# Amicus Curiae Brief — Tellabs, Inc. v. Makor Issues & Rights, Ltd.

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URL: https://www.frixlaw.com/law-library/documents/brief%3Amicro_IA40385016_0301%3A23

## Record

- **Collection:** Supreme Court brief
- **Document type:** Amicus Curiae Brief
- **Published:** January 1, 2007
- **Citation:** 551 U.S. 308

## Text

e MAR 3 — NN;
No. 06-484. MAR 3 - 200)
xg LERK O
i: SUPREME COURT US:
IN THE San cel ee

Supreme Court of the United States

TELLABS, INC., ET AL..
Petitioners.
We

MAKOR ISSUES & RIGHTS. LTD.. ET AL..
Respondents.

On Writ of Certiorari to the
United States Court Appeals
for the Seventh Circuit

BRIEF OF THE NORTH AMERICAN SECURITIES
ADMINISTRATORS ASSOCIATION, INC., AS
AMICUS CURIAE IN SUPPORT OF RESPONDENTS

ALFRED EZ T. RUSCH *
Senior Counsel
District of Columbia Securities Bureau
REX AL STAPLES
General Counsel
STEPHEN W. HALL
Deputy General Counsel
JOSEPIEV. BRADY
Associate General Counsel
LESLEY M. WALKER
Associate Counsel
NORTH AMERICAN SECURITIES
ADMINISTRATORS ASSOCIATION, INC,
750 First Street. N.E.. Suite 1140
Washington, D.C. 20002
* Counsel of Record (202) 737-0900

March 9, 2007

WILSON-EPES PRINTINGCO INC - (202) 789-0096 -— WASHINGTON D C. 20002

TABLE OF CONTENTS

FAIRS GE ALT TIRE Ui ececcccvccsncesonescccsscnsssccsosseosnse
INTEREST OF THE AMICUS CURIAE. ........cc0cc0ccc0000s
SUMMARY OF THE ARGUMENT ........... ce eeeeeeeeeee

DSi ec tA MOEN TT |
L.

THE SEVENTH CIRCUIT CORRECTLY
FORMULATED AND APPLIED THE
PLEADING STANDARD FOR SCIENTER
UNDER THE REFORM ACT ................cccssseees

A. The Seventh Circuit Test Follows The
Plain Language Of The Reform Act............

B. The Seventh Circuit Test Comports With
The Legislative History ...........ccccccsssssccssserss

C. The Seventh Circuit Test Advances The
Goal Of Limiting Groundless Class Action
Lawsuits, While Minimizing The Adverse
Impact On Meritorious Claims By Injured
Pet icciecciitecsinditenissibbebstiinteansaciaianadanciiesinnsiitions

THE TEST ADVANCED BY THE PETI-
TIONERS FINDS NO SUPPORT IN THE
REFORM ACT; IT CONFLICTS WITH
RULE 12(b)(6) AS WELL AS THE SEV-
ENTH AMENDMENT; AND [fT AGGRA-
VATES RATHER THAN AMELIORATES
THE ALREADY EXCESSSIVE BURDENS
FACING INJURED INVESTORS SEEKING
REDRESS IN THE COURTG..............ccccccsssesese

A. The Language And The Legislative His-
-tory Of The Reform Act Do Not Support
The Petitioners’ Interpretation Of The
SUNN iis cischictinncegnindonecicsiadinnntanitons

13

il
TABLE OF CONTENTS—Continued
Page

B. The Pleading Standard Advanced By The
Petitioners Conflicts With The Judicially
Established Procedures For Applying Rule
STITT sevisiniencatsdinieiisuiinliononpedinbisiiendabinidgenialdiin 15

C. The Petitioners’ Insistence That Courts
Balance Competing Inferences To Resolve
A Motion To Dismiss Conflicts With The
Seventh Amendmeni’s Right To Trial By
TY sissintistcailteicialbecleibebiia tiie ldaas iat lai 16

D. If The Seventh Circuit’s Ruling Is Re-
versed, An Increasing Number Of Inves-
tors Will Suffer Irretrievable Losses At
The Hands Of Those Committing Fraud ..... 18

TN scininsscsennconccinsninitentintieinssintaitainiadeiivedin 19

iil
TABLE OF AUTHORITIES
CASES

Anderson v. Liberty Lobby, Inc., 477 U.S. 242
ISIE UINiiiiciihaccnicetildeahdladabahddildidipenidaaiasipiaaiibiniaiimeinias
Basic Inc. v. Levinson, 485 U.S. 224 (1988).........
Beacon Theatres, Inc. v. Westover, 359 U.S. 500
Societies ioiceenisiniesliececiaiiaiapaiigdeibi
Blue Chip Stamps v. Manor Drug Stores, 421
een Pan NTTII ciisasdiidibeihalibeiedaiaebssiinenlselae
City of Monroe Employees Ret. Sys. v. Bridge-
stone Corp., 399 F.3d 651 (6th Cir.), cert.
denied, 126 S.Ct. 423 (2005)... ceceeeceeeeeeees
Conley v. Gibson, 355 U.S. 41 (1957)........... cece
Ex Parte Peterson, 253 U.S. 300 (1920)......... indie
Group Life & Health Ins. Co. v. Royal Drug Co.,
4 |. SRS areas
Helwig v. Vencor, 251 F.3d 540 (6th Cir. 2001),
cert. dismissed, 536 U.S. 935 (2002).................
Hunt v. Bradshaw, 251 F.2d 103 (4th Cir. 1958)..
In re Advanta Corp. Sec. Litig., 180 F.3d 525 (3d
Rane ensicislliiai hia casecttoanuinsicteabdanigeiiniilieiiianiidtete
In re Colonial Mortg. Bankers Corp., 324 F.3d
I i
Kaufman v. i-Stat Corp., 754 A.2d 1188 (N.J.

