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

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No. 06-484 ae HY7

TEE LEK

IN THE

Supreme Court of the Anited States

TELLABS, INCORPORATED AND RICHARD NOTEBAERT.,

Petitioners.

Vv.

MAKOR ISSUES & RIGHTS. LTD.. ef a/..

Respondents.

On Writ of Certiorari to the

United States Court of Appeals

for the Seventh Circuit

BRIEF FOR THE REGENTS OF THE UNIVERSITY

OF CALIFORNIA, THE CALIFORNIA PUBLIC

EMPLOYEES RETIREMENT SYSTEM, AND

PROFESSORS JAMES D. COX, RICHARD M.

BUXBAUM, JILL E. FISCH, C. HUGH FRIEDMAN,

FRANK PARTNOY, MARC I. STEINBERG, AND

MELVIN E. EISENBERG AS AMICI CURIAE

IN SUPPORT OF RESPONDENTS

WIHELIAM S. LERACH SANFORD SVETCOV

PATRICK J. COUGHLIN (Counsel of Record)

Hit eN HODGES SUSAN K. ALEXANDER

JOSEPIED. DALEY LERACH COUGHLIN STOLA

BYRON S, GEORGION GELLER RUDMAN &

LERACH COUGHLIN STOLA ROBBINS LLP

GILLER RUDMAY & 100 Pine Street, Suite 2600

ROBBINS LLP San Francisco, CA 9411]

655 West Broadway. Suite 1900 (415) 288-4545

San Diego, CA 92101

(619) 231-1058

Counsel for Amici Curiae

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SES a I EE EE TE LI DE IE IE EE ELE CIEL EIT

Wii. SON-EPES PRINTING CO. INC. — (202) 789-0096 —- WASHINGTON, D C 20002

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QUESTION PRESENTED

~~“ Whether the Private Securities Litigation Reform Act’s

requirement that to plead a claim of securities fraud plaintiff

must state with particularity facts raising a “strong inference”

that defendant acted with scienter changed long-established

Rule 12(b)(6) jurisprudence that, in considering a motion to

dismiss, the court must not only accept all well-pled facts, but

must draw all reasonable inferences in plaintiff's favor to

determine whether rational jurors could find from the collec-

tive allegations that the defendant acted with the required

state of mind.

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TABLE OF CONTENTS

QUESTION PRESENT ED.....0.00sccccoccscsscsccssescescnevssensess

DARE Ge TTP OIIe BMI sce ccccccccseccesccccsccresssosensecneess

I.

II.

In Making a Rule 12(b)(6) Motion, a Defen-

dant Necessarily Admits All Well-Pled Facts

an< Reasonable Inferences Drawn in Plain-

tiffs Favor, and Asserts Nonetheless that No

TESTE Se ICTY PONTE

A. The PSLRA Does Not Address the Rule

12(b)(6) Practice that Inferences Are

Drawn in Plaintiffs Favor, Which Under

Jones v. Bock Can Only Be Changed by

I TG FRI wicehtsccictecticsnscaninmnentsoninis

B. Under Liberty Lobby, The PSLRA “Strong

Inference” Test for Pleading Scienter Does

Not Change the Premise of Rule 12(b)(6)

that Plaintiff Is Entitled to All Reasonable

SUTIN ussisctinscciciessitacdiidatieeiiaanieceniaillananbiadelalnies

C. A “Strong Inference” Is Defined by the

Second Circuit to Mean Sufficient Facts

Pleaded from Which a Jury Could Find

“Morc-Likely-Than-Not” that Defendant

ACIBG WH SCRGMIOE ...00000cesccessscoscecesccessessoces

Contrary to Petitioners’ Tally, Only the Sixth

and Ninth Circuits Weigh Inferences Adverse

to Plaintiffs; All Other Circuits Correctly

Give Plaintiffs the Bencfit of All Reasonable

Inferences—as with Every Other Element of

1]

14

16

18

iv

TABLE OF CONTENTS—-Continued

Page

Ill. Contrary to the SEC’s Contentions, the PSLRA

_Does Not Require Courts to Consider Com-

peting Inferences or Explanations; Doing So

Would Violate the Right to Jury Trial ................ 22

A. The Strong Inference Standard Does Not

License Trial by Complaint...................008. 24

B. Applying Liberty Lobby by Drawing All

Reasonable Inferences in Plaintiffs’ Favor

Avoids Intrusion on the Right to Jury Trial .. 26

IV. This Court Should Reaffirm the Majority Rule

that Plaintiff Is Entitled to All Reasonable

Inferences Tested as a Totality Against the

“Strong Inference” Standard; Allowing Infer-

ences Adverse to Plaintiff Violates Rule

12(b)(6), and Would Seriously Impair Investor

Recovery for Corporate Fraud ..............c:cccceee 28

I IITY snincrcivinedissisosvsidsenitnibesiemindmninentianatinn 30

Vv

TABLE OF AUTHORITIES. __

CASES Page

ABC Arbitrage Plaintiffs Group v. Tchuruk, 291

Fe OD GOED aes BITE scxsonsntnnseeniasitenpsinsinindio 6, 29

Abrams v. Baker-Hughes, Inc., 292 F.3d 424 (Sth

Gi: TUE scesniniivnctiischdseddbeensieniimniiniaiaipnisibeentilaiaihiad 17

Adams v. Kinder-Morgan, Inc., 340 F.3d 1083

GORE Gadth HUI ccnctieceincosnmmaniinaeancnntiiiaagiedin 11, 15, 29

Aldridge v. A.T. Cross Corp., 284 F.3d 72 (lst

Eset: AINE bvsinsajanirinetnigesnttnepctacndbdetnibaabiegieiniiiadaiailade 8, 21

American Federation v. American Intern., 462

Fe Ce CHI es Pe icvencetiicvioninitesinineseiniaiaes 24

Anderson v. Liberty Lobby, Inc., 477 U.S. 242

SE acenamnneigsieibaiteksdlaiiianiadnaiéisainiaiasiemsiniebdioubbenalalite passim

Bourjaily v. United States, 483 U.S. 171 (1987)... 17-18

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

COE A, EE ccnccsestiinsinesinptinieniienmemmmmaniieids 25

City of Monroe Employees v. Bridgestone, 399

ee re Ce Ge Be ccesinsinnccndnissnnicninienitotciiie 17,19

Cohen v. Koenig, 25 F.3d 1168 (2d Cir. 1994) ...8, 17, 24

Conley v. Gibson, 355 U.S. 41 (1957)..........c:cc000 9,10

Cosmas v. Hassett, 886 F.2d 8 (2d Cir. 1989)....... 17

Desert Palace, Inc. v. Costa, 539 U.S. 90 (2003) ... 10

Eastman Kodak Co. v. Image Technical Services,

Inc., 504 U.S. 451 (1992) oe thicniienewsduhiiniies 26

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

Fla. State Bd. of Admin. v. Green Tree Fin.

Corp., 270 F.3d 645 (8th Cir. 2001).........0..... 7, 15, 21

Galloway v. United States, 319 U.S. 372 (1943)... 28

Garfield v. NDC Health Corp., 466 F.3d 1255

EERE GEE, DIUD ccritecsciscinisconstisiabiaiccmnabiatiateile 21

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

FID ccnssirsssestnicensennintingiasinsemmianamabiiisasiiaaia 18-20

vi

TABLE OF AUTHORITIES—Continued

Page

Herman & MacLean v. Huddleston, 459 U.S.

et laaiediciiaeaidn delineate 8, 10, 16, 29-30

Hill v. McDonough, 547 U.S. _, 1268S. Ct. 2096

iat itarierdiniiniareeminenenmreninntointnensane 12

Hishon v. King & Spaulding, 467 U.S. 69 (1984)... 15

Illinois v. Gates, 462 U.S. 213 (1983) 0... 26

In re Cabletron Systems Inc., 311 F.3d 11 (ist

Ss AT dtitndeieainitanccinideceengmtsetanioememgeceinneson passim

In re Cavanaugh, 306 F.3d 726 (9th Cir. 2002)... 13

In re Cendant Corp. Lit., 264 F.3d 201 (3d Cir.

EA EE ecco 13

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

EE TC Re eae Sa 20-21

In re K-Tel Intern, Inc. Sec. Litig., 300 F.3d 881

EE ER ena 21

In re PEC Solutions, Inc. Sec. Lit., 418 F.3d 379

A eee ae 22

In re Rockefeller Center Properties, Inc. Sec.

Litig., 311 F.3d 198 (3d Cir. 2002)............00.... 8, 17,21

In re Stone & Webster Sec. Lit., 414 F.3d 187

EEE ES TE a a 20

Int'l Brotherhood of Teamsters v. Daniel, 439

EEE IEE a ERE 24

Jones v. Bock, _ US. _, 127 S. Ct. 910

ATES AE Oe 5, 11-12, 24

Lampf v. Gilbertson, 501 U.S. 350 (1991) ............ 7

Leatherman v. Tarrant County, 507 U.S. 163

ECCLES a 10, 12

Lee v. City of Los Angeles, 250 F.3d 668 (9th Cir.

