Scienter and the 8th Circuit: In re Ceridian Corp. Sec. Litig.

This post examines how the 8th Circuit applied the heightened pleading standard under the Private Securities Litigation Reform Act (“PSLRA”) in the case of In re Ceridian Corp. Sec. Litig. , 2008 WL 416782 (8th Cir. Sept 11, 2008). Plaintiff, Shareholders, sued Ceridian Corp. claiming violations of §10(b) and §20(a) of the 1934 Act. The Minnesota District Court dismissed the case because the plaintiffs failed to prove scienter. The 8th Circuit affirmed.

Between February of 2004, and April of 2005, Ceridian Corporation restated its financial statement five times due to numerous GAAP violations. These violations included flawed methods of revenue-recognition, capitalization of expenditures, and amortization of trademarks.

On August 6, 2004, Plaintiffs sued Ceridian Corporation and former CEO and President, Ronald Turner, former CFO, John Eickhoff, and former accounting officer, Loren Gross in Minnesota District Court for alleged violations of § 10(b) and 20(a) of the 1934 Act. The Plaintiffs claimed that Ceridian used accounting methods that violated GAAP in preparing its financial statements for the purpose of inflating the value of Ceridian stock. Allegedly , Turner and Eickoff unloaded substantial amounts of Ceridian stock in September of 2003, when they were “in the money” because the stock price was overstated by 35%. Plaintiffs argued that the GAAP violations, along with the timing of insider trades by Ceridian executives showed scienter.

To state a claim under the PSLRA, “Plaintiffs must specifically allege such matters as the time, place, and contents of false representations, as well as who made each misrepresentation.” To avoid summary judgment, plaintiffs must state with particularity “ facts giving rise to a strong inference that the defendant acted with the required state of mind.” The required state of mind in this case was scienter. To prove scienter, a plaintiff must show that the defendant had the intent to deceive, manipulate, or defraud. Ferris, Baker Watts, Inc. v. Ernst & Young, LLP , 395 F.3d 851, 854 (8th Cir.2005).

The district court found “the sheer number of violations, and the magnitude of the restatements, give rise to an inference that the defendants were at least severely reckless,” but did not show scienter. GAAP violations alone, without proof of fraudulent intent, do not state a claim for securities fraud. Kushner v. Beverly Enters., Inc. , 317 F.3d 820, 831 (8th Cir. 2003).

The court reasoned that because the accounting errors involved “dozens of employees committing hundreds of unrelated accounting errors of many different types over many different years-it seems almost inconceivable that there could have been any unifying intent behind the errors, much less an intent to defraud.”

In addition, the district court ruled that the timing of the insider trades did not raise suspicions of scienter, since the GAAP violations continued to occur months after Turner and Eickoff sold their stock. On June 5, 2007, the court granted Ceridian’s motion to dismiss for failure to state a claim.

Less than three weeks after the district court opinion, the United States Supreme Court in Tellabs clarified the standard for sufficiently pleading scienter in securities fraud cases. The Supreme Court reinforced the heightened pleading requirement under the PSLRA:

"The inference of scienter must be more than merely “reasonable” or “permissible," it must be cogent and compelling, thus strong in light of other explanations. A complaint will survive, we hold, only if a reasonable person would deem the inference of scienter cogent and at least as compelling as any opposing inference one could draw from the facts alleged."

After Tellabs, the Plaintiffs appealed to the Court of Appeals for the 8th Circuit. The 8th Circuit agreed with the lower court that Turner and Eickoff’s stock sales were not suspicious, because they occurred before the publication of the allegedly inflated earnings report. On September 11, 2008.  The 8th Circuit affirmed the dismissal because the plaintiffs failed to show strong evidence of scienter.

The primary materials for this post are available on the DU Corporate Governance web site.