Tellabs, Inc. v. Makor Issues & Rights Ltd.

U.S. Supreme Court Requires "Cogent and Compelling" Facts of Securities Fraud for Case to Proceed

In a case which has been followed closely by corporations throughout the country, the United States Supreme Court has established a strict standard for securities fraud claims. The decision makes it easier for companies and their officers and directors to seek the dismissal of shareholder suits at the beginning of a case.

In Tellabs, Inc. v. Makor Issues & Rights Ltd., the shareholders of a high-tech company filed suit alleging that the company and its CEO had fraudulently represented the demand for the company's products, thereby resulting in an inflated stock price. A lower court held that the suit should be allowed to go forward if a reasonable person could infer from the allegations that the defendants' conduct was intended to deceive.

The Supreme Court, however, relying on the Private Securities Litigation Reform Act of 1995, held that Plaintiffs must plead more. A securities fraud lawsuit will only be allowed to proceed where the Plaintiffs plead facts which are "cogent and compelling" in demonstrating an intent to deceive investors. In assessing the allegations, a Court must take into account "plausible opposing inferences," and whether the factual allegations are as compelling as any opposing inferences which suggest an innocent motive for the defendants' action. The Court held that "an inference of [fraudulent intent] must be more than merely plausible or reasonable - it must be cogent and at least as compelling as any opposing inference of nonfraudulent intent."

In reaching its decision, the Court reviewed the legislative purpose of the 1995 Act, which was "to create a check against the abusive employment of litigation in private securities fraud actions." Among the reforms in the Act is a requirement that a securities fraud complaint must allege facts which create a "strong inference" that the defendants acted with the intent to deceive investors. The lower court's interpretation of that phrase was not strict enough, according to the High Court. The Supreme Court remanded the case to the district court to reconsider the defendants' motion to dismiss in accordance with the heightened standard.

Predictably, Plaintiffs attorneys say that most cases already meet the pleading standards identified by the Court. The new decision, however, is an unqualified victory for companies and their officers and directors. The stricter pleading standard not only benefits corporate defendants, but it also places a greater burden on investors to investigate and develop their claims before bringing an action for securities fraud.