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Pleading Standard for Securities Fraud Complaints

By Laurence Lese, David Kaufman, Michael Margulis and Alexander Santee
August 28, 2007

In Tellabs v. Makor Issues & Rights Ltd. (June 21, 2007), the U.S. Supreme Court offered clarity on the requirement in the Private Securities Litigation Reform Act of 1995 (the 'PSLRA') that plaintiffs in securities fraud actions plead with particularity facts giving rise to a 'strong inference' of scienter. Basically, the Court was asked to decide how to address pleadings when there are contrasting inferences with respect to scienter. On this point, the Court held by an 8-1 vote that to qualify as 'strong' within the meaning of ' 21D(b)(2) of the PSLRA, an inference of scienter must be more than 'merely plausible or reasonable.' The Court ruled that the trial court must balance competing inferences raised by the parties' pleadings and before the trial court and that '[a] complaint will survive only if a reasonable person would deem the inference of scienter cogent and at least as compelling as any plausible opposing inference one could draw from the facts alleged.'

There has been some disagreement on the impact of the ruling. Some commentators and most media suggest that the Tellabs decision is a positive ruling for companies and executives, making it more difficult for shareholder-plaintiffs to sue companies and executives or win substantial damages. In contrast, recognizing that the Court is seemingly pro-business, some commentators consider it a minor victory for shareholders that the Court did not adopt Justice Scalia's view (expressed in his concurring opinion) that equally competing inferences cannot establish scienter, the willful intent to commit fraud. In fact, some commentators have gone so far as to suggest that the majority's 'prescriptions' actually do not differ from what courts already follow and that the Court whiffled on a golden opportunity to drastically limit class actions.

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