# In the Supreme Court of the United States

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## Record

- **Collection:** Agency decision
- **Document type:** Agency decision

## Text

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) . . . . . . . . . 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
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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)
.
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

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Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/agency%3Asec%3A2b487cb774595774. Public record. Not legal advice.