Leatherman v. Tarrant County Narcotics
Intelligence & Coordination Unit, 507 U.S.
SU IIITTTIITTIT tdci ieee ubabecnlanstoeciatepicaaicliesiblaaaiin

Makor Issues & Rights, Ltd. v. Tellabs, Inc., 437
F.3d 588 (7th Cir. 2006), cert. granted, 127
Se MT icssiahininscitidinheeiieneciiciniadsieemmepiialiaiian

Mirkin v. Wasserman, 858 P.2d 568 (Cal. 1993) ..

Ottman v. Hanger Orthopedic Group, Inc., 353
ae EE a CIE ciintiencoccntennitisitiltininnetsiiens

Pirraglia v. Novell, Inc., 339 F.3d 1182 (10th
Sue aa cicshhntivsheesiincesinnsibetipsinisiaiteisiaeansnaibiiiinnaiabicnnichie

Page

passim

12

iV
TABLE OF AUTHORITIES—Continued

Page

Reeves v. Sanderson Plumbing Products, 530
re Ne IU ciicceniceasicnsieciidcdiieaciapiieiiienaeineiaaines 17

SEC v. Capital Gains Research Bureau, Inc., 375
Se, SEED niccditsiteniicshiinaheiendininipiadniaidasietnoienadie 8

Small vy. Fritz Companies, Inc., 65 P. 3d 1255
Se MI desniheiseilhnisticiastiaiilaaeticihiiiilataians 12-13

CONSTITUTIONS, STATUTES, AND RULES
ee ls MINIS WIP siccisiisctcatnpictenbninitsiiniteniicsiosen 16
Pub. L. No. 105-353, § 2(1), (2), 112 Stat. 3227... 11-12
Se ag ie I siiiciicishcdiieiciinisinccieinieciicsiniginibdetsiaidatint 12
Re Ride: Ie aT cericiindnscincicineonnvenienennasicinsdenies 6
a en Ee EE © TRIED sentcunindenisiinbinsnninmittenisinaiene 9
SY SIP TIE csisinsiscesshinmatiicnesnasiticsnpmtisibitedibiainin 10
a ss: UE NOTE ctistieiihiinaishesierithenpdiiianiennceseinaticeteminbiahinith 10
Ns ns Py MII ss isicicescetidiadstttenialttmadnianidnbesiie 15
SA TE Tis IU cticageiiehinsaieteptingpttudeiianeatiibsiabanieatianiebiniin l
Ns Peat TaAs SUN ictnteiennnceinnincinteirincenelapeenibncapatininnslei l
LEGISLATIVE HISTORY

H.R. Conr. REP. No. 104-369 (1995), reprinted
BES od at Dy) nae 7,8

H.R. Rep. No. 107-414 (2002), 2002 WL 661614
ST TI insuictasecsedisisstiniccltichsineedtaniciiuiinnbenigi 10

S. REP. No. 104-98 (1995), reprinted in 1995
Saas TUT cinsieiitsicnsenhcsienieibapantnesieariciidesitiie 4,8

Brief of the North American Securities Admin-
istrators Association, Inc., as Amicus Curiae,
in Support of Respondents Broudo ef ai., in
Dura Pharmaceuticals, Inc. v. Broudo, Case
No. 03-932 (U.S. Nov. 17, 2004), available at
http://www.nasaa.org/content/F iles/BroudoBri

Vv
TABLE OF AUTHORITIES—Continued

Brief of the North American Securities Admin-
istrators Association, Inc., as Amicus Curiae,
in Support of the People of the State
California, in People v. Edward D. Jones &
Co., Case No. CO53407 (Cal. Ct. App. Feb.
23, 2007), available at http://www.nasaa.org/
content/Files/ED JONES FINAL.pdf..............

- 5B CHARLES ALLEN WRIGHT & ARTHUR R.
MILLER, FEDERAL PRACTICE AND PROCEDURE
BD SSO7 COC OE, Fe i rerevenstitemnennevnntiniiataien

Joel Seligman, Rethinking Private Securities
Litigation, 73 U. Cin. L. Rev. 95 (2004)...........

Kevin S. Schmelzer, The Door Slammed Shut
Needs to be Reopened: Examining the Plead-
ing Requirements Under the Private Securities
Litigation Reform Act, 78 Temp. L. Rev. 405

Press Release, No. 2002-179, SEC, NY peceeaneen
General, NASD, NASAA, NYSE and State
Regulators Announce Historic Agreement to
Reform Investment Practices (SEC, Dec. 20,
2002), available at http://www.sec.gov/news/
SUSE EEE FOIE vicescstsviniscinbiinnnengueliiiisionennen

Press Release, State Investigation Reveals
Mutual Fund Fraud (Office of the New York
Attorney General, Sept. 3, 2003), available at
http://www.oag.state.ny.us/press/2003/sep/sep
Gh TU ccncesisvccceitesminincinmnsiasnassiaiieisiisseslimsamanaintes

Page

15

1]

vi
TABLE OF AUTHORITIES—Continued
Page

Ronald |. Miller, Todd Foster, and Elaine
Buckberg, Recent Trends in Shareholder Class
Action Litigation: Beyond the Mega-Settle-
ments, is Stabilization Ahead? Apr. 2006,
available at http://www.nera.com/image/BRO
_RecentTrends2006 SEC979_PPB-
FINAL.pdf (National Economic Associates,
ESN eee 10
Hearing on H.R. 5491, Before the House
Committee on Financial Services, Subcom-
mittee on Capital Markets, Insurance, and
Government Sponsored Enterprises, 109th
Cong. (2006) (Statement of James D. Cox),
available at www.law.duke.edu/features/pdf/
iii eretenialenisttnganseuatnesncesosues 10

IN THE

Supreme Court of the United States

No. 06-484

TELLABS, INC., ET AL.,
Petitioners,
Vv.

