Securities — Reversible Error under Tellabs to Require Inference of Scienter Be Most Compelling of Competing Inferences

From Frank v. Dana Corp., 2008 U.S. App. LEXIS 23947 (6th Cir. Nov. 19, 2008):

Pursuant to Rule 12(b)(6) of the Federal Rules of Civil Procedure, the district court dismissed the complaint.... In articulating the controlling pleading standard, the district court stated that it was "required to accept plaintiff's inferences of scienter only if those inferences are the most plausible of competing inferences.".... Because this formulation of the applicable pleading standard is contrary to the Supreme Court's decision in Tellabs, Inc. v. Makor Issues & Rights, Ltd., U.S. , 127 S. Ct. 2499 (2007), which held that a complaint will survive a motion to dismiss so long as "a reasonable person would deem the inference of scienter cogent and at least as compelling as any opposing inference one could draw from the facts alleged," id. at 2510 (emphasis added), we vacate the judgment of the district court. ***

In Tellabs, the Supreme Court prescribed a specific three-step analysis that district courts are to follow in considering a motion to dismiss private securities claims arising under Section 10(b). First, "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." Tellabs, 127 S. Ct. at 2509. 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, in particular, documents incorporated into the complaint by reference, and matters of which a court may take judicial notice." .... At the second stage, the relevant question "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." ... The PSLRA does not permit a plaintiff merely "to allege facts from which an inference of scienter rationally could be drawn." .... Rather, the inference of scienter "must be cogent and compelling, thus strong in light of other explanations." ...

Finally, in determining whether the pleaded facts give rise to a strong inference of scienter, "the court must take into account plausible opposing inferences." .... Because the strength of an inference "cannot be decided in a vacuum," the district court must conduct a "comparative inquiry" and assess the possible competing inferences that could be drawn from the allegations, including "plausible nonculpable explanations for the defendant's conduct, as well as inferences favoring the plaintiff." ....

In defining how this framework is to be applied, the Supreme Court expressly held that a complaint will survive a motion to dismiss so long as "a reasonable person would deem the inference of scienter cogent and at least as compelling as any opposing inference one could draw from the facts alleged." Id. at 2510 (emphasis added). Thus, where two equally compelling inferences can be drawn, one demonstrating scienter and the other supporting a nonculpable explanation, Tellabs instructs that the complaint should be permitted to move forward. See id. at 2510 n.5; ACA Fin. Guar. Corp. v. Advest, Inc., 512 F.3d 46, 59 (1st Cir. 2008) ("In other words, where there are equally strong inferences for and against scienter, Tellabs now awards the draw to the plaintiff."). ***

In articulating the controlling pleading standard, the district court stated that it was "required to accept plaintiff's inferences of scienter only if those inferences are the most plausible of competing inferences." ...The district court explained that, "under Tellabs, plaintiff must establish an inference of scienter that is moreover re plausible and powerful than competing inferences of defendants' state of mind." Id. at 928 (emphasis added). This standard plainly is at odds with the Supreme Court's holding in Tellabs that inferences of scienter that are "at least as compelling" as competing nonculpable inferences are sufficient for the complaint to survive a motion to dismiss.

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