Part IV: Securities Class Actions: Current And Emerging Trends
Bell Atlantic Corp. v. Twombly, discussed in the last segment of this series here, imposes one pleading standard for securities class actions. The PSLRA adds three other key pleading requirements: 1) the complaint must specify each statement alleged to be misleading; 2) each statement made on information and belief must specify all facts on which it is based; and 3) as to state of mind, Section 21D(b)(2) requires that a “strong inference” be pled.
To craft the PSLRA pleading requirements, Congress borrowed from existing law. The particularity standards were taken from Federal Civil Rule 9(b), which requires that fraud be pled with particularity. That Rule did not however impose a heightened pleading standard for state of mind, requiring only general allegations. Nevertheless, some circuit courts crafted specific pleading standards regarding scienter.
The Second Circuit was viewed as having the most stringent standard in 1995 when the PSLRA was adopted. That standard required that a strong inference of scienter be pled. Under Second Circuit case law this requirement could be met by pleading either: 1) facts establishing motive and opportunity to commit fraud; or 2) facts constituting circumstantial evidence of either reckless or conscious behavior. See, e.g. In re Time Warner, Inc., Sec. Litig., 9 F.3d 1049 (2nd Cir 1993); but see In re GlenFed, Inc, Sec. Litig., 42 F.3d 1541 (9th Cir. 1994) (en banc) (holding that notice pleading was sufficient to plead scienter).
In writing Section 21D(b)(2), Congress adopted the “strong inference” test, but not the Second Circuit case law. The legislative reports however note that the Second Circuit case law should be considered as “instructive.” H.R. Conf. Rep. No. 104-369, at 15 (1995).
Following the passage of the PSLRA, the circuits split as to what constitutes a strong inference of scienter. The Second and Third Circuits followed the Second Circuit’s pre-PSLRA case law. See, e.g., Press v. Chem. Inv. Serv. Corp., 166 F.3d 529 92nd Cir. 1999). The Ninth Circuit adopted what it called the “deliberate recklessness test,” which was a more stringent pleading standard than that used by the Second and Third Circuits. In re Silicon Graphics, Inc., Sec. Litig., 183 F.3d 970 (9th Cir. 1999). The First, Fourth, Sixth, Eighth and Tenth circuits adopted various intermediate positions. See, e.g., Greebel v. FTP Software, Inc., 194 F.3d 185 (1st Cir. 1999); Bryant v. Avado Brands, Inc., 187 F.3d 1271 (11th Cir. 1999); Helwig v. Vencor, Inc., 251 F.3d 540 (6th Cir. 2001) (en banc); City of Philadelphia v. Fleming Co., Inc., 265 F.3d 1245 (10th Cir. 2001); Florida State Bd. Of Admin. v. Green Tree Fin. Corp., 270 F.3d 646 (8th Cir. 2001).
The circuit courts also split over how to deal with competing inferences. Traditionally, under Federal Civil Rule 12(b)(6) on a motion to dismiss all inferences were drawn in favor of the plaintiff. Since Section 21D(b)(2) required that a “strong inference” be pled, a key question became how to consider the various inferences raised by the allegations in the complaint. Again the circuits split. The First Circuit concluded there was no change to existing Rule 12(B)(6) practice. See, e.g., Aldridge v. A.T. Cross Corp., 284 F.3d 72 (1st Cir. 2002). The Ninth Circuit took a similar position, but noted that there was a “tension” between the Rule and the Section. See, e.g., Gompper v. VISX, Inc., 298 F.3d 893 (9th Cir. 2002). The Tenth Circuit, in contrast, concluded that all inferences had to be considered. See, e.g., Pirraglia v. Novell Inc., 339 F.3d 1182 (10th Cir. 2003).
The Supreme Court resolved the interpretation of Section 21D(b)(2) in Tellabs v. Makor Issues & Rights, Ltd., 128 S.Ct. 761 (2007). There, the Court essentially held that the Section rewrites Rule 12(b)(6) procedure, requiring facts must be pled rendering an inference of scienter is at least as likely as any plausible opposing inference. While the Court noted that the inference must be “cogent,” the test is one of equipoise.
To assess the competing inferences, the Court held that the district court must: 1) accept all the facts in the complaint to be true as under existing Rule 12(b)(6) procedures; 2) consider the entire complaint; and 3) assess plausible opposing inferences.
Many commentators concluded that Tellabs is another pro-business decision by the Roberts Court. A review of the Circuit Court decisions applying the Tellabs decision however suggests that the impact of the case may be more difficult to assess. Clearly, the decision vests significant discretion in the district court to assess the various inferences. In many ways this may in fact mean that what constitutes a “strong inference” is in the eye of the reader or more appropriately the district court judge.
Next: The impact of Tellabs