CHRISTIAN v. BT GROUP PLC et al
OPINION. Signed by Judge Kevin McNulty on 8/1/2018. (ld, )
UNITED STATES DISTRICT COURT
FOR THE DISTRICT OF NEW JERSEY
JAMES CHRISTIAN, individually
and on behalf of all others
similarly situated, et al.,
No. 2: 17-cv-497-KM-JBC
ET GROUP PLC, GAVIN PATTERSON,
IAN LIVINGSTON, and TONY
KEVIN MCNULTY, U.S.D.J.:
Plaintiffs bring a putative securities class action against BT Group PLC
and three high-ranking individuals associated with that company. Plaintiffs
allege that defendants were knowledgeable—or reckless in their ignorance of—
fraudulent practices in one of BT Group PLC’s many subsidiaries, BT Italy.
According to plaintiffs, defendants made materially false or misleading
statements; plaintiffs relied on those statements when investing in BT Group
securities; and plaintiffs allegedly were damaged as a result. Now before the
court is defendants’ motion to dismiss the complaint for failure to state a claim.
See Fed. R. Civ. P. 12(b)(6). Defendants argue that plaintiffs have failed to plead
scienter. For the reasons stated below, the defendants’ motion to dismiss the
complaint is granted.
The lead plaintiffs, Plumbing & Mechanical Contractors Association of
Hawaii-United Association (“PAMCAH-UA”) Local 675 Pension Fund, Gary
Classen, Alice Korenblat, Robert Korenblat, and Pierre-S. Lefebvre (collectively,
“plaintiffs”) pursue a putative securities class action against BT Group PLC
(“BT Group”) and individuals associated with BT Group. (AC
1, 18-24). The
individual defendants are Ian Livingston, the CEO and a member of the Board
from 2008 until September 2013; Gavin E. Patterson, the CEO and a member
of the Board from September 2013 to the present; and Tony Chanmugam, the
Group Finance Director and a member of the Board from 2008 until July 2016.
Plaintiffs purchased BT Group American Depositary Receipts (“ADR5”)—
i.e., certificates issued by a U.S. bank representing a specified number of
shares in a foreign stock traded on a U.S. exchange. (AC
that defendants engaged in securities fraud from May 10, 2013 to January 23,
2017, inclusive (the “Class Period”). (AC
1). They pursue claims under
Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 (the “Exchange
Act”) and Rule lOb-5. (AC
A. BT Group and UT Italy
Defendant BT Group, formerly known as British Telecom, is a provider of
communication services and solutions serving customers in 180 countries. (AC
37). BT Group has six customer-facing business lines; one of them is BT
Global Services. (AC
38). BT Global Services provides technology consulting,
outsourcing, and communications systems for more than 10,000 organizations
and governments worldwide. (AC
38). Defendant Alvarez became CEO of BT
All facts and inferences are made in favor of the nonmoving party on a motion
to dismiss. References to the Amended Complaint (ECF No. 26) are abbreviated “AC.”
See American Depositary Receipts, U.S. Sec. & Exchange Commission,
https: / /www.sec.gov/fast-answers/answersadrshtm.html.
