In Tellabs, Inc., et al. v. Makor Issues & Rights, Ltd, et al., No. 06-484, 127 S.Ct. 2499 (June 21, 2007), the United States’ Supreme Court clarified the standard for determining whether a complaint alleges sufficient facts to support a claim for violation of the Private Securities Litigation Reform Act ("the Act"); in particular, facts sufficient to evince the required element of scienter, i.e., an intent to deceive, manipulate, or defraud. To support the element of intent to deceive, a plaintiff must "state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind." The Supreme Court, reversing the determination of the Seventh Circuit, considered all the allegations set forth in the Complaint and held that in order for a court to find that a complaint deserves the "strong" inference of scienter, that inference "must be more than merely a plausible or reasonable -- it must be cogent and at least as compelling as any opposing inference of nonfraudulent intent."
The Complaint in Tellabs, a manufacturer of specialized equipment for fiber optic networks, alleged that its Chief Executive Officer/President engaged in securities fraud in violation by falsely reassuring public investors that Tellabs continued to enjoy a strong demand for its products and earned record revenues, when he knew the opposite was true. Tellabs moved to dismiss arguing that the shareholders failed to plead the case with the particularity the Act requires. The District Court agreed forcing the shareholders to amend their complaint to add references to confidential sources and more specific references to the CEO/President’s mental state. The District Court dismissed an Amended Complaint despite the additional disclosure of 27 confidential sources, on grounds that the allegations of scienter still were insufficient. The Seventh Circuit disagreed holding that the "strong inference" standard was met in that the Amended Complaint alleged facts from which, if true, a reasonable person would infer that the defendant acted with the required intent.
In reversing the Seventh Circuit’s decision, the Supreme Court noted that Congress left term "strong inference" undefined in the Act and that the appellate courts were divided on its interpretation. Reasoning that Congress’ objective with respect to the Act was to establish a uniform pleading standard for Section 10(b) actions, the Court established the following prescriptions: 1) when faced with a Federal Rule 12(b)(6) motion to dismiss a Section 10(b) action, courts must, as with any such motion, accept all factual allegations in the complaint as true; 2) courts must consider the complaint in its entirety and any other sources courts commonly examine in deciding Rule 12(b)(6) motions and determine whether all of the facts alleged, taken collectively (as opposed to in isolation), give rise to a strong inference of scienter; and 3) in determining whether the pleaded facts give rise to a "strong inference" of scienter, the court must equally consider plausible opposing inferences and non-culpable explanations for the defendant’s conduct. The Supreme Court noted that the strength of an inference cannot be decided in a vacuum because the inquiry is inherently comparative. While the inference of scienter need not be irrefutable, it must be more than merely reasonable or plausible. Thus, a complaint will survive only if a reasonable person would deem the inference of scienter to be at least as compelling as any plausible opposing inference one could draw from all the facts alleged.
Tom Wilkinson, a member in Cozen O’Connor’s Philadelphia office, whose practice focuses on securities litigation, appreciated the Supreme Court’s clarification on the standard for pleading scienter. The varied interpretation by the lower courts made it difficult to judge the potential liability of a given complaint. He noted that there is always concern when the Supreme Court seeks to clarify legislative intent for such a subjective term, but in this instance, Wilkinson was pleased that shareholders will have a more difficult hill to climb when making broad-based allegations of fraud against his corporate clients.
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