Supreme Court Refines Pleading Requirements In Private Securities Fraud Litigation

On June 21, 2007, the United States Supreme Court reached its much-anticipated decision in Tellabs, Inc. v. Makor Issues & Rights, Ltd.1, clarifying the requirements for pleading fraud in private securities litigation. Tellabs concerns Congress's requirement, in the Private Securities Litigation Reform Act (the "PSLRA"), that private plaintiffs allege specific facts giving rise to "strong inference" of a defendant's fraudulent intent. The Supreme Court held that lower courts must weigh the competing inferences permitted by the plaintiff's allegations. It also held that the courts must dismiss a complaint, even if its allegations allow a reasonable inference of intent, if its allegations also permit a more plausible, nonculpable inference.

The uncertainty resolved by Tellabs was over a decade in the making. In 1995, Congress passed the PSLRA, with the intent to curb frivolous securities fraud suits. Among other things, the PSLRA required private securities plaintiffs to plead, "with particularity," facts supporting a "strong inference" that the defendant acted with "scienter"i.e., knowledge. Over the years, the federal circuit courts of appeal reached different interpretations of the "strong inference" requirement. In particular, the courts differed on whether the PSLRA required them to weigh competing inferences in deciding whether an inference of scienter is "strong." Several circuits, including the Second, Third, Eighth, and Tenth, did not require a lower court to weigh the various inferences provoked by the plaintiff's allegations. Other circuits, such as the Sixth, attached far greater consequence to the "strong inference" requirement, holding that a plaintiff must plead facts that give rise to an inference of scienter that is the most plausible of the inferences those facts support. In other words, in those circuits, trial courts must weigh the competing inferences available from the plaintiff's allegations and must grant a motion to dismiss where the allegations support an equally plausible inference that the defendant acted without the requisite intent.

In Tellabs, the Seventh Circuit joined the fray, on the plaintiff-friendly side. While recognizing that the PSLRA "unequivocally raise[d] the bar for pleading scienter," the court held that a plaintiff satisfies the "strong inference" requirement where it alleges facts from which a reasonable person could infer that the defendant acted with the necessary intent. The Seventh Circuit...