Global Services in 2012. (AC
38). Corrado Sciolla was President of BT Global
Services in Continental Europe, which includes BT Italy. (AC
Plaintiffs allege that defendants knew that BT Qroup’s operations in Italy
suffered from control problems at least from the beginning of the Class
Period—i.e., May 10, 2013. (AC
40). Since fiscal year 2013, which ended on
March 30, 2013, BT Group’s Audit & Risk Committee (“Audit Committee”) had
been assessing the “control environment” in Italy. (AC
40). Plaintiffs claim
that defendants Livingston, Patterson, and Chanmugam certified the efficacy of
BT Group’s internal controls despite rampant fraud at BT Italy. (AC
Plaintiffs allege that BT Qroup’s annual reports evince defendants’
knowledge of control problems at BT Italy. The Audit Committee stated in BT
Group’s 2014 annual report that, “This year the Audit & Risk Committee paid
special attention to several overseas locations that are important to BT Global
Services, including Italy and Brazil
We have received detailed presentations
from key personnel in each of these areas and reviewed management’s
mitigation plans.” (AC
42). Nick Rose, Chairman of the Audit Committee,
noted, “I reported last year that the committee had given particular focus to
BT’s operations in Italy. We have continued to monitor the position there and
significant progress has been made to improve the control environment.” (AC
43). Rose made a similar statement in the 2015 annual report. (AC
2015 annual report also stated that the Audit Committee “asked management
to provide us with greater detail on the governance and control in relation to
operations in Italy.” (AC
45). BT Group’s 2016 annual report stated that the
Audit Committee has “continued to monitor our operations in Italy and
progress has been made to improve the control environment.” (AC
Global Research noted that the Audit Committee had an unusual, “sustained”
level of review regarding BT Group’s control environment in Italy. (AC
B. Disclosures in 2016 and 2017
BT Group reported on October 26, 2016 that it had to take a write-down
of145 million (approximately
sigi million) due to “certain historical
accounting errors” at its BT Italy division. (AC ¶j 49-50). ST Group’s press
release stated, “Following allegations of inappropriate management behaviour
in our BT Italia operations, we have conducted an initial internal investigation
identified certain historical accounting errors and reassessed certain
areas of management judgment.” (AC
50). On October 27, 2016, the price of
ST Group ADRs fell $0.57, or 2.4%, to close at $23.25 per ADR. (AC
In a press release on January 24, 2017, ST Group announced that it
would increase the write-down regarding its Italian operations to £530 million
(approximately $700 million)—a nearly four-fold increase. (AC
Additionally, BT Group stated it no longer expected revenue growth for the next
two years. (AC
52). The company also estimated its 2016-2017 free cash flow
at £2.5 billion, about £700 million lower than the original forecast. (AC
BT Group explained that its investigations had revealed that “the extent
and complexity of inappropriate behaviour in the Italian business were far
greater than previously identified” and had revealed “improper accounting
practices and a complex set of improper sales, purchase, factoring and leasing
transactions,” resulting in the “overstatement of earnings in our Italian
business over a number of years.” (AC
53). BT Group suspended members of
ST Italy’s senior management team and appointed a new Chief Executive of BT
53). The new Chief Executive was told to review the Italian
management team and improve the governance, compliance, and financial
safeguards of the Italian business. (AC
On a conference call around this time, Simon Lowth, the company’s
Group Finance Director, made the following statement:
The majority component [of unwinding the improper working
capital transactionsj was to repay essentially working capital loans
to factoring companies where loans had been taken against
receivables and, indeed, had been taken to pay suppliers. Those
working capital loans [were] clearly improper and we are
unwinding them, and that is overwhelmingly the most significant
contributor to the onetime cash unwind in the 2016/20 17.
55). Lowth also identified “additional smaller contributors” to BT Italy’s
woes, such as “sale and leaseback transactions.” (AC
On January 24, 2017, media outlets reported that BT Group suspended
a number of senior executives in Italy, including the BT Italy CEO. (AC
They also reported that Corrado Sciolla, the President of BT Global Services in
Continental Europe, was expected to resign shortly. (AC
58). Sciolla had
previously been the BT Italy CEO from 2006 until January 2013. (AC
January 24, 2017, the price of BT Group ADRs fell $5.05, or approximately
21%, to close at $19.38 per ADR. (AC
59). On January 28, 2017, a media
outlet reported that a KPMG LLP investigation found that the misconduct had
been ongoing at ST Italy for most of the past ten years. (AC
C. Report to BT Group Vice President in 2015
On March 30, 2017, Reuters reported that, in November 2015, three BT
Italy employees warned their Madrid-based supervisor Jacinto Cavestany about
this potential fraud. (AC
62). Jacinto Cavestany was BT Global Services’ Vice
President of Iberia and Head of Sales in Europe and Latin America. (AC
The source claimed that the BT Italy employees met with Cavestany on the
sidelines of a Company gathering to express concern over the unit’s financial
results, bullying by local management, and intense pressure to meet difficult
bonus targets. (AC
62). The source added that Cavestany had replied that the
three ST Italy employees should help him steer Cimini, the then-ST Italy CEO,
“in the right direction.” (AC
BT Group claimed that it launched an internal investigation in January
2017—almost a year after the ST Italy employees met with Cavestany about the
BT Italy fraud. (AC
63). According to Reuters, a network of people at ST Italy
had exaggerated revenues from certain BT-installed phone lines, faked contract
renewals and invoices, and invented bogus supplier transactions to meet bonus
targets and disguise the unit’s true financial performance. (AC
practices had allegedly been ongoing since at least 2013. (AC
For instance, BT Italy’s purchasing office made fake purchase orders to
suppliers with no intention of receiving goods; the office would cancel the order
and ask the supplier to issue a credit note by way of refund, and the bogus
credit notes were then sold to a factoring company for cash. (AC
68). BT Italy
also had multiple internal-accounting systems that enabled staff to inflate
revenues by entering duplicate invoices for the same client. (AC
D. Criminal Complaint, Italian Government Investigation
On April 21, 2017, Reuters reported that BT Group filed a criminal
complaint with Italian prosecutors on March 21, 2017 over the accounting
72). ST Group accused several former BT Italy executives and
other employees of breaking company rules and committing unlawful conduct.
