Who Is Responsible For Financial Fraud?
Originally published on this site and the PLI Securities Law handbook September 2000 [and at 1203 PLI/Corp 651]
Financial fraud claims occupy a special place in securities litigation. One reason is that financial statements are important. According to the SEC, "[c]omplete and accurate financial reporting by public companies is of paramount importance to the disclosure system underlying the stability and efficient operation of our capital markets. Investors need reliable financial information when making investment decisions."[FN1] Another reason is that it is difficult to reduce exposure to financial fraud claims. Consider by contrast, claims based on forward-looking statements. A company may choose not to issue such statements at all. Or, if it chooses otherwise, it may accompany its projections with meaningful cautionary disclosures of the factors that could cause actual results to differ, and the Safe Harbor prohibits a securities fraud lawsuit.[FN 2] Even if a company does not do this, plaintiffs must plead and prove that the forward-looking statements were made with actual knowledge of their falsity.[FN 3] Not so for financial statements. Companies must report financial results every quarter. Moreover, if a company restates its financial statements, or if questions are raised about the accuracy of those statements, the statements rest outside of the statutory Safe Harbor, and hence recklessness liability may still exist.[FN4]
It begs the question, however, to state that financial fraud claims are significant to companies. Many persons may be involved in the preparation of financial statements. In some cases, some persons may have acted with an intent to defraud; as plaintiffs are fond of saying, "books do not cook themselves." It is an open question as to which persons' culinary malfeasance may be attributed to a company, or, conversely, when a company's misstated financials may be attributed to an individual.
In view of the significance of financial fraud claims, this article discusses issues surrounding the liability of particular defendants in financial fraud cases. The first section briefly investigates what must be alleged to plead a financial fraud claim against particular defendants. The second section investigates a more interesting question: when may a company be held liable for financial fraud?
Pleading financial fraud
In many respects, pleading a financial fraud claim is no different than pleading any other type of securities claim. The Reform Act (and perhaps also Fed. R. Civ. P. 9(b)) require dismissal if plaintiffs do not plead the circumstances of the alleged financial fraud with sufficient detail. Courts may dismiss a financial fraud complaint against all defendants on this basis.[FN 5] The Reform Act also requires plaintiffs to set forth the basis of any allegations made on information and belief, although the contours of this duty are in dispute.[FN 6] For these reasons, a complaint that may have sufficed to plead financial fraud under pre-Reform Act law, e.g., Cooper v. Pickett, 137 F.3d 616 (9th Cir. 1996), may not satisfy Reform Act standards. See Hockey v. Medhekar, 30 F. Supp. 2d 1209, 1216 (N.D. Cal. 1999).
There are also special rules that apply to pleading financial fraud claims. Most courts have held that it does not suffice to allege that financial statements were not prepared in accordance with generally accepted accounting principles ("GAAP").[FN 7] This makes eminent sense, for, as one court explained, the failure to follow GAAP could have resulted from an incorrect accounting judgment rather than an intent to defraud.[FN 8] At the same time, as one court opined, GAAP violations may be probative of scienter, depending on the nature of the alleged violations.[FN 9] It also does not suffice to allege that a company restated its financials.[FN 10] Were the rule otherwise, a company could not reassess the estimates used in financial statements or its accounting methodologies, and adjust its financial statements accordingly, without being accused of fraud.
Below these aggregate level principles, the law becomes murkier when it comes to pleading claims against particular defendants. Some district courts, ruling before appellate courts had started to interpret the Reform Act, assumed without separate analysis that if a financial fraud claim had been pleaded against a company, a claim also was stated against senior executives.[FN 11] This cannot be the law. A particular officer may not have made (or even participated in the making of) financial statements. If that is the case, under Central Bank v. First Interstate Bank, 511 U.S. 164 (1994), he or she cannot be liable.[FN 12] Moreover, the Reform Act requires plaintiffs to plead and prove fraud on an individualized basis; that is, defendant-by-defendant.[FN 13] Absent particularized allegations against a particular defendant, no claim may be stated against that defendant.
