Scienter Specificity Required to Plead Securities Fraud: Curry v. Hansen Medical, Inc.

In Curry v. Hansen Med., Inc., No. 5:09-cv-05094-JF, 2011 U.S. Dist. LEXIS 96697 (N.D. Cal. Aug. 25, 2011) (unpublished), the United States District Court, Northern District of California, dismissed a class action securities fraud complaint against Hansen Medical Inc. (“Hansen”) for failing to meet the heightened pleading standards required by Fed. R. Civ. P. 9(b) and the Private Securities Litigation Reform Act of 1995 (“PSLRA”).

According to the allegations made by the Plaintiffs, Hansen obtained the majority of its revenue from the sale and installation of Sensei Robotic Catheter Systems (“Sensei”). In August 2009 a whistleblower alerted Hansen of an irregularity in the installation of Sensei which resulted in improper revenue recognition. Hansen conducted an internal investigation with independent outside counsel. The investigation revealed that data on certain Sensei transactions had been withheld from the accounting department and independent auditors and that related documents had been falsified.

Hansen filed a Form 8-K with the Securities and Exchange Commission (“SEC”) on October 19, 2009, and restated its financial reports for several quarters. The plaintiffs alleged that Hansen and three Hansen directors (“Defendants”) knew of these revenue recognition errors and induced sales of stock at artificially inflated prices by making knowing and intentional misstatements in violation of SEC Rule 10b-5 and section 20(a) of the Securities Exchange Act of 1934.

To state a claim under SEC Rule 10b-5, “a plaintiff must plead (1) a material misrepresentation by the defendant; (2) scienter; (3) a connection [with] the purchase or sale of a security; (4) reliance; (5) economic loss; and (6) loss causation.” The plaintiff must specify each misleading statement and the reasons it was misleading. Scienter, the intent to deceive, manipulate, or defraud, requires the court to determine whether any allegation standing alone, would be sufficient. If no allegation meets the first inquiry, the court examines whether all of the allegations, taken together, create a strong inference of scienter.

Defendants asserted that the allegedly false statements were protected by the PSLRA safe harbor provision for certain forward-looking statements. The court noted that not all of the comments made by Defendants involved forward-looking statements but instead were “references to concrete rates of Sensei sales and user activity [and] would not be immune.”

Nonetheless, the court did not resolve the applicability of the safe harbor. Instead, the court found that the plaintiffs had not sufficiently alleged scienter. The plaintiffs mostly relied on confidential witnesses, the use of accounting treatment that violated Generally Accepted Accounting Principles (“GAAP”), and the relationship between the restatements and public equity offerings. The court found the allegations to be insufficient. Of the plaintiffs’ twelve confidential witnesses, only one was employed throughout the subject time period. Moreover, that witness’s statements relied on circumstantial evidence and did not address Defendants being fed doctored information. The court also determined that the GAAP violations were not so egregious as to establish Defendants’ awareness of a problem. Finally, the plaintiffs’ allegations that an inference of scienter was supported by the timing of two public equity offerings was also rejected. Despite the arguments that this provided a motive (the desire to raise capital), the court concluded that, in the Ninth Circuit, general allegations of “motive and opportunity,” were insufficient to support an inference of scienter.        

Because the plaintiffs’ section 20(a) claim relied on liability of Defendants for an SEC Rule 10b-5 violation, the court dismissed this claim. The court granted Defendants’ motion to dismiss with leave to amend.

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