Opinion ID: 784557
Heading Depth: 3
Heading Rank: 2

Heading: Standards for Scienter

Text: 11 In a securities fraud action, the term `scienter' refers to a mental state embracing intent to deceive, manipulate, or defraud. Ernst & Ernst v. Hochfelder, 425 U.S. 185, 194 n. 12, 96 S.Ct. 1375, 47 L.Ed.2d 668 (1976); see Malone v. Microdyne Corp., 26 F.3d 471, 478 (4th Cir.1994). Mere negligence will not suffice. See Phillips, 190 F.3d at 621. Additionally, every circuit that has considered the issue has held that scienter may also be established by a showing of recklessness. 3 See Hudson v. Phillips Petroleum Co. ( In re Phillips Petroleum Sec. Litig., ) 881 F.2d 1236, 1244 (3d Cir.1989); Van Dyke v. Coburn Enters., 873 F.2d 1094, 1100 (8th Cir.1989); McDonald v. Alan Bush Brokerage Co., 863 F.2d 809, 814 (11th Cir.1989); Hackbart v. Holmes, 675 F.2d 1114, 1117-18 (10th Cir.1982); Broad v. Rockwell Int'l Corp., 642 F.2d 929, 961-62 (5th Cir. Apr.1981) (en banc); Mansbach v. Prescott, Ball & Turben, 598 F.2d 1017, 1023-25 (6th Cir.1979); Sundstrand Corp. v. Sun Chem. Corp., 553 F.2d 1033, 1044-45 (7th Cir.1977); cf. Rolf v. Blyth, Eastman Dillon & Co., 570 F.2d 38, 46 (2d Cir.1978) (concluding that scienter may be established by recklessness in appropriate circumstances). However, neither this circuit nor the Supreme Court has addressed this particular question. See Ernst & Ernst, 425 U.S. at 194 n. 12, 96 S.Ct. 1375; Phillips, 190 F.3d at 620 (noting that scienter may perhaps be shown by recklessness (emphasis added)). 12 In Phillips, we defined recklessness as an act so highly unreasonable and such an extreme departure from the standard of ordinary care as to present a danger of misleading the plaintiff to the extent that the danger was either known to the defendant or so obvious that the defendant must have been aware of it. Phillips, 190 F.3d at 621 (internal quotation marks omitted); see, e.g., Nathenson v. Zonagen Inc., 267 F.3d 400, 408 (5th Cir.2001) (articulating same definition of recklessness); City of Philadelphia v. Fleming Cos., 264 F.3d 1245, 1258 (10th Cir.2001) (same); In re Advanta Corp. Sec. Litig., 180 F.3d 525, 535 (3d Cir.1999) (same). Such severe recklessness is, in essence, a slightly lesser species of intentional misconduct. Nathenson, 267 F.3d at 408 (internal quotation marks omitted). This definition of recklessness comports with the observation of the Supreme Court that [t]he words `manipulative or deceptive' used in conjunction with `device or contrivance' strongly suggest that § 10(b) was intended to proscribe knowing or intentional misconduct. Ernst & Ernst, 425 U.S. at 197, 96 S.Ct. 1375. We therefore agree with our sister circuits that a securities fraud plaintiff may allege scienter by pleading not only intentional misconduct, but also recklessness.
