Supreme Court Establishes Rigorous Pleading Standard for Investor Suits

June 22, 2007

On June 21, 2007, the Supreme Court issued an 8-1 decision in Tellabs v. Makor Issues & Rights, No. 06-484, explaining the plaintiff’s burden under § 21D(b)(2) of the PSLRA (15 U.S.C. § 78u-4(b)(2)) to plead facts giving rise to a strong inference of scienter (i.e., fraudulent intent). The Supreme Court held that, after considering all the allegations collectively, the reviewing court must conclude that the inference of scienter is “cogent” and at least as compelling as any opposing inference of nonfraudulent intent. 

The defendants had sought reversal of a Seventh Circuit decision holding that the PSLRA only requires a plaintiff to allege facts from which an inference of fraudulent intent could be drawn and does not require consideration of competing inferences of nonfraudulent intent. The Court reversed, holding that the PSLRA requires more. It requires a “powerful or cogent” inference. Because the strength of an inference cannot be decided in a vacuum, the Court reasoned, the inquiry is inherently comparative. Thus, a court must consider nonculpable explanations for the defendant’s conduct in addition to inferences favoring the plaintiff. In sum, although a scienter inference need not be irrefutable, it “must be cogent and compelling–thus strong in light of other explanations.” 

The Court agreed that omissions and ambiguities count against inferring scienter, but cautioned that “the court’s job is not to scrutinize each allegation in isolation but to assess all the allegations holistically.” The reviewing court must ask: “When the allegations are accepted as true and taken collectively, would a reasonable person deem the inference of scienter at least as strong as any opposing inference?” 

The Court further instructed lower courts to perform the following analysis when faced with a Rule 12(b)(6) motion to dismiss a §10(b) action. First, courts must accept all factual allegations in the complaint as true. Second, courts must consider the complaint in its entirety, as well as other sources courts ordinarily examine when ruling on Rule 12(b)(6) motions to dismiss. Third, in determining whether the pleaded facts give rise to a strong inference of scienter, the court must take into account plausible opposing inferences. The case was remanded to the Seventh Circuit for further determinations in light of this new standard.

The Supreme Court also held that the Seventh Amendment does not bar consideration of competing inferences of nonfraudulent conduct, because it does not inhibit Congress from establishing whatever pleading requirements it finds appropriate for federal statutory claims.

The Supreme Court’s decision is available at

Gibson Dunn participated in the case, filing an amicus brief on behalf of the American Institute of Certified Public Accountants and the leading accounting firms, which urged the Court to conclude, as it did, that the PSLRA requires a plaintiff to plead facts giving rise to a scienter inference that is cogent and compelling in light of competing inferences of nonfraudulent conduct. The brief was prepared by partners Theodore Olson, Scott Fink, Douglas Cox, and Mark Perry and associate Dana Vancea.

Gibson, Dunn & Crutcher lawyers are available to assist in addressing any questions you may have regarding these issues. Please contact the Gibson Dunn attorney with whom you work, Scott A. Fink (415-393-8267, [email protected]) in the firm’s San Francisco office, or Mark A. Perry (202-887-3667, [email protected]) in the Washington, D.C. office.

Gibson, Dunn & Crutcher’s Appellate and Constitutional Law Practice Group has played a leading role in a number of recent significant cases in the Supreme Court, and also handles appellate matters in federal and state courts throughout the country. For more information on the firm’s appellate practice, please contact any member of the firm’s Appellate and Constitutional Law Practice Group, or practice group Co-Chairs 
Miguel A. Estrada (202-955-8500, [email protected]) or 
Theodore B. Olson (202-955-8500, [email protected]) in Washington, D.C., 
Theodore J. Boutrous, Jr. (213-229-7000, [email protected]) in Los Angeles, or 
Daniel M. Kolkey (415-393-8200, [email protected]) in San Francisco.

© 2007 Gibson, Dunn & Crutcher LLP

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