- Supreme Court Clarifies Standard for Pleading Scienter in Private Securities Fraud Cases
- July 9, 2007 | Authors: Linda T. Coberly; Robert Y. Sperling; Ronald S. Betman; David E. Mollón; Gene C. Schaerr; Gail J. Standish
- Law Firm: Winston & Strawn LLP - Chicago Office
Once again, the Supreme Court has issued a ruling that takes Congress’ efforts to curb abusive private securities lawsuits seriously. In Tellabs, Inc. v. Makor Issues & Rights, No. 06-484 (June 21, 2007), the Court considered Congress’ heightened pleading requirement for scienter in securities cases. The question was whether and how the district court, on a motion to dismiss, should consider competing inferences that could be drawn from the same factual allegations. The Court held that the statutory pleading standard is satisfied if the district court finds an inference of scienter that is “at least as compelling” as any opposing inference that could be drawn from the same alleged facts. The decision thus makes it more difficult for plaintiffs to force businesses to incur the cost and disruption of defending meritless securities fraud lawsuits.
The plaintiffs in the underlying case were shareholders of Tellabs, Inc. They filed a lawsuit against the company and certain executives under the federal securities laws, alleging that the chief executive had made a series of false statements about the company’s business and financial results. The complaint also alleged facts that plaintiffs claimed were sufficient to support a “strong inference” of scienter—the mental state embracing an intent to deceive, manipulate, or defraud. The same facts, however, arguably supported the inference that the chief executive did not speak with bad intent.
The district court granted the defendants’ motion to dismiss, but the Seventh Circuit reversed. The court recognized that the Private Securities Litigation Reform Act raised the pleading bar for securities claims by requiring plaintiffs to allege facts sufficient to support a “strong inference” of scienter. But the court held that a complaint could be sustained as long as an inference of scienter was possible—or, in other words, as long as a reasonable person could infer from the alleged facts that the defendant acted with the requisite intent. The court was unwilling to consider whether the same facts would also support a contrary inference, largely because it believed that weighing competing inferences could intrude on the plaintiffs’ right to a jury trial under the Seventh Amendment.
The Supreme Court disagreed. Writing for the majority, Justice Ginsburg wrote that a district court must look at all the facts alleged, taken collectively, and decide whether they give rise to a “powerful or cogent” inference of scienter. She noted that the inquiry “is inherently comparative” and thus requires consideration of competing inferences. She concluded that a claim will survive a motion to dismiss “only if a reasonable person would deem the inference of scienter cogent and at least as compelling as any opposing inference once could draw from the facts alleged.” (Emphasis added.) This consideration of competing inferences does not offend the Seventh Amendment, particularly given that the heightened pleading standard was imposed by Congress with regard to a federal statutory claim. Just as Congress has the power to determine what a plaintiff must prove to prevail, it also has the power to determine what a plaintiff must plead to raise an issue for trial.
Justice Scalia concurred in the judgment, concluding that the majority’s standard did not go far enough. In his view, the only “natural reading” of the statutory “strong inference” language is that the inference of scienter must be more compelling than any other inference. Justice Alito agreed with that view and also wrote that the majority’s suggestion that “all” facts be taken into account ignored the requirement that facts be pleaded “with particularity.” And Justice Stevens dissented, concluding that a lesser “probable cause” standard should apply. The Court remanded the case for application of its new standard.
The case is interesting not only for its outcome, but also for what it tells us about how different Justices read statutes. Justice Ginsburg, for the majority, looked for a “workable construction” of the statutory standard that would be geared toward the statute’s goals. Justices Scalia and Alito looked at the same words and thought they had only one “natural meaning”—and it was different than what the majority had said. And Justice Stevens thought that Congress had given the courts significant discretion to decide how the statutory standard should work. These different approaches to statutory interpretation have implications far beyond this particular case.