Ninth Circuit fine tunes the pleading standard for securities fraud

Last week, the Ninth Circuit, in South Ferry LP v. Killinger, limited the use of the "core operations inference" to meet the heightened pleading standard of the Private Securities Litigation Reform Act in alleging securities fraud by a corporation's management.

The "core operations inference" is the principle that facts critical to a business's "core operations" or important transactions are known to key company officers when making statements about company operations that later turn out to be wrong or misleading.  Plaintiffs in a securities fraud case may seek to use that inference to show defendants' state of mind in making the false statements.  However, as explained by the Supreme Court in the 2007 case Tellabs, Inc. v. Makor Issues and Rights, Ltd., the PSLRA requires plaintiffs alleging securities fraud to plead facts that give rise to a "strong inference" of knowing or intentional misconduct that "must be cogent and compelling, thus strong in light of other explanations."  Given this guidance from the Supreme Court, the Ninth Circuit held that, in most circumstances, plaintiffs could not rely on the core operations inference alone to meet the PSLRA pleading standard.  Instead, the inference may be one of several factors that a district court considers as part of a holistic approach to evaluating a complaint.  In limited cases the inference might independently satisfy the PSLRA.  The court explained:

"In summary, allegations regarding management's role in a company may be relevant and help to satisfy the PSLRA scienter requirement in three circumstances.  First, the allegations may be used in any form along with other allegations that, when read together, raise an inference of scienter that is 'cogent and compelling, thus strong in light of other explanations.'  * * * This view takes such allegations into account when evaluating all circumstances together.  Second such allegations may independently satisfy the PSLRA where they are particular and suggest that defendants had actual access to the disputed information[.] * * * Finally, such allegations may conceivably satisfy the PSLRA standard in a more bare form, without accompanying particularized allegations, in rare circumstances where the nature of the relevant fact is of such prominence that it would be 'absurd' to suggest that management was without knowledge of the matter. "