In the Supreme Court of the United States

No. 06-484

In the Supreme Court of the United States

TELLABS, INC., ET AL., PETITIONERS

v.

MAKOR ISSUES & RIGHTS, LTD., ET AL.

ON WRIT OF CERTIORARI

TO THE UNITED STATES COURT OF APPEALS

FOR THE SEVENTH CIRCUIT

BRIEF FOR THE UNITED STATES

AS AMICUS CURIAE SUPPORTING PETITIONERS

BRIAN G. CARTWRIGHT

General Counsel

ANDREW N. VOLLMER

Deputy General Counsel

JACOB H. STILLMAN

Solicitor

LUIS DE LA TORRE

Senior Litigation Counsel

MICHAEL L. POST

Senior Counsel

Securities and Exchange

Commission

Washington, D.C. 20549

PAUL D. CLEMENT

Solicitor General

Counsel of Record

PETER D. KEISLER

Assistant Attorney General

THOMAS G. HUNGAR

Deputy Solicitor General

KANNON K. SHANMUGAM

Assistant to the Solicitor

General

MICHAEL JAY SINGER

JOHN S. KOPPEL

Attorneys

Department of Justice

Washington, D.C. 20530-0001

(202) 514-2217

QUESTION PRESENTED

Whether, and to what extent, a court must consider

or weigh competing inferences in determining whether

a securities fraud complaint has “state[d] with particu

larity facts giving rise to a strong inference that the de

fendant acted with the required state of mind,” as re

quired by the Private Securities Litigation Reform Act

of 1995.

(I)

TABLE OF CONTENTS

Page

Interest of the United States . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1

Statement . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2

Summary of argument . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8

Argument:

In order for a private securities fraud complaint to sat

isfy the “strong inference” requirement of the Reform

Act, there must be a high likelihood that the conclusion

that the defendant possessed scienter follows from the

facts alleged with particularity . . . . . . . . . . . . . . . . . . . . . . 10

A. Before the enactment of the Reform Act, lower

courts applied different pleading standards to

the mental-state element of securities fraud . . . . . 11

B. The Reform Act applied a heightened pleading

standard to the mental-state element of securi

ties fraud, and the court of appeals erroneously

diluted that standard . . . . . . . . . . . . . . . . . . . . . . . . . 15

C. In applying the Reform Act’s heightened

pleading standard for the mental-state element

of securities fraud, a court must consider any

competing inference or non-culpable explana

tions for the defendant’s conduct . . . . . . . . . . . . . . . 24

D. The Reform Act’s heightened pleading stan

dard for the mental-state element of securities

fraud is consistent with the Seventh Amend

ment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26

Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30

(III)

IV

TABLE OF AUTHORITIES

Cases:

Page

Abrams v. Baker Hughes Inc., 292 F.3d 424 (5th Cir.

2002) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25

Allen v. WestPoint-Pepperell, Inc., 945 F.2d 40

(2d Cir. 1991) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21

Baltimore & Carolina Line, Inc. v. Redman, 295 U.S.

654 (1935) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27

Beck v. Manufacturers Hanover Trust Co., 820 F.2d

46 (2d Cir. 1987), cert. denied, 484 U.S. 1005

(1988) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13, 14, 19

Blue Chip Stamps v. Manor Drug Stores, 421 U.S.

723 (1975) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13

Bryant v. Avado Brands, Inc., 187 F.3d 1271 (11th

Cir. 1999) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22

Burlington Coat Factory Sec. Litig., In re, 114 F.3d

1410 (3d Cir. 1997) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13

Cabletron Sys., Inc., In re, 311 F.3d 11 (1st Cir. 2002) . . . 20

Caterpillar Inc. v. Williams, 482 U.S. 386 (1987) . . . . . . . 25

Conley v. Gibson, 355 U.S. 41 (1957) . . . . . . . . . . . . . . . 11, 12

Connecticut Nat’l Bank v. Fluor Corp., 808 F.2d 957

(2d Cir. 2005) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14

Credit Suisse First Boston Corp., In re, 431 F.3d 36

(1st Cir.), cert. denied, 498 U.S. 941 (1990) . . . . 20, 21, 25

Denny v. Barber, 576 F.2d 465 (2d Cir. 1978) . . . . . . . . . . 13

DiLeo v. Ernst & Young, 901 F.2d 624 (7th Cir.),

cert. denied, 498 U.S. 941 (1990) . . . . . . . . . . . . . . . . 13, 15

Dura Pharmaceuticals v. Broudo, 544 U.S. 336

(2005) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10, 12

Ernst & Ernst v. Hochfelder, 425 U.S. 185 (1976) . . . . 10, 11

V

Cases—Continued:

Page

Fidelity & Deposit Co. v. United States, 187 U.S. 315

(1902) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27, 28, 29

Florida State Bd. of Admin. v. Green Tree Fin. Corp.,

270 F.3d 645 (8th Cir. 2001) . . . . . . . . . . . . . . . . . 12, 13, 15

Geffon v. Micrion Corp., 249 F.3d 29 (1st Cir. 2001) . . . . 29

GlenFed, Inc. Sec. Litig., In re, 42 F.3d 1541 (9th Cir.

1994) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12

Gompper v. VISX, Inc., 298 F.3d 893 (9th Cir.

2002) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25, 26

Greebel v. FTP Software, Inc., 194 F.3d 185 (1st Cir.

1999) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19

Greenstone v. Cambex Corp., 975 F.2d 22 (1st Cir.

1992) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12, 14

Gutierrez v. Peters, 111 F.3d 1364 (7th Cir. 1997) . . . . . . 25

Helwig v. Vencor, Inc., 251 F.3d 540 (6th Cir. 2001),

cert. dismissed, 536 U.S. 935 (2002) . . . . . . . . . . . . . . . . 21

Howard v. Everex Sys., Inc., 228 F.3d 1057 (9th Cir.

2001) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 29

Kramer v. Time Warner Inc., 937 F.2d 767 (2d Cir.

1991) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14

Leatherman v. Tarrant County Narcotics Intelli

gence & Coordination Unit, 507 U.S. 163 (1993) . . . . . 21

Merrill Lynch, Pierce, Fenner & Smith, Inc. v. Dabit,

126 S. Ct. 1503 (2006) . . . . . . . . . . . . . . . . . . . 15, 16, 17, 22

Nathenson v. Zonagen Inc., 267 F.3d 400 (5th Cir.

2001) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11, 14, 18

Neely v. Martin K. Eby Constr. Co., 386 U.S. 317

(1967) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28

VI

Cases—Continued:

Page

Novak v. Kasaks, 216 F.3d 300 (2d Cir.), cert. denied,

531 U.S. 1012 (2000) . . . . . . . . . . . . . . . . . . . . . . . . . . 13, 14

Ottmann v. Hanger Orthopedic Group, Inc., 353 F.3d

338 (4th Cir. 2003) . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11, 19

Pease v. Rathbun-Jones Eng’g Co., 243 U.S. 273

(1917) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28

Peterson, Ex parte, 253 U.S. 300 (1920) . . . . . . . . . . . . 27, 28

Pirraglia v. Novell , Inc., 339 F.3d 1182 (10th Cir.

2003) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25, 26

Romani v. Shearson Lehman Hutton, 929 F.2d 875

(1st Cir. 1991) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13

Ross v. A.H. Robins Co., 607 F.2d 545 (2d Cir. 1979),

cert. denied, 446 U.S. 946 (1980) . . . . . . . . . . . . . . . . . . . 13

Silicon Graphics Inc. Sec. Litig., 183 F.3d 970 (9th

Cir. 1999) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11

Time Warner Inc. Sec. Litig., In re, 9 F.3d 259 (2d

Cir. 1003), cert. denied, 511 U.S. 1017 (1994) . . . . . . . . 13

Tuchman v. DSC Comm’cns Corp., 14 F.3d 1061 (5th

Cir. 1994) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15

United States v. Oakland Cannabis Buyers’ Coop.,

532 U.S. 483 (2001) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27

Wexner v. First Manhattan Co., 902 F.2d 169 (2d Cir.

