Originally published June 21, 2007
In an effort to curb abusive securities fraud litigation, the Private Securities Litigation Reform Act of 1995 ("PSLRA") requires plaintiffs to "state with particularity facts giving rise to a strong inference that the defendant acted" with scienter, i.e., that the defendant's intention was to deceive, manipulate, or defraud. 15 U.S.C. ß 78u-4(b)(2) (emphasis added). Today, the Supreme Court held that, in order to qualify as "strong," "an inference of scienter must be more than merely plausible or reasonableóit must be cogent and at least as compelling as any opposing inference of nonfraudulent intent."
Tellabs manufactures specialized equipment for fiber optic networks. In June 2001, after the company announced declining demand for one of its main products and lowered its revenue projections, Tellabs' stock price fell precipitously. Subsequently, the company and several of its executives were sued by a class of shareholders who contended that the defendants had engaged in a scheme to deceive investors about the true value of Tellabs' stock. The district court dismissed the suit for failure to satisfy the PSLRA's pleading requirement. The Seventh Circuit reversed, holding that the statute's "strong inference" standard is met if the complaint "alleges facts from which, if true, a reasonable person could infer that the defendant acted with the required intent." In an opinion by Justice Ginsburg, the Court rejected the Seventh Circuit's standard as inadequately faithful to the language of the PSLRA.
The Court recognized that, in adopting the "strong inference" standard, Congress intended both to "raise the bar" for pleading scienter in private securities cases and to promote uniformity among the Circuits. In seeking a "workable" construction of that standard, Tellabs establishes several important propositions. First, all factual allegations in the complaint must be taken as true. Second, rather than "scrutinize each allegation in isolation," courts should instead view securities complaints "holistically," interpreting "omissions and ambiguities" against an inference of scienter. Third, and most significantly, when evaluating a complaint's scienter allegations, courts must consider "plausible opposing inferences." The Court pointed out that, because "[t]he strength of an inference cannot be decided in a vacuum," reasonable nonculpable explanations for...