Writer-Analyst
CCH, Inc.
Question Presented: Whether, and to what extent, a court must consider or weigh competing inferences in determining whether a complaint asserting a claim of securities fraud has alleged facts sufficient to establish a "strong inference" that the defendant acted with scienter, as required under the Private Securities Litigation Reform Act of 1995.The U.S. Supreme Court agreed to tackle the question above in granting a petition for certiorari in Tellabs Inc. v. Makor Issues & Rights, Ltd. (published at ¶93,642 in CCH's Federal Securities Law Reporter). In that case, arising from allegations that a fiber optic cable manufacturer misrepresented the availability of and demand for its new products, the 7th U.S. Circuit Court of Appeals observed that while the PSLRA "did not impose a more stringent substantive scienter standard, it did unequivocally raise the bar for pleading scienter."Analyzing the different approaches taken by other circuits for determining if a complaint pleaded a strong inference of scienter, the court concluded that the best approach was "for courts to examine all of the allegations in the complaint and then to decide whether collectively they establish such an inference." It also stated that the strong inference requirement did not mandate that only the most plausible of competing inferences were sufficient. Instead a complaint was sufficient if it alleged facts from which "a reasonable person could infer that the defendant acted with the required scienter." The court quoted the 10th Circuit opinion in Pirraglia v. Novell, Inc., in which the court stated that when "[f]aced 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."
While Congress may have hoped for the PSLRA to bring some certainty to the question of scienter pleading, the result has been far different. Both appellate and district courts have differed, and in some instances have seemed confused, on what the statute requires plaintiffs to plead to survive dismissal and to substantively prove in order to prevail at (the extremely rare) trial.
In the petition for certiorari, the company described the 7th Circuit approach in Tellabs "as a particularly lax standard for policing the scienter allegations in securities fraud complaints." A joint amicus brief from some major players, the U.S. Chamber of Commerce and the Securities Industry and Financial Markets Association, echoed this sentiment. According to these groups, the Seventh Circuit’s scienter test moves in the opposite direction from that chosen by Congress, significantly easing plaintiffs’ burden and thereby encouraging the abusive strike suits that the PSLRA set out to prevent with heightened pleading requirements. The lax “could infer” test will also harm defendants and the markets without providing significant enforcement benefits. In their response brief, the lead plaintiffs asserted that the petitioners were "straining to create an issue for review" in their characterization of the 7th Circuit holding. The brief took an interesting approach in its response to the question presented in the petition concerning whether, and to what extent, "competing inferences" should be considered. The respondents suggested that this issue was not squarely presented in this instance, because in their view, "fairly considered, there are no competing innocent inferences to be weighed against the powerful inferences of culpability in this case." According to the lead plaintiff's argument, the methodological approach to the evaluation of the sufficiency of the scienter inference was irrelevant in this case because any balancing of inferences would not have changed the result in this case. They concluded that the "allegations in this case are so strong and highly particularized that the complaint satisfies any formulation of the Public Securities Litigation Reform Act.”
The case (06-484) will be argued this spring, with an opinion expected by July 2007.