RES SSSR SA A Ce a 25

Matsushita Elec. Indus. Co., Lid. v. Zenith Radio

ig re Ch, FIO CRI cccccccccccccccccscccsssseeses 25-26

Miles v. Apex Marine Corp., 498 U.S. 19 (1990)... 11, 17

Vii

TABLE OF AUTHORITIES—-Continued

Page

Nathenson v. Zonagen, Inc., 267 F.3d 400 (Sth

See See arenenitisnstpeneintvcnsninedaninnnintnibemeniqnmenniies 21

Neitzke v. Williams, 490 U.S. 319 (1989).............. 10

Newby v. Enron Corp. (In re Enron Corp. Sec.

Litig.), 206 F.R.D. 427 (S.D. Tex. 2002)........... l

Novak v. Kasaks, 216 F.3d 300 (2d Cir. 2000).. 13-14, 24

Ottmann v. Hanger Orthopedic Group, Inc., 353

Fl ns SE ncnnnnatecsietninemnionninmetes 22

Papasan v. Allain, 478 U.S. 265 (1986)................ 10, 14

Parklane Hosiery Co. v. Shore, 439 U.S. 322

Ee sdancibansdiiatintiniatnsuioantentuinitiiantnein 27

Pawling v. United States, 8 U.S. [4 Cranch] 219,

EE UTI cessirsiidastecinisinentataientasidensensteaabi 5, 9-10, 27

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

Fee innctcsaadumstaunenmnsantineiiitiiaaiatiiaiiitie 8, 15, 18, 21-22

Reeves v. Sanderson Plumbing Products, Inc.,

Fe ely SE ceiiccntesincnitinaiednantionnceia 6, 15-16, 28

Rombach v. Chang, 355 F.3d 164 (2d Cir.

Te ei cciecnstisiabitaiccaiatiininieaiiamptiinaiaadiatiniaanidiintail 12, 23, 24

Ronconi v. Larkin, 253 F.3d 423 (9th Cir. 2001) .. 7

Scheuer v. Rhodes, 416 U.S. 232 (1974)............... 5,9

Shields v. Citytrust Bankcorp., 25 F.3d 1124 (2d

eh Be itiireddncnciicsininanseseess ctaianiisiiaiisiainianhbaaaiinai 12, 23

Suez Equity Investors L.P. v. Toronto-Dominion

Bank, 250 F.3d 87 (2d Cir. 2001) ...............00- 21

Swierkiewicz v. Sorema N.A., 534 U.S. 506

STII iccnionncienonistesiegibennidtiampsepiniuedneppnatieatebiiiansanton 10, 12

United States v. Malouf, 466 F.3d 21 (ist Cir.

ieee citrentnsieneninaniteniensiindssiiquaianeitanncitineiainiadeiien 21

STATUTES, RULES AND REGULATIONS

1S U.S.C.

viii

TABLE OF AUTHORITIES—Continued

Page

UTI wsissishiebcsnsiniietaiananidaiaenineiaiinaiapeenmnsiiaeei passim

UII saheniesitepeeintncsenenebisincnieneepianentesnentmmseiaeinbiiieses 25

Federal Rules Civil Procedure

UT Ui iicissiiniidiuietiididinseaiipieateanindinindiininaenastmeasanaeins 10

Se Se ccicenisensiinnnntniepemsensnnsnmnenmiatanpiiant passim

SECONDARY AUTHORITIES

H.R. Conf. Rep. 104-369, at 31 (1995), reprinted

RS i oe Re 8, 13, 30

James D. Cox & Randall S. Thomas, “Does the

Plaintiff Matter?” 106 Colum. L. Rev. 1587,

Pe Ctl iisieinscinscisensenesienstinntatpisenenuimidiiducamniiicnitncies 13

S. Rep. No. 104-98, at 15 (1995), reprinted in

1995 U.S.C.C.A.N. 679, 694 .00.....cccccesscesseceseees 11

The Economist, Classier actions (Feb. 15, 2007) .4, 7, 13

Wright & Miller, Fed. Prac. & Proc. Civil 3d,

ee I Gi eintiininsittiaraiitctinsimsiibanbinnies )

INTEREST OF AMICI CURIAE '

The Regents of the University of California (“The Re-

gents”), and the California Public Employees Retirement

System (“CalPERS”), are institutional investors in publicly

traded securities that have a strong interest in ensuring the

integrity and transparency of U.S. securities markets. Their

experience as lead plaintiff in securities class actions will

assist the Court in evaluating the policy implications of its

decision. Professors James D. Cox, Richard M. Buxbaum,

Jill E. Fisch, C. Hugh Friedman, Frank Partnoy, Marc I.

Steinberg, and Melvin E. Eisenberg, are corporate, securities

and civil procedure law specialists with strong interests in

ensuring that U.S. securities laws and procedures are consist-

ently and fairly applied to protect investors from fraudulent

practices. A brief description of each of the amici follows:

1. Article [X, section 9 of the California Constitution

grants The Regents “full powers of organization and gov-

ernment” over the University of California. As fiduciary for

the University’s pension and endowment funds for nearly

500,000 active and retired participants, The Regents’ assets of

$66 billion include substantial investments in publicly traded

securities. In 2002, The Regents were appointed lead plain-

tiff in the class suit involving Enron Corporation. Newby vy.

Enron Corp. (In re Enron Corp. Sec. Litig.), 206 F.R.D. 427

(S.D. Tex. 2002).

2. CalPERS is the largest public pension plan in the

United States. It provides retirement and health benefits to

1.5 million public employees, retirees and their families.

' This brief was not authored, in whole or in part, by counsel for either

party, and no person or entity other than amici, their members and their

counsel contributed monctarily to the submission of the bricf. The par-

ties’ gencral letters of consent to the filing of amicus briefs have been

filed with the clerk. Prior to May 2004, certain partners in the firm

representing amici were partners in the firm representing respondents

when this action was initiated, but neither they nor their firm have any

economic interest in the outcome of this litigation.

2

CalPERS is the fiduciary for the California state employee

pension fund, with some $223 billion in assets, including

substantial investment in publicly traded U.S. securities.

CalPERS has served as lead plaintiff representing classes of

investors in several cases, as follows: /n re Cendant Corp.

Sec. Litig., No. 98 Civ. 1664-WHW (D.N.J.); California

Public Employees’ Retirement System v. Chubb Corp., No. 00

Civ. 4285-GEB (D.N.J.); In re NYSE Specialist Sec. Litig.,

No. 03-Civ. 8264-RWS (S.D.N.Y.); California Public Em-

ployees’ Retirement System v. United Health Group, Inc., No.

06 Civ. 2939-JMR/FLN (D. Minn.).

3. Professor James D. Cox joined the faculty of the

School of Law at Duke University in 1979 where he special-

izes in corporate and securities law. Professor Cox earned his

law degree at the University of California, Hastings College

of the Law (J.D.) and Harvard Law School (LL. M.). In

addition to his texts Cox and Hazen on Corporations; and

Securities Regulations Cases and Materials (with Professors

Hillman & Langevoort), Professor Cox has published exten-

sively in the areas of market regulation and corporate gover-

nance as well as having testified before Congress on insider

trading and market reform issues. He is a former member of

the New York Stock Exchange (“NYSE”) Legal Advisory

Committee and a member of the National Association of

Securities Dealers (“NASD”) Legal Advisory Board.

4. Professor Richard M. Buxbaum received his law

degrees from Cornell Law School (LL.B. 1952) and the

University of California, Boalt Hall Schoo! of Law (LL.M.

1953). After practicing law for eight years, he joined the

Boalt faculty in 1961. He publishes and teaches in the fields

of corporate law and international economic law. Professor

Buxbaum has served on various state and national committees

engaged in the drafting of securities legislation.

5. Professor Jill E. Fisch is a Visiting Professor at the

University of Pennsylvania Law School and T.J. Maloney

3

Professor of Business Law at Fordham University. In 1989,

after obtaining her J.D. from Yale Law School, and three

years with the Justice Department and the Cleary Gottlieb

firm, respectively, Professor Fisch joined the Fordham faculty

where she serves as Director of the Fordham Center for Cor-

porate, Securities and Financial Law. Professor Fisch teaches

corporations, securities regulation and federal courts. She is

chair-clect of the Section on Securities Regulation of the

Association of American Law Schools. Professor Fisch’s

scholarship includes work on corporate law, securities regula-

tion, and federal courts, that have appeared in a variety of

publications including the Harvard, Columbia and Cornell

Law Reviews, and the Yale Law Journal. (E.g., Lawyers on

the Auction Block: Evaluating the Selection of Class Counsel

by Auction, 102 Colum. L. Rev. 650 (2002).

6. Professor C. Hugh Fricdman received his law degree

in 1956 from Stanford University and is a Senior Professor of

Corporation and Securities Law at the University of San

Diego School of Law, where he has practiced, taught and

written about corporation and securities law for 40 years.

