On June 15, 2023, Judge Michael A. Shipp of the United States District Court for the District of New Jersey, in an unpublished opinion, adopted a Special Master's Report and Recommendation denying a motion to dismiss claims under Section 10(b) of the Securities Exchange Act of 1934 (the "Exchange Act"), and Rule 10b-5 promulgated thereunder, against an accounting firm (the "Firm") in connection with an audit report it issued for a pharmaceutical company's (the "Company") financial statements in connection with the Company's public offering. In re Valeant Pharmaceuticals Intl., Inc. Securities Litigation, No. 15-7658 (MAS) (LHG) (D.N.J. June 15, 2023). We previously covered the district court's decision denying a motion for judgment on the pleadings in this action, as well as the district court's decision denying a motion to dismiss by other defendants in the action.

As background, plaintiff alleged that in connection with the public offering, the Firm issued and certified an audit report on the Company's 2014 financial statements that contained false and misleading statements that, once revealed, caused the Company's stock price to drop below plaintiff's original purchase price. Plaintiff filed suit against the Company and the Firm, among others, alleging in pertinent part that the Firm's audit report assured investors that the Company's financial statements complied with generally accepted accounting principles ("GAAP"), that the Company had effective internal controls, and that the Firm had conducted its audit in accordance with professional standards. Plaintiff further alleged that the financial statements contained materially false and misleading statements because, among other things, the Firm knew or recklessly disregarded several red flags regarding the Company's alleged improper business practices as well as red flags that the Company had manipulated earnings, and that a certain business combination violated GAAP. In response, the Firm filed a motion to dismiss arguing that plaintiff's allegations failed to adequately plead the requisite level of scienter.

In adopting the Special Master's Report and Recommendation to deny the Firm's motion to dismiss, the district court held that, while pleading scienter for an outside auditor is "particularly demanding," plaintiff's amended complaint was "rife with allegations of [the Firm's] scienter." In particular, the amended complaint included allegations to support an inference that the Firm failed to comply with professional auditing standards and GAAP standards, as well as allegations that the Firm knew or recklessly disregarded unusual transactions captured within the Company's financial statements. The Court further noted that while the amended complaint does not allege that the Firm had any particular motive to commit fraud, it sufficiently alleged "strong circumstantial evidence of 'conscious misbehavior or recklessness,' which can be shown by 'an extreme departure from the standards of ordinary care.'" Further, in addressing the Firm's argument that there were plausible non-culpable explanations for its conduct, the Court considered the Firm's position that the Company had provided inaccurate information to it. But the Court concluded that plaintiff sufficiently alleged that there were numerous documents that the Firm reviewed during its audit that contained accurate information reflecting some of the red flags that plaintiff alleged existed. The Court therefore found that when accepting the amended complaint's allegations as true, "a reasonable person [would] deem the inference of scienter at least as strong as" the Firm's alternate theory. Citing Tellabs, Inc. v. Makor Issues & Rights, Ltd., 551 U.S. 308, 326 (2007).

Accordingly, the Court held that plaintiffs alleged sufficient facts to survive the Firm's motion to dismiss and adopted the Special Master's Report and Recommendation.

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