A Modest Proposal for Securities Fraud Pleading After Tellabs

INTRODUCTION Pleading rules are filters. They weed out some cases while allowing others to go forward. By controlling access to the litigation system, these rules--if they function as intended--can reduce burdens on the courts, save parties from having to defend themselves against baseless charges, and facilitate the fair and efficient administration of justice. All pleading rules face the problem of error. Because decisions are made before the facts are determined, courts make mistakes in their projections about how the case will develop. As with any filter, the errors come in two types. Some cases that should not continue are allowed through, and some cases that ought to be litigated are weeded out. Ideally, pleading rules should be designed so as to minimize the joint cost of the two error types. Judges and rulemakers are like legal engineers responsible for designing systems that solve this optimization problem. Tellabs, Inc. v. Makor Issues & Rights, Ltd. (1) is a signal example of a pleading rule as filter. The Private Securities Litigation Reform Act (PSLRA) declares that in any private action arising under this title in which the plaintiff may recover money damages only on proof that the defendant acted with a particular state of mind, the complaint shall, with respect to each act or omission alleged to violate this title, state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind. (2) If a complaint does not satisfy the requirements set forth in the statute, the case will be dismissed (although the court may declare that the dismissal is without prejudice, thus allowing the plaintiff to re-plead). The PSLRA is therefore a filter: complaints that satisfy the rule go forward; ones that do not are eliminated. Tellabs concerned the interpretation of this pleading requirement. It set forth a uniform federal standard for determining when allegations in a securities fraud complaint suffice to create a strong inference of scienter (the technical term for the state of mind required to establish liability for securities fraud). In the Court's now-familiar articulation, a securities fraud complaint will survive a motion to dismiss if and "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." (3) Does the PSLRA, as interpreted in Tellabs, draw the most effective line for weeding out meritless securities fraud suits while allowing meritorious ones to proceed? This article considers that question. This article presents the argument that although Tellabs represents a creditable effort to clarify imprecise statutory language and to implement the intent of Congress, the rule articulated by the Court falls short in several respects. II INTERPRETING TELLABS Tellabs clarified the law in several respects. First, it articulated a uniform standard for scienter allegations in securities fraud complaints, thereby resolving pre-existing disagreements among the federal circuits. (4) Second, it established that the test is comparative in the sense that a court must evaluate both culpable and non-culpable inferences that could be drawn from the facts alleged. (5) Third, Tellabs indicated that ties go to the plaintiff: the plaintiff does not need to show that the inference of scienter is the most plausible one to be drawn from the facts pied in the complaint, only that it is at least as plausible as other inferences. (6) Finally, Tellabs established a middle-ground approach toward scienter pleadings. The Court made it clear that it was opting for neither the stringent standards that some circuits had developed, nor for the lenient ones that others had. (7) Even though Tellabs clarified the law in these respects, the standard articulated by the Court was itself subject to ambiguity. …