Commercial Litigation and Arbitration

PSLRA — All Facts / Scienter / Loss Causation

The Fourth Circuit’s 2-1 decision last week affirming dismissal of a securities fraud class action, Teachers' Retirement Sys. of Louisiana v. Hunter, 2007 U.S. App. LEXIS 3698 (4th Cir. Feb. 20, 2007), is notable in three respects: (1) its discussion of the ‛all facts“ requirement of the PSLRA, (2) the percentages of stock sold by the individual defendants (which did not give rise to an inference of scienter), and (3) the panel majority’s requirement that loss causation be pled with specificity in accordance with Rule 9(b).

The PSLRA requires every securities fraud complaint to specify "each statement alleged to have been misleading, the reason or reasons why the statement is misleading, and if an allegation regarding the statement or omission is made on information and belief, the complaint shall state with particularity all facts on which that belief is formed." 15 U.S.C. § 78u-4(b)(1). (This is the standard for determining the element of misrepresentation, not scienter, which is before the Supreme Court this term in its pending review of Tellabs Inc. v. Makor Issues & Rights, Ltd., 437 F.3d 588 (7th Cir. 2006).) Because class actions are almost uniformly predicated on information and belief to a substantial extent, the ‛all facts“ requirement is virtually always subject to dispute. The statutory requirement is challenging given that, taken literally, it is impossible to comply with or enforce, and surely superfluous if a valid claim for relief is stated on something short of ‛all facts.“ The majority in Teachers analyzed the statutory requirement practically and held that it imposed only a sufficiency requirement, not a Congressionally-mandated laundry list of every fact known to the plaintiffs: ‛[W]e must ascertain whether the complaint states sufficient facts to permit a reasonable person to find that the plaintiff satisfied this element of his claim -- that the defendant made a false or misleading statement.“ Accordingly, ‛[i]f the plaintiff fails to allege all facts but does allege sufficient facts to support a reasonable belief in the allegation that the defendant's statement was misleading, the court should deny the Rule 12(b)(6) motion as to this ‘misrepresentation’ element.“ This was the high point of the decision as far as the plaintiffs were concerned. The majority proceeded to find this standard unsatisfied.

The individual defendants sold 92%, 100% and 82% of their stock during the class period. The majority found this allegation to be ‛unremarkable without taking into account the defendants’ vested stock options“ — it is always important to know what the proper denominator is — and concluded that, ‛[i]n any event, the complaint does not provide the facts sufficient to generate the required ‘strong inference’“ of scienter.

Finally, the majority held that loss causation must be pled with specificity: ‛a plaintiff purporting to allege a securities fraud claim must not only prove loss causation — that the material misrepresentations or omissions alleged actually caused the loss for which the plaintiff seeks damages — but he must also plead it with sufficient specificity to enable the court to evaluate whether the necessary causal link exists.“

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