It has been a year or so since the Supreme Court's decision in Tellabs. The case construed the requirements in the PSLRA for pleading scienter. Congress inserted into the Act a requirement that plaintiffs "state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind." 15 USC §78u-4(b)(2). The "strong inference" language was undefined and the legislative history provided little illumination. As a result, the Supreme Court had something approaching a blank slate to impose its own interpretation. Moreover, given the avowed intent expressed in Stoneridge to interpret Section 10(b) to restrain litigation under the antifraud provision, the "strong inference" language provided considerable opportunity to restrict the reach of the provision.
This didn't happen. Justice Ginsburg, however, wrote the opinion. In examining the facts alleged by the plaintiff, she instructed courts to consider any "nonculpable explanations" for the defendant's behavior. In other words, the courts had to take into account any competing inference presented by the facts alleged. Nonetheless, a complaint would 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." In short, ties went to the plaintiff.
In addition, Justice Ginsburg emphasized that the allegations of scienter had to be considered in their entirety. The inquiry 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." Effectively, courts could not resolve the scienter analysis by examining and dismissing each factor seriatim.
The briefs and opinion for Tellabs are posted on the DU Corporate Governance web site. At the time Tellabs came out, we concluded that the opinion was a victory for plaintiffs. Justice Ginsburg accorded the phrase the least restrictive possible meaning. Nonetheless, we predicted a phenomena that we described as the Tellabs Excuse. Courts hostile to plaintiff class actions based upon the antifraud provisions would misuse Tellabs to dismiss cases for failing to plead a "strong inference" of scienter. The Seventh Circuit decision in Higginbotham seemed to confirm this trend.
We have had a chance to read through the appellate court cases employing the analysis in Tellabs (as part of the process of updating The Regulation of Corporate Disclosure). The analysis leads to some interesting observations. We will share those in the next post.