In In re Sketchers U.S.A., Inc. Securities Litigation,  05cv55980 (9th Cir. April 10, 2008),  the Ninth Circuit applied the recent U.S. Supreme Court decision Tellabs, Inc. v. Makor Issues & Rights Ltd., 551 U.S. ___, 127 S.Ct. 2499 (2007) and found that plaintiffs failed to plead scienter, as required by the PSLRA.  Click here to read the Ninth Circuit decision.

Plaintiffs alleged that Sketchers USA, Inc. and four of its principal  officers committed securities fraud in violation of sections 10(b) and 20(a) of the 1934 Securities Exchange Act when they made optimistic earnings projections in press releases and conference calls, knowing that the company had been experiencing a decrease in sales demand.  The United States District Court for the Central District of California found that the plaintiffs  had  failed to adequately plead scienter under the PSLRA.  The Court of Appeals for the Ninth Circuit, applying the pleading standard articulated in Tellabs (click here to read our prior discussions of Tellabs) affirmed the dismissal.

In arguing that the named defendants knew that their class period statements were false, the plaintiffs relied in large part on a confidential witness’s account of a sales meeting in February suggesting that the company’s sales were down.  However, the Ninth Circuit found that allegations that the officers knew that sales were down in February did not strongly support an inference that the officers’ optimistic statement in April were fraudulent when made two months later.  The Ninth Circuit, relying on Tellabs, stated that omissions and ambiguities count against inferring scienter and that it must consider plausible opposing inferences that are unfavorable to plaintiffs.  Accordingly, statements in the record that suggested that the company’s sales were experiencing an upswing in March were considered in negating an inference that defendants’ statements in April (optimistic earnings projections) were false.

Although the pleading standard for scienter in securities class action was always intended to be high, Tellabs now makes it clear that “plausible opposing inferences” that are unfavorable to plaintiffs must also be considered in analyzing defendants’ scienter.  This does not mean that plaintiffs’ pleading burden is  insurmountable but plaintiffs must do more than just cite to evidence supporting a strong inference of scienter:  plaintiffs must also show that their theory of fraud is at least as strong as the potential non- culpable explanation of defendants’ intent.  In this case the Ninth Circuit found it was not.

Even at this relatively early date, apparently-conflicting applications of the Tellabs decision by different Courts of Appeal suggest that the debate over scienter pleading sufficiency if far from over.  On remand, the Seventh Circuit revived the Tellabs case, and on April 16, 2008, the First Circuit revived a securities fraud case that had been dismissed by the district court in Missouri Public Employees’ Retirement System v. Boston Scientific, 07cv1794 (1st Cir. April 16, 2008).  These recent federal appellate decisions are likely just the first in a series of Circuit Court decisions taking widely different approaches to application of the Tellabs holding.  Stay tuned.