1990) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14

Wharf (Holdings) Ltd. v. United Int’l Holdings, Inc.,

532 U.S. 588 (2001) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16

Constitution, statutes, regulation and rules:

U.S. Const. Amend. VII . . . . . . . . . . . . . . . . . 9, 26, 27, 28, 29

Private Securities Litigation Reform Act of 1995,

Pub. L. No. 104-67, 109 Stat. 737 . . . . . . . . . . . . . . . . . . 11

VII

Statutes, regulation and rules—Continued:

Page

§ 101(b), 109 Stat. 743 . . . . . . . . . . . . . . . . . . . . . . . . . . 3

Securities Exchange Act of 1934, 15 U.S.C. 78a

et seq.:

§ 10(b), 15 U.S.C. 78j(b) . . . . . . . . . . . . . . . . 3, 5, 10, 22

§ 20(a), 15 U.S.C. 78t(a) . . . . . . . . . . . . . . . . . . . . . . 3, 5

§ 20A, 15 U.S.C. 78u-1 . . . . . . . . . . . . . . . . . . . . . . . . . 5

§ 21D(b), 15 U.S.C. 78u-4(b) . . . . . . . . . . . . . . . . . . . 17

§ 21D(b)(1), 15 U.S.C. 78u-4(b)(1) . . . . . . . . . . . . 16, 17

§ 21D(b)(2), 15 U.S.C. 78u-4(b)(2) . . . . . . . . . . passim

§ 21D(b)(3)(B), 15 U.S.C. 78u-4(b)(3)(B) . . . . . . . . . 17

Y2K Act, Pub. L. No. 106-37, § 8(d), 113 Stat. 198

(15 U.S.C. 6607(d)) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19

17 C.F.R. 240.10b-5 . . . . . . . . . . . . . . . . . . . . . . . . . 3, 5, 10, 22

Fed. R. Civ. P.:

Rule 8 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11

Rule 8(a)(2) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11

Rule 9(b) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8, 12, 17, 22

Rule 50(b) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28

Miscellaneous:

Black’s Law Dictionary:

6th ed. (1990) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20

8th ed. (2004) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19

H.R. Conf. Rep. No. 369, 104th Cong., 1st Sess.

(1995) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16, 17, 18, 19

VIII

Miscellaneous—Continued:

Page

James Hawthorne, Inductive Logic (last modified

Oct. 10, 2005), in Stanford Encyclopedia of Philos

ophy (Edward N. Zalta ed., 2007) <http://

plato.stanford.edu/entries/logic-inductive> . . . . . . . . . 20

S. Rep. No. 98, 104th Cong., 1st Sess.

(1995) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16, 18, 22

The American Heritage Dictionary of the English

Language (4th ed. 2000) . . . . . . . . . . . . . . . . . . . . . . . . . . 20

16 The Oxford English Dictionary (2d ed. 1989) . . . . . . . 20

Charles Alan Wright & Arthur R. Miller, Federal

Practice and Procedure:

Vol. 5A (3d ed. 2004) . . . . . . . . . . . . . . . . . . . . . . . . . . 14

Vol. 9 (2d ed. 1995) . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28

Run TOA Insert macro to place cursor for manual TOA insert

& remove this text

In the Supreme Court of the United States

No. 06-484

TELLABS, INC., ET AL., PETITIONERS

v.

MAKOR ISSUES & RIGHTS, LTD., ET AL.

ON WRIT OF CERTIORARI

TO THE UNITED STATES COURT OF APPEALS

FOR THE SEVENTH CIRCUIT

BRIEF FOR THE UNITED STATES

AS AMICUS CURIAE SUPPORTING PETITIONERS

INTEREST OF THE UNITED STATES

The United States, through the Department of Jus

tice (DOJ) and the Securities and Exchange Commission

(SEC), administers and enforces the federal securities

laws. The issue in this case concerns the interpretation

of the heightened pleading requirement for state of

mind in private securities fraud actions. Meritorious

private actions are an essential supplement to criminal

prosecutions and civil enforcement actions brought, re

spectively, by DOJ and the SEC. At the same time,

Congress has recognized a potential for such actions to

be abused in ways that impose substantial costs on com

panies that have fully complied with the applicable laws.

The United States has a strong interest in seeing that

the principles applied in private actions promote the

(1)

2

purposes of the securities laws, and has previously par

ticipated as an amicus curiae in cases involving those

principles.

STATEMENT

1. Petitioner Tellabs, Inc., manufactures equipment

used in fiber-optic networks; respondents are persons

who purchased Tellabs stock between December 11,

2000, and June 19, 2001. Petitioner Richard C.

Notebaert served as chief executive officer and presi

dent of Tellabs during the relevant period. Respondents

allege that, during that period, Notebaert and other

Tellabs executives “falsely reassured public investors, in

a series of statements * * * , that Tellabs was continu

ing to enjoy strong demand for its products and earning

record revenues.” “In truth,” respondents further al

lege, “Tellabs’ performance was being adversely af

fected by the same difficult telecommunications business

environment that its competitors had been facing.” J.A.

94, 95, 98; Pet. App. 1a, 30a.

As is relevant here, respondents more specifically

allege that Notebaert made four categories of false or

misleading statements during the relevant period. J.A.

113-144. First, Notebaert allegedly made statements

indicating that demand for the TITAN 5500, Tellabs’

flagship networking device, was continuing to grow,

when demand for that product was in fact flagging. Pet.

App. 10a-12a, 48a-50a. Second, Notebaert allegedly

made statements indicating that the TITAN 6500,

Tellabs’ next-generation networking device, was avail

able for delivery, and that demand for that product was

strong and growing, when the product was not in fact

ready for delivery and demand was weak. Id. at 12a

13a, 51a-53a. Third, Notebaert allegedly falsely repre

3

sented Tellabs’ financial results for the fourth quarter

of 2000 (and, in connection with those results, sanctioned

the practice of “channel stuffing,” under which Tellabs

flooded its customers with unwanted products). Id. at

13a-14a, 55a-57a. Fourth, Notebaert allegedly made a

series of overstated revenue projections, when demand

for the TITAN 5500 was drying up and production of the

TITAN 6500 was behind schedule. Id. at 14a-16a, 45a.

Starting in March 2001, Tellabs made progressively

more cautious statements about its projected sales. On

June 19, 2001, the last day of the relevant period,

Tellabs disclosed that demand for the TITAN 5500 had

significantly dropped, and considerably lowered its reve

nue projections for the second quarter of 2001. The fol

lowing day, the price of Tellabs stock, which had

reached a high of $67.125 during the period, dropped to

a low of $15.87. Pet. App. 3a-5a, 39a.

2. Respondents filed a class action against petition

ers and other Tellabs executives in the United States

District Court for the Northern District of Illinois. In

their complaint, as amended, respondents alleged, inter

alia, that defendants had engaged in securities fraud in

violation of Section 10(b) of the Securities Exchange Act

of 1934 (1934 Act), 15 U.S.C. 78j(b), and Rule 10b-5

thereunder, 17 C.F.R. 240.10b-5, and that the individual

defendants were derivatively liable as “controlling per

sons” under Section 20(a) of the 1934 Act, 15 U.S.C.

78t(a). J.A. 167-171.

