Inferences From Core Operations Under Tellabs

When the Supreme Court handed down its decision in Tellabs, Inc. v. Makor Issues and Rights, Ltd., 127 S.Ct. 2499 (2007), many commentators heralded the ruling as another in a line of pro-business decisions by the Court. The reality is more complex however, and depends on an analysis of the pre-Tellabs case law in each circuit. In some circuits such as the Seventh, the standard seems to be about the same. The Second Circuit, on the other hand, seems to be combining its long standing test of scienter with the Tellabs equipoise standard (discussed here).

In the Ninth Circuit, which at one time had the highest pleading standards for scienter, Tellabs has clearly reduced the standard. This was evident in the Court’s decision last week in South Ferry LP v. Killinger, Case No. 06-35511 (Sept. 9, 2008). There, the court considered the refusal of the district court to dismiss a securities fraud suit against several high ranking corporate officers. Specifically, the complaint claimed that several high ranking officers of Washington Mutual had made fraudulent statements regarding certain risks related to its mortgage loan portfolio. In support of their scienter allegations, plaintiffs pointed to key facts in the information systems of the company and argued that they were “core facts” about the business which could be fairly attributed to the individual defendants because of their high positions in the company. The district court declined to dismiss the claims as to these officers.

The Ninth Circuit vacated the order of the district court and remanded for consideration in view of the analysis in its opinion which harmonizes earlier Circuit Court’s rulings with Tellabs. The Court began by noting that, under its prior decisions, detailed facts had to be pled to establish a strong inference of scienter. Generally, under those rulings, a plaintiff would not be able to rely exclusively on inferences from core operations to plead scienter because they would not be supported by the requisite detail.

Tellabs, however, requires that the court assess the complaint as a whole, rather than just the individual scienter allegations as the Court’s prior holdings suggest. Thus, even vague or ambiguous allegations now must be considered as part of a “holistic review” when considering whether the complaint presents a strong inference of scienter.

Under this approach the Court concluded that “[a]llegations that rely on the core-operations inference are among the allegations that may be considered in the complete PSLRA analysis. The allegations, read as a whole, must raise an inference of scienter that is ‘cogent and compelling, thus strong in light of other explanations,'” quoting Tellabs. Thus, allegations regarding core operations can be considered. Absent additional detailed facts however, those inferences typically will not be sufficient. “In such cases, the inference that defendants had knowledge of the relevant facts will not be much stronger, if at all, than the inference that defendants remained unaware. As a general matter, ‘corporate management’s general awareness of the day-to-day working of the company’s business does not establish scienter – at least absent some additional allegation of specific information conveyed to management and related to the fraud’ or other allegations supporting scienter, citing Metzler Inv. GmbH v. Corinthian Colleges, Inc., No. 06-55826, 2008 WL 2853402 at *13 (9th Cir. July 25 2008). In some instances however, the core operations inference may be sufficient.