Earlier today, the U.S. Supreme Court issued its widely-anticipated decision in Tellabs, Inc. v. Makor Issues & Rights, Ltd., interpreting for the first time the heightened pleading requirements of the Private Securities Litigation Reform Act of 1995 (the “PSLRA”). In keeping with the Supreme Court’s recent decisions, today’s decision underscores the Court’s recognition that securities fraud actions “if not adequately contained, can be employed abusively to impose substantial costs on companies and individuals whose conduct conforms to the law” while “preserving investors’ ability to recover on meritorious claims.”
The specific question addressed by the Court in Tellabs is the extent to which courts can consider socalled “innocent inferences” in determining whether a securities fraud complaint adequately alleges facts giving rise to a “strong inference” of scienter or fraudulent intent, as required by the PSLRA. The Supreme Court held that a court must consider all inferences, including innocent inferences, and that an inference of scienter must be “at least as likely” as any other plausible inference:
[A] court must consider plausible nonculpable explanations for the defendant’s conduct, as well as inferences favoring the plaintiff … Yet, the inference of scienter must be more than merely “reasonable” or permissible” — it must be cogent and compelling, thus strong in light of other explanations. 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.
The Court, however, did not go as far as it could have in articulating just how strong a “strong inference” has to be. As noted in the concurring opinions by Justices Alito and Scalia, and as several lower courts had previously found, there is an argument that the PSLRA requires an inference of scienter to be the most plausible inference, not just an equally plausible inference. The majority in Tellabs was unwilling to raise the bar quite that high. Nonetheless, the decision clearly requires a more rigorous application of the “strong inference” standard than is currently applied in most courts. In the end, it is not clear that the new “cogent and at least as compelling as any other inference” standard will add much clarity to the analysis.
What makes an inference “cogent?” What makes one inference more “compelling” than another? When is one inference equally as likely as another? A clearer understanding of these issues will have to await application of the Supreme Court’s new standard.