Federal Circuit Court Says Head Scratchin' Act Not Proof of Securities Fraud Scienter

April 12, 2021

If you file a securities fraud claim under Section 10(b) of the Securities Exchange Act of 1934, a basic element of your proof must be to show that the defendant had acted with "scienter." What's scienter? Ahh, that's as easy as explaining what's cryptocurrency -- or what's "enough" or "a lot" or "frequently." In legalese, courts refer to "scienter" as a mental state embracing intent to deceive, manipulate, or defraud. Yeah, sure, that's helpful (not). Complicating things, in 1995, the Private Securities Litigation Reform Act imposed a further threshold upon plaintiffs in that they must plead a "strong inference" of scienter; and, as held in 2007 by the United States Supreme Court in Tellabs, Inc. v. Makor Issues & Rights, LTD, a securities fraud complaint must allege facts establishing that the strong inference of scienter is "cogent and at least as compelling as any opposing inference of nonfraudulent intent." Confused? Welcome to the club. See how all of this plays out in a recent Class Action.

October 2, 2017: Pre-Market Announcement

On October 2, 2017, MannKind Corporation made a pre-market-opening announcement that the Federal Drug Administration had approved a label change for its first-and-only FDA-approved drug: Afrezza, which was a rapid-acting insulin inhalant for adults with Type 1 and/or 2 diabetes. During the next three trading days, MannKind's stock price increased from $2.17 to $4.96 with a 2,000% increase in volume.

October 10, 2017: HCW Issues Buy with $7 Target

On October 10, 2017 at 4:03 AM Pacific Time, a H.C. Wainwright & Co. ("HCW") analyst published "A Breath of New Life with Afrezza Turnaround Story: Initiate with Buy and $7 Target," ("the Report"), which included a disclaimer that HCW "will seek compensation from the companies mentioned in this report for investment banking services within three months following publication of the research report." As a FINRA member firm, HCW was obligated to make said disclosure pursuant to FINRA Rule 2241(c)(4)(C)(iii). On October 10th, MannKind's stock rose to a closing price of $6.71. 

October 10/11, 2017: The Offering Announced

At 9:02 PM Pacific time on October 10th, MannKind announced that it would undertake a registered direct offering of 10,166,600 shares at $6 each, and that HCW would be the exclusive placement agent, for which the brokerage firm would receive a fee equal to 5% of the offering's proceeds.

On October 11, 2017, MannKind's stock price closed at $5.47. Ouch! -- so much for that $7 target price.

Prodanova Class Action Dismissed by CDCA

MannKind investor Daniela Prodanova filed a class action lawsuit in the United States District Court for the Central District of California ("CDCA") on behalf of "all other persons or entities that purchased MannKind securities between 4:03 AM Pacific Time on October 10, 2017 (7:03 AM Eastern Time) and 9:02 PM Pacific Time on October 10, 2017 (12:02 AM Eastern Time on October 11, 2017)." Under the Private Securities Litigation Reform Act ("PSLRA"), 15 U.S.C. § 78u-4, the district court designated Panthera Investment Fund L.P. as the lead plaintiff. Thereafter, Panthera filed Amended Complaints that that HCW, its Chief Executive Officer Mark Viklund, and the Report's author Oren Livnat fraudulently sought to inflate the price of MannKind shares before the Offering by issuing the Report, in violation of Section 10(b) of the Securities and Exchange Act of 1934")("Exchange Act"), 15 U.S.C. § 78j(b), and Rule 10b-5, 17 C.F.R. § 240.10b-5. Further, the Panthera asserted a claim against Viklund for control person liability in violation of Section 20(a) of the Exchange Act, 15 U.S.C. § 78t-1(a). Panthera added HCW's Chief Operating Officer Edward D. Silvera as an additional Defendant. 

CDCA dismissed the action based upon a finding that the Complaint had failed to sufficiently allege scienter because no plausible motive for HCW's actions were offered, and, as such, the Court could not find that HCW had intentionally made false or misleading statements or acted with deliberate recklessness. 

April 8, 2021: 9Cir Affirms CDCA


SIDE BAR: As BrokeAndBroker.com readers know, I often cite -- both favorably and unfavorably -- the manner in which regulators and courts present their various orders, opinions, decision, awards, and other efforts to the public. In particular, I compliment those who offer us explanations replete with "content and context" so as to render the presentations both intelligible and compelling. Far too often, I find myself in the role of an annoyed reader puzzled by what was said and what was meant. In rare occasions, I delight with the vibrancy of a well-crafted and well-drafted document. The 9Cir's Opinion in Prodanova is one such joy. 

Head-Scratchin' Ain't Fraud

In the spirit that 9Cir "had me at 'hello,' " consider this from the opening three paragraphs of the 9Cir Opinion:

As its name suggests, a securities fraud lawsuit requires a showing of an intent to defraud investors. Mere negligence - even head-scratching mistakes - does not amount to fraud. So if the complaint fails to plead a plausible motive for the allegedly fraudulent action, the plaintiff will face a substantial hurdle in establishing scienter. 

That is the case here. An investment bank analyst published a report setting a target price of $7 per share for a company's stock. That company's stock surged 26% that day. But later that evening, the same investment bank announced that it would act as the placing agent for a dilutive offering that priced that same stock at $6 per share. The stock price, not surprisingly, declined the next day. A securities fraud class action lawsuit against the investment bank soon followed. The complaint alleged that the bank fraudulently sought to inflate the price of the company's stock price. But the plaintiff has not articulated with particularity or plausibility the bank's motive for doing so. If anything, the bank's actions tarnished its reputation and likely frayed its relationship with its client. 

Because the complaint does not offer a plausible motive for the bank's actions or provide compelling and particularized allegations about scienter, it does not support a strong inference that the defendant intentionally made false or misleading statements or acted with deliberate recklessness. See Schueneman v. Arena Pharms., Inc., 840 F.3d 698, 705 (9th Cir. 2016). We thus affirm the district court's dismissal of the complaint.

In total, the 9Cir Opinion comprises 24 pages. If you have the time, read them all -- you will likely enjoy the quality of the writing and the compelling nature of the rationale. In a nutshell, however, the first three paragraphs pretty much let you know what you need to know. Accordingly, the 9Cir affirmed NDCA's dismissal of Plaintiff's case.