Under Section 21D(b)(2) of the 1934 Act, which was

added by the Private Securities Litigation Reform Act

of 1995 (Reform Act or PSLRA), Pub. L. No. 104-67,

§ 101(b), 109 Stat. 737, a private securities fraud com

plaint must “state with particularity facts giving rise to

a strong inference that the defendant acted with the

4

required state of mind.” 15 U.S.C. 78u-4(b)(2). Defen

dants moved to dismiss the complaint on the ground,

inter alia, that respondents had failed to meet that

heightened pleading standard.

The district court dismissed the complaint without

prejudice. Pet. App. 80a-117a. As is relevant here, the

court noted that, while respondents had contended that

“the Individual Defendants knew facts or recklessly dis

regarded information at their disposal that contradicted

their public statements,” they had failed to “individual

ize their allegations as to each of these Defendants, as

they must.” Id. at 113a. The court further noted that

“[c]onclusory allegations of reckless disregard are insuf

ficient to raise a strong inference of scienter” for pur

poses of the Reform Act. Ibid.

3. Respondents filed a second amended complaint in

which they included additional allegations concerning

defendants’ mental state. J.A. 152-160. Defendants

moved to dismiss the complaint on the ground, inter

alia, that respondents had still failed to meet the Re

form Act’s heightened pleading standard.

The district court again dismissed the complaint, this

time with prejudice. Pet. App. 28a-79a. The court held

that, as to the four categories of statements discussed

above, respondents had sufficiently alleged that the

statements were misleading. Id. at 45a-46a, 48a-59a. As

to those categories of statements, however, the court

held that respondents had insufficiently alleged the req

uisite state of mind. Id. at 46a-48a, 59a-74a. At the out

set, the court noted that “[respondents] again lump

many of their scienter allegations together with broad

statements regarding ‘Defendants’ or the ‘Individual

Defendants.’ ” Id. at 60a. The court reasoned that

5

“these allegations alone are insufficient to establish

scienter under the PSLRA.” Id. at 61a.

With regard to petitioner Notebaert more specifi

cally, the district court first observed that “[respon

dents] do not allege that CEO Notebaert sold stock dur

ing the Class Period.” Pet. App. 62a. The court then

reasoned that, while respondents had alleged that

Notebaert attended various meetings with Tellabs em

ployees and participated in regular phone calls concern

ing the status of Tellabs’ products, “[t]hese allegations

support that Notebaert was active in Tellabs’ business

as one would expect, but they do not establish scienter.”

Id. at 73a. The court explained that “[respondents] do

not disclose any details regarding what Notebaert alleg

edly learned during these calls or meetings that support

an inference of scienter.” Ibid. The court determined

that respondents’ allegations concerning “channel stuff

ing” were also insufficient, because “there is nothing

inherently wrong with several of [respondents’] channel

stuffing allegations.” Id. at 74a. Overall, the court

noted, “[respondents] rely on group pleading allegations

about Notebaert’s position in the company and general

conclusions concerning his knowledge of the allegedly

fraudulent activities without providing particulars to

reinforce their general conclusions.” Ibid.; see id. at

48a. “Such allegations,” the court concluded, “fail to

meet the mandates of the PSLRA.” Id. at 74a.

4. The court of appeals reversed as to the claims

against petitioners, and remanded for further proceed

ings. Pet. App. 1a-27a.1 The court of appeals first held

1

The court of appeals also reversed as to claims against other

Tellabs executives under Section 20(a) of the 1934 Act, 15 U.S.C. 78t(a),

and Section 20A, 15 U.S.C. 78u-1. Those claims are derivative of the

Section 10(b) and Rule 10b-5 claims against petitioners.

6

that, with regard to all four of the categories of state

ments discussed above, respondents had sufficiently

alleged that the statements were misleading. Id. at 8a

16a. Unlike the district court, however, the court of ap

peals held that respondents had sufficiently alleged that

Notebaert (and thus, by imputation, Tellabs itself) had

acted with the requisite state of mind. Id. at 16a-26a.

a. As a preliminary matter, the court of appeals rec

ognized that the Reform Act “unequivocally raise[d] the

bar for pleading scienter” by requiring plaintiffs to

“plead[] sufficient facts to create ‘a strong inference’ of

scienter.” Pet. App. 18a. But the court contended that

“Congress did not, unfortunately, throw much light on

what facts will suffice to create such an inference.” Ibid.

In the court of appeals’ view, “the best approach is for

courts to examine all of the allegations in the complaint

and then to decide whether collectively they establish

such an inference.” Id. at 20a.

The court of appeals then observed that “[a]nother

concern, independent from the question of what type of

information will support a finding of scienter, is the de

gree of imagination courts can use in divining whether

a complaint creates a ‘strong inference.’ ” Pet. App. 20a.

The court of appeals considered, but rejected, a stan

dard under which a court would consider whether the

inference of scienter was the “strongest” inference that

could be drawn from the alleged facts, on the ground

that such a standard “could potentially infringe upon

plaintiffs’ Seventh Amendment rights.” Ibid. “Instead

of accepting only the most plausible of competing infer

ences as sufficient at the pleading stage,” the court held,

“we will allow the complaint to survive if it alleges facts

from which, if true, a reasonable person could infer that

the defendant acted with the required intent.” Ibid. By

7

contrast, “[i]f a reasonable person could not draw such

an inference from the alleged facts, the defendants are

entitled to dismissal,” because “the complaint would fail

as a matter of law to meet the requirements of [the Re

form Act].” Id. at 21a.

Applying that standard, and holding that “plaintiffs

must create [the required] inference with respect to

each individual defendant in multiple defendant cases,”

Pet. App. 22a, the court of appeals determined that the

complaint had sufficiently alleged that Notebaert pos

sessed the requisite state of mind with regard to each of

the four categories of alleged misstatements. Id. at 21a

26a. As to the statements concerning the TITAN 5500,

the court concluded, based on “the significance of the

TITAN 5500 and the number of reports suggesting that

it was in trouble,” that “[respondents] have provided

enough for a reasonable person to infer that Notebaert

knew that his statements were false.” Id. at 23a. As to

the statements concerning the TITAN 6500, the court

reasoned that, “[i]f it is true that the TITAN 6500 was

not in fact available during the class period, it is hard to

accept that Notebaert’s statements were simply honest

mistakes.” Id. at 24a-25a. As to Tellabs’ financial re

sults, the court determined that respondents had

“allege[d] sufficient facts to suggest that Notebaert was

aware of the channel stuffing” and “therefore knew that

Tellabs had exaggerated its fourth quarter 2000 reve

nues.” Id. at 25a. Finally, as to the revenue projections,

the court reasoned that those projections “rest[ed] on

the company’s statements that its products were doing

better than they actually were,” and that “the scienter

for those alleged misrepresentations serves as sufficient

circumstantial evidence of scienter here.” Ibid.

8

SUMMARY OF ARGUMENT

Congress enacted the Private Securities Litigation

Reform Act of 1995 in order to curtail abusive practices

that undermine the beneficial purposes of private securi

ties litigation. As part of that effort, Congress amended

the Securities Exchange Act of 1934 to require that a

securities fraud complaint “state with particularity facts

giving rise to a strong inference that the defendant

acted with the requisite state of mind.” 15 U.S.C. 78u

4(b)(2). The court of appeals erroneously diluted that

requirement by holding that a securities fraud plaintiff

need only “allege[] facts from which, if true, a reason

able person could infer that the defendant acted with the

required intent.” Pet. App. 20a.

Before the enactment of the Reform Act, numerous

lower courts, applying Rule 9(b) of the Federal Rules of

Civil Procedure, held that it was insufficient for a securi

ties fraud plaintiff merely to allege state of mind gener

ally, and some courts held that a securities fraud plain

tiff was required to allege facts that gave rise to at least

a reasonable inference of the requisite mental state.

