The United States Supreme Court remanded plaintiffs’ securities fraud action to the Seventh Circuit following the issuance of its landmark ruling in Tellabs regarding the allegations needed to satisfy the “strong inference” of scienter requirement of the Private Securities Litigation Reform Act in order to withstand a motion to dismiss claims under Securities Exchange Act Section 10(b) and Rule 10b-5.
In the Seventh Circuit’s first opinion in Tellabs – prior to the remand – the Seventh Circuit ruled that plaintiffs (i) had adequately pleaded that defendants had made materially false statements, and (ii) had acted with the required scienter. The Supreme Court did not disturb the first ruling, but it disagreed with the Seventh Circuit’s interpretation of “strong inference,” ruling that the complaint must be dismissed unless “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.”
On remand, the Seventh Circuit identified the critical question as: How likely is it that the allegedly false statements “were the result of merely careless mistakes at the management level based on false information fed it from below, rather than of an intent to deceive or a reckless indifference to whether the statements were misleading?” In blunt language, the Court determined that it was “exceedingly unlikely” that the misstatements were the product of merely “careless” mistakes inasmuch as they all concerned Tellabs’ flagship product and its heralded successor. The Court found it “very hard to credit” the notion that no senior member of management involved in making or authorizing the statements of inflated demand for these products knew of their falsity. After concluding that the alternative to “scienter at the corporate level” – i.e., a cascade of innocent mistakes or acts of subordinate employees was a far less likely explanation for the false statements, the Seventh Circuit held that plaintiffs had satisfied their burden of pleading scienter under the PSLRA. (Makor Issues & Rights, Ltd. v. Tellabs Inc., No. 04-1687, 2008 WL 151180 (7th Cir. Jan. 17, 2008))