July 05, 2007
On June 21, 2007, the U.S. Supreme Court issued an important decision that will help protect corporate issuers from frivolous lawsuits by securities class action plaintiffs.1 The decision requires that, in order to survive a motion to dismiss under the Private Securities Litigation Reform Act of 1995 (the “Reform Act”), a complaint alleging violation of Section 10(b) of the Securities Exchange Act of 1934, as amended, and Securities and Exchange Commission Rule 10b-5 must plead facts giving rise to an inference of scienter2 that is “more than merely plausible or reasonable—it must be cogent and at least as compelling as any opposing inference of nonfraudulent intent.”
Noting that “if not adequately contained,” private securities fraud actions “can be employed abusively to impose substantial costs on companies and individuals whose conduct conforms to the law,” the Court recognized that “[e]xacting pleading requirements are among the measures” that Congress included in the Reform Act. These pleading standards were designed to “curb perceived abuses” of private actions under Section 10(b) and Rule 10b-5 including, among other things, “nuisance filings, targeting of deep-pocket defendants, vexatious discovery requests and manipulation by class action lawyers.”
The various crcuits had split, however, on the proper interpretation of the requirement under the Reform Act that, in order to survive a motion to dismiss, a complaint must contain factual allegations that give rise to a “strong inference” that defendants acted with scienter. For example, the 7th Circuit, from which this case came, had held that a complaint would survive “if it alleges facts from which, if true, a reasonable person could infer that the defendant acted with the required intent . . . . If a reasonable person could not draw such an inference from the alleged facts, the defendants are entitled to dismissal.” In other words, the 7th Circuit’s test considered only those inferences that may have been urged by plaintiffs and did not accord weight to opposing inferences.
Rejecting this approach, the Supreme Court explained that a court must “engage in a comparative evaluation; it must consider, not only inferences urged by the plaintiff, . . but also competing inferences rationally drawn from the facts alleged.” According to the court, an “inference of fraudulent intent may be plausible, yet less cogent than other, nonculpable explanations for the defendant’s conduct.” “A complaint will survive, we hold, only if a reasonable person would deem the inference of scienter cogent and at least as compelling as any opposing inference one could draw from the facts alleged.”
Any person who has a question regarding the court decision raised in this Corporate Litigation Alert may obtain additional guidance from James Masella in our New York office (212.885.5562; [email protected]) or Timothy Katsiff in our Philadelphia office (215.569.5633; [email protected]).
- Tellabs, Inc. v. Makor Issues & Rights, Ltd., No. 06-484 (U.S. June 21, 2007).
- “Scienter” refers to a mental state embracing an intent to deceive, manipulate or defraud.