Dangerous Liaisons: Collective Scienter in SEC Enforcement Actions
32 Pages Posted: 1 Jan 2010
Date Written: December 31, 2009
Scienter is an essential element of a securities-fraud action brought by the Securities and Exchange Commission (“SEC”) or private plaintiffs. Scienter generally refers to intent or knowledge of wrongdoing. Establishing scienter in a case against an individual is accomplished by pleading and proving the requisite mental state of the individual at the time he or she committed the wrongful act, usually a material misstatement or omission. Establishing scienter for a corporation, however, is more complex. A corporation is a legal artifice that does not think and cannot act on its own, although it has a legal status distinct from its shareholders and agents. A corporation acts solely through its agents. As a result, doctrines such as respondeat superior have evolved to impute the knowledge of an agent-wrongdoer to the corporation in order to hold a corporation liable for securities fraud.
Courts agree that a corporate defendant acted with scienter if the authorized corporate agent making a false statement acted with scienter. The more difficult question is whether a corporation can be held liable for securities fraud when the person responsible for the misstatement was not aware of the truth but some other corporate employee was aware, or when no single corporate employee knew the truth, but the collective knowledge of several employees would have exposed the truth. For example, if a corporate officer makes a statement and only an entry-level employee knows the statement is false, has the corporation acted with fraudulent intent? Furthermore, if a corporate officer makes a statement and no individual knows the statement is false, but by piecing together the collective knowledge of employees it becomes apparent that the statement is false, has the corporation acted with fraudulent intent?
In recent years, some private plaintiffs have resorted to a theory known as “collective scienter” to attach corporate liability on the basis of the collective knowledge of the corporation’s employees, regardless of whether those employees had any role in making the alleged false statements. While most courts have rejected the collective scienter theory, a handful of courts have permitted some derivation of collective scienter.
All of the judicial decisions in the area of collective scienter involve private securities litigation. Because it is extremely rare for a corporation to litigate with the SEC, the question of whether the SEC can and should utilize the theory of collective scienter in its enforcement actions against public companies remains unanswered. Although the SEC has never explicitly asserted a collective scienter theory, some commentators have opined that the theory may have been contemplated, if not utilized, by the agency in one SEC enforcement action.
This Article initially describes the development of the concept of corporate liability from the theory of respondent superior to collective scienter, and explains the various views espoused by courts. The Article then examines SEC enforcement actions that implicitly may have used collective scienter in reaching a settlement with a company. Finally, the Article highlights some legal and policy considerations associated with utilizing the concept of collective scienter in SEC enforcement actions. As discussed below, the SEC should avoid resorting to collective scienter in its enforcement actions because collective scienter would impose a negligence standard in conflict with other laws, chill corporations from voluntarily disclosing information, create inefficient deterrence and misplaced incentives, and would not provide sufficient notice and predictability to corporations regarding charges or penalties.
Keywords: SEC, SEC enforcement, Securities and Exchange Commission, collective scienter, collective knowledge, corporate scienter, Rule 10b-5, section 10(b), corporate liability, securities law, respondeat superior, vicarious liability, deterrence, penalty statement, seaboard
JEL Classification: K22, K20, K41, K42, K40
Suggested Citation: Suggested Citation