Federal Rule of Civil Procedure 9(b) prescribes the standards for pleading a common law fraud claim. The Rule states that “[i]n alleging fraud or mistake, a party must state with particularity the circumstances constituting fraud or mistake.” But “[m]alice, intent, knowledge, and other conditions of a person’s mind may be alleged generally.” Hence, these two sentences spell out two distinct rules: (i) there is a special requirement for pleading fraud or mistake for at least certain elements; but (ii) scienter needs to only be pled through “general” allegations.
Despite its plain language, judicial interpretation of Rule 9(b) has resulted in widely differing camps on what is actually required to plead scienter in common law fraud claims. The complexity increased when the Private Securities Litigation Reform Act (“PSLRA”) added the “strong inference” requirement for pleading scienter, but intended to do so only for claims under federal securities fraud statutes. Finding the “correct” interpretation of Rule 9(b)’s scienter requirement was further complicated when the Supreme Court put teeth into the basic pleading requirements of Rule 8 in Iqbal and Twombly, calling into question what it means to plead “generally” to begin with.
Pleading Scienter Under Rule 9(b): Time for Supreme Court Intervention
The language of the second sentence of Rule 9(b) is simple: “Malice, intent, knowledge, and other conditions of a person’s mind may be alleged generally.” F.R.C.P. 9(b). But the interpretation of that clause has resulted in a complex array of legal rules, such that the same pleading is now being treated very differently based on the Circuit in which the plaintiff happens to file. There are two reasons why the time may be ripe for Supreme Court intervention. First, there is a clear Circuit split, with the Second Circuit applying a standard (“strong inference”) that is distinct from that used by the other Circuits. Second, the other Circuits have not uniformly harmonized Rule 9(b)’s “generally” language with the newfound “plausibility” requirement of Rule 8.
- The Second Circuit’s “Strong Inference” Standard
The Second Circuit has held that Rule 9(b) requires fraud complaints to allege facts that lead to a “strong inference” that the defendant has the requisite state of mind. See, e.g., IKB Int’l S.A. v. Bank of Am. Corp., 584 F. App’x 26, 27 (2d Cir. 2014) (“We have repeatedly required plaintiffs to plead the factual basis which gives rise to a strong inference of fraudulent intent.”). When it does comment on the matter, which is rare, the Second Circuit has justified the imposition of this requirement by observing that it is a reasonable way to prevent baseless fraud claims (sometimes called strike suits) that can damage a defendant’s public r See Ross v. A.H. Robins Co., 607 F.2d 545, 558 (2d Cir. 1979) (establishing the strong inference test because “[i]t is reasonable to require that the plaintiffs specifically plead” scienter); see also O’Brien v. Nat’l Property Analysts Partners, 936 F.2d 674, 676 (2d Cir. 1991).
While protection from strike suits may be a noble cause, no other Circuit has adopted the Second Circuit’s “strong inference” requirement. These other Circuits reason that other provisions of Rule 9(b) already adequately protect defendants, without holding plaintiffs’ feet to the fire with respect to pleading scienter as well. Most notably, the first half of Rule 9(b) can be seen as doing the necessary work—under it, plaintiffs must provide defendants the tools to defend themselves by requiring they delineate the who, what, and when of the misrepresentation claim. And Rule 8 post-Iqbal/Twombly may now also be seen as a relatively powerful tool against “strike suits.”
More basically, the Second Circuit has not been followed because other courts do not view it as within their power to substitute one phrase (“generally”) with another, facially inconsistent one (“strong inference”). The Ninth Circuit has directly criticized the Second Circuit for this very reason. See In re GlenFed, Inc. Securities Litig., 42 F.3d 1541, 1546-47 (9th Cir. 1994) (superseded on other grounds) (“Whether the [strong inference] test has such an effect [of deterring ‘strike suits’] is beside the point. We are not permitted to add new requirements to Rule 9(b) simply because we like the effects of doing so.”).
It merits emphasis that the challenges of keeping the Rules straight increased when Congress passed the PSLRA. Enacted in 1995, the PSLRA expressly heightened the scienter requirement for federal securities fraud claims, requiring that “complaint[s] . . . state with particularity the facts giving rise to a strong inference that the defendant acted with the required state of mind.” 15 U.S.C. § 78u-4(b)(2) (2006). In Tellabs, Inc. v. Makor Issues & Rights., 551 U.S. 308 (2007), the Supreme Court interpreted the PSLRA’s “strong inference” language as requiring a broad balancing test: “A complaint will survive, we hold, 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.” Id. at 324. In other words, there is now a nationwide interpretation of “strong inference” for claims brought under PSLRA.
