Smallen Revocable Living Trust v. Western Union Company

Citation: Not availableDocket: 19-1154

Court: Court of Appeals for the Tenth Circuit; February 24, 2020; Federal Appellate Court

Original Court Document: View Document

SummaryOriginalCytator Case TreatmentBackward CitatorAnalysis

EnglishEspañolSimplified EnglishEspañol Fácil

The appeal involves the dismissal of a securities-fraud class action lawsuit filed by Lawrence Henry Smallen and Laura Anne Smallen Revocable Living Trust against The Western Union Company and several executives. The lawsuit, initiated after Western Union's settlements with regulators in January 2017, alleges that the defendants made false statements regarding the company's compliance with anti-money laundering (AML) and anti-fraud laws during the Class Period from February 24, 2012, to May 2, 2017. The district court dismissed the complaint, determining that the plaintiffs did not sufficiently plead scienter, which is necessary under the Private Securities Litigation Reform Act of 1995 (PSLRA). The court found that while some inferences of culpability existed, the plaintiffs failed to provide particularized facts that would establish a strong inference of scienter. The Tenth Circuit, exercising jurisdiction under 28 U.S.C. § 1291, affirmed the lower court’s ruling. The factual background highlights Western Union's significant regulatory challenges, including a $586 million settlement related to its AML compliance, which included a deferred prosecution agreement acknowledging prior failures in its compliance program.

Western Union agreed to pay $5 million to settle compliance-related charges from 49 states and the District of Columbia. Following this settlement, Western Union's stock price fell, prompting a shareholder class action lawsuit against the company and several senior executives, referred to as the "Individual Defendants." Key figures include CEO Hikmet Ersek, CFO Scott T. Scheirman, and CFO Rajesh K. Agrawal. The plaintiff alleges that these defendants violated Section 10(b) of the Securities Exchange Act and SEC Rule 10b–5 by making false and misleading statements about the company's compliance efforts regarding anti-money laundering (AML) and fraud issues during a five-year class period. The complaint also includes claims under Section 20(a) for joint liability of control persons. 

Defendants moved to dismiss the complaint, arguing it failed to meet the Private Securities Litigation Reform Act (PSLRA) standards for pleading scienter, or intent to deceive. The district court agreed, finding the statements about compliance and government investigations were not false or misleading, leading to the dismissal of the securities fraud claims. The plaintiff did not appeal this decision. Consequently, since there was no primary violation of securities laws, the Section 20(a) claims were also dismissed. On appeal, the plaintiff contends that the district court erred in its assessment of scienter, but the appellate court found the complaint lacked specific allegations demonstrating intent to defraud or conscious disregard of misleading shareholders, thus failing to meet the PSLRA’s requirements.

Section 10(b) of the Securities Exchange Act and Rule 10b–5 prohibit material misstatements or omissions in securities transactions. To establish a violation, a plaintiff must demonstrate: 1) the defendant made a misleading statement or omitted necessary facts; 2) the statement was related to securities transactions; 3) the defendant acted with scienter (intent to defraud or recklessness); 4) the plaintiff relied on these statements; and 5) the plaintiff suffered damages. The focus here is on scienter, which includes intent to deceive or recklessness, the latter defined as an extreme departure from ordinary care that poses a risk of misleading others. Recklessness must exceed mere negligence to meet the high threshold for liability under Section 10(b).

The court reviews dismissals under Federal Rule of Civil Procedure 12(b)(6) de novo, accepting well-pleaded allegations as true and generally only considering the complaint’s content. However, documents referenced in the complaint can be included if they are central to the claim and undisputed. The Private Securities Litigation Reform Act (PSLRA) imposes a heightened pleading standard for scienter, requiring plaintiffs to provide specific facts that strongly imply the defendant acted with the requisite mental state. In evaluating these allegations, courts must consider the complaint in its entirety, ensuring that the cumulative facts present a strong inference of scienter, while also weighing plausible, nonculpable explanations for the defendant's actions. The inference of scienter must be cogent and strong, surpassing mere plausibility.

