The Securities and Exchange Commission raised a few eyebrows recently when it filed a friend-of-the-court brief urging the U.S. Supreme Court to adopt an extremely tough standard that plaintiffs would have to meet when they try to sue public companies for fraud.
Although some lawyers defend the SEC’s decision to file the brief, others question the wisdom of the Commission siding with the companies it regulates on a legal issue that has no direct impact on the SEC’s own enforcement activities.
“Historically it’s not been the position of the SEC to come out against investor rights,” says Jill Fisch, a law professor at Fordham University. “The SEC has typically viewed its mandate as protecting investors, protecting shareholder rights. The position in the brief is clearly an anti-private-litigation position.”
Piazza
Michael Piazza, a former SEC attorney who is now a partner with Dorsey & Whitney, calls the Commission’s decision to intervene in this case “curious.” He says the stricter pleading standard that the Commission is advocating “may well have a chilling effect on … ‘private enforcement’ type cases” that supplement the SEC’s regulatory efforts.
“The move is a bit disingenuous at best” because the SEC is not held to the pleading requirements that private litigants face, Piazza says. “So why make it even harder for wronged shareholders to seek redress in court themselves?”
Ballard
But Gregory Ballard, a partner with Cadwalader, Wickersham & Taft, says he takes issue with those who have characterized the SEC’s position as “anti-investor.” With this court filing, he says, the SEC is trying “to give life” to the Private Securities Litigation Reform Act. And, he adds, while the Supreme Court case involves an issue that deals only with private litigation, it’s “definitely the kind of thing you would expect the SEC to weigh in on.”
Paul Bessette, chairman of the securities-litigation practice at law firm Akin Gump Strauss Hauer & Feld, agrees. “The Commission is the final arbiter of the enforcement of the securities laws,” he says. He notes that while the PSLRA standard has no direct impact on the SEC, allowing too many private suits to get past a motion to dismiss would “taint the process” and result in litigation that “is not helpful” to the SEC’s own enforcement efforts.
The SEC declined to comment on the amicus brief it filed in the upcoming Supreme Court case, Tellabs v. Makor Issues & Rights.
Taking A Position
Tellabs involves the threshold that securities-fraud plaintiffs must satisfy under the heightened pleading standard established by the PSLRA, which requires plaintiffs to “state with particularity facts giving rise to a strong inference” that the defendant acted with the requisite scienter—the legal term for the culpable mental state required for liability.
Courts have used a variety of standards to interpret what constitutes a “strong inference,” with the 7th U.S. Circuit Court of Appeals in Tellabs adopting the most plaintiff-friendly standard. Under the 7th Circuit view, any inferences offered by the company to show that it acted innocently should not be considered in determining whether the plaintiffs had established a “strong inference” of fraudulent intent. Balancing such inferences is the job of the jury, not the judge, the court ruled.
BRIEF
An excerpt from the SEC’s amicus brief in Tellabs follows.
INTEREST OF THE UNITED STATES
The United States, through the Department of Justice (DOJ) and the Securities and Exchange Commission
(SEC), administers and enforces the federal securities
laws. The issue in this case concerns the interpretation
of the heightened pleading requirement for state of
mind in private securities fraud actions. Meritorious
private actions are an essential supplement to criminal
prosecutions and civil enforcement actions brought, respectively, by DOJ and the SEC. At the same time,
Congress has recognized a potential for such actions to
be abused in ways that impose substantial costs on companies that have fully complied with the applicable laws.
The United States has a strong interest in seeing that
the principles applied in private actions promote the purposes of the securities laws, and has previously participated as an amicus curiae in cases involving those
principles.
…
SUMMARY OF ARGUMENT
Congress enacted the Private Securities Litigation
Reform Act of 1995 in order to curtail abusive practices
that undermine the beneficial purposes of private securities litigation. As part of that effort, Congress amended
the Securities Exchange Act of 1934 to require that a
securities fraud complaint “state with particularity facts
giving rise to a strong inference that the defendant
acted with the requisite state of mind.” 15 U.S.C. 78u4(b)(2). The court of appeals erroneously diluted that
requirement by holding that a securities fraud plaintiff
need only “allege[] facts from which, if true, a reasonable person could infer that the defendant acted with the
required intent.” Pet. App. 20a.
Before the enactment of the Reform Act, numerous
lower courts, applying Rule 9(b) of the Federal Rules of
Civil Procedure, held that it was insufficient for a securities fraud plaintiff merely to allege state of mind generally, and some courts held that a securities fraud plaintiff was required to allege facts that gave rise to at least a reasonable inference of the requisite mental state.
The Second Circuit, however, went further and held that
a securities fraud plaintiff was required to allege facts
that gave rise to a strong inference of scienter. In enacting the Reform Act, Congress intended to impose a
uniform and heightened pleading standard that built
upon the Second Circuit’s “strong inference” terminology.
