On June 21, the United States Supreme Court decided Tellabs, Inc. v. Makor Issues & Rights, Ltd. In an 8-1 ruling,2 the Court held that in pleading a "strong inference" of scienter — the intent to defraud — required by the federal securities laws, a plaintiff must go beyond what is "merely plausible or reasonable," and plead facts supporting scienter that are "cogent and at least as compelling as any opposing inference of nonfraudulent intent." Thus, in considering a federal securities fraud complaint, the lower courts must engage in a "comparative inquiry" in which they consider "plausible opposing inferences," as opposed to only inferences favoring the plaintiff.
By forcing plaintiffs to plead facts that more plausibly identify fraudulent intent, Tellabs makes it harder for plaintiffs to plead securities fraud claims against companies and executives, and makes it easier for defendants to prevail on motions to dismiss.
In Tellabs, purchasers of Tellabs, Inc.'s common stock brought suit under Section 10(b) of the Securities and Exchange Act of 1934 and Rule 10b-5 against the company and some of its officers, claiming that the defendants, including Tellabs' CEO, had misrepresented the company's current financial position and future prospects, artificially inflating the price of Tellabs' stock. The defendants moved to dismiss the complaint, claiming, among other things, that the plaintiffs had not met the pleading requirements of the Private Securities Litigation Reform Act of 1995 ("PSLRA").3
Among other things, the PSLRA requires a plaintiff to "state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind."4 In an action under Section 10(b), the required state of mind, or scienter, is the intent "'to deceive, manipulate or defraud.'"5 The District Court found that plaintiffs had adequately pled facts showing that statements made by Tellabs' CEO were misleading and why the statements were misleading, but dismissed the complaint because plaintiffs failed to plead facts supporting a "strong inference" of scienter. The Seventh Circuit Court of Appeals reversed, holding that a complaint should not be dismissed where the plaintiff pleads facts from which "'a reasonable person could infer that the defendant acted with the required intent.'"6
The Tellabs Decision
In her majority opinion, Justice Ginsberg began by underscoring the goals of the PSLRA, which were to set "a uniform pleading standard for § 10(b) actions," and "to curb frivolous, lawyer-driven litigation, while preserving investors' ability to recover on meritorious claims."7 This Congressional desire for stricter pleading standards then guided the Court's approach as to how a strong inference of scienter should be pled.
The Court mandated that lower courts consider inferences beyond those offered by plaintiffs, by considering "plausible opposing inferences."8 "The strength of an inference cannot be decided in a vacuum. The inquiry is inherently comparative: How likely is it that one conclusion, as compared to others, follows from the underlying facts? To determine whether the plaintiff has alleged facts that give rise to the requisite 'strong inference' of scienter, a court must consider plausible nonculpable explanations for the defendant's conduct, as well as inferences favoring the plaintiff." The Court then made clear that an inference of scienter is not "strong" just because it is "reasonable" or "permissible." Rather, an inference is not strong 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."9 (Significantly, this appears to give any "ties" to the plaintiff.10) Since the lower courts had not applied the correct test to the complaint here, the Court remanded the case for further consideration.
In sending the case back to the lower courts, the Supreme Court also stressed that there is no precise formula for pleading scienter. Rather, a "court's job is not to scrutinize each allegation in isolation but to assess all the allegations holistically." Thus, facts relating to motive "can be a relevant consideration," but their absence "is not fatal" to the complaint. The Court did agree, however, "that omissions and ambiguities [in the complaint] count against inferring scienter," since plaintiffs are required under the PSLRA to "state with particularity facts giving rise to a strong inference" of scienter.11
Tellabs will make it much harder for plaintiffs to plead securities fraud claims and to withstand motions to dismiss. While it is unclear what kinds of scienter allegations will prove "at least as compelling" as opposing innocent inferences, what lower courts will do with a "tie" in competing inferences, or how creative courts will be in formulating innocent inferences, courts will (i) have great latitude in interpreting complaints, and (ii) have been invited by the Supreme Court to hold perceived factual omissions or ambiguities in a complaint against the plaintiff.
Tellabs is even more significant when read with another recent Supreme Court decision, Bell Atlantic Corp. v. Twombly.12 There, the Court held that, on a motion to dismiss, an antitrust claim premised on a conspiracy "requires a complaint with enough factual matter (taken as true) to suggest that an [illegal] agreement was made," or "plausible grounds to infer an agreement."13 This overruled long-standing precedent regarding federal motion to dismiss standards that "a complaint should not be dismissed for failure to state a claim unless it appears beyond doubt that the plaintiff can prove no set of facts in support of his claim which would entitle him to relief."14 Nothing in Twombly limits the case to its facts, and the decision is consistent with Tellabs as to the importance of innocent inferences in assessing a complaint.
Together, Twombly and Tellabs substantially raise the bar for plaintiffs in pleading claims that can withstand motions to dismiss. Claims must now be more than just "conceivable." Instead, facts must be pled that take the claim beyond competing innocent inferences — inferences that courts may take from defendants or develop on their own. No doubt, these two decisions will require a great deal of consideration and interpretation by the lower courts, a process that will take years as the courts wrestle with these new pleading and motion to dismiss standards.