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

= rere ome me me ry

@ FILED

: | FEB - 207

| OFFICE OF THE CLERK |

No. 06-484 =| SUPREN= COURT. U.S._|

IN THE

Supreme Court of the United States

TELLABS, INCORPORATED AND RICHARD C. NOTEBAERT,

Petitioners,

Vv.

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

Respondents.

ON WRIT OF CERTIORARI TO THE

UNITED STATES COURT OF APPEALS

FOR THE SEVENTH CIRCUIT

BRIEF OF TECHNET, THE INFORMATION TECHNOL-

OGY ASSOCIATION OF AMERICA, THE SEMICONDUC-

TOR INDUSTRY ASSOCIATION, AEA, BAYBIO, THE

CALIFORNIA HEALTHCARE INSTITUTE AND THE NA-

TIONAL VENTURE CAPITAL ASSOCIATION

AS AMICI CURIAE IN SUPPORT OF PETITIONERS

BRIAN D. BOYLE SETH ARONSON

Counsel of Record O’MELVENY & MYERS LLP

; 400 SOUTH HoPE STREET

JULIA A. BERMAN Los ANGELES, CA 90071

O°’ MELVENY & MYERS LLP

213) 430-6000

1625 Eye Street, NW (213) 43

Washington, DC 20006 MEREDITH LANDY

(202) 383-5300 DALE EDMONDSON

JOSHUA BAKER

O’MELVENY & MYERS LLP

2765 Sand Hill Road

Menlo Park, CA 94025

(650) 473-2600

Counsel for TechNet, the SIA, the ITAA, AeA, BayBio, CHI

and the NVCA as Amici Curiae

i

TABLE OF CONTENTS

Page

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SUMMARY OF ARGUMENT. ..............scccscsorsssssescsesesseseees 9

TTT siciistiinliiteicicsianisidiiheabcisilipaiiliiliimpiidiimnmesees 10

L. The Plain Language Of The Reform Act’s

“Strong Inference” Requirement Compels Re-

jection Of The Seventh Circuit’s Standard ............. 10

Il. . The Legislative History Confirms Congres-

sional Intent To Screen Out Barely Plausible

Claims of Securities Fraud ................ssccsesrscsssssseee 14

Ill. | The Reform Act’s Strict Pleading Standard |

Comports Fully With The Constitution .................. 16

IV. The Facts Of This Case Demonstrate The

Need For Stringent Application Of The Re-

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TABLE OF AUTHORITIES

Page(s)

CASES

Baltimore & Carolina Line, Inc. v. Redman

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Bennett v. Spear

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Bryant v. Avado Brands, Inc.

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DiLeo v. Ernst & Young

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Dura Pharms., Inc. v. Broudo

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Exxon Mobil Corp. v. Allapattah Servs.

Se hs Ses ID CN iinciitrsesciednicsinhiacinnepsnicsiennidatiiiiiien 1]

Fenner & Smith, Inc. v. Dabit

ee es: Pe CE ircrnnscntcatssaseensensensvescnqennnnentnienaned 6

Gompper v. VISX, Inc.

yo Em | passim

Harlow v. Fitzgerald

re EE cctcncrscrtnsicecesnniccepntntvnpianinsinnndanhiainseiaie 17

Helwig v. Vencor, Inc.

pe | 8,11

In re Advanta Corp.

eee 8, 16

In re Cabletron Sys., Inc.

Pe ee 60 Ge ie Be cpeencncsscemsinavenntinnenemneninpensinn 7

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TABLE OF AUTHORITIES

(continued)

In re Comshare Inc. Sec. Litig.

183 F.3d 542 (6th Cir. 1999)... cscesseeseeseees

In re Credit Suisse First Boston Corp. Analyst

Reports Sec. Litig.

431 F.3d 36 (Ist Cir, 2005) ......cccsccssssssssssseeseee

In re Digital Island Sec. Litig.

357 F.3d 322 (3d Cir. 2004).......csccessssesesseeeeee

In re Read-Rite Corp. Sec. Litig.

335 F.3d 843 (9th Cir. 2003)...ccccccsceesssssseeseeee

In re Silicon Graphics Inc. Sec. Litig.

