In re ChinaCast Educ. Corp. Sec. Litig.

The securities common law adverse interest rule is generally not applied in cases where an innocent third party relies on an agent’s apparent authority.

Ron Chan was the CEO of ChinaCast when he committed securities fraud by embezzling millions from the corporation and misleading investors by way of omissions and false statements. Investors brought suit against Chan and ChinaCast, alleging violations of Rule 10b-5 of the Securities Exchange Act, but the claim against ChinaCast was dismissed by the district court. The district court held that the plaintiffs had failed to plead the scienter requirement sufficiently for their claim against ChinaCast after applying the “adverse interest exception,” leading the court to hold that Chan’s intent to defraud or scienter could not be imputed to ChinaCast. On appeal, the Ninth Circuit reviewed the application of the adverse interest exception. The panel disagreed with the district court’s application of the exception, finding that the exception should not have been applied in this case where it was necessary to protect the rights of third parties who dealt with ChinaCast in good faith. Further, the panel held that the district court failed to note that the adverse interest rule is not applied where innocent third parties rely on an agent’s apparent authority. In this case, the panel found that the complaint, if truthful, was sufficient to establish that Chan’s scienter could appropriately be applied to ChinaCast. REVERSED.