In evaluating whether a plaintiff has alleged facts
that “giv[e] rise” to a “strong inference” of scienter, a
court should determine whether, taking the alleged facts
as true, there is a high likelihood that the conclusion
that the defendant possessed scienter follows from those
facts. While it is impossible to specify with mathemati cal precision the degree of likelihood required for a
“strong inference,” both the plain language of the Reform Act and the backdrop against which it was enacted
show that a “strong” inference requires something considerably more than merely a “reasonable” inference.
The standard applied by the court of appeals in this case
does not appear to differ materially from the “reasonable” inference standard that it (and other courts of appeals) had applied before the enactment of the Reform Act. Congress plainly rejected that approach in favor of
a more demanding standard.
In determining whether an inference of scienter is
“strong” for purposes of the Reform Act, a court will
necessarily have to consider whether the facts alleged in
the complaint leave open a range of non-culpable explanations for the defendant’s conduct. Where the same
facts simultaneously support both the conclusion that
the defendant acted with scienter and the alternative
conclusion that the defendant acted without scienter, the
court should consider the relative strength of both inferences, because, where there is a substantial possibility that the defendant acted without scienter, the inference of scienter will not be “strong.”
Finally, the Reform Act’s heightened pleading requirement is consistent with the Seventh Amendment of the Constitution. Respondents did not claim that the dismissal of their complaint under the Reform Act would violate the Seventh Amendment. Even if they had, that claim would lack merit, because the Reform Act does not improperly assign to a court the jury’s role of resolving genuine issues of fact. Because the court of appeals misinterpreted the Reform Act’s heightened pleading standard, its decision should be vacated, and the case remanded for application of the correct standard.
…
CONCLUSION
The judgment of the court of appeals should be vacated, and the case remanded for further proceedings.
Source
Brief For The United States In Tellabs, Inc. v. Makor Issues & Rights (Filed With U.S. Supreme Court; February 2007)
The SEC’s amicus brief urges the justices to reject the 7th Circuit position, which the Commission says “erroneously diluted” the PSLRA’s “strong inference” requirement.
According to the Commission, a court considering whether plaintiffs have met the PSLRA threshold “must consider other possible explanations for the defendant’s conduct—or any competing inference that can be drawn from the same facts.”
In explaining why the SEC decided to file the brief, the Commission cites in its brief the “strong interest” of the United States “in seeing that the principles applied in private actions promote the purposes of the securities laws.”
Although the SEC explicitly recognizes that “meritorious private actions are an essential supplement to criminal prosecutions and civil enforcement actions brought, respectively, by [the Department of Justice] and the SEC,” it also stresses that “Congress has recognized a potential for such actions to be abused in ways that impose substantial costs on companies that have fully complied with the applicable laws.”
More ‘Pro-Business’ Under Cox?
The SEC’s decision to speak on the issue before the Supreme Court comes just months after the Committee on Capital Markets Regulation—more commonly known as the Paulson Committee, after Treasury Secretary Hank Paulson—issued a serious of recommendations on how to lessen the burden of corporate compliance with government regulation. One suggestion: greater clarity from the SEC on issues like the standard for bringing private lawsuits to enforce securities laws.
Thomas Kruse, a partner with the law firm Baker Hostetler, says the SEC’s amicus brief is “saying the [PSLRA] should be interpreted the way it was written. The bar needs to be kept high. What the SEC is doing is helping the public. Too many strike suits cost shareholders a lot of money.”
Stigi
But John Stigi of the law firm Sheppard Mullin Richter & Hampton, says a lot of attorneys are “shaking their heads” at the SEC’s decision to voice its opinion. “They’re taking a position that’s perceived on its face as being pro-defendant.”
Stigi says that the SEC’s position could be a reflection of the “political viewpoint” within the Commission. Or, he suggests, the SEC might be trying to head off any congressional momentum to adopt still more limits on shareholder suits. Sen. Charles Schumer, D-N.Y., and other lawmakers have been “bandying about additional protections for companies against securities class actions,” Stigi notes.
“From the SEC’s perspective, if the Supreme Court was to come out in Tellabs in a way that would be perceived as opening the door to more of these cases, perhaps Congress would react more strongly and swing the pendulum even further [against shareholders],” Stigi suggests. “Maybe the SEC is being strategic in trying to forestall more pro-defendant legislation.”
Donnelly
William Donnelly, a former SEC branch chief in the Division of Enforcement, notes that Commission Chairman Christopher Cox was “one of the principal proponents” of the PSLRA when he was in Congress in the 1990s, and it is “reasonable to assume” that Cox feels very strongly about this issue.
There’s “no good argument that [the SEC] should just butt out” of the case, says Donnelly, now a partner with the law firm LeClair Ryan. “The SEC has always viewed private enforcement of the securities laws as an important adjunct, but that doesn’t necessarily mean they’re going to always side with plaintiffs.”
Piazza at Dorsey & Whitney says the SEC’s decision to file a brief in the case may reflect a “change at senior levels” at the SEC. “It frankly could represent what people inside the Commission sensed or, depending on your perspective, feared: that the Commission was going to be more pro-business under Chairman Cox,” he says. “That may be coming to fruition.”
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