Tellabs, Inc. v. Makor Issues & Rights, Ltd.
551 U.S. 308 (2007)

Annotate this Case

SYLLABUS
OCTOBER TERM, 2006
TELLABS, INC. V. MAKOR ISSUES & RIGHTS, LTD.


SUPREME COURT OF THE UNITED STATES

TELLABS, INC., et al. v. MAKOR ISSUES & RIGHTS, LTD., et al.

certiorari to the united states court of appeals for the seventh circuit

No. 06–484. Argued March 28, 2007—Decided June 21, 2007

As a check against abusive litigation in private securities fraud actions, the Private Securities Litigation Reform Act of 1995 (PSLRA) includes exacting pleading requirements. The Act requires plaintiffs to state with particularity both the facts constituting the alleged violation, and the facts evidencing scienter, i.e., the defendant’s intention “to deceive, manipulate, or defraud.” Ernst & Ernst v. Hochfelder, 425 U. S. 185, 194, and n. 12. As set out in §21D(b)(2), plaintiffs must “state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind.” 15 U. S. C. §78u–4(b)(2). Congress left the key term “strong inference” undefined.

      Petitioner Tellabs, Inc., manufactures specialized equipment for fiber optic networks. Respondents (Shareholders) purchased Tellabs stock between December 11, 2000, and June 19, 2001. They filed a class action, alleging that Tellabs and petitioner Notebaert, then Tellabs’ chief executive officer and president, had engaged in securities fraud in violation of §10(b) of the Securities Exchange Act of 1934 and Securities and Exchange Commission Rule 10b–5, and that Notebaert was a “controlling person” under the 1934 Act, and therefore derivatively liable for the company’s fraudulent acts. Tellabs moved to dismiss the complaint on the ground that the Shareholders had failed to plead their case with the particularity the PSLRA requires. The District Court agreed, dismissing the complaint without prejudice. The Shareholders then amended their complaint, adding references to 27 confidential sources and making further, more specific, allegations concerning Notebaert’s mental state. The District Court again dismissed, this time with prejudice. The Shareholders had sufficiently pleaded that Notebaert’s statements were misleading, the court determined, but they had insufficiently alleged that he acted with scienter. The Seventh Circuit reversed in relevant part. Like the District Court, it found that the Shareholders had pleaded the misleading character of Notebaert’s statements with sufficient particularity. Unlike the District Court, however, it concluded that the Shareholders had sufficiently alleged that Notebaert acted with the requisite state of mind. In evaluating whether the PSLRA’s pleading standard is met, the Circuit said, courts should examine all of the complaint’s allegations to decide whether collectively they establish an inference of scienter; the complaint would survive, the court stated, if a reasonable person could infer from the complaint’s allegations that the defendant acted with the requisite state of mind.

Held: To qualify as “strong” within the intendment of §21D(b)(2), an inference of scienter must be more than merely plausible or reasonable—it must be cogent and at least as compelling as any opposing inference of nonfraudulent intent. Pp. 6–18.

   (a) Setting a uniform pleading standard for §10(b) actions was among Congress’ objectives in enacting the PSLRA. Designed to curb perceived abuses of the §10(b) private action, the PSLRA installed both substantive and procedural controls. As relevant here, §21D(b) of the PSLRA “impose[d] heightened pleading requirements in [§10(b) and Rule 10b–5] actions.” Dabit, 547 U. S., at 81. In the instant case, the District Court and the Seventh Circuit agreed that the complaint sufficiently specified Notebaert’s alleged misleading statements and the reasons why the statements were misleading. But those courts disagreed on whether the Shareholders, as required by §21D(b)(2), “state[d] with particularity facts giving rise to a strong inference that [Notebaert] acted with [scienter],” §78u–4(b)(2). Congress did not shed much light on what facts would create a strong inference or how courts could determine the existence of the requisite inference. With no clear guide from Congress other than its “inten[tion] to strengthen existing pleading requirements,” H. R. Conf. Rep., at 41, Courts of Appeals have diverged in construing the term “strong inference.” Among the uncertainties, should courts consider competing inferences in determining whether an inference of scienter is “strong”? This Court’s task is to prescribe a workable construction of the “strong inference” standard, a reading geared to the PSLRA’s twin goals: to curb frivolous, lawyer-driven litigation, while preserving investors’ ability to recover on meritorious claims. Pp. 6–10.

