The Sarbanes-Oxley Act of 2002 (S-Ox) requires CEOs and CFOs to certify that their companies’ financial statements are accurate and that they have designed and evaluated internal control over financial reporting. So far this year, three cases have been decided in U.S. district courts that deal with these certifications in securities fraud class actions pleadings.
In each of these cases, the shareholder plaintiffs alleged that the company’s SEC reports contained material misstatements and the defendants brought a motion to dismiss on the basis that the plaintiffs’ pleadings were inadequate. Plaintiffs in U.S. securities fraud class actions are required to plead specific facts giving rise to a strong inference of scienter, meaning that the defendants acted knowingly, or at least recklessly, in making false or misleading disclosure.
In Watchguard Securities Litigation, the plaintiffs argued that the CEO and CFO must have known that the company’s financial results contained accounting errors because the officers certified that they designed and evaluated the company’s internal control over financial reporting. The judge disagreed, holding that the certifications were insufficient by themselves to prove that the officers knew about the errors. Similarly, the judge in Invision Technologies, Inc. Securities Litigation held that the officers’ certifications were insufficient to infer scienter, and the plaintiffs failed to plead any other facts that suggested that the defendants knew that the company’s disclosure was misleading. The Watchguard and Invision cases would have been alarming had the judges decided differently, i.e., that scienter can be inferred merely from an officer’s S-Ox certification.
As in Watchguard and Invision, the plaintiffs in Lattice Semiconductor Corporation Securities Litigation pointed to the certifications as evidence of scienter, but in that case the judge agreed with the plaintiffs and denied the defendants’ motion to dismiss. However, the certifications in Lattice were not the only evidence of scienter. The plaintiffs pointed to several other compelling facts suggesting that the defendants knew that the company’s disclosure was misleading. Therefore, although the certifications played a role in helping the Lattice plaintiffs meet their pleading requirements, the outcomes of the Watchguard and Invision cases indicate that plaintiffs in securities fraud class actions will not be successful in pleading intentional wrongdoing just on the basis of CEO and CFO certifications.
In Canada, plaintiffs need not prove scienter to invoke the statutory liability-for-disclosure regime. However, when Canadian plaintiffs try to have the liability caps removed, a Canadian court will be required to decide whether there was a "knowing" disclosure violation. In that circumstance, the question addressed in these U.S. class actions will be relevant: whether a certification by itself implies consciousness of wrongdoing. We expect that the answer would be no.
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