Additionally, ST Group is being investigated by the Guardia di Finanza,
an Italian law-enforcement agency responsible for prosecuting financial crimes.
76). The Guardia di Finanza has raided BT Italy offices, interviewed
employees, and collected records. (AC
E. Fr Group’s 2017 Annual Report
BT Group’s 2017 annual report, filed on May 25, 2017, stated that
adjustments related to the investigation of BT Italy amounted to £268 million
for errors in prior years, £245 million for changes in accounting estimates, and
£15 million for investigation costs. (AC
79). BT Group stated that its
operating cashflow of £245 million was £396 million worse than last year. (AC
82). ST Group also provided a summary of adjustments reconciling the fiscal
2016 and fiscal 2015 financial years.
F. Clawback and Denial of Bonuses
BT Group clawed back previously awarded bonuses and denied bonuses
for the current year to the company’s executive directors, including defendants
Patterson and Chanmugam. (AC
84). ST Group said that this action placed
the executives in the same position they would have been in if the bonuses had
been based on accurate results. (AC
G. Allegedly Materially False or Misleading Statements
Plaintiffs allege that defendants made materially false or misleading
statements during fiscal years 2013 through 2017. (AC ¶1J 87-119). These
alleged statements include: (1) BT Group’s quarterly and year-end financial
results; (2) statements that BT Group’s internal control over financial reporting
was sufficient; (3) certifications by the CEO and CFO about internal controls
and disclosure controls; and (4) reports about the Audit Committee’s attention
to BT Italy. (AC
87-180). Plaintiffs allege that defendants knew about—or
recklessly disregarded—the issues with BT Italy but made these statements
Plaintiffs claim that these statements directly or proximately caused
plaintiffs to purchase or trade in ADRs at inflated prices, and that they were
damaged as a result. (AC
120-23). Count One alleges violations of Section
10(b) of the Exchange Act and Rule lOb-5 against BT Group. (AC ¶j 189-98).
Count Two alleges a violation of Section 20(a) against Livingston, Patterson,
and Chanmugam. (AC
Federal Rule of Civil Procedure 12(b)(6) provides for the dismissal of a
complaint, in whole or in part, if it fails to state a claim upon which relief can
be granted. The moving party bears the burden of showing that no claim has
been stated. Hedges
United States, 404 F.3d 744, 750 (3d Cir. 2005). In
deciding a motion to dismiss under Rule 12(b)(6), a court must take all
allegations in the complaint as true and view them in the light most favorable
to the plaintiff. See Wadh v. Seldin, 422 U.S. 490, 501 (1975); Phillips u. County
of Allegheny, 515 F.3d 224, 231 (3d Cir. 2008).
A plaintiff asserting securities-fraud claims pursuant to Section 10(b) of
the Securities Exchange Act and Rule lOb-S must meet the heightened
pleading standard as set forth in the Private Securities Litigation Reform Act of
1995 (“PSLRA”). 15 U.S.C.
