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In this private class action against Kid Brands, Inc, and its officers, a private shareholder's pleading requirements are examined, and clarified.
Kid Brands is the parent company of four subsidiaries, all in the business of importing low cost baby furniture and products from China, for resale to the public in the U.S. In December 2010, Kid Brands was informed by U.S. Customs and Border Protection that its import practices and procedures would be investigated in a "Focused Assessment." To help with the investigation, Kid Brands hired an outside law firm, and did not reveal that it was being investigated until the law firm completed a report.
On March 2011, Kid Brands announced that one of its subsidiaries had misidentified some products, and was subject to $7 million in fines. In August 2011, Kid Brand announced that two other subsidiaries had evaded customs duties and noted its liability for wrongdoing, in a Form 8-K, could exceed $10 million. Understandably, Kids Brands' stock price fell from $9.24 in March 2011, to $2.97 in August 2011.
Shah Rahman, is the named plaintiff in a class of shareholders that purchased Kid Brand stock from March 26, 2010 to August 16, 2011. He claimed that Kid Brands violated the Securities Exchange Act and SEC Rule 10b-5. After filing a second amended complaint, the district court dismissed the complaint with prejudice, and Rahman appealed.
Scienter Requirement of PSLRA
The Private Securities Litigation Reform Act ("PSLRA"), requires a "heightened pleading standard" of scienter, that is, "a mental state embracing intent to deceive, manipulate, or defraud." Here, the district court found, and the Third Circuit agreed, that Rahman had "failed to plead scienter with sufficient particularity." The particularity did not turn on the fact that Rahman's purported witnesses were confidential. Rather, the witnesses were not in a position to know the facts necessary to meet the pleading requirements, nor provided sufficient detail to support the scienter requirement in the pleadings.
The Third Circuit relied heavily on Supreme Court precedent to reiterate the heightened scienter requirement under the PSLRA. While it had the opportunity to decide other issues, it passed them up because it could affirm on the basis of the sufficiency of the pleadings. What position the Third Circuit will take on corporate scienter still remains to be seen.