The Pendulum Swings – A Primer on Caselaw In Bell Atlantic Corp. v. Twombly, -- U.S. ----, 127 S. Ct. 1955, 167 L. Ed. 2d 929 (2007), the Supreme Court raised the bar at the pleading stage by requiring plaintiffs to provide greater detail in their complaints than the minimal “notice pleading” standard traditionally understood as required under Rule 8 of the Federal Rules of Civil Procedure. 127 S. Ct. at 1968-69. Although Twombly was an antitrust case rather than an action brought under the federal securities laws, this decision altered the interpretation of Rule 8. Specifically, Twombly overruled Conley v. Gibson, 355 U.S. 41, 45-46, 78 S. Ct. 99, 2 L. Ed. 80 (1957), rejecting the oft-cited and very permissive standard “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.” Id. at 1968 (quoting Conley, 355 U.S. at 45-46). Instead, under Twombly, the factual allegations in a complaint must establish that plaintiff’s entitlement to relief is “plausible,” not just possible. Id. at 1965. Twombly states that “a plaintiff's obligation to provide the ‘grounds’ of his ‘entitle[ment] to relief’ requires more than labels and conclusions, and a formulaic recitation of the elements of a cause of action will not do[.] […] Factual allegations must be enough to raise a right to relief above the speculative level.” Id. at 1964-65. In Tellabs, Inc. v. Makor Issues & Rights, Ltd., -- U.S. ----, 127 S. Ct. 2499, 168 L. Ed. 2d 179 (2007), the Supreme Court resolved a split among the Circuits on how courts should interpret the “strong inference” of scienter pleading standard for securities fraud actions set forth in the PSLRA. Under the PSLRA, to survive a motion to dismiss, a plaintiff must allege with particularity facts giving rise to a strong inference that the defendant made the misrepresentations or omissions with scienter, i.e., knowingly or in a severely reckless manner. However, as the Supreme Court noted in Tellabs, the statute does not define “strong inference,” leading to different interpretations across jurisdictions. 127 S. Ct. at 2509. Through Tellabs, the Supreme Court aimed “to prescribe a workable construction of the ‘strong inference’ standard, a reading geared to the PSLRA’s twin goals: to curb frivolous, lawyer-driven litigation, while preserving investors’ ability to recover on meritorious claims.” Id. In furtherance of these goals, the Supreme Court set forth standards to be used by the district courts when evaluating the viability of a complaint. First, in ruling on a motion to dismiss a securities fraud action, “courts must, as with any motion to dismiss for failure to plead a claim on which relief may be granted, accept all factual allegations in the complaint as true.” Id. Second, courts should consider complaints in their entirety, as well as other sources of information appropriate for courts to consider on a motion to dismiss, such as documents incorporated into a complaint by reference, or public filings and other matters of which a court may take judicial notice. Id. This language suggests that district courts will have less discretion when considering a request for judicial notice. For example, in a case involving allegations of misstatements or omissions in a proxy statement, it may now be mandatory for courts to consider the entirety of the proxy statement when evaluating a motion to dismiss. In this manner, bad facts (from plaintiffs’ perspective) can no longer be ignored at the pleading stage, but now must be considered and weighed in deciding if plaintiffs’ story is at least as plausible as the facts contained in public filings. The Supreme Court further explained that the inquiry for the district court is “whether all of the facts alleged, taken collectively, give rise to a strong inference of scienter, not whether any individual allegation, scrutinized in isolation, meets that standard.” Id. Thus, the allegations of scienter are to be viewed holistically. It is important to note, however, that only well-pleaded, specific allegations should be considered. As the Supreme Court stated, “omissions and ambiguities count against inferring scienter, for plaintiffs must ‘state with particularity facts giving rise to a strong inference that defendant acted with the required state of mind.’” Id. at 2511 (quoting 15 U.S.C. § 78u-4(b)(2)). Finally, and most significantly, the Supreme Court held that, “in determining whether the pleaded facts give rise to a ‘strong’ inference of scienter, the court must take into account plausible opposing inferences.” Id. at 2510. More specifically, a court may not only consider “inferences favoring the plaintiff,” but must also “consider plausible nonculpable explanations for the defendant’s conduct.” Id. The Court explained that a district court must conduct a comparative analysis of competing inferences because the PSLRA does “not merely require plaintiffs to ‘provide a factual basis for [their] scienter allegations,’. . . i.e., to allege facts from which an inference of scienter rationally could be drawn. Instead, Congress required plaintiffs to plead with particularity facts that give rise to a ‘strong’ – i.e., a powerful or cogent – inference.” Id. Thus, per Tellabs, “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. . . . [and] at least as compelling as any opposing inference one could draw from the facts alleged.” Id. Although Tellabs requires courts to weigh inferences, it does not require the inferences advanced by the plaintiff to be the most plausible inferences, as the Sixth Circuit had held in Helwig v. Vencor, Inc., 251 F.3d 540, 553 (6th Cir. 2001). Nor is it as stringent as the standard previously in place in the 1st Circuit: if equally strong inferences exist for and against scienter, the defense prevails. In re Credit Suisse First Boston Corp., 431 F.3d 36, 49 (1st Cir. 2005) (“Scienter allegations do not pass the ‘strong inference’ test when, viewed in light of the complaint as a whole, there are legitimate explanations for the behavior that are equally convincing.”). Instead, under Tellabs, a plaintiff’s case will be permitted to proceed beyond the pleading stage when, viewed holistically, the allegations of the complaint support an inference of scienter that is at least as plausible as an inference of innocence. In most jurisdictions (other than the 6th and 1st Circuits), the Tellabs decision should represent a more difficult pleading standard to be met by shareholders. Most recently, in Stoneridge Investment Partners, LLC v. Scientific-Atlanta, Inc., -- U.S. ----, 128 S. Ct. 761 (2008), the Supreme Court held that third parties are not liable for participating in corporate wrongdoing if they did not directly mislead investors. In so ruling, the Supreme Court rejected the concept of “scheme liability,” a theory under which liability would be imposed where a defendant “engaged in conduct with the purpose and effect of creating a false appearance of material fact to further a scheme to misrepresent [an issuer’s] revenue.” 128 S. Ct. at 770. Alleging losses after purchasing Charter Communications, Inc. (“Charter”) common stock, plaintiffs filed a class action suit against Charter and others, including Scientific-Atlanta, Inc. and Motorola, Inc., “suppliers, and later customers of Charter,” alleging liability under Section 10(b) of the Securities Exchange Act of 1934. 128 S. Ct. at 766-67. Acting as Charter’s customers and suppliers, Scientific-Atlanta and Motorola had allegedly agreed to arrangements that allowed Charter to mislead its auditor and issue a misleading financial statement affecting its stock price, but they “had no role in preparing or disseminating Charter’s financial statements.” Id. at 767. Page: 3 of 4 pages for this article « First < 1 2 3 4 >
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