78u-4(b). Under the PSLRA, a complaint alleging a
false or misleading statement must: “(1) ‘specify each statement alleged to have
been misleading [and] the reason or reasons why the statement is misleading,’
§ 78u-4(b)(1), and (2) ‘state with particularity facts giving rise to a
strong inference that the defendant acted with the required state of mind,’ Id.
§ 78u-4(b)(2).” Rahman v. Kid Brands, Inc., 736 F.3d 237, 24 1-42 (3d Cir. 2013)
(quoting Tellabs, Inc. v. Makor Issues & Rights, Ltd., 551 U.S. 308, 321 (2007))
(internal quotations omitted). The required state of mind is “scienter,” which is
defined as “a mental state embracing intent to deceive, manipulate, or
defraud.” Tellabs, 551 U.S. at 319.
That PSLRA “particularity” standard has elements in common with the
pleading requirements for fraud set forth in Federal Rule of Civil Procedure
9(b). Institutional Investors Group v. Avaya, Inc., 564 F.3d 242, 253 (3d Cir.
2009); see Fed. R. Civ. P. 9(b) (“In alleging fraud or mistake, a party must state
with particularity the circumstances constituting fraud or mistake,”). Rule 9(b),
however, is both subsumed and supplemented by the requirements of Section
78u-4(b)(1) of the PSLRA. Id. (citing Miss. Pub. Emps. Ret. Sys. u. Boston
Scientfic Corp., 523 F.3d 75, 85 n.5 (1st Cir. 2008)). Like rule 9(b), the PSLRA
requires that a plaintiff plead the “who, what, when, where and how.” Id.
Section 78u-4(b)(1) adds a specialized requirement, however, where “an
allegation regarding [a defendant’s] statement or omission is made on
information or belief.” Id.; see 15 U.S.C.
§ 78u-4(b)(1). In such a case, plaintiff
must “state with particularity all facts on which that belief is formed”; that is,
the complaint must “describe the sources of information with particularity,
providing the who, what, when, where and how of the sources, as well as the
who, what, when, where, and how of the information those sources convey.” Id.
The PSLRA also exceeds the requirements for pleading scienter contained
in Rule 9(b), which permits such mental states to be alleged generally. Id. As
interpreted by the Supreme Court, PSLRA’s particularity requirement requires
that the facts pled give rise to a “strong inference” of scienter. A court
considering a motion to dismiss for failure to plead scienter must weigh the
“plausible, nonculpable explanations for the defendant’s conduct” against the
“inferences favoring the plaintiff.” Tellabs, Inc. u. Makor Issues & Rights, Ltd.,
551 U.S. 308, 323-24 (2007). A “strong inference” of scienter must thus be
“cogent and at least as compelling as any opposing inference of nonfraudulent
intent.” Id. at 314; see also id. at 324. “The inference that the defendant acted
with scienter need not be irrefutable, i.e., of the ‘smoking-gun’ genre, or even
the most plausible of competing inferences.” (internal quotation marks
omitted)). The pertinent question is “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
322-23; see also id. at 325 (“[T}he court’s job is not to scrutinize each allegation
in isolation but to assess all the allegations holistically.”). Omissions and
ambiguities “count against inferring scienter.” Id. at 326.
Those PSLRA pleading requirements apply whether the alleged
fraudulent statement at issue is an assertion of current fact or a prediction of
the future. Auaya, 564 F.3d at 253-54. However, when an allegation involves a
prediction, the Safe Harbor provision of the PSLRA immunizes from liability
any forward-looking statement that “is identified as such and accompanied by
meaningful cautionary language; or is immaterial; or [where] the plaintiff fails
to show the statement was made with actual knowledge of its falsehood.” Id. at
254; 15 U.S.C.
