Part V: Securities Class Actions: Current and Emerging Trends

An analysis of circuit court cases to date following the Supreme Court’s decision in Tellabs, discussed in the prior segment of this series here, suggests not only that the decision vests substantial discretion in the district court, but also that it is difficult to assess the impact of the decision on securities class actions. In some circuits, the case is not having any obvious impact. Some circuits are applying their pre-Tellabs case law along with the Supreme Court’s test. Only two circuits have acknowledged that the decision altered prior standards for pleading scienter. In both instances, the courts concluded that Tellabs lowered the pleading standard.

A review and analysis of decisions in the Seventh, Third and Fifth circuits does not suggest that Tellabs is having a significant impact on scienter pleading standards. Perhaps the best example of these decisions is the Seventh Circuit’s decision in Tellabs on remand from the Supreme Court which chose not to apply its teachings to the facts of the case. Makor Issues & Rights, Ltd. v. Tellabs, Inc., 513 F.3d 702 (7th Cir. 2008).

On remand, the Circuit Court began with the premise that fraud had been pled with particularity because its holding on that point had not been appealed to, or considered by, the Supreme Court. Based on that ruling, the court considered two possible inferences regarding whether senior executives of the company had made fraudulent statements about two key products. Under one possibility, the false statements were the product of an error by lower level employees that was not detected by senior officials before they made the statements. Alternatively, the statements were the result of deliberate fraud.

The Seventh Circuit concluded that plaintiffs had in fact met the Tellabs test. The Circuit Court fund that the importance of the products being discussed made it more likely that the false statements were the result of deliberate fraud than simple errors by lower level employees. The Court ruled that the case could go forward. This is the same result reached prior to the Supreme Court’s decision, suggesting that the new Supreme Court equipoise test had little impact. Makor Issues & Rights, Ltd. v. Tellabs, Inc., 437 F.3d 588 (7th Cir. 2005) rev’d, 127 S.Ct. 2499 (2007); see also Higginbotham v. Baxter Int. Inc., 495 F.3d 753 (7th Cir. 2007).

Two decisions by the Third Circuit seem to confirm this point. In Winer Family Trust, the Circuit Court reviewed a complaint based on a claim that the price of the stock had been inflated by omitting key facts from earnings reports and releases. After considering all of the competing inferences, the court concluded that a strong inference of scienter had not been pled. The Winer Family Trust v. Queen, 503 F.3d 319 (3rd Cir. 2007); see also Central Laborers’ Pension Fund v. Integrated Electrical Services, No. 06-20135, 2007 WL 236776 (5th Cir. Aug. 21, 2007) (applying an “all inferences approach to conclude that a complaint had been properly dismissed).

In contrast, in Key Equity Investors, Inc. v. Sel-Leb Marketing, Inc., No. 06-1052, 2007 WL 2510385 (3rd Cir. Sept. 6, 2007), the Circuit Court applied not only the Tellabs test, but also its prior precedents which followed the Second Circuit “motive and opportunity” test which had survived the passage of the PSLRA. Analyzing the facts pled in the complaint under both standards. The majority concluded that sufficient facts had not been pled. The dissent however, using the same approach on the same facts, reached the opposite conclusion. As with the Seventh Circuit’s post-Tellabs cases, these decisions by the Third Circuit suggest that the Supreme Court’s new standard is having little impact. See also ATSI Communications, Inc. v. The Shaar Fund, Ltd., No 05-5132-cv, 2007 WL 1989336 (2d Cir. Jul 11, 2007) (also using a duel test approach of the Tellabs “all inferences” approach and its prior “motive and opportunity” test); Crowell v. Possis Medical, Inc., No. 07-1840 (8th Cir. Mar. 21, 2008) (same).

Only two Circuits have acknowledged that Tellabs altered its prior case law. In ACA Financial Guaranty Corp. v. Advest, Inc., 512 F.3d 46 (1st Cir. 2008), the First Circuit concluded that Tellabs affirmed a portion of its prior case law, but ultimately lowered the scienter pleading standard. In reviewing the dismissal of a securities law complaint, the court first noted that Tellabs affirmed its prior holding that all inferences and the complaint as a whole must be considered. However, the court concluded that Tellabs overruled its prior holding that if the inferences are equal the defendant prevails. Since the inferences were equal here, the complaint could proceed, where as under the First Circuit’s prior case law it would have been dismissed.

The Ninth Circuit reached a similar conclusion in Mississippi Public Employees’ Retirement System v. Boston Scientific Corp., 2008 WL 173590 (9th Cir. Apr. 16, 2008). There, the court reversed the dismissal of a securities law complaint which was based on allegations revolving around a product launch and recall. After concluding that Tellabs lowered the pleading standard for scienter in the circuit, the court permitted the complaint to proceed. The reluctance of the court to permit this result is evident from its cautionary statements noting that it was not endorsing the merits of the claims, only applying the teachings of the Supreme Court. Considering this decision, as well as that of the First Circuit in ACA Financial Guaranty and those of the other circuits clearly draws into question the conclusion that Tellabs is “pro-business.” Indeed, it appears that Tellabs is having little impact in may circuits while lowering pleading standards in the First and Ninth Circuits. Since most securities class actions are filed in either the Second or Ninth Circuits the overall impact of Tellabs may be to ease the pleading burdens for plaintiffs in many instances.

Next: The group pleading doctrine