The Second Circuit, however, went further and held that

a securities fraud plaintiff was required to allege facts

that gave rise to a strong inference of scienter. In en

acting the Reform Act, Congress intended to impose a

uniform and heightened pleading standard that built

upon the Second Circuit’s “strong inference” terminol

ogy.

In evaluating whether a plaintiff has alleged facts

that “giv[e] rise” to a “strong inference” of scienter, a

court should determine whether, taking the alleged facts

as true, there is a high likelihood that the conclusion

that the defendant possessed scienter follows from those

facts. While it is impossible to specify with mathemati

9

cal precision the degree of likelihood required for a

“strong inference,” both the plain language of the Re

form Act and the backdrop against which it was enacted

show that a “strong” inference requires something con

siderably more than merely a “reasonable” inference.

The standard applied by the court of appeals in this case

does not appear to differ materially from the “reason

able” inference standard that it (and other courts of ap

peals) had applied before the enactment of the Reform

Act. Congress plainly rejected that approach in favor of

a more demanding standard.

In determining whether an inference of scienter is

“strong” for purposes of the Reform Act, a court will

necessarily have to consider whether the facts alleged in

the complaint leave open a range of non-culpable expla

nations for the defendant’s conduct. Where the same

facts simultaneously support both the conclusion that

the defendant acted with scienter and the alternative

conclusion that the defendant acted without scienter, the

court should consider the relative strength of both infer

ences, because, where there is a substantial possibility

that the defendant acted without scienter, the inference

of scienter will not be “strong.”

Finally, the Reform Act’s heightened pleading re

quirement is consistent with the Seventh Amendment of

the Constitution. Respondents did not claim that the

dismissal of their complaint under the Reform Act would

violate the Seventh Amendment. Even if they had, that

claim would lack merit, because the Reform Act does not

improperly assign to a court the jury’s role of resolving

genuine issues of fact. Because the court of appeals mis

interpreted the Reform Act’s heightened pleading stan

dard, its decision should be vacated, and the case re

manded for application of the correct standard.

10

ARGUMENT

IN ORDER FOR A PRIVATE SECURITIES FRAUD COM

PLAINT TO SATISFY THE “STRONG INFERENCE” RE

QUIREMENT OF THE REFORM ACT, THERE MUST BE A

HIGH LIKELIHOOD THAT THE CONCLUSION THAT THE

DEFENDANT POSSESSED SCIENTER FOLLOWS FROM

THE FACTS ALLEGED WITH PARTICULARITY

Section 10(b) of the Securities Exchange Act of 1934

(1934 Act) makes it unlawful to “use or employ, in con

nection with the purchase or sale of any security * * * ,

any manipulative or deceptive device or contrivance in

contravention of such rules and regulations as the [SEC]

may prescribe as necessary or appropriate in the public

interest or for the protection of investors.” 15 U.S.C.

78j(b). The SEC’s Rule 10b-5 implements Section 10(b)

by declaring it unlawful, “in connection with the pur

chase or sale of any security,” to (a) “employ any device,

scheme, or artifice to defraud”; (b) “make any untrue

statement of a material fact or to omit to state a mate

rial fact necessary in order to make the statements

made * * * not misleading”; or (c) “engage in any act,

practice, or course of business which operates or would

operate as a fraud or deceit upon any person.” 17

C.F.R. 240.10b-5. Section 10(b) has been construed to

afford a right of action to purchasers or sellers of securi

ties who have been injured by its violation. See, e.g.,

Dura Pharmaceuticals, Inc. v. Broudo, 544 U.S. 336,

341 (2005).

This Court has held that, in order to establish liabil

ity under Section 10(b) and Rule 10b-5, a private plain

tiff must prove “a mental state embracing intent to de

ceive, manipulate, or defraud.” Ernst & Ernst v. Hoch

11

felder, 425 U.S. 185, 194 n.12 (1976).2 Under the Private

Securities Litigation Reform Act of 1995 (Reform Act or

PSLRA), Pub. L. No. 104-67, 109 Stat. 737, a private

securities fraud complaint must “state with particularity

facts giving rise to a strong inference that the defendant

acted with the requisite state of mind.” 15 U.S.C. 78u

4(b)(2). The question presented in this case is whether

the court of appeals correctly interpreted that height

ened pleading standard in concluding that respondents’

allegations were sufficient.

A. Before The Enactment Of The Reform Act, Lower

Courts Applied Different Pleading Standards To The

Mental-State Element Of Securities Fraud

1. In an ordinary civil action, the sufficiency of a

complaint is governed by Rule 8 of the Federal Rules of

Civil Procedure, which requires a “short and plain state

ment of the claim showing that the pleader is entitled to

relief.” Fed. R. Civ. P. 8(a)(2). In order to satisfy that

requirement, a complaint must “set forth a claim upon

which relief could be granted,” Conley v. Gibson, 355

U.S. 41, 45 (1957), and give the defendant “fair notice of

what the plaintiff’s claim is and the grounds upon which

2

Although this Court has reserved the question, see Hochfelder, 425

U.S. at 194 n.12, lower courts have consistently held that a plaintiff may

meet the state-of-mind requirement by showing that the defendant

acted either intentionally or recklessly (although they have articulated

the degree of recklessness required in somewhat different ways). See

Ottmann v. Hanger Orthopedic Group, Inc., 353 F.3d 338, 343 (4th Cir.

2003) (citing cases); compare, e.g., Nathenson v. Zonagen Inc., 267 F.3d

400, 408 (5th Cir. 2001) (requiring “severe recklessness,” defined as

“resembl[ing] a slightly lesser species of intentional misconduct”), with

In re Silicon Graphics Inc. Sec. Litig., 183 F.3d 970, 977 (9th Cir. 1999)

(requiring “deliberate recklessness,” defined as “a form of intentional

conduct”).

12

it rests,” id. at 47. That requirement, however, is “not

meant to impose a great burden upon a plaintiff.” Dura

Pharmaceuticals, 544 U.S. at 347.

2. Before the enactment of the Reform Act, courts

consistently held that the sufficiency of a complaint for

securities fraud was governed by the more demanding

standard of Rule 9(b), which applies to “all averments of

fraud or mistake.” Rule 9(b) provides that “the circum

stances constituting fraud * * * shall be stated with

particularity,” but also provides that “[m]alice, intent,

knowledge, and other condition of mind of a person may

be averred generally.” Relying on the latter language,

the Ninth Circuit held that a securities fraud plaintiff

could allege the requisite state of mind “simply by say

ing that scienter existed,” without “alleg[ing] with par

ticularity facts giving rise to an inference of scienter.”

In re GlenFed, Inc. Sec. Litig., 42 F.3d 1541, 1546-1547

(1994) (en banc). The Ninth Circuit explained that

“add[ing] new requirements to Rule 9(b)” is “a job for

Congress, or for the various legislative, judicial, and

advisory bodies involved in the process of amending the

Federal Rules.” Id. at 1546.

Other courts of appeals, however, “uniformly held

inadequate a complaint’s general averment of the defen

dant’s [state of mind]” in securities fraud cases, Green

stone v. Cambex Corp., 975 F.2d 22, 25 (1st Cir. 1992)

(Breyer, C.J.), and instead “requir[ed] pleading of facts

that would indicate scienter,” Florida State Bd. of

Admin. v. Green Tree Fin. Corp., 270 F.3d 645, 655 (8th

Cir. 2001). Those courts expressed concern that, unless

securities fraud plaintiffs were required to do more than

make conclusory allegations of scienter, they could

readily allege what Judge Friendly famously called

“fraud by hindsight”: i.e., by making “a general aver

13

ment that defendants ‘knew’ earlier what later turned

out badly.” Greenstone, 975 F.2d at 25 (quoting Denny

v. Barber, 576 F.2d 465, 470 (2d Cir. 1978)); DiLeo v.

