The 7th Circuit again found that fraud allegations against Tellabs Inc. raised the required strong inference of scienter under the PSLRA. The U.S. Supreme Court reversed the 7th Circuit panel's earlier decision in June 2007. Applying the high court's more rigorous standard for scienter pleading, the appellate panel again found that the investor allegations were sufficient. Makor Issues & Rights, Ltd. v. Tellabs Inc., No. 04-1687 (CCH Federal Securities Law Reporter ¶94,560).
The complaint against Tellabs, a maker of equipment used in fiber optics network, arose from statements made primarily by CEO Richard Notebaert about demand for the company's principal product, a switching system. In its first review of the case, the 7th Circuit concluded that
Instead of accepting only the most plausible of competing inferences as sufficient at the pleading stage, 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.The Supreme Court rejected the 7th Circuit view, concluding that:
To determine whether the plaintiff has alleged facts giving rise to the requisite "strong inference," a court must consider plausible nonculpable explanations for the defendant's conduct, as well as inferences favoring the plaintiff. The inference that the defendant acted with scienter need not be irrefutable, but it must be more than merely "reasonable" or "permissible" --it must be cogent and compelling, thus strong in light of other explanations. A complaint will survive only if a reasonable person would deem the inference of scienter cogent and at least as compelling as any plausible opposing inference one could draw from the facts alleged.The high court did not determine, however, whether the allegations were actionable under this standard and remanded the case to the appeals court.Circuit Judges Wood and Sykes, who were on the first panel, were joined by Judge Posner, who wrote for the court. The inferences of non-culpable conduct were "highly implausible" and "very unlikely," according to Judge Posner. He observed:
that no member of the company’s senior management who was involved in authorizing or making public statements about the demand for the 5500 and 6500 knew that they were false is very hard to credit, and no plausible story has yet been told by the defendants that might dispel our incredulity. The court finally concluded that the inferences of fraudulent intent were cogent. The fact that the allegations were based in part of statements of confidential witnesses was not determinative because "are numerous and consist of persons who from the description of their jobs were in a position to know at first hand the facts to which they are prepared to testify."