Among his publications is the widely used two-volume

California Practice Guide: Corporations (The Rutter Group).

He chaired the California Securities Regulation Regulatory

Reform Commission.

7. Professor Frank Partnoy has been Professor of Law at

the University of San Diego School of Law since 1997. He

received his J.D. in 1992 from Yale University. Professor

Partnoy teaches and writes in the areas of corporate law and

financial market regulation. His publications include

Infectious Greed: How Deceit and Risk Corrupted the

Financial Markets (Henry Hoit), and more than 20 articles on

various topics related to financial market regulation.

8. Marc I. Steinberg is the Rupert and Lillian Radford

Professor of Law at the Southern Methodist University

Dedman School of Law, and has been teaching full-time since

4

1982. Professor Steinberg teaches courses in Securities

Regulation, Securities Litigation, and Business Enterprises.

From 1978 to 1982, he was an attorney with the U.S. Secur-

ities and Exchange Commission (“SEC”). He has authored

approximately 125 law journal articles and several books,

including Securities Regulation, a law school textbook.

9. Melvin A. Eisenberg is Koret Professor of Law at the

University of California, Boalt Hall School of Law. He re-

ceived his law degree from Harvard in 1959. After practicing

with the Kaye Scholer firm in New York, and serving as

assistant counsel to the Warren Commission, he joined the

Boalt Faculty in 1966. Professor Eisenberg is the author of

The Structure of the Corporation (1997) and has published

casebooks on the subjects of contracts and corporations. He

was chief reporter for the Amcrican Law Institute’s Principles

of Corporate Governance.

The issue in this case concerns the interpretation of the

Private Securities Litigation Reform Act (“PSLRA”) “strong

inference” pleading standard. If that standard is interpreted to

change the usual practice under Federal Rule of Civil Proce-

dure 12(b)(6) that courts draw all reasonable inferences from

the complaint in plaintiff's favor, to allow the weighing of

competing inferences and explanations, it could seriously im-

pair the ability of hundreds of thousands of middle class

employees, retirees, and their families, whom the institutional

amici represent, to recover devastating losses caused by fraud.

Meritorious private actions, including those brought by insti-

tutions, are an essential component of the enforcement of the

securities laws. Indeed, the PSLRA was designed to encour-

age institutional investors to serve as lead plaintiffs in securi-

ties class actions as an important means of ensuring meri-

torious suits and eliminating non-meritorious ones. Recent

studies confirm that the increased role of institutional investors

as lead plaintiffs has resulted in fewer and better securities

suits. The Economist, Classier actions (Feb. 15, 2007).

5

SUMMARY OF ARGUMENT

In making a Rule 12(b)(6) motion to dismiss, defendants

necessarily admit all well-pled allegations and all inferences

a jury can reasonably draw in plaintiff's favor, and assert

nonetheless that no claim for relief is stated. These basic

assumptions are 200 years old. As Chief Justice Marshall

explained: “The party demurring admits the truth of the testi-

mony to which he demurs and also those conclusions of fact

which a jury may fairly draw from the testimony.” Pawling

v. United States, 8 U.S. [4 Cranch] 219, 221-22 (1808). Thus,

a Rule 12(b)(6) motion tests plaintiff's best case to determine

whether——as a matter of law—he states a claim. Scheuer v.

Rhodes, 416 U.S. 232, 236 (1974). The court does not sit as a

fact finder to weigh defendants’ explanations.

Neither petitioners nor any of their amici save one even

mention Rule 12(b)(6). They doubtless prefer that this Court

disregard it. Instead, they rely entirely on the PSLRA. But,

in enacting the PSLRA, Congress did not address, let alone

‘amend the essential premises of Rule 12(b)(6). Congress

simply provided that to state a claim for securities fraud, the

“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 PSLRA did

not empower courts to draw inferences adverse to plaintiff

or weigh competing explanations. Any such change in the

“usual practice under the Federal Rules” must be obtained by

amending the Rules, “not by judicial interpretation.” Jones v.

Bock, _U.S. _, 1278S. Ct. 910, *25 (2007).

Further, this Court’s decision in Anderson v. Liberty Lobby,

Inc., 477 U.S. 242 (1986) explains why the PSLRA’s height-

ened “strong inference” standard is not inconsistent with the

inference-drawing assumptions of Rule 12(b)(6). On a dis-

positive motion, the court views the facts “through the prism

of the substantive evidentiary burden” (/d. at 254), but:

Credibility determinations, the weighing of evidence,

and the drawing of legitimate inferences from the facts

6

are jury functions, not those of a judge, whether he is

ruling on a motion for summary judgment or for a

directed verdict. The evidence of the nonmovant is to be

believed, and all justifiable inferences are to be drawn in

his favor.

Id. at 256; accord Reeves v. Sanderson Plumbing Products,

Inc., 530 U.S. 133, 150-52 (2000).

Liberty Lobby also makes clear that a judge’s determi-

nation of a dispositive motion “unavoidably asks whether

reasonable jurors could find by a preponderance of the evi-

dence” for the plaintiff. /d. at 252. In this case, the Seventh

Circuit correctly applied a test that is mandated by Liberty

Lobby. The Seventh Circuit held that the pleadings are to be

judged by whether “a reasonable person could infer that the

defendant acted with the required intent.” (App. 20a) Thus,

contrary to petitioners and their amici, the Seventh Circuit

did not ignore the PSLRA “strong inference” standard or

dilute it to a reasonable inference; it simply applied this

Court’s “reasonable jurors” approach from Liberty Lobby.

In light of its evident relevance here, it is startling that

neither petitioners nor the SEC even cite Liberty Lobby. Two

of petitioners’ amici (Washington Legal Foundation and

American Institute of Certified Public Accountants) do cite it,

but only for the proposition that an elevated standard may

apply to dispositive motions (WLF Br. 17, 20 n.9, AICPA Br.

18). These amici ignore Liberty Lobby's holding that plain-

tiffs are still entitled to “all justifiable inferences.”

The PSLRA “was not enacted to raise the pleading bur-

dens” to a level that “facially valid claims” must be “routinely

dismissed.” ABC Arbitrage Plaintiffs Group v. Tchuruk, 291

F.3d 336, 354 (Sth Cir. 2002). The PSLRA contains ample

safeguards to achieve its goal of curbing pleading abuse

without rewriting long-established Rule 12(b)(6) jurispru-

dence. In addition to the “strong inference” standard, the

statute requires that falsity and scienter be alleged with

“particularity,” and that plaintiff plead with particularity a

7

factual basis for information and belief allegations from

witness or document sources. 15 U.S.C. §78u-4(b)(1), (2).

Petitioners and their amici overlook that, since 1995, secu-

rities litigation has been taken over by respected institutional

investors, such as the amici on this brief, who meet the

lead plaintiff qualifications of the PSLRA. 15 U.S.C. 78u-

4(a)(3)(B). The parade of horribles petitioners portray ignores

the reality that there are fewer class actions today, and they

are better led and better pled. The Economist, Classier actions

(Feb. 15, 2007).

“Given the complexity of modern securities markets,”

pleading and proving the elements of a §10(b) claim “may be

difficult.” Lampf v. Gilbertson, 501 U.S. 350, 377 (1991)

(Kennedy, J. dissenting). Because private §10(b) actions are

“an essential component of the protection the law gives to

investors who have been injured by unlawful practices” (/d. at

374), raising the bar even higher than provided in the PSLRA

“will ‘thwart the legislative purpose of creating an effective

remedy’ for victims of securities fraud.” /d. at 377. “Unless

reasonable inferences from circumstances suffice to get a case

to a jury, the welfare of victimized investors and the integrity

of the stock market may be insufficiently protected from

deceptive manipulators.” Ronconi v. Larkin, 253 F.3d 423,

428 (9th Cir. 2001).

Though plaintiffs underlying inferences must be reason-

able, only the ultimate inference of scienter, based on the

“totality” of facts and justifiable inferences drawn, must

“collectively add up to a strong inference.” See, e.g., Fla.

State Bd. of Admin. v. Green Tree Fin. Corp., 270 F.3d 645,

660 (8th Cir. 2001); Jn re Cabletron Systems Inc., 311 F.3d

11, 42 (Ist Cir. 2002). In offering definitions of “strong

inference,” however, petitioners and their amici aggressively

push to clevate the standard even further suggesting that

plaintiff's allegations must be “compelling” and “leave little

room for doubt” and even “exclude the possibility of inno-

8

cence.” (Pet. Br. 25, 34) They ignore the Second Circuit

jurisprudence, which created the “strong inference” standard,

and defined it to mean sufficient facts pled from which a jury

could find “more likely than not” that defendant acted with

scienter. Cohen v. Koenig, 25 F.3d 1168, 1174 (2d Cir.

1994). That definition is consistent with this Court’s “pre-

ponderance of evidence” standard for securities cases. Herman

& MacLean v. Huddleston, 459 U.S. 375, 390 (1983).

Neither petitioners nor the SEC mention Huddleston either.

