June 21, 2007
Today the Supreme Court issued one decision, described below,
of interest to the business community.
Tellabs, Inc. v. Makor Issues &
Rights, Ltd., No. 06-484 (previously discussed in
January 8, 2007 Docket Report). In an effort to curb abusive
securities fraud litigation, the Private Securities Litigation
Reform Act of 1995 ("PSLRA") requires plaintiffs to "state with
particularity facts giving rise to a strong inference
that the defendant acted" with scienter, i.e., that the
defendant's intention was to deceive, manipulate, or defraud. 15
U.S.C. § 78u-4(b)(2) (emphasis added). Today, the Supreme Court
held that, in order to qualify as "strong," "an inference of
scienter must be more than merely plausible or reasonable--it must
be cogent and at least as compelling as any opposing inference of
Tellabs manufactures specialized equipment for fiber optic
networks. In June 2001, after the company announced declining
demand for one of its main products and lowered its revenue
projections, Tellabs' stock price fell precipitously.
Subsequently, the company and several of its executives were sued
by a class of shareholders who contended that the defendants had
engaged in a scheme to deceive investors about the true value of
Tellabs' stock. The district court dismissed the suit for failure
to satisfy the PSLRA's pleading requirement. The Seventh Circuit
reversed, holding that the statute's "strong inference" standard
is met if the complaint "alleges facts from which, if true, a
reasonable person could infer that the defendant acted with the
required intent." In an opinion by Justice Ginsburg, the Court
rejected the Seventh Circuit's standard as inadequately faithful
to the language of the PSLRA.
The Court recognized that, in adopting the "strong inference"
standard, Congress intended both to "raise the bar" for pleading
scienter in private securities cases and to promote uniformity
among the Circuits. In seeking a "workable" construction of that
standard, Tellabs establishes several important
propositions. First, all factual allegations in the
complaint must be taken as true. Second, rather than
"scrutinize each allegation in isolation," courts should instead
view securities complaints "holistically," interpreting "omissions
and ambiguities" against an inference of scienter. Third,
and most significantly, when evaluating a complaint's scienter
allegations, courts must consider "plausible opposing inferences."
The Court pointed out that, because "[t]he strength of an
inference cannot be decided in a vacuum," reasonable nonculpable
explanations for the defendant's conduct may not be ignored. In
sum, a complaint can survive "only if a reasonable person would
deem the inference of scienter cogent and at least as compelling
as any opposing inference one could draw from the facts alleged."
This decision represents an important victory for the business
community. The PSLRA's "strong inference" pleading standard was
intended to dispose of frivolous securities claims before
defendant companies have to engage in costly discovery. By
rejecting the Seventh Circuit's permissive construction of that
standard, Tellabs will make it easier for securities-fraud
defendants to get weak cases dismissed at the pleading stage. At
the same time, however, the Court did not strengthen the pleading
requirement as much as it might have. Justices Scalia and Alito,
each of whom wrote a separate concurring opinion, would have gone
further and read "strong inference" as requiring an inference of
scienter that is more plausible than any competing
inference of innocence.
Mayer, Brown, Rowe & Maw filed an amicus brief in
support of the petitioner on behalf of the Securities Industry and
Financial Markets Association and Chamber of Commerce of the
United States of America.