At about the same time, a trilogy of Second Circuit court cases, relying in part on pre-Reform Act law, held that financial fraud within an organization may not automatically be attributed to a corporate defendant. In Chill v. General Electric Co., 101 F.3d 263 (2d Cir. 1996), Glickman v. Alexander & Alexander Services, Inc., No. 93 Civ. 7594 (LAP), 1996 WL 88570 (S.D.N.Y. Feb. 29, 1996), and In re Baesa Securities Litigation, 969 F. Supp. 238 (S.D.N.Y. 1997), plaintiffs sought to hold parent corporations liable for financial frauds at their subsidiaries. In each case, the fraud resulted in improper revenue recorded on the parent's consolidated financial statements. In each case, the court dismissed the complaint because it did not plead facts giving rise to an inference that the parent companies knew of, or consciously disregarded, the subsidiaries' frauds.
This initial period of post-Reform Act financial fraud jurisprudence culminated in In re Comshare, Inc. Securities Litigation, 183 F.3d 542 (6th Cir. 1999). In that case, the complaint alleged that a foreign subsidiary had committed financial fraud by issuing side letters that precluded revenue recognition of certain contracts. The Court held that the complaint did not plead a securities claim against the parent company and its officers and directors. In reaching this conclusion, the Court explicitly followed Chill and Baesa in holding that scienter could not be presumed from the parent's purported reliance on its subsidiary's internal financial controls; and found that the complaint had not pled specific facts that "illustrate 'red flags' that should have put Defendants on notice of the revenue recognition errors, or that demonstrate reasons for Defendants to have questioned the revenue reporting of its . . . subsidiary."[FN 14]
Under Comshare, at a minimum, a complaint must plead, with factual specificity, that each defendant either intentionally published materially false financial statements, or published financial statements with awareness of facts that put them on notice of the falsity of those statements. This is not to say that it is impossible to plead a financial fraud claim against either individual or corporate defendants, at least in some courts' assessments of Reform Act pleading standards. For example, In re Imperial Credit Indus., Inc. Sec. Litig., Nos. CV 98-8844 SWV et al., slip op. (C.D. Cal. Feb. 23, 2000), was, like Chill and its progeny, a suit brought by shareholders of the parent company. In this case, however, the subsidiary had made its own statements directly to the public. The court found that the complaint pleaded a strong inference of scienter because it quoted alleged e-mail messages showing the parent's actual awareness of the true financial facts. In In re System Software Associates, Inc., No. 97 C 177, 2000 WL 283099, *14 (N.D. Ill. Mar. 8, 2000), the court found that the complaint pleaded scienter by alleging that the officers had rejected the company's outside auditors' advice that the company's revenue recognition practices and decisions did not conform to GAAP.
Nor is Comshare the final word. The decision may be questioned to the extent that it allows a lawsuit based on what a defendant objectively "should have" known about financial statements, as distinguished from the subjective, actual intent to defraud that is in the author's opinion the only form of recklessness that may qualify as intentional misconduct, i.e., scienter.[FN 15] And Comshare did not need to distinguish between the company and the individual defendants in dismissing the complaint at bar. It is to the far more difficult question of when a company may be liable that this article now turns.
The company's liability for financial fraud
Assume that, based on whatever standard a court has applied, a financial fraud claim has been pleaded against a company and certain of its officers. If no person at the company (including the defendants) engaged in financial fraud, then liability is an easy question: no one may be held liable. This almost certainly also would apply to any independent auditors named as defendants; it is difficult to imagine a company and its officials that did not intend to defraud, with auditors who did and who were able to effect their intent.