MAKOR ISSUES & RIGHTS, LTD., ET AL.,
Respondents.

On Writ of Certiorari to the
United States Court Appeals
for the Seventh Circuit

BRIEF OF THE NORTH AMERICAN SECURITIES
ADMINISTRATORS ASSOCIATION, INC., AS
AMICUS CURIAE IN SU?PORT OF RESPONDENTS

INTEREST OF THE AMICUS CURIAE '

The North American Securities Administrators Associa-
tion, Inc. (“NASAA”), is the nonprofit association of state,
provincial, and territorial securities regulators in the United
States, Canada, and Mexico. It has 67 members, including

' Pursuant to Sup. Cr. R. 37.6, NASAA represents that no counsel
for any party authored this brief in whole or in part, and no person or
entity, other than NASAA, its members, or its counsel, made any mone-
tary contribution to the preparation or submission of the brief. Pursuant to
Sup. Cr. R. 37.3, NASAA further represents that all parties to this appeal
have consented to the filing of this brief. Copies of their written consents
have been filed with the Court.

2

the securities regulators in all 50 states, the District of Colum-
bia, Puerto Rico, and the U.S. Virgin Islands. Formed in
1919, it is the oldest international organization devoted to
pratecting investors from fraud and abuse in the offer and sale
of securities.

The U.S. members of NASAA are responsible for admin-
istering state securities laws and regulations. Their activities
include regulatory functions such as licensing broker-dealers,
registering local securities offerings, and conducting compli-
ance examinations. Especially important is their enforcement
role: protecting the nation’s investors by bringing literally
thousands of enforcement actions every year against the firms
and individuals who have committed fraud and abuse in the
sale of securities. In those cases, state securities regulators
often seek restitution to help make injured investors whole,
although both state and federal regulators recognize that the
best hope of recovery for the vast majority of defrauded
investors is through the courts in private actions for damages.

NASAA supports the work of its members through training
programs, enforcement assistance, and legislative analysis.
Another important role of the association is representing the
membership’s position as amicus curiae in significant cases
brought by private plaintiffs as well as government regulators
involving the interpretation of the securities laws and the
rights of investors. See, e.g., Brief of the North American
Securities Administrators Association, Inc., as Amicus Curiae,
in Support of Respondents Broudo ef a/., in Dura Pharma-
ceuticals, Inc. v. Broudo, Case No. 03-932 (U.S. Nov. 17,
2004) (supporting investors’ position on the pleading
requirements for Joss causation in a private action for
securities fraud), available at http://www.nasaa.org/content/
Files/BroudoBrief.pdf; Brief of Amicus Curiae North Ameri-
can Securities Administrators Association, Inc., in Support of
the People of the State of California, in People v. Edward D.
Jones & Co., Case No. CO53407 (Cal. Ct. App. Feb. 23,

3

2007), available at http://www.nasaa.org/content/Files/ED _
JONES_FINAL.pdf.

NASAA and its members have a stake in the outcome of
this appeal because it will have a profound impact upon the
ability of investors to seek redress in cases where unscrupu-
lous issuers and corporate executives have perpetrated a fraud
on the market. The Seventh Circuit correctly ruled that a
complaint for securities fraud satisfies the pleading require-
ments for scienter under the Private Securities Litigation
Reform Act of 1995 (“Reform Act” or “Act”) if the allega-
tions in the complaint collectively establish a strong inference
of scienter. See Makor Issues & Rights, Lid. v. Tellabs, Inc.,
437 F.3d 588, 601 (7th Cir. 2006), cert. granted, 127 S.Ct.
853 (2007). The court rightly rejected the far more onerous
requirement that courts actually evaluate competing infer-
ences upon a motion to dismiss and afford_the plaintiff only
those inferences that are most plausible. /d. at 602. If this
Court were to reverse the lower court and establish the more
burdensome standard as the federal rule governing scienter at
the pleading stage, many victims of securities fraud with
meritorious claims would lose the opportunity to recover their
damages. As advocates for the rights of investors to seek
redress, NASAA and its members have an interest in support-
ing affirmance and minimizing this threat.

This Court’s decision will also affect the role of private
actions as a deterrent against securities fraud. Private actions
by defrauded investors are an enormously important comple-
ment to regulatory enforcement actions as a means of polic-
ing the securities marketplace. State and federal securities
regulators work tirelessly to detect, enjoin, and punish finan-
cial fraud. However, private actions not only provide the
principal means of redress for victims of securities fraud, they
also play a vitally important role in protecting the integrity of
the marketplace through deterrence. Congress and the courts
alike have recognized this fact. The Senate Report accom-

4

panying the Reform Act described the importance of private
rights of action as follows:

The SEC enforcement program and the availability of
private rights of action together provide a means for
defrauded investors to recover damages and a powerful
deterrent against violations of the securities laws. As
noted by SEC Chairman Levitt, “private rights of action
are not only fundamental to the success of our securities
markets, they are an essential complement to the SEC’s
own enforcement program.” (citation omitted)

See S. REP. No. 104-98, at 8 (1995) (“Senate Report”), re-
printed in 1995 U.S.C.C.A.N. 679, 687; see also Basic Inc. v.
Levinson, 485 U.S. 224, 230-31 (1988) (observing that the
private cause of action for violations of Section 10(b) and
Rule 10b-5 constitutes an “essential tool for enforcement of
the 1934 Act’s requirements”). To the extent that the Court
erects unwarranted barriers to recovery in private actions,
such as the pleading requirements for scienter advanced by
the Petitioners, the Court will undermine an important deter-
rent that benefits the marketplace as a whole. For this addi-
tional reason, NASAA and its members support affirmance of
the circuit court’s decision.