A complaint must survive dismissal if a reasonable person finds the inference of scienter strong and at least as compelling as any opposing inference from the alleged facts. To avoid dismissal, the Plaintiff must present particularized facts indicating that the Defendants knowingly or recklessly made false statements about Western Union's anti-money laundering (AML) and anti-fraud compliance systems. The Plaintiff argues that (1) the Individual Defendants' culpable state of mind is attributed to Western Union and (2) the complaint sufficiently alleges corporate scienter on behalf of Western Union. Both arguments fail, leading to the affirmation of the district court's dismissal.

The complaint identifies five categories of facts that the Plaintiff claims demonstrate a strong inference of fraudulent intent by Western Union executives: (1) various "red flags" concerning fraud and compliance violations; (2) discussions of compliance issues at board and committee meetings; (3) interactions with government regulators and ongoing investigations; (4) admissions in a Deferred Prosecution Agreement (DPA) and conclusions from the Federal Trade Commission (FTC) in a Joint Settlement; and (5) motives of the executives to defraud investors. 

The district court's assessment of the scienter standard under the Private Securities Litigation Reform Act (PSLRA) is reviewed de novo. Even if some plausible inference of scienter exists, it does not meet the PSLRA's requirement for a strong inference. The court found the Amended Complaint lacked sufficient allegations to suggest that the Defendants were aware of or recklessly disregarded the extent of the alleged illicit activities at Western Union, or that they condoned such actions to defraud investors.

In particular, the Plaintiff cites several red flags: (1) over 550,000 consumer complaints related to fraud transactions totaling over $632 million; (2) involvement of Western Union agents in multiple countries in fraudulent transfers; and (3) arrests of third-party agents for fraud and money laundering since 2007. The Plaintiff argues that the widespread nature of these issues indicates that the Individual Defendants must have known about the ineffectiveness of the company’s compliance programs at the time of their alleged misstatements.

Two main issues undermine the argument presented. First, the $632,721,044 in fraudulent transactions over a twelve-year period constitutes less than 1% of the $85 billion transferred through Western Union in 2014, indicating that the alleged fraud does not represent a significant portion of the company’s overall business. Comparisons are made to past cases where higher percentages of fraudulent transactions supported inferences of fraudulent intent; here, the lack of significant impact suggests otherwise. Second, the plaintiff fails to provide specific facts linking the Individual Defendants to consumer complaints or agent arrests, nor do they demonstrate that these defendants were aware of deficiencies in Western Union’s compliance program. The allegations indicate misuse of the company’s system for fraud, but do not establish that the Individual Defendants knew of or were reckless regarding these activities. Attendance at board meetings discussing compliance issues does not support an inference of knowledge, as mere presence does not imply awareness of ongoing violations. Discussions regarding regulatory scrutiny and the need for compliance improvements do not equate to knowledge of unaddressed violations. Allegations related to a 2012 settlement involving Moneygram also fail, as they suggest ‘fraud by hindsight,’ which does not meet the criteria for securities fraud. Overall, the presented arguments lack sufficient basis to imply that the Individual Defendants consciously disregarded ongoing illegality.

Plaintiff’s complaint includes extensive details about government investigations into Western Union’s legal compliance, regulatory interactions, and related SEC disclosures. While defendants acknowledge that such investigations can imply scienter, they argue that this alone is insufficient to establish a strong inference of wrongdoing. The existence of investigations will be considered as part of the overall analysis of the allegations. Plaintiff claims that Individual Defendants were aware of compliance violations due to internal reports provided to investigators, which highlighted deficiencies in Western Union's compliance programs and the company's negligence towards third-party agents involved in illegal activities. However, defendants counter that the Plaintiff has not demonstrated that the Individual Defendants engaged with regulators or were informed of any legal noncompliance during the Class Period. 