Now assume that a financial fraud claim has been pleaded, and at least one person did intend to defraud and accomplished his or her intention. If plaintiffs cannot prove that a particular defendant possessed the intent to defraud, then he or she cannot be held liable. But when may the company be held liable? This question raises the difficult topic of corporate scienter law. A corporation's knowledge and action can encompass only the knowledge and action of its directors, officers and employees; that is, it cannot encompass any other person's knowledge or actions.[FN 16] But no court has analyzed precisely which persons' knowledge and actions may be imputed to a corporation, and when they may be imputed. Indeed, there are questions as to whether this enterprise is legitimate. As one commentator noted, even before Central Bank eliminated all non-statutory forms of secondary liability, "it [was] unclear whether agency concepts will be invoked to impute to a corporation knowledge of its officers, board of directors or employees."[FN 17] Under Central Bank, one may argue that the (non-statutory) agency basis for imputing liability no longer exists. The same commentator also opined that even if the knowledge of a corporation's officers, directors, or employees may be imputed to a corporation, the specific intent to defraud - i.e., the conscious element of scienter - probably cannot be imputed.[FN 18]
With this background in mind, as an analytical construct, this article examines outcomes based on two variables:
- 1. The state of mind - either (a) no intent to defraud, (b) recklessness,[FN 19] or (c) an actual intent to defraud - of and for each of
- 2. Three particular persons: the (a) the Chief Executive Officer, (b) the Chief Financial Officer, or (c) any lower-level officer or employee.
The permutation of these variables produces a matrix of 27 different outcomes.[FN 20] Fortunately, many of the outcomes may be grouped together for analytical purposes. In recognition of this point, the remainder of this article analyzes the matrix of outcomes in what is believed to be sufficient detail, by first examining outcomes based on the second variable above. If an old mathematics major may be forgiven, the author will call this method a "partial derivative" approach.
The (relative) irrelevance of lower-level officers or employees
The first partial derivative subset of outcomes in the matrix depends on the state of mind of a lower-level officer or employee allegedly engaged in financial fraud. There are good reasons to conclude if a lower-level officer or employee acted with recklessness or an actual intent to defraud, that variable may affect that person's individual liability, but cannot by itself render the company liable.[FN 21]
First, to the extent case law has imputed scienter from an individual to a company, courts appear to have restricted this mechanism to senior officers and directors.[FN 22] This makes sense. As contended below, there is a more focused and natural target than lower-level officials in ascertaining a company's conscious intent to issue true or false financial statements.
Second, the significance of focusing on senior executives has been buttressed by the Reform Act. In deciding how to treat forward-looking statements made on behalf of an entity, Congress decided that a plaintiff must prove that the statement was "made by or with the approval of an executive officer of that entity . . . with actual knowledge by that officer that the statement was false or misleading."[FN 23] There is no reason why this reasoning should not apply to financial statements, too. Congress apparently decided that even though many persons within a company may be responsible for preparing forward-looking statements, it is not fair to blame the company if lower-level officers or employees made false representations (either within the company, to the persons who actually made the forward-looking statements; or directly to the public) in that context. But financial statements, too, are the responsibility of many employees within a company. Thus, if there is no scienter on the part of any executive officer of the company who made or approved the financial statements - i.e., if only lower-level officers or employees possessed either recklessness or an actual intent to defraud - then there should not be liability for the company.
Third, it would be anomalous under corporate governance law to hold senior officers responsible for their good faith reliance on the representations of lower level officers and employees - even if those lower level officials misled the senior officers, and as a result caused false financial statements to be issued. As one court stated, where high level officials of a corporation were not aware of the improprieties committed by lower-level officials, they "cannot be faulted," even if the improprieties severely harmed the corporation.[FN 24] If senior management's lack of knowledge of improprieties cannot give rise to a breach of fiduciary duty claim, it should not suffice to establish liability for securities fraud (which, after all, requires scienter). Then, if there are no individually liable senior managers, there is no sufficiently senior person whose liability may be imputed to the company (assuming that liability may be imputed at all). The only exception to this syllogism may be if a senior officer issued financial statements in reckless disregard of the lower level officials' financial fraud - which is probably the type of liability Comshare attempted to acknowledge. This moved the focus of the company's liability towards where it should be: the state of mind of the CFO and CEO.
The primacy of the Chief Financial Officer
The second subset of partial derivative outcomes in the matrix depends on the state of mind of the company's Chief Financial Officer. The soundest position is that the actions and state of mind of the CFO should be the primary focus in determining whether a company may be liable for issuing false financial statements.
