Securities Fraud: Courts Set Different Scienter Pleading Standards

Article by Bruce Ericson, Edward Flanders, David G. Keyko, Jill E. Klements and Takemi Ueno

The Private Securities Litigation Reform Act of 1995 (PSLRA) requires a securities fraud plaintiff to "state with particularity facts giving rise to a strong inference" of defendant's scienter. 15 U.S.C. 78u-4(b)(2). The nine circuits that have considered how a plaintiff can satisfy this pleading requirement have divided into three camps. In the Second and Third Circuits, a plaintiff can demonstrate scienter either with allegations of motive and opportunity or with allegations constituting strong circumstantial evidence of conscious misbehavior or recklessness. At the other end of the spectrum, the Ninth Circuit accepts only allegations raising a strong inference of intentional misconduct or deliberate recklessness. Thus, in addition to rejecting the motive and opportunity test, the Ninth Circuit sets a higher standard for pleading recklessness than any other circuit. In the middle, six circuits (the First, Fifth, Sixth, Eighth, Tenth, and Eleventh Circuits) have rejected motive and opportunity as a separate test but permit allegations of motive and opportunity to give rise to a strong inference of recklessness or intentional misconduct on a case-by-case basis. See generally Florida State Bd. of Admin. v. Green Tree Fin. Corp., 2001 U.S. App. LEXIS 22921 (8th Cir. Oct. 25, 2001) (discussing issue and citing cases from other circuits).

Second Circuit Continues To Use Pre-PSLRA Standard

The Second Circuit's motive and opportunity test is not satisfied by a generalized motive - one that could be imputed to any publicly owned for-profit endeavor, such as a corporation's desire to appear profitable or a corporate officer's desire to keep stock prices high to increase his or her compensation. Rather, a plaintiff must allege that the defendants benefited in a concrete and personal way from the fraud (e.g., by selling a large portion of their holdings at a substantial profit). Moreover, if no such motive is alleged, then the inference necessary to satisfy the alternative test (strong circumstantial evidence of conscious misbehavior or recklessness) must be stronger. A recent decision of the Second Circuit, Kalnit v. Eichler, 264 F.3d 131 (2d Cir. 2001), gives a good explanation of that court's test.

Allegations Concern Proposed Merger

In 1996, MediaOne Group, Inc. (MediaOne) acquired Continental Cablevision (Continental). As part of this acquisition...