Provisions of the federal securities laws don’t frequently produce constitutional disputes. The heightened pleading standard of the Private Securities Litigation Reform Act of 1995, which transformed securities fraud complaints and redefined the battleground on motions to dismiss, didn’t seem to be an exception. Now, though, the Supreme Court has granted cert on a late-blooming Seventh Amendment issue, in Tellabs, Inc. v. Makor Issues & Rights, Ltd.
The provision at issue, enacted apparently in order to make it easier for corporations and corporate officers to defraud shareholders, requires complaints in covered actions to “state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind.” Put simply, it extends the particularity requirement of Federal Rule of Civil Procedure 9(b) to allegations of scienter. (Rule 9(b) expressly permits plaintiffs to allege scienter generally, although some courts haven’t interpreted it that way.)
What can’t be put simply is what Congress meant by requiring that the arising inference be “strong.” The circuits soon split on this issue and, eventually, found a constitutional issue in it, in an unusual way that isn’t described in the cert papers. In what some have characterized as the most defendant-friendly interpretation of the “strong inference” requirement, a complaint survives only if the defendant’s culpability is the most plausible inference that could be drawn from the allegations. The Sixth Circuit adopted and applied this construction en banc in 2001. Then, in 2005, while applying that construction, a Sixth Circuit panel suggested in dictum in a footnote that the “strong inference” standard might be unconstitutional, because it requires the court to weigh competing inferences, a role the Seventh Amendment reserves to the jury. The parties had not raised the issue, however, so the court didn’t decide it. Later, the Seventh Circuit, which had not yet construed the provision, relied on that footnote and avoided the constitutional concern by interpreting the provision to require only that the complaint allege facts “from which, if true, a reasonable person could infer that the defendant acted with the required intent.” That’s the case that’s on its way to the Supreme Court.