District Of New Jersey Denies Motion To Dismiss Putative Class Action Against Information Technology Services Company, Holding Scheme Liability And Corporate Scienter Adequately Alleged

Shearman & Sterling LLP

Shearman & Sterling LLPOn June 5, 2020, Judge Esther Salas of the United States District Court for the District of New Jersey sustained in part a putative class action asserting claims under Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder against an information technology services company and certain of its current and former executives. In re Cognizant Technology Solutions Corp. Sec. Lit., No. 16-6509 (D.N.J. June 5, 2020). Plaintiffs alleged that the company made misrepresentations promoting the advantages of its facilities in India by failing to disclose an alleged scheme to bribe government officials to secure permits necessary to operate one such facility. After portions of their prior complaint were dismissed by the late Judge Walls without prejudice, plaintiffs filed an amended complaint, and the case was transferred to Judge Salas. Relying in part on the prior decision as law of the case, the Court held that plaintiffs’ allegations, which were drawn primarily from a government investigation, sufficiently alleged actionable misstatements and scienter.

With respect to alleged misstatements and omissions, the Court rejected the company’s argument that the government investigation showed that the alleged bribes were not paid for the licensing but instead, were for other types of permits. Deeming this a “distinction without a difference,” the Court concluded that plaintiffs’ allegations concerning permits that were “necessary for the construction and operation of” the facility were sufficiently broad to account for different types of licenses or permits. Slip op. at 23. In addition, relying on the prior judge’s determination as law of the case, the Court concluded that alleged misrepresentations that there were no incidents of corruption, as well as regarding financial earnings releases, were actionable as allegedly misleading because they did not mention the bribery scheme. Id. at 25–28. Importantly, the Court held that the complaint failed to establish, pursuant to Rule 10b-5(b), that the company’s former general counsel who signed the 8-K attaching earnings releases was the “maker” of certain statements in the earnings releases attached to SEC filings—i.e., that he had “ultimate authority over the statement, including its content and whether and how to communicate it.” Id. at 30 (citing Janus Capital Grp., Inc. v. First Derivative Traders, 564 U.S. 135, 142 (2011)). The Court emphasized that plaintiffs did not allege that the executive was quoted in any of the earnings releases, that his name or contact information appeared on them, or that he was responsible for reviewing them prior to issuance. Id. at 31–33.

Nevertheless, the Court held that allegations against the executive, who was ultimately criminally indicted for his role in the alleged bribery scheme, regarding the earnings releases were sufficient to allege “scheme liability” under Rule 10b-5(a) and (c) in this specific context of this action and his alleged role, for which he was criminally charged, with respect to the underlying conduct that pre-dated the releases. The Court explained that the Supreme Court’s decision in Lorenzo v. SEC, 139 S. Ct. 1094 (2019), determined that sending emails to potential investors that the sender knew to be false could give rise to “scheme liability,” even though the sender was not a “maker” of the statements because the emails were authored and approved by his supervisor. Id. at 34–35. And, although Lorenzo does not require that a plaintiff necessarily allege deceptive conduct beyond the alleged misstatement itself, the Court rejected the company’s suggestion that Lorenzo precluded liability where the dissemination of a misstatement is preceded by additional allegedly deceptive conduct. Id. at 36. The Court thus explained that it “cannot simply turn a blind eye” to allegations that the executive actually participated in devising the bribery scheme. Id. at 36–37. Similarly, the Court concluded that these allegations of scienter collectively provided a strong inference that “at minimum” the executive acted recklessly in participating in the bribery scheme and failing to report it. Id. at 48–49.

Finally, the Court engaged in an analysis of the theory of corporate scienter, under which—where the concept is accepted—scienter may be imputed to a corporate defendant based on allegations regarding the mental state of officers or employees. Id. at 49. The Court explained that, while the Third Circuit has not yet taken a position on whether to allow the corporate scienter theory or how to define it, other Circuit Courts of Appeal have taken three differing approaches. The Court held that plaintiffs adequately alleged corporate scienter under each of those approaches. Id. at 52.

In particular, the company argued that plaintiffs’ allegations were insufficient to establish corporate scienter under what the Court referred to as the “narrow approach” of the Fifth and Eleventh Circuits, which requires allegations that establish a strong inference of scienter as to an individual official responsible for the misstatement, rather than general allegations going to the collective knowledge of various officers and employees. Id. at 52. The Court found, contrary to detailed arguments from the company, that this standard applied not only for individuals who make or issue a misstatement, but also for those who merely “furnish” information for inclusion in the statement. Id. The Court concluded that plaintiffs sufficiently established a strong inference of scienter that could be imputed to the company, based on allegations that one executive authorized bribe payments and falsified documents in connection with those payments that were used to generate the allegedly misleading earnings releases, and that two executives provided false certifications regarding the company’s anti-corruption compliance practices that could have plausibly been furnished in connection with the company’s reporting no incidents of corruption. Id. at 56–58.

Based on the same reasoning, the Court determined that plaintiffs’ allegations were sufficient under the “broad approach” to corporate scienter articulated by the Second and Seventh Circuits, which requires only “a strong inference that someone whose intent could be imputed to the corporation acted with the requisite scienter.” Id. at 59–60. While the company argued that the allegations amounted to “isolated misconduct” and “immaterial payments” that were not indicative of widespread fraud, the Court observed that allegations of widespread fraud were unnecessary where “named senior officers are alleged to have had the requisite scienter.” Id. at 60. Moreover, the Court stated that the “collective allegations”—including statements by a confidential witness who allegedly observed numerous examples of falsified records and reported them to other managers—“reflect a scheme which plausibly extended beyond those named senior management.” Id. at 61–64.

Similarly, the Court held that the scienter allegations were sufficient under the “middle approach” articulated by Sixth Circuit, which permits scienter to be imputed based on allegations that a “high managerial agent or member of the board of directors . . . ratified, recklessly disregarded, or tolerated the misrepresentation after its utterance or issuance.” Id. at 67. The Court concluded that allegations that multiple top officials participated in bribery were sufficient under the “middle approach.” Id. at 68–69. Prior to the filing of the currently operative complaint, the late Judge Walls had certified the question of the proper standard for corporate scienter to the Third Circuit. Id. at 6. Once the new complaint was filed, the Third Circuit dismissed the appeal without prejudice to interlocutory review being sought again. Id. at 7. Judge Salas’ opinion suggests in a footnote that interlocutory review may not necessarily be warranted to the extent the standard for corporate scienter was not dispositive under the Court’s analysis but invites defendants to file a motion requesting certification for interlocutory review. Id. at 52 n.15.

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In re Cognizant Technology Solutions Corp. Sec. Lit.

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