By Peter A. Pease
While the press has been reporting the Supreme Court’s decision in Tellabs, Inc. v. Makor as a stirring victory for defendants, that is far from the case. Plaintiffs can take heart that Justice Ruth Bader Ginsburg has set a reasonable standard for review on motions to dismiss. As practitioners, we have met this standard for years.
The work we do to investigate allegations of fraud prior to filing, and to detail the relevant facts in the complaints we file, will continue to provide courts with good cause to sustain them.
It is true that the 7th Circuit’s decision sustaining the plaintiffs’ complaint was reversed by the Supreme Court, but the importance of the decision lies in the standard the Supreme Court prescribed for reviewing motions to dismiss in securities fraud cases. That standard is essentially the same as has been applied in the 1st, 2nd and 3rd circuits for decades, and it is more favorable than the standards that have been applied in many other circuits in recent years.
The law has been that securities fraud plaintiffs must plead their complaints to include specific facts which support a strong inference that the defendants knowingly or extremely recklessly (also referred to as “with scienter”) made false statements about their business. This 2nd Circuit standard was codified in the PSLRA passed in 1995.
In Tellabs, the 7th Circuit reinstated the plaintiff’s complaint, which had been dismissed by the district court. The 7th Circuit held that courts should examine the entirety of the allegations in the complaint to see if all those allegations together would lead a reasonable person to infer that the defendants acted knowingly. Most practitioners would agree that this relaxed the pleading requirement below the bar Congress set when it passed the PSLRA.
The Supreme Court decided that this was too generous a standard to apply, and that the requirement to show a “strong inference” required more of plaintiffs. Plaintiffs cannot merely show that an inference of knowing illegal conduct is plausible or reasonable. It must be cogent and at least as compelling as any opposing inference of innocent intent the defendants might suggest.
Defendants were asking the Supreme Court to do far more to protect them from being held liable. At oral argument, the defendants said that the Supreme Court should “force the plaintiffs to demonstrate that innocent explanations can be set aside” and, “do away with reading allegations in the light most favorable to plaintiff.” Most disturbing was that the United States filed an amicus brief on behalf of the defendants and stood up in court to make these arguments alongside defendants in the Supreme Court. The Bush administration has vigorously taken up the cause of securities fraud defendants.
The Supreme Court did not buy it. Justice Ginsburg pointedly rejected the defendants’ and the administration’s arguments. She held: (1) “courts must . . . accept all factual allegations in the complaint as true”; (2) “courts must consider the complaint in its entirety” and may not, as some circuits have done, scrutinize and reject allegations in isolation; and (3) while courts “must take into account plausible opposing inferences” raised by defendants, plaintiffs’ complaint will survive “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.”
We can meet this standard and have done so for years. Indeed, in many circuits a complaint that was likely to be dismissed will now have a much better chance of being sustained. When the Tellabs complaint is reconsidered in the courts below, it will likely survive, if the summary of the allegations reported by Justices Ginsburg and Stevens is accepted by the courts as true, as required.
Justice Ginsburg’s opinion was joined by Chief Justice Roberts and Justices Kennedy, Souter, Thomas and Breyer. Justices Scalia and Alito filed opinions concurring in the judgment, for an 8-1 majority. Justice Stevens dissented, stating that he thought the plaintiff’s complaint was more than adequate and the 7th Circuit’s standard of review was proper.
Peter A. Pease is a partner in the firm’s Boston office.