KNOWLEDGE CEO CAN BE IMPUTED TO CORPORATION

Interesting opinion of the United States Court of Appeals for the Ninth Circuit

Knowledge can be both actual and constructive. The question is under what circumstances actual knowledge, for instance the CEO’s knowledge, can be imputed to the corporation. This question was addressed by the Ninth Circuit in its opinion of 23 October 2015 (securities class action lawsuit against ChinaCast Education Corporation et al).

Summary (prepared by court staff):

Reversing the dismissal of a securities fraud claim, the panel held that a CEO’s fraud could be imputed to his corporate employer, even though his alleged embezzlement and misleading of investors through omissions and false statements were adverse to the company’s interests.

Taking the allegations in the complaint as true, the panel agreed with the Third Circuit and concluded that the CEO’s fraudulent misrepresentations – and, more specifically, his scienter or intent to defraud – could be imputed to the company because the CEO acted with apparent authority on behalf of the company, which placed him in a position of trust and confidence and controlled the level of oversight of his handling of the business.

The Court refers to a rule and its exception. The general rule as adopted by the Court: a corporation is responsible for a corporate officer’s fraud committed “within the scope of his employment” or “for a misleading statement made by an employee or other agent who has actual or apparent authority”. And then there is the common law’s so-called “adverse interest exception.”: a rogue agent’s actions or knowledge are not imputed to the principal if the agent acts adversely to the principal in a transaction or matter, intending to act solely for the agent’s own purposes or those of another person.

The interplay between these principles has been explained as follows:

The starting point is that all information known by the agent, at least when received within the scope of authority, is deemed known by the principal. But this is not so if the agent is acting contrary to the principal’s interests: the so-called “adverse interest” exception. In turn, the adverse interest exception itself has an exception: the principal is charged with even the faithless agent’s knowledge when an innocent third-party relies on representations made with apparent authority.

(Donald C. Langevoort, Agency Law Inside the Corporation: Problems of Candor and Knowledge, 71 U. Cin. L. Rev. 1187, 1214 (2003).

Furthermore, the Court noted:

In the circumstances of this case, imputation also comports with the public policy goals of both securities and agency law: namely, fair risk allocation and ensuring close and careful oversight of high-ranking corporate officials to deter securities fraud. (…)

According to the complaint, which governs our analysis at this early procedural stage, ChinaCast received an audit from Deloitte in 2011 detailing “material internal control weaknesses.” Yet the corporation and its board “turned a blind eye” and failed to take significant action or heighten oversight. Had they done so, they may have prevented much of the decimation of ChinaCast’s bottom line and share value. Indeed, the $120 million in illicit withdrawals began several months after the Deloitte report was issued. What’s more, Chan was hardly a random corporate bureaucrat or mid-level manager. He was ChinaCast’s founder and CEO, the one person on whom the board undoubtedly should have kept close tabs. (…)

Permitting imputation under these circumstances encourages appropriate corporate oversight.

It is all about fair risk allocation and ensuring close and careful oversight of high-ranking corporate officials… For further background and discussion click here.

Karel Frielink
(Attorney/Lawyer, Partner)

(26 October 2015)

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