By W. Brantley Phillips, Jr. and Shayne R. Clinton
On May 25, 2011, the Sixth Circuit entered its decision in Frank v. Dana Corp., — F.3d —, No. 09-4233, 2011 WL 2020717 (6th Cir. May 25, 2011), a case that had come before it once before already. In the first case, Frank v. Dana Corp., 547 F.3d 564, 571 (6th Cir. 2008), the court remanded the case with instructions for the district court to apply the stricter scienter standard articulated in Tellabs, Inc. v. Makor Issues & Rights, Ltd., 551 U.S. 308 (2007), and to “[re]assess the possible competing inferences . . . including ‘plausible nonculpable explanations’” and to ask the question of “‘whether all of the facts alleged, taken collectively, give rise to a strong inference of scienter, not whether any individual allegation, scrutinized in isolation, meets that standard.’” Id. at 570 (quoting Tellabs, 551 U.S. at 322-23). If such inferences of scienter are “‘at least as compelling’ as competing nonculpable inferences,” the Sixth Circuit held that complaint could survive a motion to dismiss. Id.
On remand, the district court dismissed the case once again for failing to plead scienter adequately under the Tellabs standard. On the second appeal, the Sixth Circuit disagreed and found that the allegations were sufficient to survive a motion to dismiss. 2011 WL 2020717 at *4-6. The Sixth Circuit analyzed the allegations collectively without parsing out the allegations individually in reliance on Tellabs and Matrixx Initiatives, Inc. v. Siracusano, — U.S. —, 131 S. Ct. 1309 (2011). The court determined that, as a whole, the complaint told a sufficient story of fraud by the defendants. For example, there were undisputed facts that the defendants had made false statements about positive earnings despite knowledge of internal reports that the company was under financial distress. Moreover, the court pointed to evidence that the individual defendants’ were motivated to gain millions in bonuses from positive net income, as well as the company’s need for positive earnings in order to obtain a loan. Importantly, all of this occurred while large segments of the auto industry were spiraling toward bankruptcy, and the company had multiple factory failures and other known problems. In reversing the district court’s dismissal, the court determined that the factual allegations collectively, or “holistically,” showed a strong inference of scienter that was at least as compelling as any nonculpable inferences. Id. at *5-6.
The court also reversed the district court’s dismissal of the plaintiffs Section 20(a) control person liability claim. Section 20(a) of the Securities Exchange Act of 1934 provides:
Every person who, directly or indirectly, controls any person liable under any provision of this chapter or of any rule or regulation thereunder shall also be liable jointly and severally with and to the same extent as such controlled person to any person to whom such controlled person is liable (including to the Commission in any action brought under paragraph (1) or (3) of section 78u(d) of this title), unless the controlling person acted in good faith and did not directly or indirectly induce the act or acts constituting the violation or cause of action.
15 U.S.C. § 78t(a) (emphasis added).
The Sixth Circuit joined the First, Fourth, Fifth, Seventh and Eleventh Circuits in holding that the “good faith” language of the statute allows an affirmative defense whereby a defendant “‘bears the burden, however slight, to show good faith.’” Id. at *7 (citation omitted). Under this holding, plaintiffs in the Sixth Circuit do not have to plead facts showing bad faith (or a defendant’s acting without good faith) to survive a motion to dismiss for control person liability.
(Brant Phillips is a Member of Bass, Berry & Sims PLC, where his practice focuses on complex business litigation, including securities and shareholder class action defense, derivative actions and business fraud, as well as regular work in various administrative proceedings on behalf of education, healthcare and utility industry clients. Shayne Clinton is an attorney at Bass, Berry & Sims PLC, focusing his practice on corporate and securities litigation, including cases involving class action defense, officer and director liability, and corporate and partnership disputes).