On March 9, 2007, Bernstein Liebhard LLP (“BL”) filed an amicus curiae (friend of the court) brief to the United States Supreme Court in Tellabs, Inc. v. Makor Issues & Rights, Ltd. BL submitted the brief on behalf of eight states and two public pension funds: Arkansas, Massachusetts, Michigan, Mississippi, Missouri, New Jersey, New Mexico, Rhode Island, the Pennsylvania Public School Employees Retirement System, and the Pennsylvania State Employees Retirement System.
Combined, the amici states and public pension funds manage an aggregate $400 billion invested in public markets, and are among the largest public and private money managers in the United States. Combined, they manage the retirement plans for more than 3.2 million active and retired public servants.
In Tellabs, the Supreme Court will consider the standard for pleading scienter (intent) in a securities fraud action. The standard for pleading scienter is heavily litigated and, perhaps more than any other single issue, determines whether a complaint will be dismissed at the pleading stage.
In 1995, Congress passed the Private Securities Litigation Reform Act (“PSLRA”), which raised the pleading requirements for securities fraud complaints. Chief among its various provisions is that the facts alleged in the complaint raise a “strong inference” that the defendants either intended to make materially false statements, or recklessly did so.
The new pleading requirements of the PSLRA have put onerous burdens on plaintiffs, particularly when combined with the PSLRA’s automatic stay of discovery during the pendency of any motion to dismiss. Complaints have been dismissed at much higher rates since the law’s passage, and the new requirements, coupled with other legal developments, have created huge hurdles to bringing complaints against accounting firms and other actors who participate in fraudulent schemes. In fact, Professor John Coffee of Columbia Law School has written that the PSLRA was one factor that contributed to skyrocketing fraud in the 1990s, by reducing the incentive for gatekeepers, such as accounting firms, to police their clients. There are legendary instances where investors have had their complaints against particular companies dismissed on the pleadings, only to see those companies collapse in scandal shortly thereafter. For instance, a complaint against WorldCom was dismissed not long before that company’s descent into bankruptcy.
Because the “strong inference” standard is a departure from the ordinary rule that all reasonable inferences be drawn in plaintiffs’ favor, the circuits have variously attempted to articulate how a court should go about evaluating a complaint. In so doing, they have used different language to describe the weight that will be given to competing, innocent explanations for a defendant’s conduct.
For instance, the Sixth Circuit has said that when there are “competing” inferences, some favoring the plaintiff and some favoring the defendant, “plaintiffs are entitled only to the most plausible of competing inferences.” Helwig v. Vencor, Inc., 251 F.3d 540, 550-52 (6th Cir.2001) (en banc). The Tenth Circuit, using different language, has said, “Faced with two seemingly equally strong inferences, one favoring the plaintiff and one favoring the defendant, it is inappropriate for us to make a determination as to which inference will ultimately prevail, lest we invade the traditional role of the factfinder.” Pirraglia v. Novell, Inc., 339 F.3d 1182, 1188 (10th Cir.2003).
In Tellabs, the Seventh Circuit allied itself with the Tenth Circuit and further added, “we will allow the complaint to survive if it alleges facts from which, if true, a reasonable person could infer that the defendant acted with the required intent.” Makor Issues & Rights, Ltd. v. Tellabs, Inc., 437 F.3d 588, 602 (7th Cir. 2006). Tellabs contends that there is a deep split among the circuits as to how to address competing inferences of intent when evaluating a securities fraud complaint, and that the Seventh Circuit’s formulation is too lenient.
Several third parties have allied themselves with Tellabs and have filed briefs in its support. Most significantly among them is a brief filed by the SEC, arguing for stricter pleading requirements. The SEC’s position in this matter has been decried by investors, and The New York Times reported that one securities professor commented that the SEC appeared to have been enlisted by the defense bar.
The Supreme Court’s ruling will provide important guidance to courts as to how much skepticism to apply to plaintiffs’ complaints in the future. The opinion may even touch upon the related issue of how detailed a securities fraud complaint must be to survive a motion to dismiss, which is another hot-button issue in the wake of the PSLRA.
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