What Did The Supreme Court Resolve In Tellabs?
Earlier this month, the Ninth Circuit Court of Appeals handed down a decision on pleading a strong inference of scienter under the Private Securities Litigation Reform Act (“PSLRA”). Zucco Partners, LLC v. Digmarc Corporation, Case No. 06-3558 (9th Cir. Jan. 12, 2009) (rejecting motive and opportunity evidence as insufficient and requiring a showing of intentional conduct or deliberate recklessness). While the decision purported to harmonize the circuit’s prior case law with the teachings of Tellabs, Inc. v. Makor Issues & Rights, Ltd., 127 S.Ct. 2499 (2007), in fact the court seems to have reaffirmed its earlier case law while effectively ignoring the Supreme Court, as discussed here.
Now, the same question might be asked of the Second Circuit. In ECA and Local 134 IBEW Joint Pension Trust of Chicago v. JP Morgan Chase Co., Case No. 0-1786-cv (2nd Cir. Jan. 21, 2009), the Second Circuit affirmed the dismissal of a class action securities complaint brought against JP Morgan Chase Co. The complaint was based on claims that the financial institution defrauded its shareholders, causing its share price to be improperly inflated. The alleged fraud centered on claims that JP Morgan “created disguised loans for Enron and concealed the nature of these transactions by making false statements or omissions of material fact …” in its accounting statements and SEC filings. The district court dismissed the complaint for, among other things, failing to comply with the pleading standards of the PSLRA.
The Second Circuit affirmed the dismissal of the case. In considering the question of whether a strong inference of scienter had been pled, the court turned to Tellabs and recited the holding of the case – that on a collective basis the inference of scienter must be at least as strong as that of any opposing inference. It then went on to note that “[t]he requisite scienter can be established by alleging facts to show either (1) that defendants had the motive and opportunity to commit fraud, or (2) strong circumstantial evidence of conscious misbehavior or recklessness.” After reviewing each of the allegations in the complaint, the court concluded that the district court had properly dismissed the complaint.
While Tellabs sought to resolve a split among the circuits regarding the pleading of a strong inference of scienter which, at the time, included the Second and Ninth Circuits. Prior to Tellabs, the Second Circuit, along with others, employed its two prong motive and opportunity/strong circumstantial evidence test to asses whether a strong inference of scienter had been pled under the PSLRA. See, e.g., Press v. Chem. Inv. Serv. Corp., 166 F.3d 529 (2nd Cir. 1999). The Ninth Circuit found the Second Circuit motive and opportunity test insufficient, opting for its standard of intentional conduct or deliberate recklessness in Silicon Graphics, 183 F.3d 970 (9th Cir. 1999).
Tellabs resolved the split among the circuits on pleading a strong inference of scienter within the meaning of the PSLRA. Now however, it appears that Tellabs in fact may have not resolved the split between the Second and Ninth Circuits. Both circuits cite Tellabs and purport to apply its teachings. In doing so however, each circuit has incorporated its pre-Tellabs case law into the analysis. As JP Morgan demonstrates, the Second Circuit is still using its two prong motive and opportunity/strong circumstantial evidence test. The Ninth Circuit, as Digmarc Corporation demonstrates, still rejects the motive and opportunity test in favor of Silicon Graphics.
The decisions of the Second and Ninth Circuit can be harmonized with Tellabs if they are read as interpreting the definition of scienter rather than the provisions of the PSLRA. In that instance JP Morgan and Digmarc Corporation are not inconsistent with Tellabs, since the Supreme Court did not consider the definition of scienter. That reading of the circuit court decisions is difficult to reconcile with the fact that both circuits based their test on a reading of the PSLRA statutory language and its difficult and complex history. Under either reading of the Second or Ninth Circuit, there is a split over a key pleading standard which will require resolution by the Supreme Court.