LIABILITY IN SECURITIES FRAUD ACTIONS: Part XIV: The Circuits Split on the Key Issue of Inferences
Despite the intent of Congress to create a uniform pleading standard in Section 21D(b)(2) of the Private Securities Litigation Reform Act (“PSLRA”), the circuit courts split on key issues such as the required state of mind and what evidence must be pled to support a “strong inference,” as discussed in earlier parts of this series.
The circuits also split over the key issue of competing inferences which is the issued decided by the Supreme Court in Tellabs, Inc. v. Makor Issues & Rights, Ltd., 127 S.Ct. 2499 (2007). In Section 21D(b)(2), Congress mandated that a “strong inference” of scienter be pled. This language suggests some type of consideration of the inferences presented to determine if they met the required test. Yet, typically on a motion to dismiss, competing inferences are not considered. Rather, on a Rule 12(b)(6) motion to dismiss, the facts are presumed to be true, all inferences are drawn in favor of the plaintiff and, if under any construction of the allegations in the complaint the plaintiff may be entitled to relief, the case moves forward into discovery. See, e.g., Conley v. Gibson, 355 U.S. 41 (1957).
As with the other issues under Section 21D(b)(2), the circuit courts split over the question of inferences. One view held that the Section did not change the standard for reviewing a motion to dismiss. The First Circuit adopted this position in Aldridge v. A.T. Cross Cop., 284 F.3d 72 (1st Cir. 2002). Yet, earlier in Greebel v. FTP Software, Inc. 194 F.3d 185 (1st Cir. 1999), the same circuit had held that Congress “has effectively mandated a special standard for measuring whether allegations of scienter survive a motion to dismiss … .”
Other circuits, such as the Ninth, took the position that there was a “tension” between Rule 12(b)(6) and the Act. Thus, in Gompper v. VISX, Inc., 298 F.3d 893 (9th Cir. 2002), the court rejected plaintiffs’ claim that the court not consider inferences contrary to its position, concluding that such a position would “eviscerate the PSLRA’s strong inference requirement … .”
A third position was adopted by the Tenth circuit which concluded that all inferences must be considered, but only if they are drawn from facts plead with particularity. Thus, in Pirraglia v. Norvell, Inc., 339 F.3d 1182 (10th Cir. 2003) after cautioning against weighing facts because that is a function reserved for the trier of fact, the court noted that “[i]f a plaintiff pleads facts with particularity that, in the overall context of the pleading, including potentially negative inferences, give rise to a strong inference of scienter, the scienter requirement of the Reform Act is satisfied.”
Finally, the Sixth Circuit adopted yet another variation. In its decision in Helwig v. Vencor, Inc., 251 F.3d 540 (2001), the court concluded that on a Rule 12(b)(6) motion it would “indulge” plaintiff’s inferences – provided they “leave little room for doubt … .” The court went on to hold that “strong inference” means plaintiffs are entitled “only to the most plausible of competing inferences.” See also In Re Green Tree Financial Corp. Options Litig., 270 F.3d 645 (8th Cir. 2001) (follows Helwig, but disregards inferences that “do not live up to the particularity requirements”). Thus the circuit courts split: four ways over how to interpret Section 21D(b)(2) inferences; two ways over the required state of mind; and three ways over the use of the “motive and opportunity” prong of the Second Circuit’s strong inference test and what evidence is sufficient under the Reform Act.
Next: The decision in Tellabs.