183 F.3d 970 (9th Cir. 1999)... ceecceseeeeees

In re Time Warner Inc. Sec. Litig.

9 F.3d 259 (2d Cir. 1993) ..cccccsssccssssssessesseessen

In re VISX, Inc. Sec. Litig.

Nos. C 00-0649 CRB, C-00-0815 CM,

2001 WL 210481 (N.D. Cal. February 27,

FT btiicicienbvinenicierenenssinastenvprersenseentaimaiinens

Jones v. Bock,

__§.Ct.__, Nos. 05-7058, 05-7142,

2007 WL 135890 (Jan. 22, 2007).........ccceeecee0

Makor Issues & Rights, Ltd. v. Tellabs, Inc.

437 F.3d 588 (7th Cir. 2006)..........ccc0ccecceseeees

Matsuhita Elec. Indus. Co. v. Zenith Radio

Corp.

PP I ick iecscecnmenlecnte

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TABLE OF AUTHORITIES

(continued)

Page(s)

Novak v. Kasaks

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Ottmann v. Hanger Orthopedic Group, Inc.

953 F.S6 SSB (4s Car. 2003)....0.0cccccorevsccscssecceccecsssencscsce 11

Pirraglia v. Novell, Inc.

339 F.3d 1182 (10th Cir. 2003)..........ccsecseerseeeeeneees 8,12

Ronconi v. Larkin

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Scheuer v. Rhodes

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Swierkiewicz v. Sorema, N.A.

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STATUTES

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Vv

TABLE OF AUTHORITIES

(continued)

Page(s)

RULES & REGULATIONS

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LEGISLATIVE MATERIALS

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141 Cong. Rec. $9170

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141 Cong. Rec. $19146-47 (1995)........:cccccseeseseessesereseeeesens 5

H.R. Rep. No. 104-369 (1995) (Conf. Rep.),

as reprinted in 1995 U.S.C.C.A.N. 730 ......:c000000 passim

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

FFF UBC. GED ccccccsssessccenseveceesvensnetntnnecacsensed 6,7

vi

TABLE OF AUTHORITIES

(continued)

OTHER MATERIALS

Message to the House of Representatives

Returning Without Approval the “Private

Securities Litigation Reform Act of 1995,

31 Weekly Comp. Pres. Doc. 2210 (Dec.

i STI esiasistbicueininpncanennpismacneneensssenessteseneteee

Cornerstone Research, 2006: A Year in

Review, available at

http://securities.stanford.edu/clearinghous

e research/2006_YIR/20070102-01.pdf..........

Michael A. Perino, Did the Private Securities

Litigation Reform Act Work?

8 | eee

Page(s)

INTEREST OF AMICI CURIAE'

Technology Network (“TechNet”) is a network of Chief

Executive Officers and senior partners of more than 150

companies in the information technology, biotechnology,

venture capital, investment banking and lega! industries, rep-

resenting the heart of the global innovation economy. The

association is chartered to promote the growth of the tech-

nology industry and the economy. The majority of Tech-

Net’s members lead companies that are publicly traded on

the NYSE or the NASDAQ. Other members invest in prom-

ising new ventures, some of which grow to become industry

leaders in their own right. As members and investors in the

high technology and biotechnology industries, TechNet’s

members represent the leading edge of developing, manufac-

turing, and marketing emerging technologies. The technol-

ogy industry ranks among the most vibrant sectors in the

economy, and provides both a key engine of job creation and

a spectrum of new products that improve the lives of people

across the nation and the world.

Since 1977, the Semiconductor Industry Association

(“SIA”) has been a leading voice for the $115 billion U.S.

semiconductor industry. Semiconductors are the enabling

technology for the information age, and are a key component

in everything from computers and cell phones to video

games and satellites. Moreover, semiconductor companies

are key participants in the global innovation economy, and

many semiconductor companies reinvest a quarter of their

revenue in research and development and capital expendi-

tures. The U.S. leads the world in semiconductor technol-

ogy, capturing 46% of the fiercely competitive world market.

' Both parties have consented to the submission of this brief in letters

filed with the Clerk. No counsel for a party authored this brief in whole

or in part, and no person or entity other than amici and their counsel

made a monetary contribution to its preparation or submission.

