by T. GormanPosted on Posted in SECActions

The Seventh Circuit’s decision in Makor Issues & Rights, Ltd. v. Tellabs, Inc. , 437 F.3d 558 (7th Cir. 2006), which was reviewed by the Supreme Court in Tellabs, Inc. v. Makor Issues & Rights, Ltd., 127 S.Ct. 2499 (2007), reflects the trends and splits among the circuits on key issues regarding Section 21D(b)(2) of the Private Securities Litigation Reform Act.  The case is a securities class action in which the shareholders made claims that:  (1) sales for a key product were stable, when in fact they were not; (2) statements concerning the next generation of product were wrong; (3) quarterly results were incorrect because they were based on channel stuffing; and (4) earnings and revenue projections were exaggerated.  The District Court dismissed the initial complaint and an amended complaint. 

The Seventh Circuit affirmed in part and reversed in part in an opinion which discusses each of the four key issues (discussed in an earlier posts in this series — Part XIII and Part XIV) on which the circuits had split.  Makor Issues & Rights, Ltd. v. Tellabs, Inc. , 437 F.3d 558 (7th Cir. 2006).  First, the court held that the Reform Act did not alter the definition of scienter.  This conclusion was in line with most of the courts.  At the same time, the court concluded that the Reform Act “raised the bar for pleading scienter.” 

Second, in considering the group pleading doctrine, the court noted that there is a significant amount of debate about the issue.  It went on to conclude that “[w]hile we will aggregate the allegations in the complaint to determine whether it creates a strong inference of scienter, plaintiffs must create this inference with respect to each individual defendant … .”

The key holding by the court, however, involved the question of inferences.  Initially, the court concluded that the best approach “is for courts to examine all the allegations in the complaint and then to decide whether collectively they establish … [a strong] inference.  Motive and opportunity may be useful indicators, but nowhere in the statute does it say that they are either necessary or sufficient.”  The court thus joined with those circuits which concluded that all inferences should be considered.  At the same time, the court seemed to suggest that while the motive and opportunity prong of the Second Circuit test may be sufficient evidence of a strong inference, it is more important to consider all the evidence. 

The court’s final conclusion, however, placed a different gloss on the “all evidence” test. Here, the court concluded that “we will allow the complaint to survive if it alleges facts from which, if true, a reasonable person could infer that the defendant acted with the required intent … .”  Thus while the court’s “all inferences” interpretation of Section 21D(b)(2) is consistent with some other circuits, its “reasonable person” position rejects the conclusion of the Sixth Circuit, while creating a new approach to interpreting a “strong inference.” 

Next: the opinion of the Supreme Court.

by T. GormanPosted on Posted in SECActions

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.