Ernst & Young, 901 F.2d 624, 627-629 (7th Cir.), cert.

denied, 498 U.S. 941 (1990). Plaintiffs would thereby

enable themselves to pursue discovery on unfounded

claims in the hopes of “extracting undeserved settle

ments.” In re Time Warner Inc. Sec. Litig., 9 F.3d 259,

263 (2d Cir. 1993), cert. denied, 511 U.S. 1017 (1994);

see, e.g., In re Burlington Coat Factory Sec. Litig., 114

F.3d 1410, 1418 (3d Cir. 1997) (Alito, J.); Romani v.

Shearson Lehman Hutton, 929 F.2d 875, 878 (1st Cir.

1991); Ross v. A.H. Robins Co., 607 F.2d 545, 557 (2d

Cir. 1979), cert. denied, 446 U.S. 946 (1980); see gener

ally Blue Chip Stamps v. Manor Drug Stores, 421 U.S.

723, 739 (1975) (noting that “[t]here has been wide

spread recognition that litigation under Rule 10b-5 pres

ents a danger of vexatiousness different in degree and

in kind from that which accompanies litigation in gen

eral”).

While those courts of appeals uniformly required

more than the Ninth Circuit, they articulated their

pleading standards differently. The Second Circuit re

quired securities fraud plaintiffs to “specifically plead

those [facts] which they assert give rise to a strong in

ference that the defendants had” the requisite state of

mind. Ross, 607 F.2d at 558. In subsequent cases, the

Second Circuit held that plaintiffs could meet the

“strong inference” requirement in one of two ways.

First, plaintiffs could “allege facts showing a motive for

committing fraud and a clear opportunity for doing so.”

Beck v. Manufacturers Hanover Trust Co., 820 F.2d 46,

50 (2d Cir. 1987), cert. denied, 484 U.S. 1005 (1988); see

Novak v. Kasaks, 216 F.3d 300, 311 (2d Cir.) (noting that

14

this standard was met when defendants “benefitted in a

concrete and personal way from the purported fraud”),

cert. denied, 531 U.S. 1012 (2000). Second, “[w]here

motive is not apparent,” plaintiffs could “identify[] cir

cumstances indicating conscious behavior by the defen

dant, although the strength of the circumstantial allega

tions must be correspondingly greater.” Beck, 820 F.2d

at 50 (citations omitted); see Novak, 216 F.3d at 311

(noting that this standard was met when defendants

“engaged in deliberately illegal behavior,” “knew facts

or had access to information suggesting that their public

statements were not accurate,” or “failed to check infor

mation they had a duty to monitor”). Applying that

standard, the Second Circuit required the dismissal of

numerous securities fraud complaints. See, e.g., Kramer

v. Time Warner Inc., 937 F.2d 767, 775-776 (1991);

Wexner v. First Manhattan Co., 902 F.2d 169, 172-173

(1990); Connecticut Nat’l Bank v. Fluor Corp., 808 F.2d

957, 961-962 (1987). Accordingly, at the time the Re

form Act was enacted, the Second Circuit’s standard was

regarded as the “most stringent” in the country. See

Nathenson v. Zonagen Inc., 267 F.3d 400, 407 (5th Cir.

2001).

Other courts of appeals “took an intermediate posi

tion” between the Second and Ninth Circuits and held

that, while securities fraud plaintiffs must plead specific

facts suggestive of a defendant’s mental state, those

facts need not give rise to a “strong” inference of the

requisite state of mind. 5A Charles Alan Wright & Ar

thur R. Miller, Federal Practice and Procedure § 1301.1,

at 300-302 (3d ed. 2004) (Wright & Miller). Thus, the

First Circuit required plaintiffs to “set[] forth specific

facts that make it reasonable to believe that defendant

knew that a statement was materially false or mislead

15

ing,” Greenstone, 975 F.2d at 25; the Fifth Circuit re

quired plaintiffs to “set forth specific facts that support

an inference of fraud,” Tuchman v. DSC Comm’cns

Corp., 14 F.3d 1061, 1068 (1994); and the Seventh Circuit

required plaintiffs to “afford a basis for believing that

plaintiffs could prove scienter,” DiLeo, 901 F.2d at 629.

Although those courts used slightly differing formula

tions, all of them required plaintiffs to plead facts that

supported at least a reasonable inference that the defen

dant possessed the requisite state of mind.

B. The Reform Act Applied A Heightened Pleading Stan

dard To The Mental-State Element Of Securities Fraud,

And The Court Of Appeals Erroneously Diluted That

Standard

In the Reform Act, Congress devised a heightened

pleading standard for scienter that was considerably

more stringent than the standard that the court below

(and other courts of appeals) had applied before the Re

form Act’s enactment. The court of appeals therefore

erred in this case by effectively adhering to its lower,

pre-Reform Act standard. Instead, the court of appeals

should have determined whether there was a high likeli

hood that the conclusion that petitioners possessed

scienter followed from the particular facts alleged in re

spondents’ complaint.

1. Congress’s enactment of the Reform Act was

prompted by concerns that the beneficial purposes of

private securities litigation were being “undermined by

* * * abusive and meritless suits,” which “had become

rampant in recent years.” H.R. Conf. Rep. No. 369,

104th Cong., 1st Sess. 31 (1995); Merrill Lynch, Pierce,

Fenner & Smith, Inc. v. Dabit, 126 S. Ct. 1503, 1510

16

1511 (2006).3 In particular, the Reform Act was

prompted by “the routine filing of lawsuits against issu

ers of securities * * * whenever there is a significant

change in the issuer’s stock price, without regard to any

underlying culpability of the issuer, and with only a faint

hope that the discovery process might lead eventually to

some plausible cause of action.” H.R. Conf. Rep. No.

369, supra, at 31. The legislative history noted that “[a]

complaint alleging violations of the Federal securities

laws is easy to craft and can be filed with little or no due

diligence,” S. Rep. No. 98, 104th Cong., 1st Sess. 8

(1995), while “[t]he dynamics of private securities litiga

tion create powerful incentives to settle, causing securi

ties class actions to have a much higher settlement rate

than other types of class actions,” id. at 6. Accordingly,

the Reform Act made a number of substantive and pro

cedural changes to the securities laws. See Dabit, 126

S. Ct. at 1511 (citing 15 U.S.C. 78u-4).

Of particular relevance here, the Reform Act “im

poses heightened pleading requirements in [private]

actions brought pursuant to § 10b and Rule 10b-5.”

Dabit, 126 S. Ct. at 1511; see Wharf (Holdings) Ltd. v.

United Int’l Holdings, Inc., 532 U.S. 588, 597 (2001). In

new Section 21D(b)(1) of the 1934 Act, the Reform Act

provides that, in any private securities action in which

the plaintiff alleges that the defendant made a false or

misleading statement, the complaint must “specify each

statement alleged to have been misleading [and] the

3

See, e.g., H.R. Conf. Rep. No. 369, supra, at 42 (noting that abusive

securities litigation “severely affects the willingness of corporate man

agers to disclose information to the marketplace”); S. Rep. No. 98,

104th Cong., 1st Sess. 9 (1995) (noting that such litigation “add[s] signif

icantly to the cost of raising capital and represent[s] a ‘litigation tax’ on

business”).