13 With this substantive standard in mind, we turn to the requirements for pleading scienter in securities fraud cases. The PSLRA requires that the complaint shall, with respect to each act or omission alleged to violate this chapter, state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind. 15 U.S.C.A. § 78u-4(b)(2). Congress enacted this more stringent pleading standard to curtail the filing of meritless lawsuits and to create a uniform pleading standard among the circuits. H.R. Conf. Rep. No. 104-369, at 41 (1995), reprinted in 1995 U.S.C.C.A.N. 730, 740. 14 The PSLRA thus seek[s] to heighten the standard for pleading scienter, and so changes what a plaintiff must plead in his complaint in order to survive a motion to dismiss. 4 Phillips, 190 F.3d at 620 (internal quotation marks & alteration omitted); see id. (noting that the PSLRA indisputably seeks to make pleading scienter more difficult for plaintiffs). Other circuits have reached differing conclusions regarding the proper interpretation of the requirements for pleading scienter under the PSLRA. However, we have not yet determined which pleading standard best effectuates Congress's intent. Id. at 621. 15 Prior to the enactment of the PSLRA, the Second Circuit required securities fraud plaintiffs to allege facts that give rise to a strong inference of scienter. Shields v. Citytrust Bancorp, Inc., 25 F.3d 1124, 1128 (2d Cir.1994). A strong inference could be demonstrated either (a) by alleging facts to show that defendants had both motive and opportunity to commit fraud, or (b) by alleging facts that constitute strong circumstantial evidence of conscious misbehavior or recklessness. Id. 16 In enacting the PSLRA, Congress adopted the strong inference language used by the Second Circuit, which it regarded as the most stringent pleading standard in the country. See S.Rep. No. 104-98, at 15 (1995), reprinted in 1995 U.S.C.C.A.N. 679, 694. However, it is not clear whether Congress also intended to adopt the Second Circuit rule permitting plaintiffs to show a strong inference by alleging facts demonstrating motive and opportunity. Following enactment of the PSLRA, the Second Circuit reaffirmed its pre-PSLRA standard. See Press v. Chem. Inv. Servs. Corp., 166 F.3d 529, 537-38 (2d Cir.1999) (stating that the PSLRA heightened the requirement for pleading scienter to the level used by the Second Circuit). And, the Third Circuit has held that the pleading standard of the PSLRA is essentially that of the Second Circuit. See Advanta Corp., 180 F.3d at 533-34. The Ninth Circuit, however, has concluded that Congress rejected the Second Circuit motive and opportunity standard and therefore that facts showing motive and opportunity cannot alone establish a strong inference of scienter. See Janas v. McCracken ( In re Silicon Graphics Inc. Sec. Litig. ), 183 F.3d 970, 977-79 (9th Cir.1999). Similarly, the Eleventh Circuit has held that the PSLRA did not codify the motive and opportunity standard, and thus, allegations of motive and opportunity, without more, are insufficient to plead scienter. See Bryant v. Avado Brands, Inc., 187 F.3d 1271, 1285-86 (11th Cir.1999). 17 However, a number of other circuits have concluded that, in enacting the PSLRA, Congress chose neither to adopt nor reject particular methods of pleading scienter — such as alleging facts showing motive and opportunity — but instead only required plaintiffs to plead facts that together establish a strong inference of scienter. See Fla. State Bd. of Admin. v. Green Tree Fin. Corp., 270 F.3d 645, 659-60 (8th Cir.2001); Nathenson, 267 F.3d at 411-12; Fleming Cos., 264 F.3d at 1261-63; Helwig v. Vencor, Inc., 251 F.3d 540, 550-52 (6th Cir.2001) (en banc); Greebel v. FTP Software, Inc., 194 F.3d 185, 195-96 (1st Cir.1999). In addition to noting the absence of any language in the PSLRA addressing particular methods of pleading, some of these courts have observed that the legislative history regarding whether Congress intended to adopt or reject the motive and opportunity standard is conflicting and inconclusive. See Green Tree Fin. Corp., 270 F.3d at 657-58; Nathenson, 267 F.3d at 411; Greebel, 194 F.3d at 194-95. These courts have therefore adopted a case-specific approach that examines the particular allegations in their entirety to determine whether they provide the requisite strong inference, without regard to whether those allegations fall into defined, formalistic categories such as `motive and opportunity.' Fleming Cos., 264 F.3d at 1263. Still, these circuits generally agree that specific facts showing a motive and opportunity to commit fraud (or the absence of such facts) may be relevant in determining whether a plaintiff's complaint demonstrates a strong inference of scienter. See, e.g., id.; Helwig, 251 F.3d at 550-51; Greebel, 194 F.3d at 197. 18 We agree that a flexible, case-specific analysis is appropriate in examining scienter pleadings. Both the absence of any statutory language addressing particular methods of pleading and the inconclusive legislative history regarding the adoption of Second Circuit pleading standards indicate that Congress ultimately chose not to specify particular types of facts that would or would not show a strong inference of scienter. See Helwig, 251 F.3d at 551 (In enacting the PSLRA, Congress was concerned with the quantum, not type, of proof.); Greebel, 194 F.3d at 195 (The history and text [of the PSLRA] show no agreement to restrict the types of evidence which may be used to show a strong inference of scienter.). We therefore conclude that courts should not restrict their scienter inquiry by focusing on specific categories of facts, such as those relating to motive and opportunity, but instead should examine all of the allegations in each case to determine whether they collectively establish a strong inference of scienter. And, while particular facts demonstrating a motive and opportunity to commit fraud (or lack of such facts) may be relevant to the scienter inquiry, the weight accorded to those facts should depend on the circumstances of each case.