Further, contrary to petitioners’ count (Petition 4, 17), only

the Sixth and Ninth Circuits hold that the PSLRA permits

courts to weigh inferences adverse to plaintiffs. All other -

circuits, including the Seventh Circuit here (App. 7a, 20a-

21a), continue to recognize that under Rule 12(b)(6) plaintiffs

are entitled to all reasonable inferences, provided the facts are

alleged with particularity. See, e.g., In re Rockefeller Center

Properties, Inc. Sec. Litig:, 311 F.3d 198, 224 (3d Cir. 2002);

Pirraglia v. Novell, 339 F.3d 1182, 1188 (10th Cir. 2003).

More specifically, the First Circuit held it was error under

Rule 12(b)(6) to draw “inferences in the defendant’s favor.”

Aldridge v. A.T. Cross Corp., 284 F.3d 72, 79 (ist Cir. 2002).

In sum, petitioners’ theory that inferences adverse to plain-

tiff may be drawn should be rejected. It not only violates

Rule 12(b)(6), but would impair private securities litigation as

“an indispensable tool with which defrauded investors can

recover their losses without having to rely on government

action” which Congress retained in enacting the PSLRA.

H.R. Conf. Rep. 104-369, at *31 (1995), reprinted in 1995

U.S.C.C.A.N. 730; Huddleston, 459 U.S. at 390 (defrauded

investors are “the very individuals Congress sought to

protect”).

9

ARGUMENT

I. In Making a Rule 12(b)(6) Motion, a Defendant

Necessarily Admits All Well-Pled Facts and Rea-

sonable Inferences Drawn in Plaintiff's Favor, and

Asserts Nonctheless that No Claim Is Stated

The jurisprudential basis of a Rule 12(b)(6) motion to

dismiss a complaint for failure to state a claim does not

permit the drawing of adverse inferences. By filing such a

motion, defendants convey to the court the message that: even

if it accepts all well-pled facts as true, and draws all reason-

able inferences “in the light most favorable to the plaintiff,”

as a matter of law, plaintiffs are not entitled to relief. See

Wright & Miller, Fed. Prac. & Proc. Civil 3d, Vol. 5B,

§1357 at 417. There is no room in that process for weighing

against plaintiff potential conflicting inferences or explana-

tions asserted by defendants. The court considers plaintiff's

best case—not defendant’s most plausible defense. Such

weighing of disputed inferences is for the jury.

Since the adoption of Rule 12 in 1937, all federal courts

have uniformly adhered to the rule that on a motion to dis-

miss, all facts and reasonable inferences are construed in

plaintiff's favor. In Conley v. Gibson, 355 U.S. 41 (1957),

this Court reaffirmed that “a complaint should not be dis-

missed 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.” /d. at 45-46. In

passing on a motion to dismiss for failure to state a claim,

“the allegations of the complaint should be construed favor-

ably to the pleader.” Scheuer, 416 U.S. at 236.

These principles can be traced back nearly 200 years. In

1808, Chicf Justice Marshall stated: “The party demurring

admits the truth of the testimony to which he demurs and also

those conclusions of fact which a jury may fairly draw from

that testimony. Forced and violent inferences he does not

admit; but the testimony is to be taken most strongly against

him, and such conclusions as a jury might justifiably draw

10

the court ought to draw.” Pawling, 8 U.S. [4 Cranch] at 221-

22 (emphasis added).

This Court has acknowledged the importance of inference-

drawing in a securities fraud action: “proof of scienter re-

quired in fraud cases is often a matter of inference from

circumstantial evidence.” Huddleston, 459 U.S. at 387-90 &

n.30 (holding that plaintiff must prove fraud only by a pre-

ponderance of the evidence). “‘Circumstantial evidence is

not only sufficient but may also be more certain, satisfying

and persuasive than direct evidence.’”” Desert Palace, Inc. v.

Costa, 539 U.S. 90, 100 (2003) (citation omitted).

To guard against pleading abuses, however, this Court made

it clear that courts “are not bound to accept as true a legal

conclusion couched as a factual allegation.” Papasan v.

Allain, 478 U.S. 265, 286 (1986). The Securities Industry

group, the only amici to even mention Rule 12(b)(6), assert

that “courts need not accept the truthfulness of allegations

that are merely conclusions, characterizations, or inferences.”

(Sec. Ind. Br. 20 & n.3) But their assertion omits the crucial

word “unwarranted” from all of the cases they cite. The

omission is significant. All courts hold that judges must

accept reasonable inferences warranted by well-pled facts.

Indeed, as this Court made clear, “What Rule 12(b)(6) does

not countenance are dismissals based on a judge’s disbelief

of a complaint’s factual allegations.” Neitzke v. Williams,

490 U.S. 319, 327 (1989). Well-pled factual allegations

must be accepted “as true” and construed in plaintiff's favor.

Leatherman v. Tarrant County, 507 U.S. 163, 164 (1993);

Swierkiewicz v. Sorema N.A., 534 U.S. 506, 508 n.1 (2002).

Petitioners and the SEC incorrectly treat Fed. R. Civ. P. 8

as the source of the inference-drawing rule, but in doing so

fail to cite Rule 12(b)(6). (Pet. Br. 15, 21; SEC Br. 11-12)

They cite Conley only for this Court’s holding that under

Rule 8 a plaintiff is not required to “detail the facts upon

which he bases a claim” (355 U.S. at 47), but they ignore the

separate holding of Conley that the adequacy of the complaint

1]

on a Rule 12(b)(6) motion is judged by the best case plaintiff

can plead. /d. at 45-46.

A. The PSLRA Does Not Address the Rule

12(b)(6) Practice that Inferences Are Drawn in

Plaintiff's Favor, Which Under Jones v. Bock

Can Only Be Changed by Amending the Rules

Petitioners’ assertion that courts may consider inferences

adverse to plaintiffs is not justified by any language in the

PSLRA. The statute simply provides that in pleading fraud,

plaintiffs “complaint” 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). But as

Liberty Lobby explained, a higher “strong inference” standard

does not alter the civil rules. This Court assumes that Con-

gress is “aware of existing law when it passes legislation.”

Miles v. Apex Marine Corp., 498 U.S. 19, 32 (1990).

Because the PSLRA says nothing about amending Rule

12(b)(6), it did not disturb bedrock jurisprudence requiring

that reasonable inferences arising from complaint allegations

be drawn in plaintiff's favor, and does not empower courts to

draw inferences adverse to plaintiffs.

The plain language of the statute provides that “the com-

plaint shall . . . state with particularity facts giving rise to a

strong inference” of scienter. The statute and its legislative

history says nothing about drawing or weighing adverse

inferences. 15 U.S.C. §78u-4(b). Further, the Senate Com-

mittee stated that in adopting the “strong inference” standard:

“The Committee does not adopt a new and untested pleading

standard that would generate additional litigation.” S. Rep.

No. 104-98, at 15 (1995), reprinted in 1995 U.S.C.C.A.N.

679, 694. “The PSLRA did not. . . purport to move up the

trial to the pleadings stage.” Adams v. Kinder-Morgan, Inc.,

340 F.3d 1083, 1101 (10th Cir. 2003). To accept the peti-

tioners’ theory would supplant the function of a trial.

12

Prior to the PSLRA, the “strong inference” standard had

long been in use in the Second Circuit. Shields v. Citytrust

Bankcorp., 25 F.3d 1124, 1128 (2d Cir. 1994). That circuit,

both before and since the PSLRA, adhered to the jurispruden-

tial premise of Rule 12(b)(6) that “all reasonable inferences

[are drawn] in plaintiff's favor” to assess whether the best

case that he can plead meets the strong inference standard.

Rombach v. Chang, 355 F.3d 164, 169 (2d Cir. 2004).

In January 2007, this Court unanimously held that “courts

should generally not depart from the usual practice under the

Federal Rules,” except “by the process of amending the

Federal Rules, and not by judicial interpretation.” Jones, 127

S. Ct. 910 at *25; quoting Leatherman, 507 U.S. at 168;

accord Swierkiewicz, 534 U.S. at 515; Hill v. McDonough,

547 U.S. _, 126 S. Ct. 2096, 2103 (2006). Although, unlike

the statute in Jones, the PSLRA does require plaintiff to plead

a “strong inference” with particularity, the PSLRA nowhere

provides that courts can consider and weigh adverse infer-

ences or competing explanations in determining a Rule

12(b)(6) motion. Under Jones, imposing such a “different

and more onerous” inference-drawing regime “to deal with

particular categories of cases should be done through estab-

lished rule making procedures, and not on a case-by-case

basis by the courts.” Jones, 127 S. Ct. at *45-*46.