17

reason or reasons why the statement is misleading.” 15

U.S.C. 78u-4(b)(1). Moreover, if the allegation that the

statement is false or misleading is made on information

and belief, the complaint must “state with particularity

all facts on which that belief is formed.” Ibid. In new

Section 21D(b)(2) of the 1934 Act—the provision at issue

in this case—the Reform Act further states that, in any

private securities action in which the plaintiff must show

that the defendant acted with a particular mental state

in order to recover money damages, the complaint must,

“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

requisite state of mind.” 15 U.S.C. 78u-4(b)(2).4

The legislative history of the Reform Act confirms

what is apparent from the terms of Section 21D(b): viz.,

that Congress, in enacting that provision, intended to

adopt “uniform and more stringent pleading require

ments” for private securities fraud actions, H.R. Conf.

Rep. No. 369, supra, at 41, and thereby “deter or at

least quickly dispose of those suits whose nuisance value

outweighs their merits,” Dabit, 126 S. Ct. at 1511. The

legislative history expressed concern that the applica

tion of Rule 9(b) to securities fraud actions “ha[d] not

prevented abuse of the securities laws by private liti

gants,” and noted that “the courts of appeals ha[d] inter

preted Rule 9(b)’s requirement in conflicting ways, cre

ating distinctly different standards among the circuits.”

H.R. Conf. Rep. No. 369, supra, at 41. And it expressed

concern that those differences had “creat[ed] substantial

uncertainties and opportunities for abuses,” in light of

4

The Reform Act also provides for a stay of all discovery during the

pendency of a motion to dismiss, subject to limited exceptions. See 15

U.S.C. 78u-4(b)(3)(B).

18

the potential for forum shopping in securities fraud ac

tions. S. Rep. No. 98, supra, at 4.

It is clear, therefore, that, in adopting Section

21D(b)(2), Congress was reacting to the various court of

appeals decisions articulating differing standards for

pleading scienter in securities fraud cases (and to the

continuing abuses under those standards). By using the

“strong inference” standard, Congress rejected both the

standard of the Ninth Circuit, which allowed securities

fraud plaintiffs simply to state that scienter existed, and

the “intermediate” standard of other circuits, which re

quired plaintiffs to plead facts that supported at least a

reasonable inference of scienter. Instead, Congress

built upon the Second Circuit’s “strong inference” termi

nology and added various other pleading requirements,

resulting in a statute that was “intend[ed] to strengthen

existing pleading requirements.” H.R. Conf. Rep. No.

369, supra, at 41 (emphasis added). Section 21D(b)(2)

was “not intend[ed] to codify the Second Circuit’s case

law interpreting [its] pleading standard.” Ibid. At a

minimum, however, Section 21D(b)(2) was intended to

require dismissal in any case that would have been sub

ject to dismissal under the Second Circuit’s preexisting

“strong inference” standard. See Nathenson, 267 F.3d

at 412.5

5

The Statement of Managers accompanying the Conference Com

mittee Report on the PSLRA (and endorsed by the members of the

Committee) described the “strong inference” test in these terms:

Regarded as the most stringent pleading standard, the Second

Circuit requirement is that the plaintiff state facts with partic

ularity, and that these facts, in turn, must give rise to a “strong

inference” of the defendant’s fraudulent intent. Because the

Conference Committee intends to strengthen existing pleading

requirements, it does not intend to codify the Second Circuit’s

case law interpreting this pleading standard.

19

2. As noted above, Section 21D(b)(2) requires that

a securities fraud plaintiff “state with particularity facts

giving rise to a strong inference that the defendant

acted with the requisite state of mind.” 15 U.S.C. 78u

4(b)(2).6 An “inference” is “[a] conclusion reached by

considering other facts and deducing a logical conse

quence from them.” Black’s Law Dictionary 793 (8th

ed. 2004). In articulating the pleading requirement in

terms of “inferences,” Congress “acknowledg[ed] the

role of indirect and circumstantial evidence” in proving

a defendant’s state of mind. Greebel v. FTP Software,

Inc., 194 F.3d 185, 195 (1st Cir. 1999).

In Section 21D(b)(2), however, Congress did not

merely require a plaintiff to allege particular facts from

which an inference of scienter could be drawn, but inH.R. Conf. Rep. No. 369, supra, at 41. The courts of appeals are in

disagreement as to whether the Reform Act codified the Second Cir

cuit’s explanation of the alternative methods by which a securities fraud

plaintiff could plead scienter (i.e., either by “alleg[ing] facts showing a

motive for committing fraud and a clear opportunity for doing so” or by

“identifying circumstances indicating conscious behavior by the defen

dant,” Beck, 820 F.2d at 50), and specifically, whether a plaintiff can

plead scienter solely by alleging facts showing a motive and opportunity

to defraud. See Ottmann, 353 F.3d at 344-346 (citing cases). This case

presents no question concerning the proper role of motive-and-opportu

nity allegations under the PSLRA, because respondents have not al

leged that petitioner Notebaert had a motive and opportunity to de

fraud, at least as that concept was defined by the Second Circuit (e.g.,

by alleging that Notebaert engaged in unusual trading in Tellabs stock

during the relevant period).

6

The “strong inference” requirement is also included in the Y2K Act,

Pub. L. No. 106-37, § 8(d), 113 Stat. 198, which provides that, in any

qualifying “Y2K action,” “there shall be filed with the complaint, with

respect to each element of [the] claim, a statement of the facts giving

rise to a strong inference that the defendant acted with the required

state of mind.” 15 U.S.C. 6607(d).

20

stead required a plaintiff to allege particular facts that

“giv[e] rise” to a “strong” inference of scienter. The

strength of an inference, in turn, is measured by the

degree of confidence that the conclusion at issue (here,

that the defendant acted with scienter) follows from the

underlying facts—or, in other words, by the extent to

which the underlying facts tend to establish the conclu

sion at issue. See, e.g., James Hawthorne, Inductive

Logic (last modified Oct. 10, 2005), in Stanford Encyclo

pedia of Philosophy (Edward N. Zalta ed., 2007)

<http://plato.stanford.edu/entries/logic-inductive>.

A “strong” inference therefore exists when there is

a high degree of confidence—i.e., a high likelihood—that

the conclusion at issue follows from the underlying facts.

The ordinary meaning of the word “strong” amply con

firms that interpretation. See Black’s Law Dictionary

1423 (6th ed. 1990) (defining “strong” as “[c]ogent, pow

erful, forcible, forceful”); The American Heritage Dic

tionary of the English Language 1717 (4th ed. 2000)

(defining “strong,” with regard to an argument, as

“[p]ersuasive, effective, and cogent”); 16 The Oxford

English Dictionary 949 (2d ed. 1989) (defining “strong,”

with regard to an argument, evidence, or proof, as

“[p]owerful to demonstrate or convince; hard to confute

or overthrow”). Accordingly, in evaluating whether a

plaintiff has alleged particular facts that “giv[e] rise” to

a “strong” inference of scienter, a court should deter

mine whether, taking the alleged facts as true, there is

a high likelihood that the conclusion that the defendant

possessed scienter follows from those facts. See, e.g., In

re Credit Suisse First Boston Corp., 431 F.3d 36, 48-49

(1st Cir. 2005) (concluding that “a plaintiff’s allegations

must show a high likelihood of scienter in order to sat

isfy the PSLRA standard”). It is clear that a “strong”

21

inference requires something considerably more than

merely a “reasonable,” “possible,” “plausible,” or “mar

ginal” inference, even if it does not require that the in

ference be an “ironclad” or “irrefutable” one. See Credit

Suisse, 431 F.3d at 49, 51; In re Cabletron Sys., Inc., 311

F.3d 11, 38, 40 (1st Cir. 2002); Helwig v. Vencor, Inc.,

251 F.3d 540, 551, 553 (6th Cir. 2001) (en banc), cert.

dismissed, 536 U.S. 935 (2002). While it is impossible to

specify with mathematical precision the degree of likeli

hood required under Section 21D(b)(2), “facts giving rise

to a strong inference” of scienter cannot be ambiguous

facts; the inference cannot be merely borderline or a

close call.

