Intent to Backdate, Causing Slightly Overstated Earnings, Does Not Infer Intent to Defraud

Rosenberg v. Gould, --- F.3d ----, 2009 WL 50721 (11th Cir. Jan 09, 2009).

The district court held, and the 11th Circuit affirmed, that the complaint failed to satisfy the heightened standard for pleading scienter.

This case addressed whether a complaint alleging that a CEO (and the company) who granted and received backdated options in 2000 and 2001, and overstated earnings between 2004 and 2006, satisfied the heightened standard for pleading scienter, under section 10(b), of the Securities Exchange Act, 15 U.S.C. § 78j(b).
The Private Securities Litigation Reform Act of 1995 imposed a heightened standard for pleading scienter. Tellabs, Inc. v. Makor Issues & Rights, Ltd., 551 U.S. 308, 127 S.Ct. 2499, 2504, 168 L.Ed.2d 179 (2007). A plaintiff must “state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind.” 15 U.S.C. § 78u-4(b)(2). “An inference of scienter must be more than merely plausible or reasonable-it must be cogent and at least as compelling as any opposing inference of nonfraudulent intent.” Tellabs, 127 S.Ct. at 2504-05.

The court reasoned that intent can not be inferred merely because backdating is inherently intentional. Further, any inference that the CEO knew that backdated options in 2000 - 2001 led to overstated earnings several years later was not as compelling as the competing inference that he was unaware that the options had affected financial statements several years later. In support of its conclusion, the court pointed out that the impact on the financial statements was only 0.5 percent of revenue in 2004 and 0.17 percent of revenue in 2005. “The de minimis change in the financial statements did not amount to a glaring “red flag” that would have put the CEO on notice that he was overstating earnings when he announced the quarterly results.” Rosenberg, 2009 WL 50721, 4 (11th Cir. Jan. 9, 2009). The complaint it rested “on speculation and conclusory allegations.” NDC Health, 466 F.3d at 1265, 1266 (quoting Hoffman v. Comshare, Inc. (In re Comshare Inc. Sec. Litig.), 183 F.3d 542, 533 (6th Cir.1999)).

The 11th Circuit affirmed the district court’s dismissal of the shareholders’ complaint with prejudice. ...continue