The Impact of Tellabs: Another Suit Dismissed

The Supreme Court’s decision in Tellabs, Inc. v. Makor Issues & Rights, Ltd., 551 U.S. 308 (2007) continues to have a significant impact on private securities actions. In Tellabs, discussed here, the Court construed Section 21D(b)(2) of the Private Securities Litigation Reform Act of 2005. That section requires that a strong inference of the “required state of mind” be pled as part of a cause of action for securities fraud in a suit for damages. The Fifth Circuit’s decision in Flaherty & Crumrine Preferred Income Fund Inc., v. TXU Corp., Case No. 08-10414 (5th Cir. Decided April 8, 2009) is the most recent circuit court decision to affirm the dismissal of a securities fraud complaint.

The complaint in TXU centers on plaintiffs’ claim that defendants misrepresented the dividend policy and an eventual dividend increase to induce them to tender their shares. Four months before a tender offer, TXU announced in a press release that the company did not anticipate a dividend increase until two years later when certain financial benchmarks were reached. The release did however, state that the board of directors might consider other factors in determining whether to authorize a dividend increase. The day before the expiration of the tender offer, the company made a presentation to certain credit rating agencies for the purpose of facilitating the agencies’ determination of whether an increase in the dividend would impact its credit rating.

Plaintiffs tendered their shares at the end of the offer period. Six days later, management furnished the board with materials proposing a dividend change, recommending a 350% increase in the annual dividend on common stock and a 400% increase in the stock repurchase program. Three days later, the board approved the recommendation, increasing the dividend from $0.50 to $2.25 and to repurchase about 50 million common shares. The share price jumped about 20% on the announcement.

Plaintiffs brought suit claiming that the company made false and misleading statements regarding the change in dividend policy to induce them to tender. The district court initially dismissed the complaint. During an initial appeal the Supreme Court decided Tellabs. Accordingly the circuit court remanded the case for reconsideration in view of the Supreme Court’s decision. After permitting plaintiffs to amend their complaint, the court again dismissed it. The Fifth Circuit affirmed.

The Fifth circuit read Tellabs as requiring essentially a four step test: 1) all allegations must be assumed to be true; 2) the facts must be viewed collectively and not in isolation; 3) the court must consider plausible inferences opposing as well as supporting a strong inference of scienter; and 4) omissions and ambiguities count against an inference of scienter.

In evaluating plaintiffs’ claims, the court began by noting that allegations of motive and opportunity — a component of the traditional Second Circuit test of the evidence of scienter — “standing alone will not suffice to meet the scienter requirement, [but] motive and opportunity allegations may meaningfully enhance the strength of the inference of scienter.” Essentially plaintiffs claim that they relied on the accuracy of the pre-tender press release regarding the dividend policy and that several subsequent statements were false and misleading which focused primarily on whether that policy was under review and if the company had made adequate disclosure of that fact. After reviewing each statement the court concluded that “it is not clear that Appellees [defendants] ever issued a materially misleading statement,” although the court noted that the timing of the announcement gave some support to plaintiffs’ claim.

The court went on to reject an argument that the disclosure stating that the policy “was under review” was not sufficient. In considering this question the court held that it “advises that a ‘middle course’ is proper when making disclosures concerning future plans which have not been fully determined in the context of a tender offer. … TXU could not have disclosed that a dividend increase was likely during the tender offer without running a risk of liability if the dividend increase was not ultimately approved.”

The court concluded by noting that Tellabs requires that it consider opposing inferences. Since the company disclosed that the dividend policy was under review during the tender period the court held that “the inference of non-fraudulent intent weights in favor of the” defendants.

The Fifth Circuit’s decision is consistent with those in other circuits. Since the Supreme Court decided Tellabs, most circuit courts have affirmed the dismissal of securities fraud suits after applying the teachings of the Supreme Court. A notable exception to this general rule is the Tellabs case on remand where the Seventh Circuit again determined that the complaint was sufficient. Makor Issues & Rights, Ltd. v. Tellabs, Inc., 513 F.3d 702 (7th Cir. 2008) (the case is now in discovery). Other exceptions are the decisions by the First and Sixth Circuits concluding that the Supreme Court lowered the pleading burden on plaintiffs. Mississippi Public Employees’ Retirement System v. Boston Scientific Corp., 2008 WL 173590 (1st Cir. April 16, 2008) (reversing dismissal and acknowledging lower standard); Frank v. Plumbers & Pipefitters National Pension Fund v. Dana Corp., Case No. 07-4325 (6th Cir. Decided Nov. 19, 2008) (acknowledging lower standard); but see ACA Financial Guaranty Corp. v. Advest, Inc., 512 F.3d 46 (1st Cir. 2008)(acknowledging lower standard but affirming dismissal).