Commercial Litigation and Arbitration

SEC vs. Private 10b-5 Actions — Differences in Elements — Does the PSLRA Inferentially Demonstrate That Recklessness Is Enough?

From Gebhart v. SEC, 2010 U.S. App. LEXIS 3043 (9th Cir. Feb. 17, 2010):

[Footnote] 8 The elements of a section 10(b) or Rule 10b-5 claim vary depending on the identities of the parties and the nature of the relief sought. In a private securities fraud action, the plaintiff generally must prove five elements: (1) a material misrepresentation or omission of fact; (2) scienter; (3) a connection with the purchase or sale of a security; (4) transaction and loss causation; and (5) economic loss. Zucco Partners, LLC v. Digimarc Corp., 552 F.3d 981, 990 (9th Cir. 2009). Our focus here is on the elements that the SEC must establish. The fourth and fifth elements of a private claim are therefore inapplicable. ***

Scienter may be established *** by showing that the defendants knew their statements were false, or by showing that defendants were reckless as to the truth or falsity of their statements. ***

[Footnote] 9 In some circumstances not relevant here, the Private Securities Litigation Reform Act (PSLRA) requires a showing that the defendants knew their statements were false. See 15 U.S.C. § 78u-5(c)(1)(B)(i) (requiring "actual knowledge . . . that the statement was false or misleading" in private securities actions challenging forward-looking statements). The claims in this case are not covered by the PSLRA, so scienter can be established by either knowledge or recklessness.

***[Footnote] 10 The conclusion that we require either knowledge of falsity or conscious recklessness is supported by our decision in In re Silicon Graphics Inc. Securities Litigation, 183 F.3d 970 (9th Cir. 1999), abrogation on other grounds recognized by South Ferry LP, 542 F.3d at 784, where we explained that, in the securities fraud context, scienter requires "deliberate recklessness," which we defined as conduct reflecting "some degree of intentional or conscious misconduct." Id. at 977.


Scienter *** is a subjective inquiry. It turns on the defendant's actual state of mind. *** Thus, although we may consider the objective unreasonableness of the defendant's conduct to raise an inference of scienter, the ultimate question is whether the defendant knew his or her statements were false, or was consciously reckless as to their truth or falsity. See Ernst & Ernst v. Hochfelder, 425 U.S. 185, 206, 96 S. Ct. 1375, 47 L. Ed. 2d 668 (1976) ("There is no indication that Congress intended anyone to be made liable for such practices unless he acted other than in good faith."); Hollinger, 914 F.2d at 1570 (scienter requires "something more egregious than even 'white heart/empty head' good faith."***); Kaplan v. Rose, 49 F.3d 1363, 1379-81 (9th Cir. 1994) (applying good faith standard); *** cf. Restatement (Second) of Torts § 526 cmt. d ("The fact that the misrepresentation is one that a man of ordinary care and intelligence in the maker's situation would have recognized as false is not enough to impose liability . . . , but it is evidence from which his lack of honest belief may be inferred." (emphasis added)).

[Footnote] 11 Our decision in Kaplan is illustrative of the respective roles played by the objective and subjective components of the scienter inquiry. We began by citing Hollinger and observing that scienter can be established by showing an extreme departure from the ordinary standards of care and an obvious danger of misleading investors. 49 F.3d at 1378. But we also observed that several defendants had submitted sworn declarations testifying that they believed in good faith that their statements were true. Id. at 1379. The plaintiff argued that he had presented sufficient evidence of scienter to survive summary judgment because "[t]hese statements are so false that defendants must have known they were false and must have intended to mislead the public." Id. We disagreed, explaining that plaintiff's argument "does not suffice to rebut the declarations of good faith made by the defendants." Id. Kaplan shows that the objective unreasonableness of the defendant's actions may raise an inference of scienter, but the factfinder must consider the direct and circumstantial evidence as a whole to determine whether the defendant knew his or her statements were false, or consciously disregarded the risk that they were false. See Kaplan, 49 F.3d at 1379-80; Worlds of Wonder, 35 F.3d at 1424-25; Apple, 886 F.2d at 1117-18. In Kaplan, as to those particular defendants, the evidence as a whole was insufficient to survive summary judgment.

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