The PSLRA’s stringent pleading standard reflects

the critical importance of the pleading stage in private

securities litigation. Securities fraud plaintiffs enjoyed,

and under the PSLRA continue to enjoy, considerable

latitude in pleading their complaints. They choose and

craft the allegations in the complaint, see, e.g., Allen v.

WestPoint-Pepperell, Inc., 945 F.2d 40, 44 (2d Cir. 1991)

(noting that, in ruling on a motion to dismiss, a court

must confine its consideration “to facts stated on the

face of the complaint, in documents appended to the

complaint or incorporated in the complaint by reference,

and to matters of which judicial notice may be taken”),

and all of the allegations in the complaint must be ac

cepted as true when tested by a motion to dismiss, see,

e.g., Leatherman v. Tarrant County Narcotics Intelli

gence & Coordination Unit, 507 U.S. 163, 164 (1993).

Congress determined, however, that the preexisting

pleading standards were leading to serious abuse in the

private securities litigation context, in which “nuisance

filings,” followed by “vexatious discovery requests” and

resulting “extortionate settlements,” had become “ram

22

pant in recent years.” Dabit, 126 S. Ct. at 1510-1511.

Congress concluded that the costs and dynamics of pri

vate securities litigation too often caused innocent par

ties to settle cases for large sums without regard to the

merit of the claims—without any “evidence of fraud,”

S. Rep. No. 98, supra, at 4, for which scienter is essen

tial under Section 10(b) and Rule 10b-5. If a securities

case is not dismissed at the pleading stage, the practical

reality is that the defendant will usually be forced to

settle and the case will never reach an adjudication on

the merits. Many years of effort by courts to screen

cases under Rule 9(b) had not prevented the abuses.

In sum, Congress “structur[ed] the [Reform Act] to

permit the dismissal of frivolous cases at the earliest

feasible stage of the litigation, thereby reducing the cost

to the company, and by derivation, to its shareholders,

in defending a baseless action.” Bryant v. Avado

Brands, Inc., 187 F.3d 1271, 1278 (11th Cir. 1999). En

forcing the “strong inference” requirement by requiring

particularized allegations that give rise to a high likeli

hood of scienter is thus a crucial element of the reforms

enacted by Congress.

3. In this case, the court of appeals correctly recog

nized that the Reform Act “unequivocally raise[d] the

bar for pleading scienter” by requiring plaintiffs to

“plead[] sufficient facts to create a ‘strong inference’ of

scienter.” Pet. App. 18a. The court of appeals erred,

however, by failing to give force to Congress’ clear in

tent, as reflected by the text, and instead holding that a

securities fraud complaint would satisfy the Reform

Act’s “strong inference” standard “if it alleges facts

from which, if true, a reasonable person could infer that

the defendant acted with the required intent.” Id. at

20a; see id. at 20a-21a (noting that a complaint should be

23

dismissed “[i]f a reasonable person could not draw such

an inference from the alleged facts”). Although the

court of appeals recognized Congress’s unequivocal in

tent to raise the bar, the court of appeals’ standard ap

pears to be equivalent to the standard that it (and some

other courts of appeals) had applied before the enact

ment of the Reform Act, under which a complaint was

sufficient if the plaintiff pleaded facts that supported at

least a reasonable inference of state of mind.7 As ex

plained above, however, Congress’s insistence on a

“strong” inference of scienter plainly requires some

thing considerably more than a “reasonable” inference

(or a permissible inference by a reasonable person). The

court of appeals erred in asking whether respondents

had alleged facts from which an inference of scienter

could reasonably have been drawn. Instead, the court

should have determined whether, as to each false or mis

leading statement at issue, there was a high likelihood

that the conclusion that petitioner Notebaert possessed

scienter followed from the alleged facts.

7

By looking to the inference that a reasonable person “could” draw,

the court of appeals seemingly allows as sufficient a permissible infer

ence for a reasonable person, which appears to be no different from (or,

if anything, less demanding than) a reasonable inference. The key is

the relative strength of the inference required, not the nature of the

person drawing the inference. Presumably, Congress and all of the

courts of appeals pre- and post-Reform Act have had in mind the infer

ence that a reasonable, as opposed to unreasonable, person would draw.

The Reform Act clearly requires more than a permissible inference; it

requires a strong one.

24

C. In Applying The Reform Act’s Heightened Pleading

Standard For The Mental-State Element Of Securities

Fraud, A Court Must Consider Any Competing Inference

Or Non-Culpable Explanations For The Defendant’s

Conduct

In determining whether there is a high likelihood

that the conclusion that the defendant possessed the

requisite state of mind follows from the facts alleged in

the complaint, a court must consider other possible ex

planations for the defendant’s conduct—or any compet

ing inference that can be drawn from the same facts.

The probabilistic inquiry required by the “strong infer

ence” test demands as much.

1. By its terms, Section 21D(b)(2) requires a court

to determine whether the plaintiff has alleged particu

larized facts giving rise to a strong inference that the

defendant acted with the requisite state of mind. To

make that determination, a court will necessarily have

to consider whether the facts leave open non-culpable

explanations for the defendant’s conduct, even where

those facts do not affirmatively buttress the conclusion

that the defendant acted without scienter. Where, for

example, a plaintiff alleges, with regard to scienter, only

that a corporate executive sold a higher (but not dramat

ically higher) number of shares than usual during the

relevant period, a court should consider the high proba

bility that there are innocent explanations for the execu

tive’s increased trading activity—a consideration that

forecloses the conclusion that the facts give rise to a

strong inference that the executive acted with scienter.8

8

By contrast, a sharp and atypical spike in trading activity could,

depending on the circumstances, provide a strong basis for inferring

scienter, because innocent explanations would be less probable.

25

Many of the leading cases apply precisely that mode of

analysis. See, e.g., Credit Suisse, 431 F.3d at 51 (noting

that a court is not required to “turn a blind eye to the

universe of possible conclusions stemming from a given

fact or set of facts” where a complaint “leaves * * * a

myriad of other possibilities wide open”); Pirraglia v.

Novell, Inc., 339 F.3d 1182, 1187 (10th Cir. 2003) (con

tending that “[w]hether an inference is a strong one can

not be decided in a vacuum”).

2. In some cases, a court may determine that some

facts in the complaint support the conclusion that the

defendant acted with scienter, whereas other facts actu

ally support the conclusion that the defendant acted

without scienter. As the court of appeals in this case

seemingly recognized (Pet. App. 20a), however, Section

21D(b)(2) requires a court to consider whether all of the

facts alleged in the complaint, taken together, give rise

to a strong inference of the requisite state of mind. See

Gompper v. VISX, Inc., 298 F.3d 893, 897 (9th Cir.

2002); Abrams v. Baker Hughes Inc., 292 F.3d 424, 431

(5th Cir. 2002). Such an approach is consistent with the

broader principle that the plaintiff is the master of his

complaint, see, e.g., Caterpillar Inc. v. Williams, 482

U.S. 386, 392 (1987)—and that a plaintiff may plead him

self out of court by including allegations that undermine

his claim. See, e.g., Gutierrez v. Peters, 111 F.3d 1364,

1374 (7th Cir. 1997). When the facts alleged in the com

plaint give rise to a substantial possibility that the de

fendant acted without scienter, the necessary “strong

inference” of scienter will be lacking, because there will

be an insufficient likelihood that the conclusion that the

defendant acted with scienter follows from the facts al

leged in the complaint as a whole.