The strongest case for scienter pertains to Mr. Ersek, the CEO, who was reportedly briefed by a former high-level compliance officer (CW4) on compliance issues. While this indicates that Ersek was involved in compliance matters, it does not suffice to infer scienter solely based on his position. The accounts from other confidential witnesses do not substantiate that Ersek reviewed relevant documents or was made aware of ongoing compliance issues during the Class Period. Other witnesses provided insights into internal reporting practices and the company's decision to avoid implementing stronger anti-money laundering protocols, but none directly link Ersek to knowledge of the alleged compliance failures.

CW3 asserts that the Individual Defendants were aware of ongoing investigations leading to the Joint Settlement, as upper management cooperated with these investigations. However, none of the confidential witnesses (CW1, CW2, CW3) provided direct evidence that the Individual Defendants were informed about failures in Western Union’s compliance systems or engaged in discussions about fraudulent transactions. The evidence from these witnesses adds minimal support to the Plaintiff’s claims of scienter.

The Plaintiff references a July 2013 report regarding suspicious fraudulent activity by an agent in India, which was escalated to Regional Compliance; however, there are no details on the resolution of this issue or how it indicates the Individual Defendants' knowledge of compliance failures. The Plaintiff attempts to link the Individual Defendants to knowledge of ongoing legal violations through Western Union's admissions in the Deferred Prosecution Agreement (DPA) and the Federal Trade Commission (FTC) complaints, both acknowledging serious compliance issues. Nevertheless, the PSLRA prohibits relying on hindsight to establish fraud, meaning the Plaintiff cannot argue that later revelations about compliance failures invalidate earlier optimistic statements.

The Plaintiff must show specific allegations indicating that the Individual Defendants knowingly or recklessly disregarded the falsity of their statements at the time they were made. The DPA and FTC Complaint indicate some executives were aware of violations but do not connect the Individual Defendants to those issues or demonstrate their awareness of illegal activities and compliance failures during the Class Period. 

Moreover, the Plaintiff claims the Individual Defendants had a motive to defraud investors by selling stock at inflated prices based on nonpublic information, citing specific sales made by Mr. Ersek and Mr. Agrawal during the relevant period.

The complaint includes allegations against non-defendant executives for profiting from selling Western Union stock during the Class Period. A previous ruling dismissed similar claims against Western Union’s board, noting that the Deferred Prosecution Agreement (DPA) did not imply knowledge of wrongdoing by the board or individual directors, including Mr. Ersek, who has served since 2010. The DPA does not mention Mr. Scheirman or Mr. Agrawal, and the conduct acknowledged occurred before Agrawal became CFO and made his first allegedly misleading statement. While personal financial gain can suggest motive, it is generally insufficient alone to establish a strong inference of scienter. Suspicious insider trading can indicate motive but must be evaluated against various factors such as the profit amount, portion of shares sold, changes in insider sales volume, and the count of insiders involved. Even if Ersek’s and Agrawal’s sales appear suspicious due to timing, they were linked to expiring options and were not unusual; both increased their holdings during the Class Period and their sales were minor relative to their total stock. Additionally, the absence of stock sales by Mr. Scheirman weakens the argument that negative information was concealed for financial gain. The complaint lacks details about other executives' stock sales, such as initial purchase prices or the percentage of total shares sold, making it difficult to assess the nature of these transactions. Ultimately, there is insufficient evidence to infer a motive to defraud investors among the Individual Defendants.

