The Supreme Court has issued its much-anticipated opinion in the Tellabs case. The opinion can be found here. The case examined the question of what a plaintiff is required to plead under the Private Securities Litigation Reform Act (PSLRA) in order to establish a “strong inference” that the defendant acted with the requisite mental state. The Court’s opinion, written for an 8-1 majority by Justice Ruth Bader Ginsburg, rejected both the Seventh Circuit’s standard (by which the statute’s requirements could be met if the complaint alleged facts “from which, if true, a reasonable person could infer that the defendant acted with the required intent”) and the more demanding standard sought by the SEC in its amicus brief (urging the Court to require plaintiff to allege facts that establish a “high likelihood” that the plaintiff acted with intent).
The Court held that 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 nonfraudulent intent.” The Court specifically held that in considering whether an inference is “strong,” a court must consider competing inferences, something which the Seventh Circuit had expressly declined to do. The inquiry, the Court said, is “inherently comparative.” The inference “need not be irrefutable,” but “it must be more than merely ‘reasonable’ or ‘permissible’ — it must be cogent and compelling, thus strong in light of other explanations.” A complaint should 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 inferences one would draw from the facts alleged.”
In looking at the Tellabs case itself, the Court noted that “motive can be a relevant consideration” and that “personal financial gain may weigh heavily in favor of a scienter inference” but the Court also agreed that “the absence of a motive allegation is not fatal.” The significance of an allegation of motive “depends on the entirety of the complaint.” The court’s job “is not to scrutinize each allegation in isolation but to assess all the allegations holistically.” The court’s job is to ask: “When the allegations are accepted as true and taken collectively, would a reasonable person deem the inference of scienter at least as strong as any opposing inference?”
While the Supreme Court says that the district court must weigh competing inferences, the Court rejected the Seventh Circuit’s suggestion that this type of comparative process usurps the jury’s role and violates the Seventh Amendment: “A Court’s comparative assessment of plausible inferences, while constantly assuming the plaintiff’s allegations to be true, we think it plain, does not impinge upon the Seventh Amendment right to a jury trial.”
With respect to the Tellabs case, the Court said that neither the District Court nor the Seventh Circuit “had the opportunity to consider the matter in light of the prescriptions we announce today.” The Court vacated the Seventh Circuit’s judgment and said that the case should be reexamined in accord with the Court’s construction of the PSLRA.
Even though the Court rejected the Seventh Circuit’s standard, the Supreme Court’s opinion does not go quite as far as the SEC and others may have hoped. Although the Supreme Court requires the court to weigh inferences, it does not require the inference the plaintiff urges to be the most plausible inference, only that it be at least as plausible as other inferences. A Wall Street Journal article discussing the opinion (here) quotes Barbara Hart of the Labaton Sucharow & Rudoff law firm as saying “these are the types of cases we are bringing already; our cases already meet this standard.”
The Court clearly aimed to achieve a balanced approach. It described its task in ruling on the Tellabs case as being to “prescribe a workable construction of the ‘strong inference’ standard” and to come up with “a reading geared to the PSLRA’s twin goals: to curb frivolous, lawyer-driven litigation, while preserving investors’ ability to recover on meritorious claims.” And while the majority accepted the notion that trial courts must weigh inferences in determining whether the PSLRA’s requirements must be met, it expressly rejected the position urged by Justices Scalia and Alito that “the test should be whether the inference of scienter (if any) is more plausible than the inference of innocence.” (Italics in Justice Scalia’s original concurring opinion) The majority’s rejection of this heightened standard is consistent with the Court’s stated goal of prescribing a workable construction that balances the “twin goals” of the PSLRA.
Because the Court deliberately strove for a balanced approach based on a “workable construction,” it seems unlikely that this decision will have an outcome-determinative impact on a significant number of future securities suits, and even less of an impact on whether or not suits get filed. The heightened standard that Justices Scalia and Alito urged might well have had a more significant impact, but the majority’s approach seems less likely to affect as many cases. The early commentary seems consistent with this view. For example, the Business Law Prof blog notes (here):
The majority standard is not what the defense bar wanted; they wanted the standard of the concurring judges, which the court rejected. This is not a defense bar victory; it is a draw at best. Reporters will fail to get this correct and will rack this up as another victory for corporate America; it is not. The majority held, importantly, that the pleading standard was not higher that the standard of proof required at trial; the defense bar argued that Congress so intended it to be higher. This is a big difference.
The SEC Actions blog (here) agrees, noting:
the decision should not be viewed as a clear victory for either side. Rather, the decision reflects a balance between the competing interests Justice Ginsburg sought to reflect in her opinion, permitting meritorious classes to proceed, but weeding out those that lack merit… In the standard adopted today, the Court blended together the requirement that plaintiff plead a cause of action properly and the heightened pleading requirements of the PSLRA. At the same time, the Court rejected definitions of “strong inference” that would have made it virtually impossible to plead such a case. Overall, it was a balanced decision by the Court.
The WSJ.com Law Blog has a round up of securities lawyers’ views on the Tellabs opinion (here), and they all seem to be consistent that while the Tellabs defendants successfully got the Seventh Circuit opinion thrown out, the decision is not a huge victory for defendants generally. While the Tellabs case will undoubtedly define where the battle lines will be drawn at the pleading stage in future securities litigation, the decision may not have as significant impact as it might have.
The 10b-5 Daily blog has a good summary of the case, here.
The Case of the Stolen Jade Falcon: An interesting sidelight is the interplay between majority and concurring opinions discussing Justice Scalia’s concurring opinion’s use of the example of the stolen jade falcon. Justice Scalia’s concurring opinion asks “If a jade falcon were stolen from a room to which only A and B had access, could it possibly be said that there was a ‘strong inference’ that B was the thief?”
Justice Ginsburg responds (in footnote 5) that “I suspect…that law enforcement officials as well as the owner of the precious falcon would find the inference of guilt as to B quite strong –certainly strong enough to warrant further investigation.”
Justice Scalia, committed to getting in the last word on the fabulous stolen jade falcon, responds (in a footnote to his opinion) the “it is quite clear (from the dispassionate perspective of one who does not own a jade falcon) that a possibility, even a strong possibility, that B is responsible is not a strong inference that B is responsible.”
There is also a vigorous verbal volley between Justice Scalia and Justice Stevens, whose lone dissent urged adoption of the Seventh Circuit’s more permissive standard. Justice Stevens characterized the standard Justice Scalia urges as “clearly wrong” and Justice Scalia referred to Justice Stevens as “mistaken.” The WSJ.com law blog captures this exchange, here.
An apology to all of my readers: This blog comment was originally posted yesterday at 11:30 am but my syndication service was offline due to technical difficulties until early this morning, so I have reposted it to facilitate the syndication emails.