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Tellabs redux

By Harvard Law School Program on Corporate Governance

(Editor’s Note I: As the hit counter on the right hand side of this blog indicates, our Harvard Law School Corporate Governance Blog crossed the 1-million-hits mark this past weekend. We express our appreciation to all contributors and to our readers.)

(Editor’s Note II: The post below comes to us from Byron Georgiou and Joseph D. Daley at Coughlin Stoia Geller Rudman & Robbins LLP.)

On Thursday, January 17, a Seventh Circuit Court of Appeals panel led by Judge Richard A. Posner handed down the Circuit’s second crack at the ?strong inference? standard in the Tellabs matter. Makor Issues & Rights, Ltd. v. Tellabs, Inc., __ F.3d __, No. 04-1687, 2008 U.S. App. LEXIS 975 (7th Cir. Jan. 17, 2008). This latest Tellabs opinion (?Tellabs II?) arose out of a ?comeback? case for the Seventh Circuit, following the United States Supreme Court’s June 2007 rejection of the Circuit’s initial attempt to divine the Securities Exchange Act of 1934’s ?strong inference? of scienter requirement, as amended by the Private Securities Litigation Reform Act of 1995 (?PSLRA?). See Tellabs, Inc. v. Makor Issues & Rights, Ltd., ___ U.S. ___, 127 S. Ct. 2499 (2007) (vacating and remanding Makor Issues & Rights, Ltd. v. Tellabs, Inc. (?Tellabs I?), 437 F.3d 588 (7th Cir. 2006)).

By way of background, the Tellabs saga involved a manufacturer of specialized fiber-optic equipment which, along with several of its top officers, was accused of securities fraud by investors. After repeatedly providing optimistic reassurances in late 2000/early 2001 about the company’s financials, projected revenues/earnings, and demand for its main products, the bombshell, contradictory truth burst in mid-2001: the fiber-optics bubble had already burst in the prior year, purported demand for Tellabs’s core products was actually a sham, and the company’s revenues and profits were plummeting. Not surprisingly, Tellabs stock fell from its class-period peak of $67 to just under $16, and outraged investors filed suit.

Following the district court’s dismissal of the investors’ securities-fraud complaint, the Seventh Circuit reversed in part and held that the investors had met the ?strong inference? of scienter standard by alleging facts ?from which, if true, a reasonable person could infer that the defendant acted with the requisite intent.? (While stating that holding, the Seventh Circuit explicitly rejected a more-stringent standard that had been adopted by the Sixth Circuit ? i.e., that plaintiffs’ inferences had to be more plausible than any competing inferences. Cf. Fidel v. Farley, 392 F.3d 220, 227 (6th Cir. 2004) (PSLRA’s heightened pleading requirements mean that ??plaintiffs are entitled only to the most plausible of competing inferences’?)).

Granting certiorari, the Supreme Court rejected both views: While the scienter inferences in plaintiffs’ favor need not be irrefutable, or even the most plausible of competing inferences, nor will they suffice if merely ??reasonable’ or ?permissible.’? Plaintiffs satisfied the PSLRA’s strong-inference requirement ?only if 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.?

On remand to the Seventh Circuit, the Tellabs II panel applied the Supreme Court’s newly enunciated standard. Judge Posner’s opinion is wide-ranging, to be sure, but within its wide expanse there are several gems that are sure to provoke a flurry of supplemental briefing in securities-fraud cases around the country. (Oddly, on the case’s remand the Tellabs II panel was composed of just two of three Circuit judges from Tellabs I; Judge Posner replaced Judge Ripple.) In no particular order, here are several ? albeit not all ? of the conclusions that Tellabs II reaches concerning strong-inference factors:

Full post as published by The Harvard Law School Corporate Governance Blog on January 28, 2008 (boomark / email).