SUMMARY OF THE ARGUMENT

The Seventh Circuit correctly held that a complaint for
securities fraud satisfies the pleading requirements for sci-
enter under the Reform Act if the allegations in the complaint
collectively establish a strong inference of scienter. This
formulation is precisely what the Reform Act says and what
Congress intended the courts to apply. Moreover, the Sev-
enth Circuit’s rule advances the Congressional policy of
discouraging meritless lawsuits, while minimizing restrictions
on access to the courts by the ever-increasing number of
investors who are genuine victims of securities fraud. The
rule advanced by Petitioners and their amici, suggesting that
courts must instead evaluate competing inferences upon a

5

motion to dismiss and afford the plaintiff only those infer-
ences that are most plausible, should be rejected. It has no
support in the language or legislative history of the Reform
Act. Moreover, by calling upon courts to weigh competing
evidentiary claims, it violates the universally accepted inter-
pretation of Rule 12(b)(6), as well as the Seventh Amendment
guarantee of trial by jury. And the Petitioners’ rule would
severely limit access to the courts for injured investors, at a
time when the need to address rampant financial fraud far
outweighs the need to protect companies and their executives
from strike suits.

ARGUMENT

I. THE SEVENTH CIRCUIT CORRECTLY FOR-
MULATED AND APPLIED THE PLEADING
STANDARD FOR SCIENTER UNDER THE
REFORM ACT |

The Seventh Circuit held that when evaluating the ade-
quacy of scienter allegations on a motion to dismiss under the
Reform Act, courts should examine all of the allegations in
the complaint and decide whether collectively they establish a
strong inference of scienter. Makor, 437 F.3d at 601. This
simple test faithfully adheres to the actual language of the
Reform Act, it comports with the Act’s legislative history,
and it strikes the right balance between the two policies
underlying the Act: eliminating meritless strike suits while
preserving the right of investors to seek damages for securi-
ties fraud. The circuit court’s interpretation of the Reform
Act was therefore correct and should be affirmed.

A. The Seventh Circuit’s Test Follows The Plain
Language Of The Reform Act

“[ T]he starting point in any case involving the meaning of
a statute is the language of the statute itself.” Group Life &
Health Ins. Co. v. Royal Drug Co., 440 U.S. 205, 210 (1979);
In re Advanta Corp. Sec. Litig., 180 F.3d 525, 533 (3rd Cir.

6

1999) (focusing attention on the Reform Act’s plain lan-
guage, “which is the customary starting point in statutory
interpretation”). With respect to allegations of scienter, the
Reform Act simply provides that a complaint alleging securi-
ties fraud must “state with particularity facts giving rise to a
strong inference that the defendant acted with the required
state of mind.” 15 U.S.C. § 78u-4(b)(2) (emphasis added).
This is precisely the test that the Seventh Circuit adopted in
its opinion. See, e.g., Makor, 437 F.3d at 603 (“We can now
assess whether the complaint states, with respect to each of
these actionable statements, facts that give rise to a strong
inference of scienter.”) (emphasis added); id. at 605 (“[W]e
find that the complaint contains enough detail to establish a-
strong inference that Notebaert knew of the channel stuffing
and therefore knew Tellabs had exaggerated its fourth quarter
2000 revenues.”) (emphasis added); id. at 604 (“We conclude
that the plaintiffs have pleaded sufficient facts to ‘giv[e] rise
to a strong inference,’ 15 U.S.C. § 78u-4(b)(2), that Notebaert
knowingly lied . . . .”) (emphasis added).? The Seventh
Circuit clearly based its analysis on an accurate reading of the
Reform Act.

? These excerpts from the Seventh Circuit's opinion refute any sug-
gestion that the court’s test for pleading scienter afier adoption of the
Reform Act is no more stringent than the test applicable before adoption
of the Reform Act. See also Makor, 437 F.3d at 601 (the Reform Act “did
unequivocally raise the bar for pleading scienter”); id. at 600 (adequately
pleading scienter under the Reform Act requires plaintiffs to clear “another,
even more arduous hurdle”). Nor does the Seventh Circuit’s reference to
a “reasonable person” standard support the Petitioners’ contention on this
issue. The court used that phrase not to dilute the “strong inference”
requirement, but as an alternative to the Sixth Circuit’s unacceptable sug-
gestion that courts must weigh competing inferences and afford plaintiffs
only those that are most reasonable. /d. at 602. Rather than balancing
inferences, the court’s role under the Seventh Circuit's analysis is simply
to determine if a “reasonable person” could arrive at the requisite strong
inference.