But although Tellabs may have brought consistency to the standards for pleading claims under the federal securities fraud statutes, it has only increased the confusion for pleading other types of fraud. Congress plainly did not intend to re-write the pleading rules for any other type of claim—even, common law claims brought in the same complaint on the same securities. See Frank v. Dana Corp., 547 F.3d 564, 570 (6th Cir. 2008) (“the PSLRA imposes additional and more ‘[e]xacting pleading requirements’ for pleading scienter in a securities fraud case”). And it is clear that Congress did not intend to codify the Second Circuit’s case law that determined what strong inference means. See, e.g., H.R. Conf. Rep. 104-369, at 740 (1995).
This has caused problems in many ways. Within the Second Circuit, courts are now expected to apply one “strong inference” test to the common law portions of a complaint, and another purportedly higher “strong inference” test to the federal statutory portions of the same complaint. It is questionable whether courts can faithfully and consistently apply two different “strong inference” standards at all, let alone whether they could do so while still hewing to the plain meaning of the “may be alleged generally” text of Rule 9(b). See JBCHoldings NY, LLC v. Pakter, 931 F. Supp. 2d 514, 533 n. 15 (S.D.N.Y. 2013) (“It is worth nothing that Tellabs interpreted the ‘strong inference’ requirement of the Private Securities Litigation Reform Act, and not the general pleading requirements under Rule 9(b). . . However, numerous district courts in this Circuit have applied the Tellabs framework to common law fraud laws.”).
But even worse, because of the sheer number of securities-fraud cases handled in New York, the amount of confusing precedent can create trouble for litigants and courts even outside the Second Circuit. Courts elsewhere may not fully understand that many Second Circuit dismissals are the product of a pleading standard that is inapplicable to the claims brought before them, and may miss the fact the PSRLA is simply irrelevant to common law claims despite the fact the Second Circuit has used confusingly identical language long before its passage. See, e.g., The Prudential Ins. Co. of Am. v. Bank of America, N.A., 14 F. Supp. 3d 591, 599 (D.N.J. Apr. 17, 2014) (applying “strong inference” pleading standard to common law fraud claims based on reading of Third Circuit case involving a federal statutory claim, which in turn cited to Second Circuit cases applying the different “strong inference” standard that pre-dated the PSLRA).
- Different Approaches Even to Pleading "Generally”
Apart from the split between the Second Circuit and every other Circuit, there is a second reason why Supreme Court intervention on Rule 9(b) may be necessary: courts are confused on what it means to plead scienter “generally” in light of the recently invigorated Rule 8.
In Bell Atl. Corp. v. Twombly, 550 U.S. 544 (2007), the Supreme Court held that “a plaintiff’s obligation to provide the ‘grounds’ of his ‘entitlement to relief ’ requires more than labels and conclusions, and a formulaic recitation of the elements of a cause of action will not do[.]” Id. at 555. The Court did not mean to “impose a probability requirement at the pleading stage,” instead, it was “[a]sking for plausible grounds to infer an agreement[.]” Id. at 556. Two years later, the Supreme Court again spoke on the general pleading standard in Ashcroft v. Iqbal, 556 U.S. 662 (2009). The Court held that the plausibility standard in Twombly did not require “detailed factual allegations, but it demanded more than an unadorned, the-defendant- unlawfully-harmed-me accusation . . . A claim has facial plausibility when the plaintiff pleads factual content that allows the court to draw the reasonable inference that the defendant is liable for the misconduct alleged.” Id. at 677-78.
If Rule 8’s “plausibility” requirement trumps the second part of Rule 9(b), then to plead “generally” just means that scienter must be plead “plausibly” like everything else under Iqbal/Twombly. In this reading, the second sentence of Rule 9(b) (state of mind “may be alleged generally”) is merely meant to ensure that the burden of pleading state of mind is no higher than that normally expected of plaintiffs, a clarifying sentence made necessary because of the targeted provisions of the first sentence of Rule 9(b) (“circumstances” must be pled with “particularity”).
