Adverse Interest Exception Not Applied in Securities Class Action

On Oct. 23, the U.S. Court of Appeals for the Ninth Circuit decided the following issue of first impression: Whether, when assessing the pleading adequacy of a securities class action complaint’s scienter (fraudulent intent) allegations, a court may impute a corporate officer’s scienter to the corporation under the “adverse interest exception” even where the officer allegedly acted out of his or her own interests and contrary to the interests of the company. In its opinion, In re ChinaCast Education Securities Litigation, No. 12-57232, 2015 U.S. App. LEXIS 18462 (9th Cir. Oct. 23, 2015), the Ninth Circuit answered this question in the affirmative, holding that, where a complaint alleges that a corporate officer acted with apparent authority, the court should impute the officer’s scienter to the defendant corporation—regardless of whether the officer’s fraudulent conduct was adverse to the corporation’s interest. The Ninth Circuit’s decision in ChinaCast is particularly noteworthy for parties litigating securities class actions in the Third Circuit because it expands the application of the Third Circuit’s recent decision in Belmont v. MB Investment Partners, 708 F.3d 470 (3d Cir. 2013), which was not a class action, to the securities class action context where plaintiffs are not required to plead and prove direct reliance on a defendant’s representations.

Factual and Procedural Background

According to the Ninth Circuit’s opinion, which draws the facts from the plaintiffs’ complaint, ChinaCast Education Corp. is a for-profit post-secondary education and e-learning services provider based in China. From June 2011 through April 2012, ChinaCast’s founder and CEO, Ron Chan Tze Ngon, allegedly “looted the company’s coffers, including proceeds from the U.S. stock offerings.” Specifically, Chan allegedly transferred $120 million from the company to outside accounts controlled by him and his allies; permitted a company vice president to move $5.6 million of ChinaCast funds to his son; shifted control of two of ChinaCast’s private colleges to outside the company; and pledged $37 million in company assets to secure third-party loans unrelated to ChinaCast’s business. According to the court, these actions brought the company to “financial ruin.”