7

B. The Seventh Circuit’s Test Comports With The
Legislative History

The Seventh Circuit also considered the legislative history
of the Reform Act. Although generally regarded as “contra-
dictory and inconclusive,” see Makor, 437 F.3d at 601 (quot-
ing In re Advanta Corp., 180 F.3d at 533), the legislative
history is clear at least on this point: Congress deliberately
chose to fashion a strong but simple test, unencumbered with
embellishments derived from the case law. The Conference
Report confirms that the standard was intended to be pre-
cisely what the statute says: the plaintiff's facts, stated with
particularity, “must give rise to a ‘strong inference’ of the
defendant’s fraudulent intent.” H.R. CONF. REP. No. 104-
369, at 41 (1995) (“Conference Report”), reprinted in 1995
U.S.C.C.A.N. 730, 740. While acknowledging that the stan-
dard was derived in part from the test in the Second Circuit,
the Report expressly disavows any intention “to codify the
Second Circuit’s case law interpreting this pleading stan-
dard.” /d. The report further explains that “for this reason,
the Conference Report chose not to include in the pleading
standard certain language relating to motive, opportunity, or
recklessness.” Conference Repori at n.23. The legislative
history thus supports the Seventh Circuit’s observation,
shared by the majority of the federal circuit courts, that
“Congress chose neither to adopt nor reject particular meth-
ods of pleading scienter-—such as alleging facts showing
motive and opportunity—but instead only required plaintiffs
to plead facts that together establish a strong inference of
scienter.” See Makor, 437 F. 3d at 601 (quoting Ottman v.
Hanger Orthopedic Group, Inc., 353 F.3d 338, 345 (4th Cir.
2003)).

8

C. The Seventh Circuit’s Test Advances The Goal
Of Limiting Groundless Class Action Lawsuits,
While Minimizing The Adverse Impact On
Meritorious Claims By Injured Investors

In the Reform Act, Congress sought to “strike the right
balance between protecting the rights of victims of securities
fraud and the rights of public companies to avoid costly and
meritless litigation.” See Senate Report at 10. Congress
clearly wanted to inhibit abusive lawsuits, but at the same
time it recognized that “[p]|rivate securities litigation is an
indispensable tool with which defrauded investors can re-
cover their losses without having to rely upon government
action.” See Conference Report at 31. Moreover, Congress
recognized that “[s]uch private lawsuits promote public and
global confidence in our capital markets and help to deter
wrongdoing and to guarantee that corporate officers, auditors,
directors, lawyers and others properly perform their jobs.” Jd.
The Conference Report begins with the affirmation that “(t]he
overriding purpose of our nation’s securities laws is to protect
investors and to maintain confidence in our capital markets
.... (emphasis added). See Conference Report at 31; see
also Makor, 437 F.3d at 595 (establishing, as a backdrop to
its analysis, that “the modern securities laws were designed

. . to ‘substitute a philosophy of full disclosure for the
philosophy of caveat emptor and thus to achieve a high stan-
dard of business ethics in the securities industry”) (quoting
SEC v. Capital Gains Research Bureau, Inc., 375 U.S. 180,
186 (1963)).

The Seventh Circuit’s interpretation of the Reform Act's
heightened pleading standard for allegations of scienter
accommodates both of these Congressional policy goals. The
circuit court’s analysis obviously recognizes that allegations
of scienter in a securities fraud action must be subjected to
more “arduous” scrutiny under the Reform Act. See Makor,
437 F.3d at 600. The court’s holding thus serves the purpose

9

of deterring unfounded lawsuits. At the same time, however,
the court refused to graft onto the statute’s plain language the
vastly more repressive balancing-of-inferences test advocated
by the Petitioners. The court’s holding thus also advances
Congress’s goal of preserving meaningful recourse for bona
fide victims of securities fraud.”

The need to ensure that investors have meaningful private
remedies in federal court has become starkly apparent since
the passage of the Reform Act. Over the last several years,
there has been a marked rise in the incidence of corporate
accounting fraud and securities law violations affecting large
classes of investors. See, e.g., Press Release, No. 2002-179,
SEC, NY Attorney General, NASD, NASAA, NYSE and
State Regulators Announce Historic Agreement to Reform
Investment Practices (SEC, Dec. 20, 2002), available at
http://www.sec.gov/news/press/2002-179.htm; see also Press
Release, State Investigation Reveals Mutual Fund Fraud
(Office of New York Attorney General, Sept. 3, 2003),
available at http://www.oag.state.ny.us/press/2003/sep/sep
03a_03.html.

Congress recognized the seriousness of the problem, and
the need for at least a partial legislative response, when it
enacted the Sarbanes-Oxley Act of 2002, 15 U.S.C. §§ 7201-
7266. The House Report accompanying the House bill aptly
describes the problem of deceptive corporate practices that
harm investors:

The collapse of the Enron Corporation provided irrefu-
table evidence of serious, systemic problems in our

* On its face, at least, the Seventh Circuit’s disposition of the Peti-
tioners’ specific challenges to the complaint suggests that the “strong
inference” standard is a rigorous screening mechanism for fraud claims.
Although the court sustained a number of fraud allegations against one of
the two individual defendants, it dismissed all of the complaint’s allega-
tions against the other individual defendant, finding that “the plaintiffs did
not meet the strict PSLRA standards for pleading Birck’s scienter.” See
Makor, 437 F.3d at 603-04.

10

financial reporting system and our capital markets. Far
from being an isolated instance, Enron was only the
most spectacular example of what has become a com-
mon phenomenon---earnings manipulation and deceptive
accounting by our largest companies. Before Enron,
company after company—Waste Management, Sun-
beam, Cendant, W.R. Grace, and many others—-were
found to have manipulated their accounting to present
a picture to investors that did not match reality. As
evidenced by the record number of investigations
opened by the SEC thus far this year [2002], the problem
has only become more acute.