A. Section 10(b) and Rule lOb-5 Allegations
To state a claim for securities fraud under Section 10(b) of the Exchange
Act and Rule lOb-5, a plaintiff must allege: (1) a material misrepresentation or
omission; (2) scienter; (3) a connection between the misrepresentation or
omission and the purchase or sale of a security; (4) reliance upon the
misrepresentation or omission; (5) economic loss; and (6) loss causation. City of
Edinburgh Council u. Pfizer, Inc., 754 F.3d 159, 167 (3d Cir. 2014). As
discussed in detail above, the element of scienter must be pled with
particularity. Institutional Investors Group v. Avaya, Inc., 564 F.3d 242, 253 (3d
Cir. 2009). Defendants move to dismiss the amended complaint solely on the
basis of the element of scienter.
I will first discuss (1) whether plaintiffs adequately alleged scienter in
relation to the Audit Committee and the individual defendants. I will then
discuss (ii) whether plaintiffs can satislr the scienter requirement by pleading
1. Scienter of the Audit Committee and Individual
Plaintiffs posit that the Audit Committee and the individual defendants—
i.e., Livingston, Patterson, and Chanmugam—were aware that the internal
controls in BT Italy were insufficient. According to plaintiffs, these defendants
possessed scienter because they knew, or were reckless in ignoring, significant
concerns that were raised in BT Group’s annual reports.
In the 2013 annual report, the Chair of the Audit Committee noted that,
“We received updates on security and resilience, cybersecurity, BT’s network,
major contracts, BT’s operations in Italy, customer data handling, litigation
trends, as well as updates on major litigation and competition and regulation.”
The 2014 annual report stated as follows:
This year the Audit & Risk Committee paid special attention to
several overseas locations that are important to BT Global
Services, including Italy and Brazil, to data security and to the
increasing cyber security threat.... I reported last year that the
committee had given particular focus to BT’s operations in Italy.
We have continued to monitor the position there and significant
progress has been made to improve the control environment.
The 2015 annual report reported that the Audit Committee “asked
management to provide us with greater detail on the governance and control in
operations in Italy.” (AC
107). The Audit Committee chairperson
also stated, “I reported last year that the committee had given particular focus
to BT’s operations in Italy and Brazil. We have continued to monitor the
position and significant progress has been made to improve the control
107). The Board also visited ET Italy to “review
operational matters with senior managers, me[et] with employees as well as
customers, government officials and opinion leaders.” (AC
The 2016 annual report included this statement from the Audit
Committee: “We have continued to monitor our operations in Italy and progress
has been made to improve the control environment. We continue to keep under
review the current trends of security risks facing BT and the progress made to
manage these risks.” (AC
Defendants state that BT Italy contributed “approximately one percent to
BT Group’s EBITDA”3 and employed “only about one percent of BT Group’s
total workforce.” (ECF No. 28-2, p. 5). Defendants suggest that the highranking officers and executives at BT Group did not know the specifics
regarding the control environment at BT Italy, one of 300 subsidiaries.
Plaintiffs counter that BT Group and the individual defendants should have
been alerted by the Audit Committee’s focus on BT Italy. (ECF No. 33, p. 15).
As a result, plaintiffs claim, the individual defendants were at least reckless in
certifying the effectiveness of BT’s internal controls in Sarbanes-Oxley
disclosures. (ECF No. 33, p. 18).
The theory, then, is that BT Group was put on notice of fraud at BT Italy
by the Audit Committee’s interest, and that the individual defendants were
therefore reckless in failing to discover and disclose it. Plaintiffs rely on Auaya,
where the Third Circuit wrote that a defendant who was “not aware of the full
extent” of fraudulent practices “might be culpable as long as what he knew
made obvious the risk that his confident, unhedged denial of [fraudulent
practices} misled investors.” Institutional Investors Gip. v. Avaya, Inc., 564 F.3d
242, 270 (3d Cir. 2009). In Avaya, the Third Circuit held that the defendant’s
Earnings before interest, taxes, depreciation, and amortization.
conduct was potentially reckless because the CFO “explicitly denied the
existence of [unusual] discounting” several times even though several signs
pointed to it: confidential witnesses alleged widespread discounting with some
of the company’s largest clients, discounting was of central importance to
market competitiveness, there were repeated questions about discounting by
analysts and investors, and there was a steep decline in the company’s
“all-important margins” (which were directly tied to discounts and pricing). Id.
at 26g-7 1. The Third Circuit accepted that those indicators would reasonably
have alerted the CFO that his categorical, unhedged denials were incorrect. Id.