2

There are 234,000 people employed in the semiconductor

industry in the U.S. The SIA unites all of the nation’s major

semiconductor companies, who are collectively responsible

for more than 85% of semiconductor production in America.

The SIA further shapes public policy on issues critical to the

industry and provides a spectrum of services to aid members

in growing their own businesses.

The Information Technology Association of America

(ITAA) provides global public policy, business networking,

and national leadership to promote the continued rapid

growth of the IT industry. ITAA consists of approximately

325 members throughout the U.S., and is secretariat of the

World Information Technology and Services Alliance, a

global network of 67 countries’ IT associations. [ITAA plays

a leading role in issues of IT industry concern including in-

formation security, taxes and finance policy, digital intellec-

tual property protection, telecommunications competition,

workforce and education, immigration, online privacy and

consumer protection, government IT procurement, human

resources and e-commerce policy. ITAA members range

from the smallest IT start-ups to industry leaders in the

Internet, software, IT services, digital content, systems inte-

gration, telecommunications, and enterprise solution fields.

AeA (formerly the American Electronics Association) is

the largest association of high-tech companies in the United

States with about 2,500 companies, representing all segments

of the technology industry and 1.8 million employees. As a

nationwide non-profit trade association, AeA provides a

broad range of services in the business and public policy

arenas to member companies active in the software, medical

device, telecommunications, instrumentation, computer,

semiconductor, aerospace, defense, and manufacturing sec-

tors. Founded in 1943, AeA now has eighteen offices across

the U.S., as well as offices in Europe and Asia.

The National Venture Capital Association (NVCA) is a

trade association that represents the U.S. venture capital in-

dustry. It is a member-based organization, which consists of

venture capital firms that manage pools of risk equity capital

designated to be invested in high growth companies.

NVCA’s mission is to foster greater understanding of the

importance of venture capital to the U.S. economy, and sup-

port entrepreneurial activity and innovation. The NVCA

represents the public policy interests of the venture capital

community, strives to maintain high professional standards,

provides reliable industry data, sponsors professional devel-

opment, and facilitates interaction among its members.

BayBio is an independent, non-profit trade association

serving the life science industry in Northern California.

BayBio represents more than 350 member organizations en-

gaged in or supportive of the development of life sciences

products. BayBio provides these services through represen-

tatives in South San Francisco and through coalition partners

in Sacramento and Washington, DC. Through advocacy,

membership services, programs and more, BayBio brings the

world's largest life science community together.

The California Healthcare Institute (“CHI”) is a non-

profit, public policy research and advocacy organization for

California’s biomedical industry. Founded in 1993, CHI has

more than 200 members, including California’s leading bio-

technology, medical device and pharmaceutical companies,

as well as the state’s premier universities and private re-

search institutions. CHI’s mission is to advance responsible

public policies that promote scientific discovery and foster

medical innovation. CHI conducts economic and public pol-

icy research, produces industry analyses, develops educa-

tional programs, formulates policy, serves as a clearinghouse

for information about California’s biomedical industry, and

4

engages in direct advocacy on behalf of the biomedical R&D

enterprise and the patient community it serves.

The question presented by this case—the standard for

pleading a “strong inference” of fraudulent intent in securi-

ties cases governed by the Private Securities Litigation Re-

form Act of 1995 (the “Reform Act”}—is an issue of great

importance to amici, and to the entire technology commu-

nity. The Reform Act was calculated to allow valid fraud

claims to proceed while blocking “the routine filing of law-

suits against issuers of securities . .. whenever there is a sig-

nificant change in an issuer’s stock price, without regard to

any underlying culpability of the issuer.” H.R. Rep. No.

