Held |
|---|---|---|---|
| Whether scienter was adequately pleaded for Section 10(b)/Rule 10b-5 | Wyche: motive to commit fraud because GAAP compliance would have caused covenant breach; bonuses and insider sale show motive | Defs: allegations are not particular or unusual enough to show motive or intent; bonus returns and modest sale not suspicious | Court: insufficient scienter pleaded; motive allegations not particularized or convincing; insider sale not "unusual" |
| Whether circumstantial allegations show conscious misbehavior or recklessness | Wyche: GAAP violations and internal issues infer recklessness/conscious misbehavior | Defs: no allegations that defendants directed fraud or were told about accounting concerns; alleged GAAP errors alone don't show intent | Court: circumstantial allegations too weak; did not create an inference of scienter at least as compelling as opposing inferences |
| Whether corporate scienter (ADS) was adequately pleaded via imputing intent of individuals | Wyche: corporate scienter can be inferred from alleged misconduct | Defs: no individual with requisite intent pleaded | Court: insufficient to impute scienter to ADS; pleaded facts must show someone whose intent is imputable acted with scienter |
| Whether Section 20(a) claim survives without a primary Section 10(b) violation | Wyche: derivative claim follows from alleged primary violations | Defs: no primary violation pleaded, so derivative claim fails | Court: Section 20(a) claim fails because no primary Section 10(b) violation was adequately pleaded |
Key Cases Cited
- Tellabs, Inc. v. Makor Issues & Rights, Ltd., 551 U.S. 308 (standard for evaluating competing scienter inferences)
- ECA & Local 134 IBEW Joint Pension Tr. of Chi. v. JP Morgan Chase Co., 553 F.3d 187 (PSLRA/Rule 9(b) pleading requirements for securities fraud)
- Kalnit v. Eichler, 264 F.3d 131 (motive must be concrete and personal; scienter by inference standards)
- Acito v. IMCERA Grp., Inc., 47 F.3d 47 (insider stock sales must be unusual to support scienter inference)
- Novak v. Kasaks, 216 F.3d 300 (alleged accounting irregularities alone do not necessarily show fraudulent intent)
- In re Carter-Wallace, Inc. Sec. Litig., 220 F.3d 36 (circumstantial pleading of recklessness/intent guidance)
- Teamsters Local 445 Freight Div. Pension Fund v. Dynex Capital Inc., 531 F.3d 190 (corporate scienter requires someone whose intent is imputable to the corporation)
- ATSI Commc’ns, Inc. v. Shaar Fund, Ltd., 493 F.3d 87 (Section 20(a) requires primary violation under Section 10(b))
- Bogle-Assegai v. Connecticut, 470 F.3d 498 (forfeiture of arguments not raised below)