Pleading Scienter: The Remand of Makor Issues v. Tellabs
Professor of Law and William M. Rains
Fellow at Loyola Law School, Los Angeles
The Seventh Circuit on remand applied the Supreme Court's new Tellabs standard for pleading scienter under the Private Securities Litigation Reform Act (PSLRA) in Makor Issues & Rights, Ltd. v. Tellabs, Inc. This commentary, written by Georgene Vairo, Professor and author and editor of several books including several chapters in Moore's Federal Practice, discusses how the Seventh Circuit interpreted Tellabs and addresses how lower courts may apply the standard in the future.
Professor Vairo writes: The PSLRA requires courts to determine whether the complaint contains the required ``strong inference.'' A complaint that on its face creates only a weak or bare inference of scienter, suggesting that the plaintiff would prevail only if there were no defense case at all, must be dismissed. The Seventh Circuit continued: ``Apparently Congress does not believe that weak complaints should put a defendant to the expense of discovery in a securities fraud case, which is likely to be complex–as this case is.''
Unquestionably, to prove liability in a securities fraud action, the plaintiff must show that the defendant either knew a material statement was false, or was reckless in disregarding a substantial risk that it was false. The PSLRA provides that the complaint must ``state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind'' [15 U.S.C. § 78u-4(b)(2)]. Under the Supreme Court's interpretation of this language, a court must dismiss a complaint unless ``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.'' Moreover, the plaintiff ``must plead facts rendering an inference of scienter at least as likely as any plausible opposing inference.''
The Seventh Circuit correctly articulated the three aspects of the Supreme Court’s new test: 1) cogency; 2) comparability; and 3) plausibility. It also noted the departure of the Court’s new test from established pleading rules: ``[t]o judges raised on notice pleading, the idea of drawing a `strong inference' from factual allegations is mysterious.'' Further, it noted that even when a plaintiff is required by Rule 9(b) to plead facts with particularity, the district court must treat the pleaded facts as true and draw all reasonable inferences in favor of the plaintiff. Thus, the Tellabs court on remand had to deal with a brave new world beyond notice pleading and presumptions favoring plaintiffs.
To purchase the entire Expert Commentary on lexis.com (subscription required), please click here.