It makes sense to assign this primacy to the CFO. If it ever may be proper to impute the conscious element of scienter from an individual to a company, the company's conscious intent to issue financial statements that are either true or false should depend on the person charged with preparing the financial statements: the CFO. This functionalist principle corresponds with investors' expectations: investors know that a company's CFO is charged with the responsibility for preparing its financial statements. It also corresponds with the pre-Reform Act group pleading doctrine, now abrogated, which allowed plaintiffs to plead a claim against particular individuals based on the functional roles that those individuals fulfilled within the company.[FN 25] If a claim is based on false financial statements, it makes sense to look at the Finance officials. It further is consistent with the SEC's administrative mission to regulate accounting practices and the accounting profession. While the SEC may sanction any person who issues false financial statements, the Commission appears to pay particular attention to the accountant or auditor who engages in such misconduct.[FN 26] And the Commission recently directed companies to adopt Audit Committee charters, again signaling the special significance of the Finance function in a company (and up through its directors).
The primacy of the CFO also make sense because another actor is important in insuring the integrity of a company's financial statements: the independent auditors. Investors often look to a company's independent auditors (among others) to fulfill this role; and case law establishes that if a company follows the informed advice of its independent auditors, it may not be liable because it lacks scienter.[FN 27] The significance of the independent auditors buttresses the primacy of the company officer most likely to be responsible for the company's relationship with the auditors, i.e., the CFO.
It follows from the primacy of the CFO that if a company issued false financial statements and liability is proven against the CFO individually, this is the situation in which it is most likely that a company also may be responsible for financial fraud. In contrast, iF the CFO had no intent to defraud, the company should not be liable for issuing false financial statements, even if someone else at the company was reckless or had the actual intent to defraud. Where that other, fraudulent person is a lower-level officer or employee (i.e., both the CFO and the CEO lacked an intent to defraud), this should be a relatively non-controversial conclusion for the reasons set forth in the previous section. Where that other person is the CEO, the question is more difficult. It is to that question that this article now turns.
The Chief Executive Officer
The third subset of partial derivative outcomes in the matrix depends on the state of mind of the company's Chief Executive Officer. If CEO had no intent to defraud, he or she may not be liable, and liability rests solely on the state of mind of the CFO. But what if the CEO intended to defraud, via either recklessness or the actual intent to defraud? How should this affect the company's liability?
It may seem counterintuitive that a CEO may be liable for issuing false financial statements but his or her company may not be liable. In an ideal(istic) world, it is never appropriate to say that it is someone else's responsibility to follow proper accounting policies. Rather, if an employee has any information relevant to insuring that the company's rules are followed, that employee should communicate that information to the persons responsible for preparing or reviewing the financial statements. This renders the CEO important, for the CEO is in a superior position to make it clear that responsibility and honesty in the preparation of financial statements is an integral part of a company's ethics. Moreover, a purpose of the private securities lawsuit is to compensate investors damaged by fraud. If a company is not liable for issuing false financial statements, then there is one fewer defendant from whom compensation may be obtained.
But as counterintuitive as it may be to find that a company is not automatically responsible for financial fraud when the CEO is liable, the converse proposition is worse. For it may be the case that while the CEO intended to issue false financial statements, the CFO did not. Some would argue that financial frauds require the intervention of a CFO (although, in any event, a CFO's complicity must be pleaded and proven, not assumed). Yet it is easy to imagine an alternative scenario.
Consider, for example, Comshare under a slightly different set of facts. In reality, the complaint did not plead any specific facts from which it could be inferred that any person within the company's management was aware of the subsidiary's side letters. But what if it could be pleaded and proven that the CEO authorized the side letters, but that the CFO did not? What if it also was the case that CFO had no specific reason to suspect that there were side letters, or even that the CFO had been told by the CEO that there were no side letters? In all of these scenarios, the most logical conclusion is that the company - through the CFO charged with preparing its financial statements - did not intend to issue false financial statements, and hence may not be liable for lack of scienter. If false financial statements nevertheless were issued, it was only by the CEO's circumvention of the intent of the CFO and the company's internal controls.
