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E-MailMuch has been written about the conservative shift at the Supreme Court; among other things, there is the perception that the Court is taking an increasingly pro-business approach in its decisions. As an example, commentators often point to Tellabs, Inc. v. Makor Issues, an 8-1 decision that toughened the pleading standards in securities class actions. Defendants, according to attorneys at Wachtell, Lipton, “won an important battle in the fight against meritless litigation.” (The firm’s analysis was covered on this blog here.) The blog Legal Pad labeled Tellabs “the latest in a series of setbacks that class action plaintiffs in business related cases have been dealt by the High Court.”
In fact, the case was a victory for shareholders. And to the extent there was a surprise, it was the refusal of Chief Justice Roberts and Justices Kennedy and Thomas to side with their conservative brethren, Justices Scalia and Alito, both of whom wrote concurring opinions that favored an even stricter interpretation.
I think Tellabs is a victory for shareholders for two reasons. First, the decision was written by Justice Ginsburg. Justice Ginsburg wrote the majority opinion in United States v. O’Hagan, the case that upheld the misappropriation theory of insider trading. Justice Ginsburg is certainly no friend to narrow interpretation of the securities laws.
Second, the case was a potential opportunity to drastically limit class actions, and the Court did not do so. The PSLRA left the burden of proof for class action plaintiffs to survive a motion to dismiss–that plaintiffs show a “strong inference” that fraud took place–undefined. Nor did the legislative history provide any meaningful insight as to what that phrase meant. The Court, therefore, was writing on a blank slate–and in a position to make the “strong inference” phrasing a real barrier to judicial access for aggrieved shareholders. This is more or less what the Petitioners wanted. They didn’t get it.
The Petitioners argued that the “strong inference” language requires plaintiffs to allege motive; that each fact had to be examined individually to determine whether the facts supported allegations of scienter; and contended that plaintiffs should be required to plead facts that would establish “a substantially meritorious case,” a standard viewed by the Justices as higher even than the standard plaintiffs must meet to survive a motion for summary judgment. Note this exchange in the oral argument:
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Justice Alito: Doesn’t that–doesn’t the standard at the pleading stage have to be the same as the standard at the summary judgment stage? If–suppose that a certain set of facts is sufficient to defeat summary judgment. If the plaintiff alleges all of those facts in the complaint, are you saying that that complaint could be dismissed even though supporting those facts at the summary judgment stage would be enough to defeat a summary judgment motion?
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Mr. Phillips: I think at the end of the day I would make that argument.
The federal government went even further. To the extent that the Court was concerned about imposing a higher standard at the pleading stage than plaintiffs faced at summary judgment, the Government argued that “it is more consistent with Congress’s intent to apply the strong inference requirement at the proof stage as well as the pleading stage rather than to water down the strong inference requirement that Congress adopted at the pleading stage.”
In other words, the Supreme Court could have–if it had wanted to–used Tellabs not only to raise the pleading standards but also to raise the standard of proof at summary judgment. That certainly would have been a loss for shareholders. But the actual holding is relatively oblique and harmless. The Court concluded that a “complaint will survive . . . 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.” This is not very different than what courts already do. For example, in determining motive in securities-fraud suits, courts often look to trading by insiders. But they do not simply conclude that trading alone is enough to establish scienter. Instead, they typically require a showing of unusual amounts of trading at unusual times. In other words, the courts only accept as evidence of scienter trading patterns that are “at least as compelling as any opposing inference”.
The more important consequence of Tellabs is what Justice Ginsburg refused to do. With respect to the possibility that the “strong inference” language elevated the burden shareholders faced at the pleading stage beyond the proof required to survive a motion for summary judgment, the Court emphatically rejected that notion:
We emphasize, as well, that under our construction of the “strong inference” standard, a plaintiff is not forced to plead more than she would be required to prove at trial. A plaintiff alleging fraud in a 10(b) action, we hold today, must plead facts rendering an inference of scienter at least as likely as any plausible opposing inference. At trial, she must then prove her case by a ‘preponderance of the evidence.’ Stated otherwise, she must demonstrate that it is more likely than not that the defendant acted with scienter.
With respect to the implication that, in determining whether a plaintiff’s evidence met the “strong inference” standard, facts should be examined one at a time, Justice Ginsburg again disagreed. The determination will be made based upon “the complaint in its entirety;” courts should not examine “whether any individual allegation, scrutinized in isolation, meets that standard.”
What about the argument that plaintiff shareholders must plead motive to survive a motion to dismiss? Same result: the Court held that, “[w]hile it is true that motive can be a relevant consideration, and personal financial gain may weigh heavily in favor of a scienter inference, we agree with the Seventh Circuit that the absence of a motive allegation is not fatal.”
So Tellabs is more remarkable for what it did not do rather than for what it did. As a practical matter, it will not result in any significant change from what courts are already doing. The evidence? The Court sent the case back to the Seventh Circuit to apply the new standard. On remand, the case will be reassigned to the same panel of judges that decided it the first time. My prediction? The new test notwithstanding, the outcome will be the same.
