Supreme Court Talks About Recklessness Being Tantamount to Scienter

As part of its opinion this week interpreting what constitutes a strong inference of fraud under the Private Securities Litigation Reform Act, the US Supreme Court also mentioned that it had previously reserved the question whether reckless behavior is sufficient for civil liability under Rule 10b–5. See Ernst & Ernst v. Hochfelder, 425 U. S. 185, 194, n. 12 (1976). In other words, the issue of whether recklessness is tantamount to scienter or an intent to defraud has never been decided by the Supreme Court. And, unfortunately, the question whether and when recklessness satisfies the scienter requirement is not presented in the Tellabs case.

But in fn. 5 of its opinion, the Court did say that every federal court of appeals that has considered the issue has held that a plaintiff may meet the scienter requirement by showing that the defendant acted intentionally or recklessly, though the Circuits differ on the degree of recklessness required. The Court cited the Fourth Circuit panel opinion in Ottmann v. Hanger Orthopedic Group, 353 F. 3d 338, CCH FSLR ¶92,465.

The type recklessness we are talking about here is an act so highly unreasonable and such an extreme departure from the standard of ordinary care as to present a danger of misleading the plaintiff to the extent that the danger was either known to the defendant or so obvious that the defendant must have been aware of it. Such severe recklessness is essentially a slightly lesser species of intentional misconduct.

Following the enactment of the PSLRA, questions had arisen concerning the validity of pre-PSLRA federal court decisions holding that scienter could be established by a showing of recklessness. See Nathenson v. Zonagen Inc., (5th Cir. 2001) 267 F.3d 400, CCH FSLR ¶91,548. In Ottmann, the Fourth Circuit panel concluded that the PSLRA did not alter the substantive standard for proving scienter in securities fraud actions.

It is possible that, in fn. 5, the Supreme Court was giving its tacit approval to the conclusion that the passage of the PSLRA did not affect judicial holdings that severe recklessness is tantamount to scienter. The Court reached out to mention that all of the federal appellate courts that have considered this issue have held that recklessness is tantamount to scienter for Rule 10b-5 purposes. The Court did not have to do this to decide the case.