Put in other terms, the reasons why the CFO's state of mind should be paramount in a financial fraud case also mean that the CEO's state of mind is not dispositive of the company's liability. To find the intent underlying a company's financial statements, look to the head Finance officer. At the very least, it should be the case that as between the CEO and CFO, the CFO's state of mind is more important. To be certain, one of a CEO's responsibilities is to insure that a company issues true financial statements. But for a CFO, issuing true financial statements is the prime responsibility, and both investors and the SEC expect a CFO to fulfill this responsibility.
There is one other factor by which to fine-tune the analysis of a company's liability for financial fraud. Securities fraud liability is no longer an all-or-nothing proposition. The Reform Act now distinguishes between knowing violators of the securities laws - those persons who "make an untrue statement of a material fact, with actual knowledge that the representation is false; or omit to state a fact necessary in order to make the statement not misleading, with actual knowledge that, as a result of the omission, one of the material representations of the person is false [FN 28] - and non-knowing violators, which is everyone else. Only knowing violators are jointly and severally liable.[FN 29] Non-knowing violators are liable solely for that portion of the judgment that corresponds to their percentage of responsibility.[FN 30] Each defendant is entitled to pose special interrogatories on these topics to the trier of fact.[FN 31] While there is little, if any, analysis of these terms in the legislative history of the Reform Act, it would not be surprising to find courts concluding that the distinction between knowing and non-knowing violators is analogous to the distinction between liability based on the actual intent to defraud and recklessness liability.
The distinction between types of liability means that if the CFO is found personally liable for issuing false financial statements, and the company's liability derives from the CFO's liability, it matters if the CFO was reckless or possessed an actual intent to defraud. If the CFO was reckless, a company may contend that a lower-level officer or employee also was involved in and responsible for the financial fraud, and hence that the company's liability should be apportioned to reflect the lower-level employee's responsibility.[FN 32] (Thus, while the state of mind of a lower-level officer or employee should not influence whether the company may be responsible, it may affect the extent of liability.) Conversely, a court may conclude - and this is a particularly difficult question - that under particularly egregious factual circumstances, if the CEO had the intent to defraud and the CFO was reckless in issuing false financial statements that reflected the CEO's dishonest intent, the company's state of mind reflected an actual intent to defraud.
Points for further analysis . . . and a reversal in perspective?
Under present law, there are few easy answers to the questions regarding corporate liability for financial fraud. This article will not be the last word on the topic, nor does it exhaust the factors that may be considered - three of which are presented below.
First, there should be a comprehensive theory of the Reform Act's proportionate liability provisions. As noted above, each defendant is entitled to special interrogatories regarding the pertinent facts. How may a jury apportion liability between a company defendant and an individual defendant? Must a jury avoid "double counting" liability as between an individual defendant and a corporate defendant; for example, if a CFO and a company are the only defendants, the CFO is only a non-knowing violator, and the CFO's liability also is imputed to the company, must the CFO's proportionate liability plus the company's proportionate liability equal 100%? Unfortunately, the legislative history of the Reform Act is silent on these topics.
Second, there should be an analysis of the relationship between corporate liability and indemnification obligations. Even if a company lacks the scienter required to become responsible for a financial fraud to plaintiffs, a company still may face indemnification demands from persons who are liable.
Third, there may be an alternative test of corporate liability that is divorced from any officer's individual liability: a company may be liable for issuing false financial statements if and only if its internal controls intentionally or recklessly allowed the publication of false financial statements. This test would render it difficult to hold a company responsible for financial fraud when the CEO (and perhaps even the CFO) intended to defraud. The most difficult internal controls to devise - and hence the most difficult ones to second-guess - are the controls that may not be circumvented by the most senior officers. Thus, it will be difficult to plead or prove that a company intentionally or recklessly maintained fraudulent internal controls, when those controls were circumvented by those persons charged with maintaining them.
