More on Today’s Opinion in Tellabs, Inc. v. Makor Issues and Rights
on Jun 21, 2007 at 7:55 pm
This entry was authored by Carolyn Hadgikosti, a summer associate at Akin Gump and a student at the University of Michigan Law School.
In 1995, Congress enacted the Private Securities Litigation Reform Act (â€œPSLRAâ€), which was intended to curb abusive private securities fraud suits. Reflecting Congressâ€™s belief that traditional notice pleadings failed to prevent investors from filing bringing frivolous suits, the Act imposed a heightened pleading standard — requiring plaintiffs to â€œstate with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind.â€ Today, by a vote of eight to one, the Supreme Court attempted to clarify what Congress meant by â€œstrong inference.â€ In Tellabs v. Makor Issues and Rights, the Court â€“ in an opinion by Justice Ginsburg â€“ held that to qualify as â€œstrong,â€ an inference of wrongful intent must be “more than merely plausible or reasonable — it must be cogent and at least as compelling as any opposing inference” suggesting lack of intent to defraud.
The dispute in Tellabs began in December 2002, when Tellabs shareholders filed a securities fraud claim alleging (inter alia) that the companyâ€™s Chief Executive Officer, Richard Notebaert, purposely misled the public when â€“ despite being aware that demand for the companyâ€™s new fiber-optic networking product was declining â€“ he boasted of rosy financial expectations for the product. The district court dismissed the case for failure to meet the heightened pleading requirements imposed by the PSLRA. [For more background on the case, you can read Anitha Reddyâ€™s pre-argument summary here.]
As relevant here, the Seventh Circuit reversed. It held that the shareholders had sufficiently alleged facts giving rise to a â€œstrong inferenceâ€ that Notebaert knowingly violated the law. In the courtâ€™s view, a complaintâ€™s allegations meet the â€œstrong inferenceâ€ standard as long as a â€œreasonable person could infer [from them] that the defendant acted with the required intentâ€; a court need not accept â€œonly . . . the most plausible of competing inferencesâ€ as sufficient at the pleading stage. The court reasoned that, in the face of â€œtwo seemingly equally strong inferences, one favoring the plaintiff and one favoring the defendant,â€ it would be inappropriate for a court to determine at the pleadings stage which will ultimately prevail, as to do so would invade the juryâ€™s factfinding role.
Today, the Court rejected the Seventh Circuitâ€™s interpretation as failing to adequately embody Congressâ€™s intent to raise the pleading requirement in securities fraud cases. When determining whether to dismiss a securities fraud complaint, the Court held, courts must consider not only inferences favoring the plaintiff filing the securities fraud suit but also any â€œplausible nonculpable explanationsâ€ for the defendantâ€™s conduct. And although an inference need not be â€œirrefutable,â€ it must be more than merely the â€œreasonableâ€ inference required by the Seventh Circuit. The Court also dismissed the Seventh Circuitâ€™s concern that requiring courts to weigh the plausible inferences arising from the facts alleged would infringe on the Seventh Amendment right to a jury trial. A plaintiff alleging securities fraud, the Court explained, will have to plead facts â€œrendering an inference of scienter at least as likely as any plausible opposing inferenceâ€ and will then need to prove her case by a â€œpreponderance of the evidenceâ€ at trial. Finally, the Court remanded the case to the lower courts for application of the new â€œcogent and compelling inferenceâ€ test.
In his concurring opinion, Justice Scalia criticized the new standard. In his view, the phrase â€œstrong inferenceâ€ cannot conceivably mean â€œat least as compelling as any opposing inference.â€ To illustrate his critique, he asks: â€œif a jade falcon were stolen from a room to which only A and B had access, could it be said there was a strong inference that B was the thief?â€ Instead, he posits, a natural reading of the statute would result in a test that asks whether an inference of scienter is â€œmore plausible than the inference of innocence.â€
Justice Alito, in a separate concurrence, agreed with Justice Scaliaâ€™s interpretation, which he characterized as in line with a summary judgment inquiry. Moreover, Justice
Alito added, when Congress heightened the pleadings standard for securities suits, it could not have meant to adopt an approach previously â€œunknown in civil litigationâ€ and would have instead adopted a â€œknown quantityâ€ such as the summary judgment standard. Justice Alito also disagreed with the portion of the majority opinion holding that a court should consider all allegations of scienter to determine whether the â€œstrong inferenceâ€ standard is met. In his view, this approach would â€“ contrary to the statutory language â€“ allow an inference to be drawn from facts that were not stated with particularity in the plaintiffâ€™s complaint.
Justice Stevens filed a dissenting opinion. Suggesting that it is unnecessary to weigh competing inferences to determine whether pleaded facts give rise to a strong inference of scienter, he would take an entirely different approach and use the â€œprobable cause standardâ€ instead.