Does Tellabs Have Any Impact In the Second Circuit?

Part IV of the series Securities Class Actions: Current and Emerging Trends discusses the impact of the Supreme Court’s decision in Tellabs. That decision construed the “strong inference” of scienter requirement of PSLRA Section 21D(b)(2). That part of the series concluded that at least in some circuits Tellabs appears to be having little impact. A recent decision by the Second Circuit Court of Appeals confirms that conclusion for that circuit.

In Bay Harbour Management LLC v. Carothers, Case No. 07-1124-cv (2nd Cir. June 24, 2008), the court reviewed the dismissal of a securities fraud complaint for failure to comply with the pleading requirements of Federal Civil Rule 9(b), which requires that fraud be pled with particularity, and the PSLRA. In discussing the adequacy of the complaint with respect to pleading scienter, the circuit court did not cite or discuss the Supreme Court’s decision last year in Tellabs v. Makor Issues & Rights, Ltd., 128 S.Ct. 761 (2007). Rather, the court relied on one of its own pre-Tellabs decision, applying the two-prong test crafted prior to the passage of the PSLRA: “We have held that a securities fraud plaintiff’s scienter allegations must ‘give rise to a strong inference of fraudulent intent,’ and that such a plaintiff may establish the requisite intent either ‘(a) by alleging facts to show that defendants had both motive and opportunity to commit fraud, or (b) by alleging facts that constitute strong circumstantial evidence of conscious misbehavior or recklessness,” quoting Learner v. Fleet Bank, N.A., 459 F.3d 273, 290-91 (2d Cir. 2006).

In analyzing the scienter allegations in the Bay Harbour complaint, the circuit court applied its traditional two-prong test of scienter rather than Tellabs. There is no mention of Tellabs or the Supreme Court’s directives to consider: 1) all the allegations in the complaint; 2) assess whether there was a strong, cogent inference of scienter; or 3) determine whether that inference is at least as strong as any competing inference. Indeed, in discussing scienter, the court did not even cite its own decision applying Tellabs which incorporated the teachings of the Supreme Court and the circuit’s traditional two-prong test. See ATSI Communications, Inc. v. Shaar Fund, Ltd., 493 F.3d 87 (2nd Cir. 2007). Rather, the test the court applied is the same one it has used since the passage of the PSLRA. Indeed, it is the same test the court has used since prior to the passage of that Act. Compare Press v. Chem. Inv. Serv. Corp., 166 F.3d 529 (2nd Cir. 1999) with In re Time Warner, Inc., Sec. Litig., 9 F.3d 1049 (2nd Cir. 1993).

Perhaps the Second Circuit concluded that only half of its ATSI Communications analysis was required to affirm the dismissal of what it apparently viewed as a weak complaint. Yet, it would seem that any analysis of this question should start with Tellabs, not omit the Supreme Court’s newly minted test. In fact, Bay Harbour, like some others decisions discussed in the earlier post analyzing circuit court decisions following Tellabs, suggests that at least in some circuits the Supreme Court’s teachings are having little impact.