Argument Preview: Tellabs v. Makor on 3/28

The following argument preview was written by Anitha Reddy of the Stanford Supreme Court Litigation Clinic.

Tomorrow in Tellabs, Inc. v. Makor Issues & Rights, Ltd. (No. 06-484), the Court will consider how strictly courts should interpret the heightened pleading requirements of the Private Securities Litigation Reform Act (PSLRA) when ruling on a motion to dismiss a securities fraud complaint. The case asks whether a court must weigh competing inferences of innocence in determining whether the plaintiff has alleged facts sufficient to give rise to a “strong inference” that – as mandated by the Act – the defendant acted with the required state of mind.

Carter G. Phillips of Sidley Austin in Washington, D.C. will argue on behalf of petitioners Tellabs and Notebaert. Professor Arthur Miller of Harvard Law School will argue on behalf of the respondent shareholders. Assistant to the Solicitor General Kannon Shanmugam will argue for the United States as an amicus in support of Tellabs. The briefs of both parties along with some of the amicus briefs, including that of the United States, are available here.

The plaintiffs (respondents in the Supreme Court) are a class of Tellabs stockholders. They filed a securities fraud claim against Tellabs, a fiber-optic equipment maker, and Robert C. Notebaert and Michael J. Birck, who served as the company’s CEO and chairman, respectively, during the period of the alleged fraud. The shareholders alleged that the defendants (petitioners before the Supreme Court) had violated §10(b) of the Securities and Exchange Act of 1934 by making misleading statements about the company’s current and expected performance. The shareholders accused the company and the officers of misleading investors about the availability of and demand for certain products, falsely representing certain financial results, and exaggerating future earnings and revenue projections.

The district court granted the defendants’ motion to dismiss for failure to state a claim, holding that the shareholders had failed to adequately allege scienter (i.e., a culpable state of mind) for any of the defendants. The Seventh Circuit affirmed in part and reversed in part, holding that the shareholders had alleged facts sufficient to support a “strong inference” that Notebaert – and thus Tellabs – had acted with scienter, but had failed to do so with regard to Birck. In reaching that conclusion, the court declined to weigh inferences favoring a defendant against those favoring the plaintiffs, on the ground that such balancing could constitute an impermissible encroachment into the province of the jury. Instead, the court held that a securities fraud complaint establishes the necessary “strong inference” if it alleges facts from which, if true, a reasonable person could infer that the defendant acted with the required intent. The Supreme Court granted certiorari to review that holding.

Congress passed the PSLRA in 1995 to curtail securities fraud “strike suits.” The legislative history suggests that, in Congress’s view, summary judgment was not adequately disposing of weak claims in securities fraud suits; companies felt compelled to settle meritless shareholder suits that survived motions to dismiss rather than accept the risk of a huge loss at trial. The PLSRA thus imposes on plaintiffs in securities fraud cases a heightened burden of pleading, requiring them to “state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind.”

Tellabs argues that in determining whether a complaint alleges facts sufficient to give rise to the PSLRA’s “strong inference,” a court must weigh all of the allegations of the complaint and any other material properly before it, including any facts that support an inference of innocence. Because the facts alleged “must meaningfully tend to exclude the possibility of innocence,” Tellabs contends, complaints that allege facts which are as consistent with innocence as guilt do not satisfy the PSLRA’s heightened pleading requirements and should be dismissed. Thus, for example, although the shareholders allege that company reports document a decline in business conditions, they fail to specifically allege that Notebaert learned of these reports before making the allegedly misleading statements. Moreover, Tellabs argues, respondents failed to allege any motive for the fraud or explain why it repeatedly reduced its projections for the remainder of the year during the period of the alleged fraud. If competing inferences of innocence like these are taken into account, Tellabs argues, respondents have not established facts sufficient to give rise to a “strong inference” that the defendants acted with the required state of mind.

In an amicus brief filed in support of Tellabs, the United States argues that in deciding whether to dismiss a securities fraud complaint, a court should determine whether, taking the allegations as true, there is a high likelihood that the conclusion that the defendant possessed scienter follows. In making this determination, the United States argues, a court should weigh competing inferences that the defendant did not act with scienter: “[A] court will necessarily have to consider whether the facts alleged in the complaint leave open a range of non-culpable explanations for the defendant’s conduct.” The United States argues that, in holding that a complaint survives a motion to dismiss if it alleges facts that give rise to a “reasonable”—rather than “strong”—inference that the defendant acted with scienter, the Seventh Circuit erroneously diluted the PLSRA’s heightened pleading requirement, and that Congress plainly rejected the Seventh Circuit’s relatively lenient standard when it passed the PLSRA.

The respondent-shareholders argue that a complaint satisfies the PLSRA’s pleading requirements if it alleges facts that could convince a reasonable person that a defendant more likely than not acted with scienter. In deciding whether a complaint survives a motion to dismiss under this standard, the shareholders argue, the plaintiff should have the benefit of all reasonable inferences without any weighing of competing inferences. The shareholders argue that although Congress intended complaints alleging securities fraud to be held to a higher standard of proof, it did not intend to disturb the traditional rule requiring a court to draw all reasonable inferences in the plaintiff’s favor when deciding a motion to dismiss. Under this interpretation of the standard, the shareholders argue, the complaint against Tellabs alleges particular facts sufficient to establish a “strong inference” that the defendants acted with scienter. The shareholders argue that the stricter pleading standards advocated by Tellabs and the United States violate the Seventh Amendment because they require a court to act as a fact-finder on the merits of the suit. As they write in their brief: “Unless a court concludes as a matter of law that no reasonable jury could find scienter by a preponderance of the evidence, the matter must be left to the jury.”