A Major Victory For Defendants In Securities Class Actions: Tellabs, Inc. v. Makor Issues & Rights, Ltd.

Article by Kevin P. Muck, Felix S. Lee and Gaurav Mathur

On June 21, 2007, the U.S. Supreme Court handed down a decision that provides welcome news to any public company, officer or director facing the prospect of a securities class action lawsuit. In Tellabs, Inc. v. Makor Issues & Rights, Ltd., the Court resolved a significant and long-standing split on how courts should interpret the "strong inference" of scienter pleading standard set forth in the Private Securities Litigation Reform Act of 1995 ("Reform Act") for securities fraud actions. After emphasizing that "securities fraud actions if not adequately contained, can be employed abusively to impose substantial costs on companies and individuals whose conduct conforms to the law," the Court made clear that courts must be vigilant in scrutinizing - and filtering - such actions at the pleading stage. In particular, the Court held that a securities fraud complaint may survive dismissal only if the inference of scienter arising from the well-plead facts stated therein was "cogent and at least as compelling as any opposing inference one could draw from the facts alleged."

Background

The Reform Act sets forth a heightened pleading standard for securities fraud complaints. With respect to the scienter requirement of a claim under Section 10(b) of the Securities Exchange Act of 1934, the Reform Act requires that a complaint "state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind [i.e., the intent to deceive investors]." At issue in Tellabs was the extent to which a court must weigh competing factual inferences in determining whether a strong inference of scienter had been plead. Some circuits had ruled that, in effect, a court should consider only those inferences favorable to plaintiffs. Other courts, including the Ninth Circuit, held that the Reform Act instead requires courts to consider the factual allegations and weigh all competing inferences, including those unfavorable to the plaintiff.

The plaintiffs in Tellabs purported to represent a class of shareholders who purchased stock between December 11, 2000 and June 19, 2001. Their complaint was premised principally on allegedly false and misleading statements by the CEO concerning the company's financial health.

Tellabs moved to dismiss the complaint on the ground that plaintiffs had failed to plead their claims with the factual particularity required by the Reform...