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United States: In Re Chinacast Education Corporation Securities Litigation: Court Finds Corporate Scienter Can Be Imputed In Certain Circumstances Even Though Employee's Actions Were Adverse To The Company's Interests
On 23 October 2015, in In re Chinacast Education Corporation
Securities Litigation, the federal appellate court based in
California addressed an issue of first impression within the
jurisdiction of this court: whether an employee's intent to
defraud may be imputed to the corporation as a basis for the
company's liability for securities fraud under Section 10(b) of
the Securities Exchange Act even where the employee acted for his
or her own personal benefit and against the company's
interests. The court held that, even though the intent of such an
employee ordinarily may not be imputed to the company, imputation
is permissible where the employee acts with apparent authority and
an innocent third party relies on the employee's actions.
In In re Chinacast, the CEO and founder of a for-profit
educational services provider defrauded the company of over $120
million and thus devastated its finances. There was no dispute that
the CEO committed securities fraud. The only issue was whether his
fraudulent intent could be imputed to the company. While the
actions of corporate agents ordinarily are imputed to the company,
an "adverse interest exception" protects the corporation
from liability for the conduct of employees who act for their own
personal benefit and against the company's interests. But the
court held that when the employee acts under the cloak of apparent
authority from the company and an innocent third party relies on
the employee's actions, an "exception to the
exception" allows the employee's adverse actions to be
imputed to the corporation. This rule is meant to ensure the fair
allocation of risk in protecting innocent parties who rely on an
agent's apparent authority and to incentivize corporations to
carefully choose and monitor high-ranking corporate officials (who
are the most likely employees to have such authority). In this
case, the securities fraud claims were based on disclosures that
the CEO made with apparent authority concerning the company's
finances and innocent investors relied on these statements.
Although this was an issue of first impression within the
jurisdiction of this court, the court here noted that other courts
around the country have adopted the same rule. The court found it
particularly significant that the employee at issue was the
company's CEO and founder and that the corporation's board
failed to properly oversee him. In addition, the court explained
that at the pleading stage of a securities class action, whenever
an employee acts with fraudulent intent under his or her apparent
authority from the company and a claim for securities fraud is
brought by a legitimate investor, that intent will be imputed to
the company at this initial stage because all investors are
presumed at this early point to have relied on the alleged
misrepresentations or omissions at issue.
The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.
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