The First, Third, Fifth, Sixth, Seventh, Eighth, and Federal Circuits have seemingly taken something akin to a ‘generally means plausible’ approach, which— intentionally or not—can be seen as harmonizing the two Rules post-Iqbal/Twombly while still stopping far short of the Second Circuit’s “strong inference” conclusion. See, e.g., Schatz v. Republican State Leadership Comm., 669 F.3d 50, 58 (1st Cir. 2012) (“But, to make out a plausible [ ] claim . . . a plaintiff must still lay out enough facts from which [scienter] might reasonably be inferred.”); Faistl v. Energy Plus Holdings, LLC, 2012 WL 3835815, at *4 (D.N.J. Sept. 4, 2012) (“Plaintiff has failed to plead any facts that would allow this Court to draw the reasonable inference that any of the Defendants knew any representations they made, respectively, were in fact false.”); Flaherty & Crumrine Preferred Income Fund, Inc. v. TXU Corp., 565 F.3d 200, 213 (5th Cir. 2009) (requiring facts that “support an inference” of scienter); Heinrich v. Waiting Angels Adoption Servs., Inc., 668 F.3d 393, 406 (6th Cir. 2012) (“The courts have uniformly held inadequate a complaint’s general averment of [scienter] . . . unless a complaint also sets forth specific facts that make it reasonable[.]”); Tricontinental Indus., Ltd. v. PricewaterhouseCoopers, LLP, 475 F.3d 824, 833 (7th Cir. 2007) (“[S]tates of mind [ ] may be pleaded generally under Rule 9(b); nevertheless, the complaint must afford a basis for believe that plaintiffs could prove scienter.”); In re K-tel Int’l, Inc. Sec. Litig., 300 F.3d 881, 894 (8th Cir. 2002); Exergen Corp. v. Wal-Mart Stores, Inc., 575 F.3d 1312, 1327 (Fed. Cir. 2009).
On the other hand, some would argue that even this does violence to the plain text and history of Rule 9(b). In this view, Rule 9(b)’s second sentence is more than just a carve-out to the first-sentence of Rule 9(b), but an explicit denial of the requirement to do anything more than simply say that the act was done knowingly. The legislative history supports this view. The Advisory Committee Notes to Rule 9(b) indicate that the rule was drawn from Rule 22 of the English Practice Rules of 1937. The English Rule provides that knowledge may be alleged without asserting the facts from which that knowledge is inferred: “Wherever it is material to allege malice, fraudulent intention, knowledge, or other condition of the mind of any person, it shall be sufficient to allege the same as a fact without setting out the circumstances from which the same is to be inferred.” See The Annual Practice, Order 19, Rule 22 (1937).
There is also Circuit-level precedent (though most of it pre-Iqbal/Twombly) supporting the view that “generally” means scienter can be alleged simply by saying it existed. The Ninth and Tenth Circuits historically took this position, holding that plaintiffs “may aver scienter generally, just as the rule states—that is, simply by saying that scienter existed.” In re GlenFed, 42 F.3d at 1546-47; Schwartz v. Celestial Seasonings, Inc., 124 F.3d 1246, 1252 (10th Cir. 1997) (same); but see United States v. Corinthian Colleges, 655 F.3d 984, 997 (9th Cir. 2011) (asking whether there were facts to “support an inference or render plausible” the claim). There is some support for the view that the District of Columbia, Fourth, and Eleventh Circuits also interpreted Rule 9(b) this way— at least prior to Iqbal/Twombly. See, e.g., U.S. ex rel. Totten v. Bombardier Corp., 286 F.3d 542, 552 (D.C. Cir. 2002); Harrison v. Westinghouse Savannah River Co., 176 F.3d 776, 784 (4th Cir. 1999) (“The second sentence of Rule 9(b) allows conclusory allegations.”); Urquilla-Diaz v. Kaplan Univ., 780 F.3d 1039, 1051 (11th Cir. 2015).
Expressly clarifying how Rule 9(b) and Rule 8 interact following Iqbal/Twombly is something every Circuit Court should do, though Supreme Court ruling interpreting Rule 9(b) for all courts would obviously be preferable.
In sum, the federal courts are currently split over the proper interpretation of Rule 9(b), and the situation cries out for Supreme Court intervention. The bench and bar need clarification as to whether the Rule allowing allegations of scienter to be pled “generally” is or is not compatible with either the “strong inference” standard that has long been used in the Second Circuit, or the “strong inference” standard created by the PSRLA and interpreted by the Court in Tellabs. They also need clarification as to how Rule 9(b)’s “generally” allowance should be harmonized with Rule 8’s “plausibility” requirement. Does pleading “generally” under Rule 9(b) simply mean that scienter need only be pled to the same “plausible” level as other elements of other claims? Or does it suffice to simply say scienter existed, as was the case under the English rule upon which Rule 9 was based, and as was long the case in many Circuits?
Given Rule 9(b) comes into play in virtually every fraud-based civil filing made in federal court, it is of the utmost importance for there to be a nationwide standard of application, so that a plaintiff is not dismissed for insufficient pleading merely because its case is venued in one Circuit rather than another. Until the Supreme Court brings consistency to this area of the law, all counsel should be mindful of the potentially important differences between the Circuits.