The absence of an alleged motive does not undermine Plaintiff's claims but does impact the evaluation of scienter. The court must determine if a reasonable person would find the inference of scienter more compelling than any plausible counter-inference from the facts. Two competing inferences exist: one suggests the Individual Defendants were aware of ongoing illegalities at Western Union yet continued to assure compliance with AML and anti-fraud laws; the other suggests they were simply overly optimistic about compliance systems without awareness of the illicit behavior. The allegations do not strongly support the inference of scienter but rather lean towards negligence or gross negligence due to a lack of specific facts indicating intentional misrepresentation. The court concluded that the complaint did not sufficiently allege that the Individual Defendants acted with the intent to deceive, leading to the dismissal of Plaintiff’s Section 10(b) claims. Although the Individual Defendants' scienter is inadequately pleaded, a strong inference of Western Union's state of mind could still arise, as a corporation's state of mind is derived from its agents. The critical question remains regarding which agent's state of mind is relevant.

The standard for imputing a non-defendant corporate agent's state of mind to a corporate defendant under the PSLRA remains unresolved in this circuit. It has been established that the scienter of senior controlling officers can be attributed to the corporation when acting within their authority. In the Adams case, a strong inference of scienter was found regarding Kinder-Morgan's CEO and CFO due to their involvement in misleading financial statements. However, the court disagrees with the plaintiff's assertion that the scienter of any Western Union agent, including lower-level officers uninvolved in the misstatement, can be imputed to the corporation. Such a broad application could lead to unwarranted liability based on the knowledge of minor employees, contrary to the PSLRA's heightened pleading standards designed to deter frivolous lawsuits. The court emphasizes that liability should focus on the state of mind of specific corporate officials directly responsible for the statements in question. Although the plaintiff argues that the scienter of certain Western Union executives, including the Chief Compliance Officer, should be attributed to the company, the allegations against these individuals do not sufficiently demonstrate a strong inference of scienter. Even if their state of mind could be considered for Western Union, the complaint fails to establish that any acted with the requisite scienter.

Mr. Koch's role is central to determining whether he should have been aware of deficiencies in Western Union's compliance systems, yet the evidence presented lacks sufficient particularized facts to infer scienter. The only pertinent fact cited is a September 2013 report about a master agent's failure to record transactions properly; however, Western Union had already taken remedial actions and did not terminate the agent. The plaintiff's argument that these measures were inadequate is unconvincing, as it does not demonstrate Mr. Koch's knowledge or conscious disregard of compliance issues. Furthermore, the plaintiff has dropped claims against Mr. Koch, as his statements were dismissed by the district court as neither false nor misleading.

Regarding Mr. Stockdale, the plaintiff references a June 2010 communication about efforts to retain an agent involved in fraudulent transactions. However, this communication occurred nearly two years before the Class Period began in February 2012 and prior to any identified misstatements. Additionally, the agent was terminated in December 2011, further weakening the claim that Mr. Stockdale was aware of ongoing violations during the Class Period. 

The plaintiff also asserts that the company's counsel and compliance officer should be held liable, citing a witness who stated that the General Counsel was briefed on agent discipline and investigations. This allegation, however, does not sufficiently support a strong inference of awareness of ongoing illegalities.

Lastly, the complaint argues for "corporate scienter," allowing for pleading against the corporation without identifying specific individuals. This doctrine has been discussed in other jurisdictions but is rarely applied to establish scienter. The overall evidence fails to establish a strong inference of scienter against any identifiable Western Union officer.

A company’s public statements can be so significantly false that they may imply some corporate officials were aware of their falsity at the time of publication. However, the court has not yet accepted or rejected this theory of corporate scienter. In this case involving Western Union, while the compliance violations were serious, they did not meet the threshold of the extreme hypotheticals described in other cases, such as a scenario where a company falsely claims to have sold a million vehicles. Therefore, even if it were possible to establish corporate scienter without individual scienter, the facts presented did not support such a claim. Consequently, the plaintiff failed to adequately plead scienter related to Western Union, leading to the dismissal of the 10(b) claim. Additionally, the plaintiff could not establish a control-person claim against the Individual Defendants under Section 20(a) of the Securities Exchange Act because there was no underlying primary violation of securities laws. As a result, the district court's dismissal of the complaint was affirmed.