On January 5, 2007, the U.S. Supreme Court granted certiorari in a case that will likely resolve the major unanswered issue under the Private Securities Litigation Reform Act of 1995 (the “PSLRA”) – what is the standard a plaintiff must meet to properly plead scienter (i.e. the intent to defraud) in a securities fraud case? The PSLRA requires that a securities fraud plaintiff “state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind.” 15 U.S.C. § 78u-4. Under the PSLRA, complaints that fail to plead scienter with the required specificity are dismissed, and the litigation is terminated before discovery commences. The failure to plead scienter with factual specificity is one of the primary defenses typically raised to a complaint alleging securities fraud. Since the PSLRA was enacted, the federal circuits have been unable to reach a consensus as to (i) what type of factual allegations give rise to a “strong inference” of scienter; and (ii) what role facts giving rise to a competing “innocent inference” – such as stock purchases during the class period – should play in that analysis.
The Supreme Court will review the Seventh Circuit’s decision in Makor Issues & Rights, Ltd. v. Tellabs, Inc., 437 F.3d 588 (7th Cir. 2006) which held that innocent inferences could not be used to overcome allegations that, when viewed in isolation, give rise to a strong inference of scienter. In reaching this conclusion, the Seventh Circuit adopted a pleading standard that is far more lenient than those articulated by the other circuits that have addressed the issue of competing inferences (the First, Fourth, Sixth, Eighth, Ninth and Tenth Circuits). The Seventh Circuit also joined the six circuits that have held that Congress did not entirely reject the Second Circuit’s pre-PSLRA “motive and opportunity” pleading practice – “‘but instead only required plaintiffs to plead facts that together establish a strong inference of scienter’” (which can include allegations of motive and opportunity, since “nowhere in the statute does it say that [such allegations] are either necessary or sufficient”). This is contrary to the Ninth and Eleventh Circuits, which have held that, in passing the PSLRA, Congress rejected motive and opportunity as a pleading practice, and intended to increase the pleading burden on plaintiffs.
The Supreme Court has ordered expedited briefing, which must be completed by March 20, 2007, in time for the case to be heard during the Court’s March 2007 session.