From the front page of the New York Times: “Investors' Suits Face Higher Bar, Supreme Court Rules.”
Issued yesterday, the Court's majority opinion in the Tellabs case starts from the proposition that plaintiffs bringing securities fraud suits must allege (in their initial complaints — in advance of discovery) facts in sufficient detail to show statements attributable to defendants to be false either because of affirmative misrepresentations or because of notable omissions — and also facts suggesting defendants knew the statements were false (the so-called scienter requirement). There's nothing new in this. But the majority also held (this was new) that, to be well-pled, facts regarding scienter, more or less like facts regarding falsity, must appear from the allegations to suggest that inferences of scienter are not just plausible or reasonable — but rather cogent, at least as compelling as any opposing suggestion, given the alleged facts, that there was no knowledge of falsity on the part of defendants.
Too complicated, too boring: who cares?
Securities fraud suits are important — the possibility that false statements influence stock prices, it has seemed at least since 1929, provokes corrosive suspicion of securities markets, increased economic anxiety, and a generalized wish to punish wrong-doers. But securities fraud suits may not always be a good thing — just opportunities for lawyers to practice discovery abuse and force settlements and attorney fees even in cases where nothing much wrong happened. Some economists argue that markets themselves drive out false information, or at least provide good ways for investors to protect themselves (diversified portfolios, etc.) Trying to strike a balance, Congress passed a statute in 1995 requiring pleadings alleging facts sufficient to give rise “a strong inference that the defendant acted with the required state of mind.” The Tellabs case raised the question of what “strong inference” means (Congress chose not to define the term).
Justice Ginsburg wrote the majority opinion. Her definition of “strong inference” was more rigorous than the one deployed by the court below — a requirement only that plaintiffs allege facts supporting a reasonable inference of knowledge of falsity. But other courts had opted for even more demanding rules than Ginsburg's — for example, that the inference of knowledge of falsity be the “most plausible” suggested by the facts alleged. Whether Ginsburg set a “higher bar” depends, therefore, on which of the conflicting lower court decisions you treat as the point of departure. Notably, Justice Scalia would have opted for a “more plausible” test, and Justice Alito agreed with Scalia, thinking that “more plausible” fits better with tests that would be applied later in the course of a lawsuit (if plaintiffs passed the pleading test). Justice Stevens, to be sure, dissented, and proposed borrowing the “probable cause” test from criminal law, thus excluding any consideration of competing inferences.
Maybe Stevens proposed a test more pro-plaintiff than Ginsburg's. (Do we really know what probable cause means? Isn't criminal procedure too different in its underlying preoccupations to provide a useful model?) It is clear that Ginsburg meant to reject Scalia's formula (cheerfully needling him in the course of her opinion) and that she thought that Alito had no comprehension of how civil procedure works (a point made rather sternly).
But that's not what's most important here. How are plaintiffs or their lawyers supposed to find out facts they can plead in advance of discovery? This is a standard problem in corporate law generally — so-called derivative suits require shareholders to plead with particularity too. And the Delaware courts — the most important corporate law courts — treat no access to discovery as no problem: “use the tools at hand,” they say. Shareholders, it turns out, have state law rights (often) to obtain information about corporate decisonmaking independently of litigation. There are complications, of course: but why can't these state law rights be used to get information for purposes of federal suits? Even if that won't work, if plainitffs have facts available to them showing that representations were false, and if the facts can be shown to have been available before matters came to a head, doesn't that suggest, maybe, that defendants may have (or might cogently be supposed to have) known of those facts too? Justice Ginsburge says that what's “cogent” isn't a matter of any particular smoking gun document, or even whether or not defendant had an obvious financial reason to withhold the truth. The inquiry, she insists, is “holistic.” Plainly, she leaves lots of room within which smart lawyers might work (that was Justice Alito's main worry, it appears).
You don't have to be interested in corporate law to think that this is important. In constitutional law, in equal protection cases, plainttifs must allege and prove discriminatory purpose. When the Supreme Court discovered this requirement in the 1970s, the initial reaction of many was that the Court had just killed off equal protection litigation. Not so: such suits are harder, but there's plently of leeway for circumstantial inference, precisely after the fashion of the securities litigaiton Justice Ginsburg is discussing (interestingly, the scienter requirement was discovered by the Supreme Court at just about the same time).
Consider this possibility: Next week the Supreme Court decides the Seattle and Louisville school desegration cases against plaintiffs. School systems can no longer include race as an explicit factor in pupil assignment formulas. But school systems suspect, and likely will know for sure within a year, that using parental choice formulas without including a racial preference leads to racially segregated schools as a matter of fact. Would this be purposeful discrimination? How plain is this likelihood? What other reasons would school systems have to opt for parental choice unmodified? What if there ways to assign students that reduced segregation in fact — say redrawn districts or efforts to achieve economic diversity within schools — that were also practical? What would we make of parental choice then? Notice that these questions are just versions of the questions that Justice Ginsberg thinks are pertinent to the holisitic inquiry show wants to see in cases like Tellabs. Notice, therefore, that within the terms of her approach, the Seattle and Louisville decisions — if they come out the way Supreme Court sportswriters are predicting — may just open the way for new lawsuits in which plaintiffs may in fact be better positioned (if we know anything, we know that defending affirmative action in courts these days is not easy).
Who knows, though, what the Court will do next week. Stay tuned.