Petitioners and their amici, including the SEC, dwell on

alleged pleading abuses as if they still exist. They totally

ignore that as a result of the enactment of the PSLRA,

securities class actions are better led and better pled due to

the increasing role of large public pension fund fiduciaries—

including amici on this brief—acting as institutional “lead

plaintiffs.” Such institutional plaintiffs provide responsible

vigorous supervision of the litigation, precisely as Congress

intended in enacting the lead plaintiff provision of the

PSLRA. 15 U.S.C. §78u-4(a)(3)(B)(iii)(D(bb). By creating a

presumption that the “most adequate” candidate for lead

plaintiff is the person or group that “has the largest financial

13

interest in the relief sought by the class,” Congress intended

to attract institutional investors to that role and specifically

said as much in the legislative history. “The Conference

Committee believes that increasing the role of institutional -

investors—{including public “pension funds” representing

“small investors”|-~—in class actions will ultimately benefit

shareholders and assist courts by improving the quality of

representation in securities class actions.” H.R. Conf. Rep.

104-369 (1995), at *34, reprinted in 1995 U.S.C.C.A.N. 730,

733; see In re Cendant Corp. Lit., 264 F.3d 201, 261, 264 (3d

Cir. 2001); accord In re Cavanaugh, 306 F.3d 726, 738 (9th

Cir. 2002).

Thus, it is both obsolete and wrong for petitioners, their

industry amici, and also the SEC, to seek further judicially-

created restrictions on private securitics actions. Pension

funds like amici here are experienced fiduciaries, governed

by respected boards and advised by independent fund coun-

sel, not simply by securities litigation counsel. They are not

“lawyer-driven” or “professional plaintiffs” filing sham suits.

Today, “shareholder class actions are fewer in number,” but

“better led” by pension funds and other institutional investors.

The Economist, Classier actions (Feb. 15, 2007). There is

empirical support for this. See James D. Cox & Randall S.

Thomas, “Does the Plaintiff Matter?” 106 Colum. L. Rev.

1587, 1631 (2006). Institutional lead plaintiffs tmcrease

recoveries by statistically significant amounts.

In addition to the role of institutional plaintiffs, the PSLRA

contains ample procedural safeguards to prevent sham con-

clusory pleading and the statute has been successful in doing

so. The statute’s “strong inference” and “particularity” re-

quirements provide the principal protections. 15 U.S.C.

§78u-4(b)(2). Further protection is provided by the PSLRA

requirement that plaintiff plead a specific factual basis for

allegations made on information and belief from witness

and document sources. 15 U.S.C. §78u-4(b)(1); Cabletron,

311 F.3d at 28-33 (1st Cir. 2002); Novak v. Kasaks, 216 F.3d

14

300, 314 (2d Cir. 2000). Another is the court’s ability to

reject inferences in plaintiff's favor when they are unrea-

sonable or unwarranted by the facts alleged. Papasan, 478

U.S. at 286. In light of these protections, the long-established

analysis under Rule 12(b)(6) that focuses on the sufficiency

of allegations and inferences construed in plaintiff's favor,

viewed colicctively, without competing explanations, does

not thwart Congress’ basic purpose in the PSLRA. Congress

wanted to limit abusive, vague suits—not careful, measured

actions of substance.

B. Under Liberty Lobby, The PSLRA “Strong

Inference” Test for Pleading Scienter Does Not

Change the Premise of Rule 12(b)(6) that

Plaintiff Is Entitled to All Reasonable

Inferences

This Court has held that in ruling on a dispositive motign

as to a claim with an elevated standard of proof, though the

court must view the facts “through the prism of the sub-

stantive evidentiary burden,” still “[t]he evidence of the

nonmovant is to be believed, and all justifiable inferences are

to be drawn in his favor.” Liberty Lobby, 477 U.S. at 254-56.

This Court explained that its “holding that the clear-and-

convincing standard of proof should be taken into account in

ruling on summary judgment motions does not denigrate the

role of the jury.” Jd. at 255. The Court reaffirmed that “the

weighing of the evidence, and the draw-ing of legitimate

inferences from the facts are jury functions.” /d.

Although Liberty Lobby arose on summary judgment, the

same reasoning applies with even greater force on a Rule

12(b)(6) motion because at that pretrial stage the court is

precluded from even considcring evidence—let alone resolv-

ing evidentiary disputes. The whole point of Rule 12(b)(6) is

to assess plaintiff's best case—without competing explana-

tions or possible adverse inferences—to determine whether

“relief could be granted under any set of facts that could be

15

proved consistent with the allegations.” Hishon v. King &

Spaulding, 467 U.S. 69, 73 (1984).

Petitioners and the SEC totally overlook Liberty Lobby.

They incorrectly assert that the Seventh Circuit erred in

applying a “could infer” approach that somehow “diluted” the

strong inference standard to mean only a reasonable infer-

ence. (SEC Br. 23) The SEC confuses “the relative strength

of the inference required” with “the nature of the person

drawing [it].”. (/d. 23 n.7) Whether a rational juror “could

infer” a strong inference of scienter from the totality of facts

and inferences pled, viewed in plaintiff's favor, is precisely

what Liberty Lobby and Rule 12(b)(6) require. As framed by

this Court, when addressing a dispositive motion, “[t}he

judge’s inquiry, therefore, unavoidably asks whether reason-

able jurors could find by a prepondcrance of the evidence” —

here the facts alleged——“that the plaintiff is entitled to a

- verdict.” Liberty Lobby, 477 U.S. at 252 (emphasis added).

In Reeves, 530 U.S. at 150, this Court applied Liberty

Lobby in the context of a motion for judgment as a matter of

law. This Court held that though a court reviews all of the

evidence presented at trial, it “must draw all reasonable

inferences in favor of the nonmoving party” and “must

disregard all evidence favorable to the moving party that the

jury is not required to believe.” Reeves, at 150-51 (emphasis

added). Reeves further held that the court impermissibly

substitutes its judgment for that of the jury when it fails “to

draw all inferences in favor of [nonmovant].” /d. at 152.

These principles plainly apply on a Rule 12(b)(6) motion.

When a court is “[f]aced with two seemingly equally strong

inferences” at the pleading stage, one favoring plaintiff and

one not, resolution is for the fact finder. Pirraglia, 339 F.3d

at 1188. “The strong-inference pleading standard does not

license us to resolve disputed facts at this stage of the case.”

Green Tree, 270 F.3d at 666. The PSLRA did not enact trial

by complaint. Adams, 340 F.3d at 1101.

16

Thus, the Seventh Circuit’s “could infer” approach is con-

sistent with Liberty Lobby, Reeves, Rule 12(b)(6), and the

PSLRA. It does not dilute the strong inference standard—it

correctly applied it. Nowhere in its opinion does the Seventh

Circuit equate a strong inference to one that is merely reason-

able. The court simply concluded that reasonable inferences

considered collectively, must add up to a strong inference.

“*We [Junderstand a “strong inference” of scienter to be a

conclusion logically based upon particular facts that would

convince a reasonable person that the defendant knew a

statement was false or misleading.’” (App. 21a).

C. A “Strong Inference” Is Defined by the Second

Circuit to Mean Sufficient Facts Pleaded from

Which a Jury Could Find “More-Likely-Than-

Not” that Defendant Acted with Scienter

Petitioners define a “strong inference as one that is “com-

pelling,” and “meaningfully tends to exclude the possibility

of innocence” and leaves “little room for doubt.” (Pet. Br.

25, 34.n.15) The SEC suggests a “high likelihood” standard.

(SEC Br. 20-21) Such definitions would import a clear-and-

convincing evidence or even a beyond-a-reasonable-doubt

hurdle as hinted at by petitioners’ “exclude . . . innocence”

and “little room for doubt” rubrics (Pet. Br. 34), that are

wrong under Huddleston. There, this Court rejected a clear-

and-convincing test in securities cases and set a “pre-

ponderance-of-the-evidence” standard that is untouched by

the PSLRA. Huddleston, 459 U.S. at 390. Nothing in the

PSLRA suggests that Congress intended to impose a pleading

standard that is so dramatically more demanding than the

burden of proof at trial. In Liberty Lobby, this Court held that

the standard at trial should also apply to a dispositive motion.

477 USS. at 254-55.

The petitioners and the SEC never mention that the Second

Circuit not only coined the term “strong inference,” but also

defined it. A strong inference of scienter is alleged when

17

“sufficient facts were pleaded to suggest that plaintiffs may

be able to prove that defendants more likely than not knew

their financial representations were false.” Cohen, 25 F.3d at

1174 (emphasis added). This definition, articulated in the

year before enactment of the PSLRA, was presumably known

to Congress when it adopted the strong inference standard.

Miles, 498 U.S. at 32.

The Second Circuit definition is consistent with the pre-

ponderance of evidence standard of Huddleston, and with this

Court’s explanation in Liberty Lobby that in ruling on a

dispositive motion “through the prism” of any heightened

standard, the judge “unavoidably asks whether reasonable

jurors could find by a preponderance of the evidence’ that

plaintiff is entitled to a verdict—here on the issue of scicnter.

Liberty Lobby, 477 U.S. at 252, 254 (emphasis added).

Further, the Second Circuit analysis required that only the

ultimate inference of scienter—drawn from the facts alleged

and inferences drawn viewed collectively—must be strong;

the underlying component inferences need simply be reason-

able ones. Cosmas v. Hassett, 886 F.2d 8, 11, 13 (2d Cir.

