Second Circuit: Securities Class Suit Failed to Plead Corporate Scienter Against Dynex and Merit

Holding:

In this appeal, the U.S. Court of Appeals for the Second Circuit overturned a district court's ruling that plaintiff-appellee Local 445 Freight Division Pension Fund was able to adequately plead scienter in its securities fraud complaint. The district court earlier dismissed fraud charges against top officers of financial services companies Dynex Capital, Inc. ("Dynex") and Merit Securities Corp. ("Merit"), but found that a strong inference of scienter was demonstrated against these corporate defendants-appellants. On appeal, the Second Circuit rejected the notion that a failure to show scienter on the part of individual officers should likewise give rise to a finding of no-scienter against corporate defendants in a securities case. Congress has imposed strict requirements on securities fraud pleading, but the Second Circuit did not believe they have imposed the rule that in no case can corporate scienter be pleaded in the absence of successfully pleading scienter as to an expressly named officer. Nonetheless, the Second Circuit ruled in favor of Dynex and Merit, stating that plaintiffs-appellees failed to allege the existence of misleading information given out to investors, and the existence as well of a motive to mislead. The Second Circuit thus remanded the case with instructions to dismiss as to Dynex and Merit with leave to replead.

Detailed Summary:

In this securities fraud class action, defendants-appellants Dynex and Merit appealed an order entered on February 10, 2006 in the U.S. District Court for the Southern District of New York denying a motion by Dynex and Merit to dismiss the action as to them. Opinion, p. 3. In this appeal, defendants argued that the district court erred when it found that plaintiff had successfully pleaded scienter against Dynex and Merit despite failing to find scienter pleaded as to any specific officer or employee of either company.

Dynex, a Virginia-based financial services company, invests in bonds secured by mortgages on manufactured housing.…

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