See H.R. Rep. No. 107-414 (2002). 2002 WL 661614, *47
(Minority Views).*

This corporate fraud has harmed millions of investors
nationwide, inflicting huge personal losses. Yet the number
of securities fraud class action lawsuits filed in the federal
courts has declined, and dismissal rates have increased, since
the Reform Act was passed. See generally Hearing on H.R.
5491, Before the House Committee on Financial Services,
Subcommittee on Capital Markets, Insurance, and Govern-
ment Sponsored Enterprises, 109th Cong. (2006) (Statement
of James D. Cox), available at http://www.law.duke.edu/
features/pdf/ coxtestimony.pdf; Ronald I. Miller, Todd Foster,
and Elaine Buckberg, Recent Trends in Shareholder Class
Action Litigation: Beyond the Mega-Setilements, is Stabili-
zation Ahead? Apr. 2006, available at http://www.nera.

* For the most part, the laudable provisions of Sarbanes-Oxley are

focused on enhancing the regulatory oversight of corporate accounting
practices and toughening the penalties for violations of the securities laws.
See, e.g., Title 1, 15 U.S.C. §§ 7211-19 (establishing an accounting over-
sight board for public companies); Title VIII, Section 807, 18 U.S.C.
§ 1348 (increasing criminal penalties for defrauding shareholders of pub-
licly traded companies). It remains for the courts to interpret the securi-
ties laws in a manner that affords investors an adequate means of redress
for corporate malfeasance.

1]

com/image/BRO_RecentTrends2006_SEC979_PPB-FINAL.
pdf (National Economic Research Associates, Inc.). These
conflicting trends have prompted experts in the securities
field to surmise that because of the Reform Act, “the balance
has been tipped too far in favor of preventing claims (some of
which would, after discovery, turn out to have merit) rather
than protecting investors who have suffered losses. That is,
Congress swung the pendulum too far in protecting defen-
dants.” Kevin S. Schmelzer, The Door Slammed Shut Needs
to be Reopened: Examining the Pleading Requirements
Under the Private Securities Litigation Reform Act, 78 Temp.
L. Rev. 405, 426 (2005); see also Joel Seligman, Rethinking
Private Securities Litigation, 73 U. Cin. L. Rev. 95, 113
(2004) (“the diminution in the effectiveness of private federal
securities litigation was one of the several facts that con-
tributed to a reduction in fraud deterrence.”). The Seventh
Circuit’s ruling at least minimizes this regulatory imbalance
that favors defendants at the expense of investors.

Another factor supporting the Seventh Circuit’s interpreta-
tion of the Reform Act is the limited availability of alternative
recourse for the victims of securities fraud in the state courts.
This Court has observed that the disadvantages posed by a
restrictive interpretation of federal securities law can be
“attenuated” where adequate remedies are available under
state law. See Blue Chip Stamps v. Manor Drug Stores, 421
U.S. 723, 738 n.9 (1975) (standing to bring private cause
of action under Rule 10b-5 limited to actual purchasers or
sellers). Conversely, where state courts do not offer an ade-
quate alternative forum for plaintiffs’ claims, federal courts
have a correspondingly greater justification for providing
relief.

In this case, state law offers limited recourse for investors
in the Respondents’ position. Congress has expressly limited
the use of class action suits seeking recovery for securities
fraud under state law. In 1998, Congress enacted the Securi-

12

ties Litigation Uniform Standards Act (“SLUSA”) to address
the concern that “securities class action lawsuits [had] shifted
from Federal to state courts” as a means of circumventing the
Reform Act. See Pub. L. No. 105-353, § 2(1), (2), 112 Stat.
3227. With certain exceptions, SLUSA provides that no class
action based upon state law may be maintained in any state
court on behalf of more than 50 class members. See 15
U.S.C. § 77p(b). Moreover, state courts generally have not
recognized the doctrine of fraud-on-the-market in cases
seeking relief under state common law, further limiting the
state courts as an alternative forum for investors aggrieved by
large-scale market manipuiation of the sort alleged in this
case. See, e.g., Kaufman v. i-Stat Corp., 754 A.2d 1188,
1193-94 (N.J. 2000); Mirkin v. Wasserman, 858 P.2d 568,
584 (Cal. 1993).

Precisely because of the massive corporate frauds that have
surfaced in recent years, some state courts have recognized
the need to reevaluate barriers to civil actions alleging
securities fraud. The California Supreme Court, for example,
has cited the troubling increase in corporate fraud as a reason
to recalibrate the balance between the interests of investors
and the interests of corporations, in favor of providing greater
judicial recourse to victims of fraud:

When Congress enacted the Private Securities Litigation
Reform Act of 1995 and the Uniform Standards Act of
1998, it was almost entirely concerned with preventing
nonmeritorious suits. (Stout, supra, 38 Ariz. L. Rev.
711). But events since 1998 have changed the perspec-
tive. The last few years have seen repeated reports of
false financial statements and accounting fraud, demon-
strating that many charges of corporate fraud were
neither speculative nor attempts to extort settlement
money, but were based on actval misconduct. “To open
the newspaper today is to receive a daily dose of scan-
dal, from Adelphia to Enron and beyond. Sadly, each of
us knows that these newly publicized instances of
accounting-related securities fraud are no longer out of

13

the ordinary, save perhaps in scale alone.” (Schulman,
et al., The Sarbanes-Oxley Act: The Impact on Civil
Litigation under the Federal Securities Laws from the
Plaintiff's Perspective (2002 ALI-ABA Cont. Legal Ed.
p.l1.) The victims of the reported frauds, moreover, are
often persons who were induced to hold corporate stock
by rosy but false financial reports, while others who
knew the true state of affairs exercised stock options and
sold at inflated prices. (See Purcell, The Enron Bank-
ruptcy and Employer Stock in Retirement Plans, Con-
gressional Research Service (Mar. 11, 2002)). Eliminat-
ing barriers that deny redress to actual victims of fraud
now assumes an importance equal to that of deterring
nonmeritorious suits.