The final question (and the analysis in this article) may well lead us to a reversal in the common perspective of corporate scienter. Typically, plaintiffs are the party who contends that scienter may be pleaded and proved under "collective scienter" analysis.[FN 33] Under plaintiffs' approach, a company's scienter is defined to be the collective product of all of its directors', officers', and employees' states of mind (or, in some variants, of the directors and officers); and, hence, if any one of those directors, officers, or employees intended to defraud, then so did the company. But if the question in financial fraud cases is whether a company's key Finance officials intended to defraud; or, as theorized in the previous paragraph, whether the company's internal controls intentionally or recklessly allowed false finacial statements; then "collective scienter" has a very different meaning. A company's scienter (if that theory applies at all) may well be ascertained on a collective basis -- not in plaintiffs' sense, in which any single person's intent to defraud dooms the company to liability; but in a new sense, in which the company's core or majority intent not to issue false fianancial statements saves the company from liability.
 Request for Comment on Increasing the Level of Involvement of the Independent Accountant with Interim Financial Information, Release Nos. 33-6837; 34-26929; 35-24907; IC-17016, 54 Fed. Reg. 27,023, at 27,024 (June 20, 1989).
 See Securities Exchange Act of 1934 § 21E(c)(1)(A)(i), 15 U.S.C. § 78u-5(c)(1)(A)(i) (written forward-looking statements); Securities Exchange Act of 1934 § 21E(c)(2), 15 U.S.C. § 78u-5(c)(2) (oral forward-looking statements).
 See Securities Exchange Act of 1934 § 21E(c)(1)(B)(i), 15 U.S.C. § 78u-5(c)(1)(B)(i) (forward-looking statement made by natural person); Securities Exchange Act of 1934 § 21E(c)(2)(1)(ii), 15 U.S.C. § 78u-5(c)(1)(B)(ii) (forward-looking statement made by business entity).
 See Securities Exchange Act of 1934 § 21E(b)(2)(A), 15 U.S.C. § 78u-5(b)(s)(A) (Safe Harbor does not apply to forward-looking statements included with a financial statement prepared in accordance with generally accepted accounting principles); Securities Exchange Act of 1934 § 21E(c)(1)(i)(1);15 U.S.C. § 78u-5(c)(1)(i)(1) (definition of "forward-looking statement").
 See, e.g., Wilson v. CKS Group, No. C98-4229 MMC, slip op. at 9-11 (N.D. Cal. Mar. 21, 2000); In re Versant Object Tech. Corp. Sec. Litig., No. C 98-00299 CW, slip op. at 22-24 (N.D. Cal. May 18, 2000); Ree v. Pinckert, No. C99-0562 MMC, slip op. at 16-18 (N.D. Cal. Mar. 28, 2000); Branca v. Paymentech, Inc., No. Civ. A 3:97-CV-2507-L, 2000 WL 145083(N.D. Tex. Feb. 8, 2000).
 Compare In re Silicon Graphics, Inc. Sec. Litig., 183 F.3d 970, 985 (9th Cir. 1999) (In the Ninth Circuit, a plaintiff must plead, "in great detail, all the relevant facts forming the basis of [its] belief."); and Novak v. Kasaks, 216 F.3d 300, 313 (2d Cir. 2000) (need not name sources of allegations).
 See In re Milestone Sec. Litig., 103 F. Supp. 2d 425, 472-73 (D.N.J. 2000) (quoting Stevelman v. Alia Research, Inc., 174 F.3d 79, 84-85 (2d Cir. 1999)); see also Head v. Netmanage, Inc., No. C 97-4385 CRB, 1998 WL 917794, *6 (N.D. Cal. Dec. 30, 1998) ("the mere fact that [a company] changed its publicly-disclosed accounting policy that may have violated GAAP, and that the change led to lower reported revenues in the following quarter, does not support any inference of scienter, let alone the required strong inference.").