The factual circumstances in Avaya were different from those alleged
here. The CFO in Avaya was confronted with facts about large clients and core
products, facts that directly contradicted his unhedged public statements.
Here, by contrast, the individual defendants had reports of internal-control
problems at one of BT Group’s 300 subsidiaries. The reports did not reveal
fraud or point out problems with the company’s core operations or products.
The warnings, such as they were, involved potential control issues; in
themselves, they did not alert these defendants that the company’s public
statements were incorrect.
Plaintiffs argue that the individual defendants should have inquired
about BT Italy’s situation sooner. It is true that an officer or director cannot
ignore the facts and plead ignorance of the risk.” Makor Issues & Rights, Ltd. u.
Teflabs Inc., 513 F.3d 702, 704 (7th Cir. 2008); see Avaya, 564 F.3d at 270.
However, “an allegation of mismanagement on the part of defendant will not
alone support a claim under § 10(b) or Rule lOb-5; nor will an allegation that a
defendant failed to disclose the existence of mismanagement.” Hayes v. Gross,
982 F.2d 104, 106 (3d Cir. 1992) (citing Shapiro v. UBJ Fin. Corp., 964 F.2d
272, 280-83 (3d Cir. 1992)). Here, the mere fact that the Audit Committee was
looking into the management and accounting controls in place at BT Italy was
not enough to tip the balance, given the stiff PSLRA pleading standard:
“Knowing enough to launch an investigation,” the Seventh Circuit has written,
“is a very great distance from convincing proof of intent to deceive.”
Higginbotham v. Baxter Int’l, Inc., 495 F.3d 753, 758 (7th Cir. 2007). “[F]raud
cannot be inferred simply because [the parent corporation] might have been
more curious or concerned about the activity at [its subsidiary].” In re
Stonepath Grp., Inc. Sec. Litig., No. 4-cv-4515, 2006 WL 890767, at *12 (E.D.
Pa. Apr. 3, 2006), affd sub. nom. Globis Capital Partners, L.P. v. Stonepath Grp.,
Inc., 241 F. App5c 832 (3d Cir. 2007); see Chill u. Sen. Elec. Co., 101 F.3d 263,
270 (2d Cir. 1996) (same); see also In re Comshare, Inc. Sec. Litig., 183 F.3d
542, 554 (6th Cir. 1999) (holding that courts “should not presume recklessness
or intentional misconduct from a parent corporation’s reliance on its
subsidiary’s internal controls”). The issue, after all, is not negligence, but
The allegations in this complaint do not raise a plausible inference that
the individual defendants turned a “blind eye” to “red flags” or had “no
reasonable basis” for certifying the Sarbanes-Oxley reports. The more
reasonable inference is that these individual defendants were unaware of the
fraud or other problems at BT Italy that later emerged.
Plaintiffs therefore do not sufficiently plead scienter regarding the
individual defendants. In the next subsection, I will address whether the
plaintiffs can pursue their Section 10(a) and Rule lOb-S claims by pleading
ii. Corporate Scienter
Plaintiffs attempt to invoke the “corporate scienter” doctrine to impute
scienter to BT Group. Other courts have permitted plaintiffs to plead “corporate
scienter” without successfully pleading scienter against any individual
defendant. See, e.g., City of Monroe Emps. Ret. Sys. v. Bridgestone Corp., 399
F.3d 651, 656-59 (6th Cir. 2005). Such decisions require a strong inference
that someone in the corporation—who is not, but could have been an
individual defendant—must have acted with scienter in making materially false
or misleading statements. See id.; see also Makor Issues & Rights, Ltd. v.
Tellabs Inc., 513 F.3d 702, 710 (7th Cir. 2008).
The Third Circuit has “neither
accepted nor rejected the doctrine of
corporate scienter in securities fraud actions.” Rahman v. Kid Brands, Inc., 736
F.3d 237, 246 (3d Cir. 2013); see also City of Roseville Emps. Ret. Sys. v.
