Second Circuit Affirms Dismissal Of Exchange Act Claims For Failure To Adequately Plead Scienter

by Shearman & Sterling LLP
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On April 13, 2018, the United States Court of Appeals for the Second Circuit, in a summary order, affirmed the dismissal of a putative class action against Deutsche Bank and certain of its officers asserting claims under Section 10(b) of the Securities Exchange Act of 1934.  In re Deutsche Bank Aktiengesellschaft Sec. Litig., No. 17-2560, 2018 WL 1773502 (2d Cir. 2018).  Plaintiffs alleged that defendants misrepresented the effectiveness of the bank’s anti-money laundering controls, and that weaknesses in those controls were subsequently revealed in the public fallout surrounding the bank’s use of so-called “mirror trades” to move funds out of Russia.  Applying the “more stringent rule for inferences involving scienter” under the Private Securities Litigation Reform Act, the Second Circuit affirmed the dismissal of plaintiffs’ complaint for failure to adequately plead scienter.

The Second Circuit evaluated plaintiffs’ allegations under the standard for scienter set forth in ECA & Local 134 IBEW Joint Pension Trust of Chicago v. JP Morgan Chase Co., 553 F.3d 187, 196 (2d Cir. 2009), which requires factual allegations showing either “motive and opportunity to commit fraud” or “strong circumstantial evidence of conscious misbehavior or recklessness.”  Slip op. at 4.   With respect to motive and opportunity, the Second Circuit noted that plaintiffs failed to adequately allege that the individual defendants realized any “concrete and personal benefit” from the alleged fraud.  Specifically, although plaintiffs alleged that the bank’s Russia office had a culture of “greed and corruption,” they failed to allege how any of the individual defendants “personally benefited from making the alleged misrepresentations.”  Id.

The Second Circuit also found that plaintiffs had not sufficiently alleged conscious misbehavior or recklessness.  Plaintiffs did not attempt to demonstrate conscious misbehavior, but instead argued that the individual defendants recklessly disregarded facts that called into question their representations concerning the bank’s internal controls.  For this argument, plaintiffs relied on a consent order between the bank and the New York Department of Financial Services entered on January 30, 2017, in which the bank admitted that it had “serious compliance deficiencies . . . that spanned [its] global enterprise” which allowed a group of Moscow-based bank traders and offshore entities to transfer more than $10 billion out of Russia.  Id. at 5–6.  The Second Circuit noted, however, that the consent order made clear that no concerns about suspicious trading activities were escalated out of Russia, such that it was only “[o]nce the mirror trade scheme became sufficiently elevated within” the bank’s investigation function (in March 2015) that “the Bank commenced an internal investigation designed to identify the background of the suspicious trades.”  Id. at 6.  The Second Circuit thus found that the consent order itself contradicted plaintiffs’ claims that defendants were aware of wrongdoing at the time they made the alleged misrepresentations.  

The Second Circuit also rejected plaintiffs’ arguments that an inference that the individual defendants recklessly disregarded facts undermining their alleged misrepresentations could be found based on other documents.  Plaintiffs pointed to regulatory reports from the Federal Reserve between 2002 and 2013, which the Second Circuit found merely warned the bank about “weaknesses in the bank’s reporting framework” but did not concern anti-money laundering controls.  Id. at 6–7.  Plaintiffs also pointed to a 2005 agreement among the bank, the Federal Reserve, and the New York State Banking Department, under which the bank agreed to improve its anti-money laundering controls; however, the Second Circuit noted that there was no record that the bank failed to abide by that agreement.  Id. at 7.  Finally, the Second Circuit rejected allegations based on publicly disclosed fines and enforcement actions against the bank in 2015 related to anti-money laundering controls, which the Court found failed to establish that defendants were aware of those deficiencies at the time of their alleged misrepresentations or that the deficiencies were so obvious that defendants “must have been aware” of them.  Id.

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