On June 21, 2007, the Supreme Court issued a significant decision for securities litigators and D&O insurers that eliminated a circuit split over the interpretation of a key pleading requirement of the Private Securities Litigation Reform Act (the “PSLRA”). See Tellabs, Inc. v. Makor Issues & Rights, LTD. et al., 2007 WL 1773208 (June 21, 2007). The decision interpreted the PSLRA’s requirement that plaintiffs bringing securities class actions must “state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind.” The Supreme Court held that, to satisfy the PSLRA, plaintiffs must plead facts which give rise to a “cogent inference of scienter” that is “at least as compelling” as any competing inference. (The Court did not, however, resolve the circuit split over the applicable scienter standard, which varies among jurisdictions from recklessness to deliberate recklessness.)
Before Tellabs, the federal appellate courts were divided over the meaning of the “strong inference” standard. The Second and Third Circuits had interpreted the “strong inference” standard to require plaintiffs to plead either motive or opportunity or strong circumstantial evidence of scienter. The Ninth Circuit, however, had held that, under the PSLRA, plaintiffs must plead facts that raise a “strong inference” of scienter, and held that pleading motive or opportunity was insufficient. Other circuits employed variations on these standards.
In interpreting the “strong inference” requirement, the Supreme Court set forth a number of “prescriptions” for courts applying the PSLRA. First, a court must accept all factual allegations in the complaint as true. Second, a court must consider the facts collectively, rather than individually. Thus, a court may not ask whether a specific fact in itself gives rise to a strong inference of scienter, but rather whether all of the facts considered collectively give rise to a strong inference of scienter. Third, a court must compare competing inferences that arise from the alleged facts and take into account plausible opposing inferences. Accordingly, the Supreme Court formulated the standard as follows: “[w]hen the allegations are accepted as true and are taken collectively, would a reasonable person deem the inference of scienter at least as strong as any opposing inference?”
The Tellabs decision should result in a more uniform application of the pleading requirements for establishing a strong inference of scienter.
A copy of the opinion is available here.