Horizon Lines, LLC, 442 F. App’x 672, 676-77 (3d Cir. 2011) (declining to decide
it were possible to plead scienter against a corporation without pleading
scienter against an individual”). In City of Roseville, however, the Third Circuit
suggested that plaintiffs might invoke the corporate-scienter doctrine in unique
and extraordinary circumstances. 442 F. App5c at 676-76. Roseville pointed to
Bridgestone Corp., where a tire manufacturer and its subsidiary Firestone had
information that their tires were rupturing and causing problems, including a
significant number of rollover accidents. City of Roseville, 442 F. App’x at 67676 (citing Bridgestone Corp., 399 F.3d at 656-59). Bridgestone and Firestone
allegedly engaged in a variety of tactics, including a large-scale secret
settlement with State Farm Insurance Co., to keep news of the scope of the
problem from reaching safety regulators and investors. Bridgestone Corp., 399
F.3d at 690-9 1. After the truth was revealed, plaintiffs filed a securities-fraud
action. The Sixth Circuit affirmed dismissal of the claims against the individual
defendants but held that the facts supported corporate scienter. Id.
In Roseville, the Third Circuit cited a hypothetical posited by the Seventh
Circuit to explain when an inference of corporate scienter might be appropriate:
Suppose General Motors announced that it had sold one million
SUVs in 2006, and the actual number was zero. There would be a
strong inference of corporate scienter, since so dramatic an
announcement would have been approved by corporate officials
sufficiently knowledgeable about the company to know that the
announcement was false.
City of Roseville, 442 F. App’x at 676-77 (citing Tellabs, 513 F.3d at 710).
In the Tellabs case, the corporate defendant announced that its principal
product, accounting for more than half its sales, was being replaced by a
successor product. 513 F.3d at 706. The corporate defendant asserted that the
successor product was “available now,” that “customers [wejre embracing” it,
and that Sprint had signed a multiyear $100 million contract to buy it. Id. The
product was not actually sold at all during the class period. Id. The Seventh
Circuit inferred corporate scienter because it was highly implausible that key
executives in the corporation would not have known whether its principal
product was currently being sold. Id.
Assuming arguendo that the Third Circuit would permit a complaint to
plead “corporate scienter” without pleading scienter against an individual, the
facts alleged by plaintiffs here would not suffice to create such an inference. I
consider the facts alleged in support of corporate scienter:
(a) BT Italy executives were aware of the fraud. First, the Third Circuit
has declined to impute the scienter of a subsidiary to a parent. See Rahman v.
Kid Brands, Inc., 736 F.3d 237, 246 (3d Cir. 2013). The “knowledge and actions
of a subsidiary company’s agents cannot be imputed to the parent company.”
Pathfinder Mgmt., Inc. a Mayne Pharma, Inc., No. 6-cv-2204, 2009 WL
4250061, at *9 (D.N.J. Nov. 25, 2009). That BT Italy executives were allegedly
knowledgeable about the fraud does not mean that the parent company’s
executives from BT Group were aware. Moreover, as stated above, BT Italy is a
small subsidiary representing a small fraction of EBITDA.
(b) Jacinto Cavestany, BT Group Services’ Vice President of Iberia & Head
of Sales in Europe and Latin America, was informed through news articles about
potentialfraud at BTItaly. This does not support an inference of corporate
scienter. Even assuming that the news-article allegations are credible, they do
not support an inference of corporate scienter. Cavestany worked for BT Group
Services, a subsidiary of BT Group. Even on the generous assumption that
The Second Circuit has placed more emphasis on the identification of an
individual whose scienter can be imputed to the corporation—i.e., when “the pleaded
create a strong inference that someone whose intent could be imputed to the
corporation acted with the requisite scienter.” Teamsters Local 445 Freight Div. Pension
Fund v. Dynex Capital Inc., 531 F.3d 190, 195 (2d Cir. 2008).
Cavestany knew of fraud at BT Italy, his knowledge cannot be imputed to BT
Group. Cf City of Roseville Emps. Ret. Sys. v. Horizon Lines, Inc., 713 F. Supp.
2d 378, 403 (D. Del. 2010) (“[A] corporate defendant will not be held liable
absent a showing that at least one individual officer who made, or participated
in the making of, a false or misleading statement did so with scienter.”).