 See Mortensen v. Americredit Corp., No. Civ. A. 3:99-CV-0789, 2000 WL 472865, *6 (N.D. Tex. Apr. 21, 2000); see also Mathews v. Centex Telemanagement, Inc., [1994-95 Tr. Binder] Fed. Sec. L. Rep. (CCH) 98,440, at 91,037 (N.D. Cal. June 8, 1994) (so long as defendants method of projection used in setting accounts receivable reserves was reasonable, summary judgment is appropriate).
 In re the Baan Co. Sec. Litig., 103 F. Supp. 2d 1, 21 (D.D.C. 2000); accord, In re Reliance Sec. Litig., MDL No. 1304 (C.D. Del. Apr. 19, 2000) (alleged violations of GAAP gave rise to an inference of recklessness).
 Mortensen, 2000 WL 472865; In re Evans Sys., Inc. Sec. Litig., No. H-99-2182, slip op. (S.D. Tex. May 31, 2000); Alabaster v. Bastiaens, Civ. No. 99-10237-NG, slip op. (D.Mass. July 27, 2000).
 See Rehm v. Eagle Fin. Corp., 954 F. Supp. 1246 (N.D. Ill. 1997) (claim stated against CEO, President, and CFO); In re Wellcare Mgm't Group Sec. Litig., 964 F. Supp. 632 (N.D.N.Y. 1997) (CEO and CFO); In re Ancor Communications, Ins. Sec. Litig., No. 97-1696, 1998 U.S. Dist. LEXIS 10988 (D. Minn. July 14, 1998) (CEO and CFO); Epstein v. Itron, Inc., 993 F. Supp. 1314 (E.D. Wash. 1998) (CEO); Marksman Partners, L.P. v. Chantal Pharm. Corp., 927 F. Supp. 1297 (C.D. Cal. 1996) (CEO).
 See Wright v. Ernst & Young LLP, 152 F.3d 169, 175 (2d Cir. 1998) ("If Central Bank is to have any real meaning, a defendant must actually make a false or misleading statement in order to be held liable under Section 10(b).") (quotations omitted); cf. In re Software Toolworks Sec. Litig., 50 F.3d 615, 628 n.3 (9th Cir. 1994) (auditing firm that co-authored letter to SEC may be liable for statements contained therein).
 See Brinker Capital Holdings, Inc. v. Imagex Services, Inc., No. 96-CV-0038 (FJS), 1998 WL 139416, *2 (N.D.N.Y. Mar. 26, 1998) ("Additionally, to create a strong inference of scienter on the part of a defendant the [Reform Act] requires that facts be alleged with particularity as to that defendant.").
 183 F.3d at 553-54.
 See Ernst & Ernst v. Hochfelder, 425 U.S. 185, 193 n.12 (1976).
 Gould v. American-Hawaiian S.S. Co., 535 F.2d 761, 780 (3d Cir. 1976).
 5 Arnold S. Jacobs, Litigation & Practice Under Rule 10b-5, §63 at 3-339 (1982).
 Jacobs, §63 n.76 (discussing Gerstle v. Gamble-Skogmo, Inc., 478 F.2d 1281 (2d Cir. 1973)).
 This article assumes for heuristic purposes only that recklessness suffices as scienter.
 For example, the lower-level officer or employee may have acted with recklessness, the CFO with no intent to defraud, and the CEO with actual intent to defraud; the lower-level officer or employee and the CFO may have acted with no intent to defraud, while the CEO acted with recklessly; and so on.
 As shown in the final subsection, the lower-level officer or employee's state of mind may affect the extent of the company's liability.
 See, e.g., Nordstrom v. Chubb & Son, Inc., 54 F.3d 1424, 1435 (9th Cir. 1995) (insurance dispute following settlement of securities case) ("a corporation may be liable for actions by senior management personnel that are 'intrinsically corporate and bear the imprimatur of the corporation itself.'") (quotation omitted).
 Securities Exchange Act of 1934 § 21E(c)(1)(B)(ii), 15 U.S.C. § 78u-5(c)(1)(B)(ii) (emphasis added).
