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In the context of pleading auditor scienter for a securities fraud claim under the Private Securities Litigation Reform Act of 1995, a complaint might reach the "no audit at all" threshold by alleging that the auditor disregarded specific red flags that would place a reasonable auditor on notice that the audited company was engaged in wrongdoing to the detriment of its investors. Alternatively, allegations of particularly large frauds might go far toward creating a compelling inference of auditor scienter based on recklessness even where actual knowledge of the fraud by the defendant auditor is not alleged. However, under this framework, merely alleging that the auditor had access to the information by which it could have discovered the fraud is not sufficient.
Plaintiffs brought this securities fraud class action under Sections 10(b) and 20(a) of the Securities Exchange Act, 15 U.S.C. §§ 78j and 78t(a), and Rule 10b-5 promulgated thereunder by the Securities and Exchange Commission ("SEC"), 17 C.F.R. § 240.10b-5, on behalf of all persons and entities who purchased or acquired common stock in IMAX Corporation ("IMAX" or the "Company") between February 27, 2003 and July 20, 2007 (the "class period"). The consolidated amended class action complaint (the "complaint") alleged that the defendants, IMAX, Richard L. Gelfond ("Gelfond"), Bradley J. Wechsler ("Wechsler"), Francis T. Joyce ("Joyce"), Kathryn A. Gamble ("Gamble" and collectively, the "IMAX defendants"), and Pricewaterhouse Coopers LLP ("PWC"), issued materially false and misleading statements concerning IMAX's accounting of theater system revenue.
Was the mere fact that an individual defendant's executive compensation dependent on stock value or entailed some other performance-based component adequate to plead scienter under the Private Securities Litigation Reform Act of 1995?
The court found that the motives ascribed to the officers were inadequate to plead scienter under the Private Securities Litigation Reform Act of 1995 because the mere fact that an individual defendant's executive compensation was dependent on stock value or entailed some other performance-based component could not have, by itself, supported an inference of scienter. The complaint fairly pled an inference of scienter based on recklessness or conscious disregard because, inter alia, the complaint suggested that defendants had a sophisticated understanding of the relevant accounting principles, yet employed aggressive tactics to meet their revenue targets. An inference that the auditor reviewed various documents tracking theater installation that could have revealed if the company was violating its own accounting policy, and thus was reckless in not detecting the alleged violations, was strong enough for the case against the auditor to proceed. Finally, the complaint sufficiently pled loss causation because it alleged that the price of the company's shares fell by almost 41 percent when it was announced that the Securities and Exchange Commission was conducting an informal inquiry.