Tuesday, February 20, 2007

Does a Serial Recidivist = Corporate Scienter?

The following was first published last week over at Securities Litigation Watch, my new blog.

If you want current postings and updates on the wide world of securities litigation, I encourage you to update your bookmarks and subscriptions.

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If a company engages in two separate alleged securities frauds six years apart, with an

intervening bankruptcy reorganization but retains at least six officers or directors from the predecessor entities, is it possible that the prior allegations could be used to bolster the corporate scienter allegations in the new litigation?

Sounds a little complicated, so let's break it down.

Way back in February 2001, Globalstar, L.P., Globalstar Capital Corporation and Globalstar Telecommunications Limited (collectively "Old Globalstar") were accused of making false and misleading statements regarding Globalstar’s financial prospects and condition. That case culminated in one of those ultra-rare securities class action trials, and ultimately settled for $20 million.

After the complaints in the first case were filed, but before that case went to trial, all of the Old Globalstar entities filed for bankruptcy protection.

Fast forward to 2007.

The Globalstar entities have reorganized as Globalstar, Inc. (NASDAQ: GSAT), filed a registration statement for a new IPO, and, as of last week, been hit with a fresh group of securities class actions.

How then do allegations of serial recidivism help to establish the scienter of a defendant corporation?

There are at least three distinct tests for corporate scienter, including two versions of the "collective scienter" theory being applied by the courts today.

Under the collective scienter theory, the analysis is based on the collective knowledge of the corporation's employees.

Under the stronger version of the collective scienter theory, a plaintiff can establish that the corporation acted with fraudulent intent without any reference to a particular employee. See, e.g. In re Dynex Capital, Inc. Sec. Litig., 2006 WL 1517580 (S.D.N.Y. June 2, 2006).

Under the weaker version of the collective scienter theory, a plaintiff need only establish that a management-level employee of the corporation acted with the requisite fraudulent intent, even if that employee is not a defendant and did not make any alleged false statement. See, e.g. In re Sonus Networks, Inc. Sec. Litig., 2006 WL 1308165 (D. Mass. May 10, 2006); In re Marsh & McLennan Companies, Inc. Sec. Litig., 2006 WL 2057194 (S.D.N.Y. July 20, 2006).

At the far end of the spectrum, and seemingly losing support by the day, is the concept that the corporate scienter analysis could only be determined by looking:

to the state of mind of the individual corporate official or officials who make or issue the statement . . . rather than generally to the collective knowledge of all the corporation's officers and employees acquired in the course of their employment.

Southland Sec. Corp. v. INSpire Ins. Solutions, Inc., 365 F.3d 353 (5th Cir. 2004).

While the new Globalstar cases have just been filed, the overlap of six senior officers or directors between the old and new entities (none of whom are currently named as defendants in the new litigation) may provide an interesting test case for the limits of the collective scienter theory.

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