Tellabs Decision Puts the Supreme Court in the Defendants' Camp

June 22, 2007

Yesterday the U.S. Supreme Court, while acknowledging the importance of private class actions in enforcing the securities laws, also recognized their potential for abuse. The Court’s 8-1 opinion in a shareholder suit against telecomm equipment maker Tellabs Inc. puts teeth into the Private Securities Litigation Reform Act of 1995 by reversing the Seventh Circuit's reasonable inference standard. As reported today in the business press, the court ruled that—to meet the congressional mandate of a "strong inference of fraud"—any competing inferences must be weighed and, if explanations suggesting that the defendant’s intent was not fraudulent are found to be more cogent, the case must be dismissed at the pleading stage. The Court held that a tie, in terms of cogency, must go to the plaintiff.

The decision in Tellabs v. Makor Issues and Rights did not guarantee victory for Tellabs, however. Rather, the case was sent back to the lower court for consideration of the pleadings in light of the newly established inference standard. The practical effect of the Tellabs opinion is that every securities class action will be met with a motion to dismiss. Such a motion will stay all discovery. In cases involving competing plaintiffs, class counsel will then have to be selected, a process that usually takes six months. A consolidated complaint would then be filed and the motion to dismiss based on the Tellabs standard and the weighing of inferences would need to be done. In short, to accommodate this process, no securities case is likely to begin for at least a year after its filing.

One need look no further than the Court’s recent decisions in Credit Suisse Securities (USA) LLC v. Billing and Bell Atlantic v. Twombly to conclude that the Court this term is in a decidedly pro-defendant mood.

Nevertheless, as with the 2005 Dura decision, the actual effect of the Court’s decision depends on each district court's willingness to follow the Supreme Court's lead. After all, a “strong inference" lies in the eye of the beholder. By not applying this test to the complaint before it, the Court missed an opportunity to give a concrete example of exactly how it intends that this test should be applied.

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