   (b) The Court establishes the following prescriptions: First, faced with a Federal Rule of Civil Procedure 12(b)(6) motion to dismiss a §10(b) action, courts must, as with any motion to dismiss for failure to plead a claim on which relief can be granted, accept all factual allegations in the complaint as true. See Leatherman v. Tarrant County Narcotics Intelligence and Coordination Unit, 507 U. S. 163, 164. 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. 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. 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 Seventh Circuit expressly declined to engage in such a comparative inquiry. But in §21D(b)(2), Congress did not merely require plaintiffs to allege facts from which an inference of scienter rationally could be drawn. Instead, Congress required plaintiffs to plead with particularity facts that give rise to a “strong”—i.e., a powerful or cogent—inference. To determine whether the plaintiff has alleged facts giving rise to the requisite “strong inference,” a court must consider plausible nonculpable explanations for the defendant’s conduct, as well as inferences favoring the plaintiff. The inference that the defendant acted with scienter need not be irrefutable, but it must be more than merely “reasonable” or “permissible”—it must be cogent and compelling, thus strong in light of other explanations. 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. Pp. 11–13.

   (c) Tellabs contends that when competing inferences are considered, Notebaert’s evident lack of pecuniary motive will be dispositive. The Court agrees that motive can be a relevant consideration, and personal financial gain may weigh heavily in favor of a scienter inference. The absence of a motive allegation, however, is not fatal for allegations must be considered collectively; the significance that can be ascribed to an allegation of motive, or lack thereof, depends on the complaint’s entirety. Tellabs also maintains that several of the Shareholders’ allegations are too vague or ambiguous to contribute to a strong inference of scienter. While omissions and ambiguities count against inferring scienter, the court’s job is not to scrutinize each allegation in isolation but to access all the allegations holistically. Pp. 13–15.

   (d) The Seventh Circuit was unduly concerned that a court’s comparative assessment of plausible inferences would impinge upon the Seventh Amendment right to jury trial. Congress, as creator of federal statutory claims, has power to prescribe what must be pleaded to state the claim, just as it has power to determine what must be proved to prevail on the merits. It is the federal lawmaker’s prerogative, therefore, to allow, disallow, or shape the contours of—including the pleading and proof requirements for—§10(b) private actions. This Court has never questioned that authority in general, or suggested, in particular, that the Seventh Amendment inhibits Congress from establishing whatever pleading requirements it finds appropriate for federal statutory claims. Provided that the Shareholders have satisfied the congressionally “prescribe[d] … means of making an issue,” Fidelity & Deposit Co. of Md. v. United States, 187 U. S. 315, 320, the case will fall within the jury’s authority to assess the credibility of witnesses, resolve genuine issues of fact, and make the ultimate determination whether Notebaert and, by imputation, Tellabs acted with scienter. Under this Court’s construction of the “strong inference” standard, a plaintiff is not forced to plead more than she would be required to prove at trial. A plaintiff alleging fraud under §10(b) must plead facts rendering an inference of scienter at least as likely as any plausible opposing inference. At trial, she must then prove her case by a “preponderance of the evidence.” Pp. 15–17.

   (e) Neither the District Court nor the Court of Appeals had the opportunity to consider whether the Shareholders’ allegations warrant “a strong inference that [Notebaert and Tellabs] acted with the required state of mind,” 15 U. S. C. §78u–4(b)(2), in light of the prescriptions announced today. Thus, the case is remanded for a determination under this Court’s construction of §21D(b)(2). P. 18.

437 F. 3d 588, vacated and remanded.

   Ginsburg, J., delivered the opinion of the Court, in which Roberts, C. J., and Kennedy, Souter, Thomas, and Breyer, JJ., joined. Scalia, J., and Alito, J., filed opinions concurring in the judgment. Stevens, J., filed a dissenting opinion.

Primary Holding
Under the Private Securities Litigation Reform Act of 1995, an inference of scienter must be objectively found to be cogent and at least as compelling as any opposing inference of non-fraudulent intent to meet the meaning of "strong" within its provisions.
Facts
After purchasing Tellabs stock over a seven-month period, shareholders brought a class action under the Private Securities Litigation Reform Act of 1995. They argued that Tellabs and its CEO and president, Notebaert, violated Section 10(b) of the Securities Exchange Act of 1934 and SEC Rule 10b-5, which are designed to prevent securities fraud. Their complaint stated that Notebaert, in his position as representative of Tellabs, had falsely issued a series of statements that Tellabs was earning record revenues and receiving strong demand for its products when he was aware that this was not true. He allegedly had made these statements to reassure public investors. The price of Tellabs stock fell after the seven-month period from $67 per share to $16 per share, once it was revealed that the demand for its products had diminished.