See Small v. Fritz Companies, Inc., 65 P.3d 1255, 1263-64
(Cal. 2003) (a person wrongfully inducedto hold stock may
bring an action for fraud under state common law). However,
unless and until this shift in state law gains currency, inves-
tors must depend upon the federal courts to afford complete
relief where corporate executives and others have perpetrated
a fraud on the market. As financial crimes abound and as
alternative forums for aggrieved investors remain limited, it is
especially important that the federal courts interpret federal
law in a way that, to the extent possible, affords meaningful
remedies to victims of securities fraud. The Seventh Circuit’s
ruling accomplishes this objective and should be affirmed.

Il. THE TEST ADVANCED BY THE PETITION-
ERS FINDS NO SUPPORT IN THE REFORM
ACT; IT CONFLICTS WITH RULE 12(b)(6) AS
WELL AS THE SEVENTH AMENDMENT; AND
IT AGGRAVATES RATHER THAN AMELIO-
RATES THE ALREADY EXCESSIVE BURDENS
FACING INJURED INVESTORS SEEKING
REDRESS IN THE COURTS

The Petitioners argue that the “strong inference” standard
requires courts to apply a host of additional! tests to determine

14

if a complaint adequately pleads scienter under the Reform
Act. At the heart of the Petitioners’ argument is the notion
that a court must exclude the possibility of innocence by
entertaining inferences that favor the defendant as well as the
plaintiff, and balancing those inferences to determine which
are more plausible—those that indicate innocence or those
that support culpability. See, e.g., Brief of Petitioners, No.
06-484, 2007 WL 432763 at *25-26 (S.Ct. Feb. 9, 2007)
(“Reform Act requires the complaint to paint a detailed
picture of the facts that meaningfully tends to exclude the
possibility of innocence. . . . “); id. at 35 (inference cannot be
strong if claimed culpable inference appears no more plaus-
ible than alternative, innocent inferences). This standard,
however, finds no support in the language or the legislative
history of the Reform Act. Moreover, it conflicts with the
time-honored principle that on a motion to dismiss, ail rea-
sonable inferences are to be drawn in favor of the plaintiff.
It also violates the right to trial by jury by asking courts to
choose between competing factual interpretations. Finally,
and perhaps most important, the Petitioners’ harsh formula
undermines the policies that the Reform Act and the secu-
rities laws more generally were intended to serve: it will
routinely extinguish meritorious fraud claims at the pleading
stage without significantly enhancing the goal of discourag-
ing frivolous suits.

A. The Language And The Legislative History Of
The Reform Act Do Not Support The
Petitioners’ Interpretation Of The Pleading
Standard

Nowhere does the Reform Act make any reference to
drawing inferences that favor the defendant, balancing com-
peting inferences regarding scienter, or excluding the pos-
sibility of innocence. As discussed above, a complaint
satisfies the Act if it pleads facts giving rise to a strong
inference of scienter. The legislative history also contains no
hint that Congress intended to incorporate the Petitioners’

15

burdensome standard into the Reform Act. On the contrary,
as discussed supra, the Conference Report disavows any
Congressional intent to incorporate specific requirements
other than the “strong inference” test.

B. The Pleading Standard Advanced By The
Petitioners Conflicts With The Judicially
Established Procedures For Applying Rule
12(b)(6)

An enormous body of case law developed under Rule
12(b)(6) of the Federal Rules of Civil Procedure, FED. R. Civ.
P. 12(b)(6), has established three core principles that apply
whenever a court entertains a motion to dismiss for failure to
state a claim upon which relief can be granted. First, the
complaint is construed in the light most favorable to the
plaintiff. Second, the allegations as pled in the complaint are
taken as true. Third, and most important for the purposes of
this appeal, all reasonable inferences that can be drawn from
the pleading are drawn in favor of the pleader. 5B CHARLES
ALLEN WRIGHT & ARTHUR R. MILLER, FEDERAL PRACTICE
AND PROCEDURE §1357 (3d ed. 2004). When considering a
motion to dismiss pursuant to Rule 12(b)(6), a court is bound
to “assume the truth of all well-pleaded facts and indulge all
reasonable inferences that fit the plaintiff's stated theory of
liability.” See In re Colonial Mortg. Bankers Corp., 324 F.3d
12, 15 (1st Cir. 2003). The rationale for this doctrine is that,
on a motion to dismiss, the court is not weighing evidence,
but only testing the legal sufficiency of the plaintiff's claim to
determine if relief may be granted. See Pirraglia v. Novell,
Inc., 339 F.3d 1182, 1187 (10th Cir. 2003). This Court has
instructed that “a complaint should not be dismissed for
failure to state a claim unless it appears beyond doubt that
plaintiff can prove no set of facts in support of his claim
which would entitle him to relief.” Conley v. Gibson, 355
U.S. 41, 45-46 (1957). This instruction leaves no room for

16

the trial judge to consider the ihferences that cast a defendant
in the best light.

Congress evinced no intent to amend Rule 12(b)(6) or
overturn its judicial underpinnings when it adopted the
Reform Act. “[{T]he Reform Act did not reverse the polarity
of securities pleading.” Helwig v. Vencor, Inc., 251 F.3d 540,
553 (6th Cir. 2001), cert. dismissed, 536 U.S. 935 (2002). In
the absence of such an amendment, federal courts are bound
to follow the dictates of Rule 12(b)(6). See Leatherman v.
Tarrant County Narcotics Intelligence & Coordination Unit,
507 U.S. 163 (1993). Accordingly, its requirements apply no
less to allegations of scienter in a securities fraud case than
they do to any other case. The Petitioners’ assertion that on a
motion to dismiss, courts must entertain inferences in favor of
the defendant directly conflicts with the canons of Rule
12(b)(6). The Seventh Circuit’s interpretation of the pleading
standard for scienter creates no such conflict, and for this
reason, the court’s ruling should be affirmed.

