SEC v. Blackburn: FRCP 9(b) – The Need to Sufficiently Allege Scienter

In SEC v. Blackburn, 2015 BL 293662 (E.D. La. Sept. 10, 2015), the United States District Court for the Eastern District of Louisiana granted in part and denied in part, Defendant Lee C. Schlesinger’s (“Schlesinger”) Partial Motion to Dismiss in a securities fraud case brought against Treaty Energy Corporation (“Treaty”) and six Treaty employees: Ronald Blackburn, Andrew Reid, Bruce Gwyn, Michael Mulshine, Lee Schlesinger (Treaty’s former Chief Investment Officer), and Samuel Whitley (collectively, “Defendants”). 

According to the allegations, Treaty is a publicly traded oil and gas company. The Securities and Exchange Commission (“SEC”) alleged that six of Treaty’s employees violated Section 10(b) of the Securities Exchange Act of 1934 (“Exchange Act”) and Rule 10b-5 by operating a widespread scheme to defraud investors and violate federal securities laws between 2009 and 2013. The SEC alleged Schlesinger aided and abetted Treaty’s reporting violations. The SEC further alleged Schlesinger failed to disclose Ronald Blackburn’s (“Blackburn”) control over Treaty, and Schlesinger took part in unregistered public offerings of restricted stock.

Schlesinger, the former Chief Investment Officer, filed a Partial Motion to Dismiss, challenging the SEC’s securities fraud and aiding and abetting claims against him. Schlesinger primarily argued the SEC’s claims did not specify how he committed any legal wrong.

To prevail on a securities fraud claim for Section 10(b) of the Exchange Act and Rule 10b-5 violations, a party’s claims, if true, must establish the actor made: a misstatement or omission of material fact in connection with the purchase or sale of a security, with the intent to deceive, manipulate, or defraud the public. The SEC may only succeed on an aiding and abetting claim if it can prove: (1) the primary party committed a securities violation; (2) the aider and abettor was generally aware of its role in violating the law; and (3) the aider and abettor knowingly rendered substantial assistance in furtherance of the violation.

A party alleging fraud must satisfy a heightened pleading standard and allege the circumstances constituting fraud with particularity. The Fifth Circuit interprets Rule 9(b) strictly. In order to satisfy this strict interpretation, a plaintiff alleging fraud must specifically identify: (1) statements alleged to be fraudulent, (2) the identity of the speaker, and (3) when and where the statements were made, and must explain why the statements were fraudulent.

In addressing the motion to dismiss, the court considered the SEC’s request to take judicial notice of Treaty’s Forms 10-K filed for the years 2011 and 2012. The court stated it may consider the contents of public disclosure documents that are (1) required to be filed, or (2) are actually filed with the SEC. The court agreed to take judicial notice of statements within the documents but not do so with respect to the truth of those statements.

The court held the SEC failed to state a claim against Schlesinger. The SEC did sufficiently allege that Schlesinger was the maker of false statements because he had signed the relevant reports filed on Form 10-K. The court, however, found that the SEC had not sufficiently alleged scienter. The SEC did not provide specific facts sufficient to demonstrate that Schlesinger acted consciously with respect to the statements alleged to be false or had a sufficient motive to commit securities fraud.

The court also held the SEC’s complaint failed to state a claim against Schlesinger for aiding and abetting. According to the court, Schlesinger’s signature on two Forms 10-K did not support an inference Schlesinger acted with conscious intent or that Schlesinger’s alleged actions constituted an extreme departure from the standards of ordinary care.

The primary materials for this post can be found at the DU Corporate Governance website.