Frank v. Dana Corp.: Pleading Standards under §§ 10(b) and 20(a)

In Frank v. Dana Corp., No. 09-4233, 2011 WL 2020717 (6th Cir. May 25, 2011), the court held that the plaintiffs, as members of a class action, successfully pled their § 10(b) scienter claim and § 20(a) controlling person claim under the Securities Exchange Act of 1934.  The defendants include Dana Corporation, an auto parts manufacturer, Dana’s chief executive officer, Michael Burns, and Dana’s chief financial officer, Robert Richter.  The plaintiffs alleged that despite Dana’s decreasing earnings, large costs, and suffering drive shaft and light axle divisions, Burns and Richter consistently told investors that Dana was growing profitably throughout 2004 and 2005.

Burns and Richter began to recant their optimistic statements on September 15, 2005.  They announced that due to an increase in the price of steel, which in 2004 grew from seventy-five to 120 percent, Dana’s projected earnings decreased by fifty percent.  On October 10, 2005, the defendants told investors that despite Dana’s earlier declaration that the accounting was “sound,” it now determined that the accounting system contained “material weaknesses.”  Dana’s stock dropped fifty-five percent and continued to fall.  After Dana restated its earnings, investors discovered that during the first and second quarters of 2005, Dana earned $44 million less than it initially stated.  Additionally, Dana lost $1.27 billion during the year’s third quarter.  In early 2006, the Securities and Exchange Commission began inspecting Dana’s accounting system.  A month later, Dana filed for bankruptcy and Richter retired.

§ 10(b) of the Securities Exchange Act requires that plaintiffs plead “(1) a material misrepresentation or omission; (2) scienter; (3) a connection between the misrepresentation or omission and purchase or sale of a security; (4) reliance; (5) economic loss and (6) loss causation.”  In re Cell Therapeutics, Inc. Class Action Litig., 2011 U.S. Dist. LEXIS 11157, at *4-5 (W.D. Wash. Feb. 4, 2011).  The presence of scienter is determined “through knowledge of falsity or reckless indifference to falsity.”  Id. at 6.  In pleading § 10(b) claims, “plaintiffs must state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind,” and a plaintiff’s claim is sufficient if the claim is “at least as compelling as any opposing inference one could draw from the facts alleged.”

In analyzing whether the plaintiffs met this standard, the court stated that it would view the facts “holistically,” meaning that the plaintiffs’ allegations should be viewed “collectively” and not “scrutinized in isolation.” The court held that the defendants’ actions supported a strong inference of scienter under § 10(b) after considering the plaintiffs’ assertions that internal reports should have alerted Burns and Richter that Dana was suffering financially, Burns announced that he and Richter found the accounting processes to be accurate when in fact they were “functioning improperly,” Dana’s financial statements were incorrect, Burns’ and Richter’s false statements “were quickly followed by contrary company announcements,” Burns and Richter had much to gain by giving the impression that Dana was succeeding, and Richter curiously retired on the day that Dana filed for bankruptcy.

Under § 20(a), “every person who, directly or indirectly, controls any person liable…shall also be liable jointly and severally with and to the same extent as such controlled person…”  The court held that pleading scienter as to the “senior controlling officers of a corporation” is sufficient to plead scienter as to the corporation itself.  Therefore, the court ruled that because the plaintiffs pled a successful claim of scienter against Burns and Richter, they also pled scienter against Dana.

Additionally, the court noted that the plaintiffs were not required to state in their § 20(a) claim that the defendants acted in the absence of good faith, because “good faith is an affirmative defense that the defendant has the burden of establishing” in this type of action.

The primary materials for this case may be found at the DU Corporate Governance website.