C. The Petitioners’ Insistence That Courts Bal-
ance Competing Inferences To Resolve A
Motion To Dismiss Conflicts With The Seventh
Amendment’s Right To Trial By Jury

The Seventh Amendment to the Constitution provides that
“the right of trial by jury shall be preserved, and no fact tried
by a jury, shall be otherwise reexamined in any Court of the
United States, than according to the rules of the common
law.” U.S. Const. amend. VII. It is well settled that “when
there is a debatable issue of fact in the trial of a suit at com-
mon law in a court of the United States, the right to have it
determined by a jury is guaranteed by the Seventh Amend-
ment of the Constitution.” See Hunt v. Bradshaw, 251 F.2d
103, 108 (4th Cir. 1958). The Seventh Amendment ensures
“the enjoyment of the right of trial by jury be not obstructed,
and that the ultimate determination of issues of fact by the
jury be not interfered with.” Ex Parte Peterson, 253 U.S.

17

300, 309-310 (1920). “[MJaintenance of the jury as a fact-
finding body is of such importance and occupies so firm
a place in our history and jurisprudence that any seeming
curtailment of the right to a jury trial should be scrutinized

with the utmost care.” Beacon Theatres, Inc. v. Westover.
359 U.S. 500, 501 (1959).

The right to trial by jury places limits on the nature of the
issues that a judge may decide on a dispositive motion, such
as a motion to dismiss or a motion for summary judgment.
Courts certainly are empowered to make procedural rulings
with a view to formulating the issues. However, when a court
weighs competing inferences and “fails to draw all reasonable
inferences in favor of [the plaintiff],” it acts as a fact finder
and “impermissibly substitute[s] its judgment concerning the
weight of the evidence for the jury’s.” Reeves v. Sanderson
Plumbing Products, 530 U.S. 133, 153 (2000); cf Anderson
v. Liberty Lobby, Inc., 477 U.S. 242, 255 (1986) (“Credibility
determinations, the weighing of the evidence and the drawing
of legitimate inferences from the facts are jury functions, not
those of a judge, whether ruling on a motion for summary
judgment or for a directed verdict.”). .

The Petitioners’ interpretation of the Reform Act calls upon
courts to engage in just these sorts of factual determinations:
considering the relative weight of inferences drawn in favor
of both parties, in conflict with the Seventh Amendment. The
Seventh Circuit recognized the constitutional implications of
the Petitioners’ test:

{W]e think it wiser to adopt an approach that cannot be
misunderstood as a usurpation of the jury’s role. Instead
of accepting only the most plausible of competing infer-
ences as sufficient at the pleading stage. 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. “Faced with two seem-
ingly equally strong inferences, one favoring the plaintiff

18

and one favoring the defendant, it is inappropriate for us
to make a determination as to which inference will
ultimately prevail, lest we invade the traditional role of
the factfinder.”

See Makor, 437 F.3d at 602 (quoting Pirraglia, 339 F.3d at
1188); see also City of Monroe Employees Ret. Sys. v.
Bridgestone Corp., 399 F.3d 651, 683 n.25 (6th Cir.), cert.
denied, 126 S.Ct. 423 (2005) (“One might argue that for cases
where a juror could conclude that the facts pleaded show
scienter, but that conclusion would not be the most plausible
of competing inferences, a Seventh Amendment problem is
presented.”). Unlike the Petitioners’ test, the Seventh Cir-
cuit’s interpretation of the Reform Act avoids a conflict with

the right to trial by jury, and for this reason the court’s ruling
should be affirmed.

D. If The Seventh Circuit’s Ruling Is Reversed,
An Increasing Number Of Investors Will Suf‘er
Irretrievable Losses At The Hands Of Those
Committing Fraud

While the Seventh Circuit’s ruling imposes manageable
burdens on investors who have legitimate claims for securi-
ties fraud, the Petitioners’ formula for pleading scienter under
the Reform Act heaps additional, unreasonable requirements
on those same investors. Under that formula, meritorious
claims involving fraud on the market will be barred in
instances where a class of plaintiffs, at the pleading stage and
without the benefit of discovery, cannot yet perform the
daunting task of disproving all innocent explanations for the
defendants’ fraudulent conduct. As a result, plaintiffs will be
unjustly deprived of the right to recover damages for fraud
and abuse that unquestionably caused them injury. Because
the Petitioners’ interpretation of the pleading requirements for
scienter under the Reform Act will so undermine the purposes
of the securities laws, and because it is neither compelled nor
warranted by the applicable statutory language, it should be

19

rejected. The Seventh Circuit’s ruling avoids this unfairness
to investors, without betraying the obligation to fulfill
Congress’s policy objectives under the Reform Act, and it
should therefore be affirmed.

CONCLUSION

For the reasons set forth above, the decision of the Seventh
Circuit should be affirmed.

Respectfully submitted,

ALFRED E. T. RUSCH *
Senior Counsel
District of Columbia Securities Bureau
REX A. STAPLES
General Counsel
STEPHEN W. HALL.
Deputy General Counsel
JOSEPH V. BRADY
Associate General Counsel
LESLEY M. WALKER
Associate Counsel
NORTH AMERICAN SECURITIES
ADMINISTRATORS ASSOCIATION, INC.
750 First Street, N.E., Suite 1140
Washington, D.C. 20002
* Counsel of Record (202) 737-0900

March 9, 2007

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Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/brief%3Amicro_IA40385016_0301%3A23. Public record. Not legal advice.