Supreme Court Clarifies Securities Fraud Standards

In a new 8-1 decision favorable to issuers, the U.S. Supreme Court has interpreted the pleading requirements for securities fraud claims under section 10(b) of the Securities Exchange Act as imposing a heightened burden on allegations concerning a defendant's state of mind.

The opinion in Tellabs, Inc. v. Makor Issues & Rights Ltd., 06-484 (June 21, 2007) clarifies the provision of the Private Securities Litigation Reform Act of 1995 ("PSLRA") that obligates securities fraud plaintiffs to allege "facts giving rise to a strong inference" that the defendant acted with "scienter"a mental state embracing recklessness or the intent to deceive, manipulate or defraud. Resolving multiple lower court interpretations of the "strong inference" standard, the Supreme Court concludes in Tellabs that the inference of scienter must be more than merely reasonable or permissible, and that it is not sufficient for a plaintiff merely to plead facts from which recklessness or intent could be inferred. Instead, the Tellabs Court holds that, when considering a motion to dismiss under the PSLRA, a reviewing court must construe the complaint in its entirety, weighing the inference of scienter against all plausible opposing inferences. And to be "strong" enough to survive a motion to dismiss, the inference of scienter must be "cogent and at least as compelling" as any reasonable alternate explanation for the defendant's conduct.

Underlying Facts

In 2001, the stock price of Tellabs, Inc. fell on news that demand for its products was down. A number of shareholders sued the company and its former CEO in a putative class action. The plaintiffs alleged that the company illegally inflated revenues in the fourth quarter of 2000 and that its CEO made false projections in 2001, supposedly assuring analysts that demand was growing when defendants knew the market was evaporating.

Rulings Below

Defendants moved to dismiss the action for failing to satisfy the requirements of the PSLRA, which Congress enacted to curb perceived abuses of private securities actions. Among other things, the PSLRA imposes heightened pleading standards providing that all private securities complaints alleging false or misleading statements must (1) "specify each statement alleged to have been misleading [and] the reason or reasons why the statement is misleading," and (2) "state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind."...