1989) (holding that underlying facts and reasonable infer-

ences collectively gave rise to a strong inference, reading the

complaint in plaintiff's favor). All circuits agree that the

court must consider the totality of well-pled allegations and

inferences drawn in plaintiff's favor. See, e.g., Abrams v.

Baker-Hughes, Inc., 292 F.3d 424, 430-31 (Sth Cir. 2002)

(“allegations should not be read in isolation, but taken to-

gether as a whole to sce if they raise the necessary strong

inference of scienter”); City of Monroe Employees v. Bridge-

stone, 399 F.3d 651, 683 (6th Cir. 2005) (the judges “employ

a totality of circumstances analysis whereby the facts argued

collectively must give rise to a strong inference.”); see Rocke-

feller, 311 F.3d at 224-25 (allegations are not vicwed as a

totality unless they are stated with particularity).

This Court has itself emphasized the importance of viewing

facts collectively and not in isolation. Bourjaily v. United

18

States, 483 U.S. 171, 179 (1987). As then Chief Justice

Rehnquist explained, “individual pieces of evidence, insuffi-

cient in themselves to prove a point, may in cumulation prove

it. The sum of an evidentiary presentation may well be

greater than its constituent parts.” /d. at 179-80.

In sum, evaluating motions to dismiss under the PSLRA is

no different than any other Rule 12(b)(6) motion. Whether

the complaint meets the “strong inference” standard can be

determined consistently with Rule 12(b)(6) without doing

violence to the Rule’s premise that plaintiff is entitled to all

justifiable inferences by analyzing the best case he can plead,

as a totality, against the heightened standard.

Il. Contrary to Petitioners’ Tally, Only the Sixth and

Ninth Circuits Weigh Inferences Adverse to Plain-

tiffs; All Other Circuits Correctly Give Plaintiffs

the Benefit of Ail Reasonable Inferences—as with

Every Other Element of Fraud

Contrary to petitioners’ assertion that four or more circuits

allow adverse inferences (Pet. 4), only two circuits, the Sixth

and Ninth, have held that the PSLRA’s “strong inference”

standard allows district courts to consider and weigh adverse

inferences in assessing scienter pleading. Helwig v. Vencor,

Inc., 251 F.3d 540, 553 (6th Cir. 2001) (en banc); Gompper v.

VISX, Inc., 298 F.3d 893, 896-97 (9th Cir. 2002). All other

circuits adhere to Rule 12(b)(6) and afford plaintiff the bene-

fit of all reasonable inferences. Indeed, for the elements of

fraud other than scienter, all circuits agree that reasonable

inferences from complaint allegations must be drawn in plain-

tiffs favor. Helwig, 251 F.3d at 553; Gompper, 298 F.3d at

895; Pirraglia, 339 F.3d at 1188.

With respect to scienter, the Sixth Circuit in He/wig held

that, under the PSLRA, in determining whether plaintiff's

complaint has sufficiently alleged a “strong inference” that

defendants acted with scienter (intent, knowledge, reckless-

ness), plaintiff's allegations “are entitled only to the most

19

plausible of competing inferences.” 251 F.3d at 553 (em-

phasis added). Petitioners’ theory is even more extreme than

the position of the Sixth Circuit. They boldly urge that

plaintiff's complaint must “exclude the possibility of inno-

cence.” (Pet. Br. 17) The Sixth Circuit in Helwig rejected

that approach: “Inferences must be reasonable and strong—

but not irrefutable.” 251 F.3d at 553; accord Cabletron, 311

F.3d at 38. “Plaintiffs need not foreclose all other characteri-

zations of fact, as the task of weighing contrary accounts is

reserved for the fact finder.” Helwig, 251 F.3d at 553.

Moreover, in He/wig and in subsequent cases, the Sixth

Circuit has been, to say the least, ambivalent. In He/wig, for

example, the majority stated: “Contrary to defendants’ con-

tention, the Reform Act did not reverse the polarity of securi-

ties pleading.” /d. The court added: “*When an allegation is

capable of more than one inference, it must be construed in

the plaintiffs favor.’” Jd. (citation omitted). Indeed, the

_Court said: “Our willingness to draw inferences in favor of

the plaintiff remains unchanged by the PSLRA.” /d. Ina

later case, the court backtracked even further: “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.” Bridgestone, 399 F.3d

at 683. The Seventh Circuit agreed. (App. 20a)

In Gompper, 298 F.3d at 896-97, the Ninth Circuit rejected

plaintiff's argument that where the facts alleged give rise to

reasonable inferences of scienter, the court must accept these

inferences without considering competing plausible infer-

ences suggested by defendants. /d. at 896-97. Believing

there was an “inevitable tension” between Rule 12(b)(6) and

the PSLRA, the court held that in determining whether plain-

uff has sufficiently alleged a “strong inference” of scienter,

“the court must consider all reasonable inferences to be

drawn from the allegations, including inferences unfavorable

to the plaintiffs.” Jd. at 897 (emphasis by the court).

20

In Gompper, the court reasoned that, if courts are required

to consider only inferences favorable to plaintiffs when there

are “equally or more plausible” adverse inferences, it would

“eviscerate the PSLRA’s strong inference requirement by

allowing plaintiffs to plead in a vacuum,” and “would allow

all plaintiffs who engage in careful measured pleading to

demonstrate a strong inference of scienter” that “would

thwart Congress’s basic purpose in raising the bar in the first

place.” Jd. at 896-97. The Ninth Circuit’s fears are mis-

placed. It overlooked the fact that to benefit from the

inferences in the first place, or to have them considered

collectively, the PSLRA requires that all of plaintiff's scienter

allegations be stated with “particularity” and to have a spe-

cific “factual basis.” 15 U.S.C. §78u-4(b). Thus, the particu-

larity requirement ensures that plaintiffs do not plead in a

vacuum. Moreover, contrary to the Ninth Circuit observa-

tion, “careful, measured pleading” is precisely what the

PSLRA demands and courts should expect.

All other circuits that have engaged in the PSLRA strong

inference analysis continue to give plaintiff the benefit of all

reasonable inferences as contemplated by Rule 12(b)(6). The

First Circuit explained that the PSLRA strong-inference

standard does not change the rule that “a court must draw all

reasonable inferences in plaintiff's favor” and then weigh

them together to determine if “they satisfy” the strong infer-

ence standard. /n re Stone & Webster Sec. Lit., 414 F.3d 187,

195 (lst Cir. 2005); accord Cabletron, 311 F.3d at 28, 38

(Despite the PSLRA “strong inference” standard, the court

“continues to give all reasonable inferences to plaintiffs” that,

as a “totality” must be strong “but need not be irrefutable”).

Contrary to petitioners’ assertion (Br. 34-37), the First —

Circuit did not change its approach in Jn re Credit Suisse

First Boston Corp., 431 F.3d 36 (1st Cir. 2005). There, the

court reaffirmed: “In considering a motion to dismiss, the

district court is bound to ‘assume the truth of all well-pleaded

facts and indulge all reasonable inferences that fit the

21

plaintiff's stated theory of liability.” Jd. at 45 (emphasis

added). Although Credit Suisse observed that there were

“legitimate explanations” that are “equally convincing” (/d. at

49), such weighing of conflicting explanations is contrary

to the First Circuit’s earlier holding that it is error to draw

“inferences in the defendants’ favor.” Aldridge, 284 F.3d at

79. Because the earlier panel decision states circuit law, and

can only be changed en banc, Aldridge is binding and cannot

be overruled by the Credit Suisse panel. See United States v.

Malouf, 466 F.3d 21, 26-27 (1st Cir. 2006).

The Eighth Circuit also expressly rejected Helwig 's “com-

peting inferences” theory. Jn re K-Tel Intern, Inc. Sec. Litig.,

300 F.3d 881, 889 n.6 (8th Cir. 2002). “The strong inference

pleading standard does not license us to resolve disputed facts

at this stage of the case.” Green Tree, 270 F.3d at 666. The

Second, Fifth and Eleventh Circuits likewise continue to draw

inferences in plaintiff's favor. Suez Equity Investors L.P. v.

Toronto-Dominion Bank, 250 F.3d 87, 100 (2d Cir. 2001);

Nathenson v. Zonagen, Inc., 267 F.3d 400, 424-25 (Sth Cir.

2001); Garfield v. NDC Health Corp., 466 F.3d 1255, 1261

(11th Cir. 2006). The Third Circuit agrees, but explained that

under the PSLRA the plaintiff gets the benefit of reasonable

inferences provided the facts in the complaint are alleged

with particularity. Rockefeller, 311 F.3d at 224.