(c) BT Group clawed back compensation from the individual defendants
Patterson and Chanmuyam. BT Group’s reduction of the pay of executives to
reflect actual performance does not give rise to a compelling inference of
scienter. No facts are pled to suggest that the reduction in pay was due to their
participation in any fraud. Cf City of Roseville, 713 F. Supp. 2d at 398. The
complaint alleges that the Remuneration Committee recalculated the bonuses
to reflect the actual financial results of BT Italy’s business.
(d) The Italian government has investigated BT Italy. The existence of an
investigation by the Italian government does not support a strong inference of
scienter on the part of BT Group.
[Cjourts have considered a governmental investigation as one piece
of the puzzle when taking a ‘holistic’ view of the purported facts as
they relate to scienter.... [WJhile the existence of an investigation
alone is not sufficient to give rise to a requisite cogent and
compelling inference of scienter, it may be considered by the Court
as part of its analysis.
In re Gentiva Sec. Litig., 932 F. Supp. 2d 352, 380 (E.D.N.Y. 2013). I consider
the Italian investigation, but in context with the other facts it does not support
a strong inference of scienter.
(e) There were GAAP violations. GAAP violations do not themselves create
a strong inference of scienter. Courts have found that GAAP violations can
support an inference of scienter, but do not independently create such an
inference. See In re Intelligroup Sec. Litig., 527 F. Supp. 2d 262, 349-52 (D.N.J.
2007) (synthesizing case law).
(f) High-ranking officials resigned or were terminated after the fraud was
disclosed. The termination of BT Italy and BT Global Services employees does
not give rise to a strong inference of scienter. As stated before, the “knowledge
and actions of a subsidiary company’s agents cannot be imputed to the parent
company.” Pathfinder Mgmt., 2009 WL 4250061, at *9• Even if the employees of
a ST Group subsidiary knew about or participated in the fraud, no facts
compel the inference that BT Group officers or executives possessed scienter.
(g) Other miscellaneous facts, such as the duration of the fraud or the
Board’s visit to Italy. These do not create a compelling inference of scienter
among individuals whose scienter could be imputed to the parent company.
“[Tjaken collectively,” as called for by Tellabs, 551 U.S. at 323, the facts
and allegations presented by plaintiffs are not so fundamental and pervasive as
to support an inference of corporate scienter, as in the Bridgestone case
(rupturing tires, followed by a covemp) or the General Motors hypothetical
(nonexistent SUV sales). There, it
inconceivable that the corporation lacked
scienter, even if a particular individual with scienter was not identified and
sued. Here, the control issues at BT Italy did not implicate such fundamental
corporate matters. Here, based on the allegations, it is at least as likely that
key individuals at BT Group were unaware of the fraud, were not reckless in
ignoring it, and reacted appropriately when the relevant facts came out. Even if
the corporate-scienter doctrine was permitted in this Circuit, these facts would
not satisfy that doctrine. Plaintiffs’ Section 10(b) and Rule lob-S claims are
thus dismissed for failure to adequately plead corporate scienter.
B. Section 20(a) Allegations
Since plaintiffs fail to adequately state Section 10(b) and Rule lOb-S
claims, the Section 20(a) claims against the individual defendants fail as well.
Liability under Section 20(a) is predicated upon an independent violation of
“this chapter or the rules or regulations thereunder.” 15 U.S.C.
Greebel u. FTP Software, Inc., 194 F.3d 185, 207 (1st Cir. 1999). Claims under
Section 20(a) therefore, are “derivative—requiring proof of a separate
underlying violation of the Exchange Act.” In re Milestone Scientific Sec. Litig.,
103 F. Supp. 2d 425, 474 (D.N.J. 2000). Because the plaintiffs have not pled a
predicate violation of Section 10(b) or Rule lOb-5, the Section 20(a) claim is
For the foregoing reasons, defendants’ motion to dismiss is granted,
without prejudice, to the filing of an amended complaint within 30 days.
An appropriate order accompanies this opinion.
Dated: August 1, 2018
United States District Judge”
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