Once the court dismissed the initial complaint without prejudice, the shareholders filed an amended complaint with more specific allegations and more confidential sources. The court dismissed the second complaint with prejudice because they had failed to state a claim with the required particularity, since the Act required that the facts in the complaint must give rise to a strong inference that the defendant acted with the required state of mind. The appellate court reversed the dismissal on the grounds that the strong inference standard should be defined as alleging facts that, if true, would lead a reasonable person to infer that the defendant acted with the required level of intent.

Opinions

Majority

  • Ruth Bader Ginsburg (Author)
  • John G. Roberts, Jr.
  • Anthony M. Kennedy
  • David H. Souter
  • Clarence Thomas
  • Stephen G. Breyer

The heightened pleading requirements under this Act failed to define the term "strong inference." The appellate court defined it too loosely, however, since its interpretation does not reflect the intent of Congress to provide an enhanced standard in this area. The standard should further the main goals of the Act, which are to prevent frivolous litigation by plaintiffs' lawyers and allow investors to pursue meritorious claims. As a result, courts should treat all factual allegations in the complaint as true when evaluating a motion to dismiss for failure to state a claim. They also must consider both the entire complaint and other sources that courts commonly use when ruling on a motion to dismiss. The allegations should be considered as a whole rather than in isolation, and the court must consider plausible opposing inferences.

The inference must be strong rather than simply reasonable, so courts must determine whether there are plausible explanations for the actions of the defendant that are not illegal. However, the inference does not need to be irrefutable. Financial motive may be a useful factor to consider, and the presence of a financial motive may be a reason to find a strong inference, but the lack of a financial motive does not mean that a strong inference cannot be shown. The financial motive factor must be assessed in view of any other allegations and the surrounding circumstances.

The Seventh Amendment right to a jury trial is not infringed by the heightened pleading requirements because Congress has the power to shape private causes of action under federal securities laws. It can decide what should be pleaded in the initial complaint as much as it can decide what must be proven to succeed on the merits.

Concurrence

  • Antonin Scalia (Author)

A strong inference is not an inference that is at least as compelling as any opposing inference. It must be more compelling than any opposing inference. This merely complies with the ordinary meaning of the phrase, which must be assumed to have been intended by Congress in the absence of evidence to the contrary.

Concurrence

  • Samuel A. Alito, Jr. (Author)

The lower court should consider only the facts that are alleged with particularity, rather than all of the facts in their entirety. Scalia's interpretation of the definition of a strong inference is correct.

Dissent

  • John Paul Stevens (Author)

The Act was intended to protect defendants from being brought into litigation and being burdened with unnecessary discovery requests regarding claims that lack any foundation. Rather than a strong inference, the appropriate standard should be probable cause, which is used in the criminal context. The purposes of this law are similar to the goals of protecting criminal defendants, and it would be strange for Congress to impose a higher standard for a civil case than a criminal case. Using the probable cause standard, it appears that the strong inference element was satisfied.

Case Commentary

The concept of general notice pleading clashes with the requirement of drawing a strong inference from the factual allegations, which would be difficult to determine at the stage of the complaint without having received information from the defendant. Since discovery is expensive in securities fraud cases, this decision seems designed to avoid the unnecessary litigation caused by cases that are likely to succeed only if the defendants have no counterarguments at all, which is unlikely to happen.

Disclaimer: Justia Annotations is a forum for attorneys to summarize, comment on, and analyze case law published on our site. Justia makes no guarantees or warranties that the annotations are accurate or reflect the current state of law, and no annotation is intended to be, nor should it be construed as, legal advice. Contacting Justia or any attorney through this site, via web form, email, or otherwise, does not create an attorney-client relationship.

Disclaimer: Official Supreme Court case law is only found in the print version of the United States Reports. Justia case law is provided for general informational purposes only, and may not reflect current legal developments, verdicts or settlements. We make no warranties or guarantees about the accuracy, completeness, or adequacy of the information contained on this site or information linked to from this site. Please check official sources.