 In re Caremark Int'l Inc. Derivative Litig., 698 A.2d 959 (1996) (approving settlement of derivative claim for zero dollars during pendency of motion to dismiss). See the author's article, Directors' Reliance on Internal Controls in Light of Caremark and W.R. Grace
 The best analyses confirm that as the Reform Act requires that falsity and scienter be pleaded on an individualized basis, it "codifies a ban against group pleading." Coates v. Heartland Wireless Communications, Inc., 26 F. Supp. 2d 910, 916 (N.D. Tex. 1998); Calliot v. HFS, Inc., No. Civ. A. 3:97CV0924I (N.D. Tex. Mar. 31, 2000) (doctrine does not survive Reform Act); Branca v. Paymentech, Inc., No. Civ. A.3:97-CV-2507-L, 2000 WL 145083, *8 (N.D. Tex. Feb. 8, 2000) (same); Marra v. Tel-Save Holdings, Inc., Master File No. 98-3145, 1999 WL 317103, *5 (E.D. Pa. May 18, 1999) (same); In re Ascend Communications Sec. Litig., No. CV 97-8861 MRP, slip op. at 12 (C.D. Cal. Feb. 2, 1999) (same); see also Allison v. Brooktree Corp., 999 F. Supp. 1342, 1350 (S.D. Cal. 1998) ("To permit a judicial presumption as to particularity simply cannot be reconciled with the statutory mandate that plaintiffs must plead specific facts as to each act or omission by the defendant."). When the group pleading doctrine was the law, it applied only to a "narrowly defined group of officers who had direct involvement not only in the day-to-day affairs of [the company] in general but also in [the company's challenged] financial statements in particular." Wool v. Tandem Computers, Inc., 818 F.2d 1433, 1440 (9th Cir. 1987).
 A recent uncontested enforcement action illustrates this point. In In the Matter of Micro Warehouse, Inc., 1999 WL 548531 (S.E.C. July 28, 1999), charges were brought against a company's corporate controller \ chief accounting officer, and a senior accounting manager. The SEC found by consent decree that these persons "knew, or were reckless in not knowing, that they were engaged in a fraudulent scheme that caused the financial statements to be materially false and misleading. Their state of mind may be imputed to [the company]." Id. at *5. While it is doubtful that a court would impute scienter from such lower-level officials to a company in a private securities action, this SEC case shows that when it comes to financial statements, a company's Finance department is crucial. In a private securities action, the intersection of the sets "Finance department" and "senior executives" is one person: the CFO.
 In re Worlds of Wonder Sec. Litig., 35 F.3d 1407, 1426 (9th Cir. 1994). There undoubtedly are other questions regarding auditors' responsibility for financial fraud that are not discussed in this article.
 Securities & Exchange Act of 1934 §21D(g)(10)(A)(i), 15 U.S.C. § 78u-4(g)(10)(A)(i). It must also be the case that "persons are likely to reasonable rely on that misrepresentation or omission."
 Securities & Exchange Act of 1934 §21D(g)(2)(A), 15 U.S.C. § 78u-4(g)(2)(A).
 Securities & Exchange Act of 1934 §21D(g)(2)(B)(i), 15 U.S.C. § 78u-4(g)(2)(B)(i).
 Securities & Exchange Act of 1934 §21D(g)(3)(A), 15 U.S.C. § 78u-4(g)(3)(A).
 Securities & Exchange Act of 1934 §21D(g)(3)(A)(ii), 15 U.S.C. § 78u-4(g)(3)(A)(ii) (defendant entitled to special jury interrogatories with respect to each defendant "and each of the other persons claimed by any of the parties to have caused or contributed to the loss incurred by the plaintiff" concerning "[t]he percentage of responsibility of such person, measured as a percentage of the total fault of all persons who caused or contributed to the loss incurred by the plaintiff"); Harold S. Bloomenthal, Private Securities Litigation Reform Act: Special Update 61 (Clark Boardman Callaghan 1996) (under this provision, defendants may "try the empty chair").
 Thus, plaintiffs contend that Nordstrom , 54 F.3d 1424, endorsed such an analysis, when it did not.