Similarly, contrary to petitioners’ description, the Tenth

Circuit declined to draw adverse inferences, and instead took

what it termed a “more contextual approach” stating:

Whether an inference is a strong one cannot be decided

in a vacuum. In evaluating the strength of a plaintiff's

inference of scienter, we may recognize the possibility

of negative inferences that may be drawn against the

plaintiff. We do so, not in a preclusive manner, but in an

evaluative manner. That is to say, we consider the

inference suggested by the plaintiff while acknowl-

edging other possible inferences, to determine whether

22

plaintiff's suggested inference is “strong” in light of its

overall context. :

Pirraglia, 339 F.3d at 1187. Had the Tenth Circuit stopped

there, its approach would be at odds with the Rule 12(b)(6)

framework requiring consideration of plaintiff's best case.

But the Court in Pirraglia proceeded to make clear that:

[T]his process does not involve a ‘weighing’ of the

plaintiff's suggested inferences against other inferences.

Faced with two seemingly strong inferences, one favor-

ing plaintiff and one favoring defendant, it is inappropri-

ate for us to make a determination as to which inference

will ultimately prevail, lest we invade the traditional role

of the fact finder.

Id. at 1188. The Seventh Circuit agreed—correctly. (App. 21a)

Petitioners are also mistaken about the position of the

Fourth Circuit, which continues to draw “reasonable infer-

ences in [plaintiff's] favor.” /n re PEC Solutions, Inc. Sec.

Lit., 418 F.3d 379, 387 (4th Cir. 2005). That court takes a

“flexible case-specific” approach to pleading with particu-

larity facts giving rise to a strong inference. /d.; Ottmann v.

Hanger Orthopedic Group, Inc., 353 F.3d 383, 344-45 (Sth

Cir. 2003).

In sum, with the very limited exceptions of the Sixth and

Ninth Circuits, all the others continue to recognize the

essential premise of Rule 12(b)(6) and afford plaintiff the

benefit of all reasonable inferences in assessing scienter under

the PSLRA “strong inference” standard. Under Liberty

Lobby, the majority view is correct.

Ill. Contrary to the SEC’s Contentions, the PSLRA

Does Not Require Courts to Consider Competing

Inferences or Explanations; Doing So Would

Violate the Right to Jury Trial

Eviscerating entirely the core premise of Rule 12(b)(6), the

SEC asserts that in determining a “strong inference” under

the PSLRA, courts “must” consider “other possible [non-

culpable] explanations” or “any competing inference that can

23

be drawn.” (SEC Br. 24) The SEC’s position is wrong under

Liberty Lobby—a decision the SEC simply ignores.

As discussed earlier, in Liberty Lobby this Court explained

that in ruling on a dispositive motion, “the judge must view

the evidence through the prism of the substantive evidentiary

burden.” Liberty Lobby, 477 U.S. at 254. The court empha-

sized, however, that the higher standard does not license the

weighing of a competing story: “the weighing of evidence

and the drawing of legitimate inferences from the facts are

jury functions, not those of a judge .... The evidence of the

nonmovant is to be believed, and all justifiable infercnces are

to be drawn in his [nonmovant’s] favor.” /d. at 255.

The SEC’s theory is at odds with its view that the PSLRA

made the then-existing Second Circuit strong inference test

into a uniform national standard. (SEC Br. 8, 18) The SEC

overlooks that the Second Circuit has been faithful to Rule

12(b)(6) by drawing all reasonable inferences in plaintiffs

favor in determining whether a strong inference has been

alleged—and did so both before and since the enactment of

the PSLRA. Shields, 25 F.3d at 1128; Rombach, 355 F.3d

at 169.

The SEC is also wrong in asserting that when reasonable

inferences supporting scienter are matched by equally plaus-

ible non-culpable inferences, the ultimate inference of scien-

ter is not strong because there is a “substantial possibility”

that defendant acted without scienter. (SEC. Br. 25) When

summary judgment evidence—or complaint allegation—and

inferences drawn in nonmovant’s favor—‘may reasonably be

resolved in favor of either party,” the motion should be

denicd and the issue must be submitted to a fact finder for

trial. Liberty Lobby, 477 U.S. at 250.

The SEC amicus brief represents a sharp shift in its posi-

tion. The SEC has in numerous briefs previously stated that

the PSLRA adopted the Second Circuit’s strong inference test

as a national rule. See, e.g., SEC Br. in Novak v. Kasaks, No.

24

98-9641 (2d Cir. 1998) at 1-2. Novak is one of the SEC

briefs filed between 1997 and 2001, in which the SEC

consistently stated that the PSLRA adopted the Second

Circuit pleading standard. See also SEC Br. in Nathenson v.

Zonagen, No. 99-20449 (Sth Cir. 1999) at 10-15. That

standard was considered “the most stringent in the nation.”

Novak, 216 F.3d at 310-11. But even under that standard,

both before and since the PSLRA, the Second Circuit draws

all reasonable inferences in plaintiffs’ favor. Cohen, 25 F.3d

at 1174; Rombach, 355 F.3d at 169.

The SEC now seeks to distort the usual inference-drawing

practice under Rule 12(b)(6) by calling for a judicial amend-

ment rather than formal rulemaking, urging that courts “must

consider competing inferences and non-culpable explanations

for the defendant’s conduct”—at the pleading stage. (SEC

Br. 8-9, 20-21, 24-26) First, the SEC’s approach is contrary

to Jones v. Bock, which held Federal Rules practice can only

be changed by amending the rules. 127 S.Ct. 910 at “25.

Second, when the SEC changes position, this Court has not

accorded it deference. /nt’l Brotherhood of Teamsters vy.

Daniel, 439 U.S. 551, 566 n.20 (1979) (collecting cases); see

also American Federation v. American Intern., 462 F.3d 121,

129 (2d Cir. 2006). This Court should not defer to the SEC

here because to do so would be contrary to the SEC’s long-

standing position—to which it now only pays lip-service—

that “meritorious private actions are an essential supplement”

to government enforcement, presumably for the protection of

investors. (SEC Br. 1) But, “[{s]etting the pleading threshold

too high” by accepting the SEC position would “bar meri-

torious claims,” and make it virtually impossible to plead

securities fraud and violate Rule 12(b)(6).

A. The Strong Inference Standard Does Not

License Trial by Complaint

Petitioners go even further and contend the Court “should

consider and weigh” not only the allegations of the complaint,

25

but also “facts that support an inference of innocence”

including “other facts properly before [it].” (Pet. Br. 17)

A motion to dismiss is not the stage of proceedings to .

consider evidence, Ict alone asserted facts outside the com-

plaint. When evidence outside the complaint is offered, the

motion to dismiss must be converted into one for summary

judgment. Fed. R. Civ. P. 12(b). Although judicial notice of

“undisputed facts” is permitted in connection with a Rule

12(b)(6) motion, courts cannot accept the truth of “disputed

facts.” Lee v. City of Los Angeles, 250 F.3d 668, 688-90 (9th

Cir. 2001). Even for documents filed with the SEC, judicial

notice is limited to determining what “the . . . documents

contain, not to prove the truth of the documents contents.”

Bryant v. Avado Brands, Inc., 187 F.3d 1271, 1275-77 (11th

Cir. 1999). Congress recognized that filing a document with

the SEC does not mean it is “true” and, indeed, may be “false

or misleading.” 15 U.S.C. §782z.

Petitioners cite Matsushita Elec. Indus. Co., Ltd. v. Zenith

Radio Corp., 475 U.S. 574, 587-88 (1986), where they say

that this Court in an antitrust price-fixing case held that courts

may consider and weigh competing inferences from evidence

submitted on summary judgment. (Pet. Br. 30-31) Matsushita

is not pertinent here. That decision addresses a unique

concern in price-fixing cases that lawful conduct that encour-

ages competition could be misconstrued as collusive, because

“cutting prices to increase business often is the very essence

of competition” which “antitrust laws are designed to pro-

tect.” Matsushita at 593-94. There is no comparable concern

here. Securities laws are designed to protect investors from

deceptive conduct, and there is little or no danger that

accounting manipulation, false financial projections, or active

concealment of a company’s financial problems would be

misconstrued as legitimate conduct.

This Court has subsequently explained that Matsushita is

limited to cases where the evidence consists only of prima

facie \egitimate and pro-compcetitive conduct, and, “in that

26

context,” the inference of antitrust conspiracy was “specula-

tive” and not “reasonable.” Eastman Kodak Co. v. Image

Technical Services, Inc., 504 U.S. 451, 468 (1992). This

Court reiterated in Eastman Kodak, citing Liberty Lobby, that

“all justifiable inferences are to be drawn in [plaintiff's]

favor.” /d. at 456. Doubtless recognizing that Matsushita is

inapposite here, the SEC never mentions it.

Petitioners also contend that the absence of allegations can

be considered, particularly the absence of “economic motive”

to commit fraud. (Pet. Br. 17) In fact, the absence of certain

categories of allegations is “not decisive.” Cabletron, 311

F.3d at 32. “Sufficient evidence of one type might reduce or

eliminate the need for evidence in other categories, without

thwarting the legislative intent behind the PSLRA.” /d.; see

also Illinois v. Gates, 462 U.S. 213, 238 (1983) (holding a

deficiency in one element of probable cause can be offset by

a strong showing as to the other element). The absence of

motive cannot trump pleading of a strong inference based, for

example, on defendants’ admissions of fraud, or on witness

and document sources.

