Supreme Court tightens pleading standards for securities fraud

On June 21, 2007, the United States Supreme Court issued an opinion in Tellabs, Inc v. Makor Issues & Rights, Ltd. which makes it more difficult for plaintiffs to state a claim for securities fraud under Section 10(b) of the Securities Exchange Act of 1934.  The Private Securities Litigation Reform Act of 1995 requires plaintiffs to "state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind" - i.e., an intent "to deceive, manipulate, or defraud."  In Tellabs, the Court stated that, to qualify as "strong," an inference of fraudulent intent must be more than merely plausible or reasonable - it must be cogent and at least as compelling as any opposing inference of nonfraudulent intent.  Accordingly, the Court must take into account plausible, nonculpable explanations for the defendant's conduct as well as inferences favoring the plaintiff.  In sum, "[a] complaint will survive . . . only if a reasonable person would deem the inference of scienter cogent and at least as compelling as any opposing inference one could draw from the facts alleged."

The Court rejected the argument that, by engaging in a comparative assessment of competing inferences, a court reviewing a securities complaint would usurp the role of the jury.  The Court explained that Congress, as creator of federal statutory claims, "has the power to prescribe what must be pleaded to state the claim, just as it has power to determine what must be proved to prevail on the merits."

From the plaintiffs' view, the decision is not as bad as it could have been.  Justice Scalia, in dissent, would have upheld an even stricter pleading standard.  Instead of letting plaintiffs proceed on the basis of an inference "at least as compelling as any opposing inference," Justice Scalia would have adopted a test of "whether the inference of scienter (if any) is more plausible than the inference of innocence."