26

3. In other cases, a court may determine that the

same facts simultaneously provide affirmative support

both for the conclusion that the defendant acted with

scienter and for the alternative conclusion that the de

fendant acted without scienter. The existence of a plau

sible competing inference, however, “quite clearly im

pedes the plaintiffs’ progress toward building the requi

site strong inference of scienter.” Gompper, 298 F.3d at

897. And where the facts as alleged give rise to a sub

stantial possibility that the defendant acted without

scienter, the inference of scienter cannot be said to be

“strong” in the relevant sense (i.e., “powerful,” “force

ful,” or “hard to confute”). In such a case, the presence

of a substantial contrary inference would foreclose the

conclusion that scienter was highly likely on the basis of

the facts alleged. Plainly, therefore, if the alleged facts

give rise to “two seemingly equally strong [competing]

inferences,” Pet. App. 20a (quoting Pirraglia, 339 F.3d

at 1188), a court must conclude that the inference of

scienter is not itself “strong.” See, e.g., Gompper, 298

F.3d at 897.

D. The Reform Act’s Heightened Pleading Standard For

The Mental-State Element Of Securities Fraud Is Con

sistent With The Seventh Amendment

Finally, requiring a plaintiff to allege facts that

“giv[e] rise” to a “strong” inference of scienter does not

raise any valid concerns under the Seventh Amendment

of the Constitution.

1. In diluting Section 21D(b)(2)’s “strong inference”

requirement, the court of appeals expressed concern

that a more stringent standard would potentially violate

the Seventh Amendment. See Pet. App. 20a. But the

text of Section 21D(b)(2) quite clearly commands a

27

heightened pleading standard, and the canon of constitu

tional avoidance “has no application in the absence of

statutory ambiguity.” United States v. Oakland Canna

bis Buyers’ Coop., 532 U.S. 483, 494 (2001).

2. Respondents did not claim that dismissal of their

complaint under Section 21D(b)(2) would violate the

Seventh Amendment. Even if they had, that claim

would lack merit.

This Court has explained that the purpose of the Sev

enth Amendment was “to preserve the substance of the

common-law right of trial by jury, as distinguished from

mere matters of form or procedure” and “particularly to

retain the common-law distinction between the province

of the court and that of the jury, whereby * * * issues

of law are to be resolved by the court and issues of fact

are to be determined by the jury.” Baltimore &

Carolina Line, Inc. v. Redman, 295 U.S. 654, 657 (1935).

This Court has never held that a pleading requirement

violates the Seventh Amendment. To the contrary, the

Court has upheld against Seventh Amendment challenge

a requirement that the defendant in a contract action

file an affidavit “stating * * * , in precise and distinct

terms, the grounds of his defense, which must be such as

would, if true, be sufficient to defeat the plaintiff’s claim

in whole or in part.” Fidelity & Deposit Co. v. United

States, 187 U.S. 315, 318 (1902); see Ex parte Peterson,

253 U.S. 300, 310 (1920) (Brandeis, J.) (concluding that

“[i]t does not infringe the constitutional right to a trial

by jury, to require, with a view to formulating the issues,

an oath by each party to the facts relied upon”). The

Court rejected the argument that “the rule deprived the

[defendant] of the right to trial by jury.” Fidelity &

Deposit Co., 187 U.S. at 320. Instead, the Court rea

soned that the rule merely “prescribe[d] the means of

28

making an issue” and that, when “[t]he issue [was] made

as prescribed, the right of trial by jury accrues.” Ibid.

Moreover, in approving the appointment of an auditor to

streamline the issues for trial, the Court rejected a Sev

enth Amendment challenge by characterizing the audi

tor’s role as being “the same as that of pleading.” Peter

son, 253 U.S. at 310. The Court explained that “[n]o one

is entitled in a civil case to trial by jury unless and ex

cept so far as there are issues of fact to be determined.”

Ibid.

Like the requirement at issue in Fidelity & Deposit

Co., the heightened pleading requirement in Section

21D(b)(2) merely imposes a threshold legal hurdle that

a plaintiff must surmount in order to state a claim (and

thereby obtain discovery); it does not trench upon the

jury’s prerogative to resolve disputed issues of fact. Cf.

Neely v. Martin K. Eby Constr. Co., 386 U.S. 317, 321

(1967) (stating that it is “settled” that Rule 50(b), which

governs judgment as a matter of law after trial, does not

violate the Seventh Amendment); Pease v. RathbunJones Eng’g Co., 243 U.S. 273, 278 (1917) (concluding

that “[t]he constitutional right of trial by jury presents

no obstacle” to granting summary judgment).

It is true that, in an ordinary case, when a plaintiff

presents sufficient evidence at trial that would support

at least a reasonable inference in the plaintiff’s favor as

to each element of the claim, the plaintiff would be enti

tled to reach the jury on that claim, and the defendant

would not be entitled to judgment on that claim as a

matter of law. See 9A Wright & Miller § 2528, at 288

289 & nn.2-3 (2d ed. 1995) (citing cases). 9 The practical

9

There appears to be a circuit conflict on the question whether the

Reform Act alters not just the pleading standard but the substantive

29

effect of Section 21D(b)(2) is to prevent a plaintiff who

alleges facts that give rise only to a reasonable inference

of scienter from proceeding to discovery, even if the

plaintiff would ultimately be able to prove those facts at

trial. But all heightened pleading standards have the

effect of preventing a plaintiff from getting discovery on

a claim that might have gone to the jury, had discovery

occurred and yielded substantial evidence. Heightened

pleading requirements have nevertheless not been

thought to raise serious Seventh Amendment problems.

The Reform Act’s heightened pleading requirement for

scienter likewise raises no such problems, because the

jury retains the power to resolve any disputed factual

issue once the plaintiff has satisfied the congressionally

“prescribe[d] * * * means of making an issue.” Fidel

ity & Deposit Co., 187 U.S. at 320.

proof standard for scienter as well. Compare Geffon v. Micrion Corp.,

249 F.3d 29, 36 (1st Cir. 2001) (stating that “we agree with the district

court that the judicial reasoning applicable to imposing heightened

pleading requirements is at least as forceful, if not more so, with regard

to proof requirements that a trial judge must consider in deciding

whether to allow a motion for summary judgment”) (internal quotation

marks and brackets omitted), with Howard v. Everex Sys., Inc., 228

F.3d 1057, 1064 (9th Cir. 2000) (stating that, under the Reform Act, “the

standard of summary judgment or [judgment as a matter of law] re

mains unaltered”). To the extent that the Reform Act altered the proof

standard, it would eliminate any Seventh Amendment concerns, no

matter what the standard at the pleading stage. For the reasons out

lined in the text, however, Section 21D(b)(2)’s heightened pleading

requirement does not implicate any such concerns, and the Court there

fore need not address the question at this time.

30

CONCLUSION

The judgment of the court of appeals should be va

cated, and the case remanded for further proceedings.

Respectfully submitted.

BRIAN G. CARTWRIGHT

General Counsel

ANDREW N. VOLLMER

Deputy General Counsel

JACOB H. STILLMAN

Solicitor

LUIS DE LA TORRE

Senior Litigation Counsel

MICHAEL L. POST

Senior Counsel

Securities and Exchange

Commission

FEBRUARY 2007

PAUL D. CLEMENT

Solicitor General

PETER D. KEISLER

Assistant Attorney General

THOMAS G. HUNGAR

Deputy Solicitor General

KANNON K. SHANMUGAM

Assistant to the Solicitor

General

MICHAEL JAY SINGER

JOHN S. KOPPEL

Attorneys