When the inferences of culpability, viewed collectively,

allow rational jurors to find a strong inference, even though

there are seemingly plausible inferences to the contrary, Rule

12(b)(6) requires that a motion to dismiss be denied, and

deferred to a jury for resolution.

B. Applying Liberty Lobby by Drawing All Rea-

sonable Inferences in Plaintiffs’ Favor Avoids

Intrusion on the Right to Jury Trial

The SEC misconceives the issue when it asserts that the

“strong inference” standard does not raise Seventh Amend-

ment concerns. (SEC Br. 26-29) The constitutional issue is

not presented by the Congressional standard, but by the

government’s assertion that judges deciding a Rule 12(b)(6)

motion “must consider any competing inferences and non-

culpable explanations.” (SEC Br. 24) As discussed above,

27

under Rule 12(b)(6), the judge does not consider defendant’s

explanations or inferences—the jury does. If the totality of

facts alleged and reasonable inferences drawn support a

strong inference of conscious fraud, plaintiff is entitled to a

jury trial. Liberty Lobby, 477 U.S. at 255.

The cases cited by the SEC hold that the right to a jury trial

presents no obstacle to directed verdict or summary judgment

because a determination had been made that the nonmovant

did not have a triable case as a matter of law—but only after

viewing the evidence in the nonmovant’s favor. “‘No one is

entitled in a civil case to trial by jury unless and except so far

as there are issues of fact to be determined.”” Parklane

Hosiery Co. v. Shore, 439 U.S. 322, 336 (1979); citing Ex

Parte Peterson, 253 U.S. 300, 310 (1920). But summary

judgment will not lie if the dispute about a material fact is

“genuine,” that is when “the evidence is such that a

reasonable jury could return a verdict for the nonmoving

party.” Liberty Lobby, 477 U.S. at 248. The “judge’s func-

tion is not himself to weigh” the evidence or inferences, but

only to determine whether they “may reasonably be resolved

in favor of either party.” Id. at 249-50 (emphasis added).

As noted above, these principles were drawn from the com-

mon law demurrer, as succinctly explained by Chief Justice

Marshall in 1808: “The party demurring admits the truth of

the testusony to which he demurs . . . and such conclusions

[inferences of fact] as a jury might justifiably draw [in

plaintiff's favor] the court ought to draw.” Pawling, 8 U.S. [4

Cranch] at 221-22. Thus, allowing a judge charged with

deciding a dispositive motion, as a matter of law, to become a

fact finder who can weigh competing inferences and explana-

tions would invade the right to a jury trial.

In sum, drawing inferences in plaintiffs’ favor on a disposi-

tive motion is not simply one of the “procedural incidents” of

jury trial (e.g., a court’s exclusion of “evidence for irrel-

evancy”), but one of “its most fundamental elements” be-

cause such inference-drawing is dispositive of whether there

28

are issues of fact for a jury. Galloway v. United States, 319

U.S. 372, 389-90, 392, (1943). When a court ruling on a

dispositive motion weighs competing inferences and “fails to

draw all reasonable inferences in favor of [plaintiff],” it acts

as a fact finder and “impermissibly substitute[s] its judgment

concerning the weight of the evidence for the jury’s.”

Reeves, 530 U.S. at 153. The Seventh Amendment ensures

“that the ultimate determination of issues of fact by the jury be

not interfered with.” Peterson, 253 U.S. at 310. Applying

Liberty Lobby and Reeves here—by drawing inferences in

plaintiffs’ favor—avoids any Seventh Amendment issue.

IV. This Court Should Reaffirm the Majority Rule

that Plaintiff Is Entitled to All Reasonable Infer-

ences Tested as a Totality Against the “Strong

Inference” Standard; Allowing Inferences Adverse

to Plaintiff Violates Rule 12(b)(6), and Would —

Seriously Impair Investor Recovery for Corporate

Fraud

Setting aside the hyperbole of petitioners and their amici

who dwell on abuses reported in some securities actions prior

to the 1995 enactment of the PSLRA, this case arises against

a very different factual landscape. For the past five years—

the Enron era—our markets have suffered an unprecedented

number of corporate accounting scandals causing $7 trillion

in losses to investors and retirees. Millions of Americans

have watched their entire retirement income disappear. But

securities fraud is not confined to huge scandals like Enron.

There are many small and medium size frauds that have

caused investors, including public pension funds whose middle

class members can ill afford the loss of their entire retirement

savings, to suffer substantial injury. When corporate insiders

manipulate the market, often with the complicity of banks,

accountants and lawyers, courts should be cautious not to

raise the bar of the PSLRA any higher than its already height-

ened standards requiring particularity, a factual basis and a

strong inference. 15 U.S.C. §78u-4(b).

29

Petitioners’ adverse inference theory endorses trial on the

complaint—without evidence. That approach would produce

needless confusion and inconsistency. Congress did not con-

template such a far-reaching change in long-standing plead-

ing practice. “The PSLRA did not . . . purport to move up the

trial to the pleading stage.” Adams, 340 F.3d at 1101.

Pctitioners’ approach sends the wrong message at the wrong

time. “Unless reasonable inferences from circumstances

suffice to get a case to a jury, the welfare of victimized

investors and the integrity of the stock market may be

insufficiently protected from deceptive manipulations.”

Ronconi, 253 F.3d at 428. The PSLRA “was not enacted to

raise the pleading burdens” to a level that “facially valid

claims” must be “routinely dismissed on Rule 9(b) and

12(b)(6) motions.” ABC Arbitrage, 291 F.3d at 354; accord

Cabletron, 311 F.3d at 30.

The Grundfest amici seek to narrow the scope of the

private cause of action in securities fraud even beyond the

limits imposed by Congress in the PSLRA. (Grundfest Br. 4)

In the process, they ignore and appear willing to undermine

longstanding Rule 12(b)(6) jurisprudence. They also ignore

entirely the teaching of Liberty Lobby that, despite a height-

ened standard, in ruling on a dispositive motion, “all justifi-

able inferences are to be drawn in [plaintiff's] favor.” 477

U.S. at 255. Contrary to Grundfest’s assertion (Br. 4),

weighing and comparison of possible competing inferences

from the facts “are jury functions, mot those of a judge.” Id.

(emphasis added). Grundfest never mentions Liberty Lobby,

worse yet, there is no mention of Rule 12(b)(6). Grundfest,

like other amici, discuss ad nauseum asserted pleading abuses

that led to the PSLRA. (/d. at 12-16) They simply refuse to

face the reality that sccuritics actions today are fewer and

better-——and both better led and better pled by institutional

investors like the amici on this brief.

This Court’s decision in Huddleston further contradicts

amici's theories. The Court reversed a Court of Appeals

30

ruling that plaintiffs must prove a §10(b) claim by clear and

convincing evidence, and held that a preponderance of the

evidence suffices. 459 U.S. at 387-91. The Court reasoned

that “{a]ny other standard expresses a preference for one

side’s interests.” Jd. at 390. The Court recognized that “the

interests of plaintiffs in such suits are significant. Defrauded

investors are among the very individuals Congress sought to

protect in the securities laws.” Jd. This Court emphasized

that the “existence of [a private §10(b) action] is simply

beyond peradventure.” /d. at 380. Indeed, Congress codified

such actions in the PSLRA. 15 U.S.C. §78u-4(a)(1).

Congress adopted the strong inference standard to deter

pleading abuses, not to do away with private suits entirely—

which a rule allowing the weighing of competing inferences

could bring about. In enacting the PSLRA, Congress made

clear that: “Private securities litigation is an indispensable

tool with which defrauded investors can recover their losses

without having to rely upon government action. Such 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.” H.R. Conf. Rep. 104-369 at *31

(1995), reprinted in 1995 U.S.C.C.A.N. 730.

In sum, this Court should reaffirm the majority rule that,

despite the heightened standard in the PSLRA, Rule 12(b)(6)

still requires that the court consider whether plaintiffs best

case, drawing all inferences in plaintiff's favor and consid-

ered as a “totality,” raises a “strong inference” of scienter.

CONCLUSION

The Court should affirm the holding of the Seventh Circuit

that on a motion to dismiss, plaintiff is entitled to all

reasonable inferences from well-pled facts.

Respectfully submitted,

WILLIAM S. LERACH SANFORD SVETCOV

PATRICK J. COUGHLIN (Counsel of Record)

HELEN HODGES SUSAN K. ALEXANDER

JOSEPH D. DALEY LERACH COUGHLIN STOIA

BYRON S. GEORGIOU GELLER RUDMAN &

LERACH COUGHLIN STOIA ROBBINS LLP

GELLER RUDMAN & 100 Pine Street, Suite 2600

ROBBINS LLP San Francisco, CA 94111

655 West Broadway, Suite 1900 (415) 288-4545

San Diego, CA 92101

(619) 231-1058

Counsel for Amici Curiae