(The news featured below is a selection from the news covered in Federal Securities Law Reporter, which is distributed to subscribers of Federal Securities Law Reporter.)

First Circuit Examines PSLRA Pleading Standards

The 1st U.S. Circuit Court of Appeals vacated in part a lower court's dismissal of a securities suit alleging that a construction company underbid various projects, exaggerated revenue and fraudulently reported expected profits. While the panel affirmed several of the lower court's rulings on pleading scienter, it notably differed on the level of particularity needed to plead fraud and the limits of the Private Securities Litigation Reform Act's safe harbor for forward-looking statements.

In finding that the complaint adequately pleaded fraud with particularity for several of its claims, the panel found that, while "not overwhelming impressive," the sources of information relied on included sources within the company who most likely had access to the kind of information for which they were cited. The allegations were determined not to be merely conclusory, but supported by details that provided a factual basis for the assertions of fraud. Reiterating its previous ruling that the PSLRA did not require a plaintiff to plead evidence, the court stated, "As we understand it, it was not Congress's intention to bar all suits as to which the plaintiff could not yet prove a prima facie case at the time of the complaint, but rather to prevent suits based on a guess that fraud may be found."

The appellate court also vacated the lower court's ruling that a statement made concerning the company's current access to cash to meet future expenses was not actionable because of the PSLRA's safe harbor for forward-looking statements. Because the statement included a reference to anticipated future needs for funds, the district court found it to be a protected forward-looking statement. The panel rejected this characterization, because the claim of fraud was not that the company was underestimating the amount of its future cash needs, but that the company was in a liquidity crunch and was misrepresenting its present access to funds. "The mere fact that a statement contains some reference to a projection of future events cannot sensibly bring the statement within the safe harbor if the allegation of falsehood relates to non-forward-looking aspects of the statement," stated the court.

On the question of pleading facts supporting a strong inference of scienter, the appellate court affirmed most of the lower court's rulings, requiring a much more detailed analysis of why the accounting irregularities rose to an intent to defraud. Likewise, without a fuller explanation of the severe nature of the accounting irregularities, the mere fact that the company's auditor missed warning signs did not support a conclusion of recklessness or willful blindness.