104-369, at 31 (1995) (Conf. Rep.), as reprinted in 1995

U.S.C.C.A.N. 730, 730. Because technology stock prices are

often highly volatile, as the market potential of emerging

technologies fluctuates, technology companies have been

frequent targets of abusive securities suits. See, e.g. 141

Cong. Rec. H2763 (1995) (statement of Rep. Cox) (“High-

tech and biotech companies have paid 40 percent of the costs

of strike suit settlements ... .””). Even in the post-Reform

Act era, companies in the technology industries remain the

target of over 40% of all private securities litigation. Mi-

chael A. Perino, Did the Private Securities Litigation Reform

Act Work?, 2003 U. Ill. L. Rev. 913, 959. The securities

cases before this Court illustrate the frequent targeting of

technology companies; both this case and the recent suit

against Dura Pharmaceuticals involve information technol-

ogy or biotechnology companies. See, e.g., Dura Pharms.,

Inc. v. Broudo, 544 U.S. 336 (2005).

In light of the continual litigation against technology

companies, it is vital to amici, and to the innovation econ-

omy itself, that the Reform Act’s protections be stringently

enforced. As one of the key constituencies that the Reform

Act was intended to protect, as well as one of the principal

5

beneficiaries of a healthy capital market structure, the tech-

nology community has a unique perspective on the proper

balance between safeguards against litigation abuses and

measures to preserve valid claims. The “strong inference”

requirement forms a critical part of that balance, which must

be fully implemented if the Reform Act is to serve its in-

tended purpose. Amici therefore respectfully submit this

brief in support of Petitioners.

STATEMENT

Congress passed the Reform Act in response to wide-

spread abuses in securities litigation. Following extensive

hearings, Congress found that while meritorious suits may

promote “public and global confidence in our capital mar-

kets” and help deter wrongdoing, “significant evidence” in-

dicated that these benefits were being “undermined” by fre-

quent meritless suits. H.R. Rep. No. 104-369, at 31 (1995)

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

Abuses Congress identified included (1) the routine filing of

“cookie cutter” complaints following every stock drop, with-

out regard to an issuer’s culpability and with only a “faint

hope” that later discovery might produce a “plausible” claim;

(2) the targeting of “deep pocket defendants” solely for set-

tlement value; and (3) discovery practices designed to im-

pose “massive costs,” making it more economical for defen-

dants to settle than to litigate? H.R. Rep. No. 104-369, at

* These abuses have “turned out to be a special danger to new companies,

particularly high-technology ventures with volatile stock prices. The

Country has a strong interest in encouraging these companies and shield-

ing them from a style of legal assault that is not far from extortion.” 141

Cong. Rec. $19146-47 (1995) (statement of Sen. D'Amato) (quoting Edi-

torial, Override the Securities Bill Veto, Washington Post, Dec. 22, 1995,

at A18); see also 141 Cong. Rec. E184 (1995) (statement of Rep. Mi-

neta) (litigation costs “result in less capital for the R&D investments U.S.

high-tech companies use to maintain their position at the cutting edge of

the world market. For these reasons, securities litigation reform is a top

priority for our Nation's high technology community.”).

6

31-32 (1995) (Conf. Rep.), as reprinted in 1995

U.S.C.C.A.N. 730, 730-31; S. Rep. No. 104-98, at 16 (1995),

as reprinted in 1995 U.S.C.C.A.N. 680, 695. Congress

found that as a result of these practices, “innocent parties are

often forced to pay exorbitant ‘settlements’” with the result

that “the issuer’s own investors . . . are the ultimate losers.”

H.R. Rep. No. 104-369, at 32. Congress further concluded

that “fear that inaccurate projections will trigger the filing of

securities class action lawsuit [sic] has muzzled corporate

management,” denying investors crucial information. /d. at

43. The House Report concluded that through such prac-

tices, “the class action device was being used to injure ‘the

entire U.S. economy.” H.R. Rep. No. 104-369, p. 31 (1995),”

quoted in Merrill Lynch, Pierce, Fenner & Smith, Inc. v.

Dabit, 126 S. Ct. 1503, 1510 (2006).

Prompted by these findings, a bipartisan Congress en-

acted “uniform and more stringent pleading requirements”

for securities cases. H.R. Rep. No. 104-369, at 41 (1995)

(Conf. Rep.), as reprinted in 1995 U.S.C.C.A.N. 730, 740.

These heightened standards, as set forth in the Reform Act,

require that a “complaint shall specify each statement alleged

to have been misleading, the reason or reasons why the state-

ment is misleading, and, if an allegation regarding the state-

ment or omission is made on information and belief, the

complaint shall state with particularity all facts on which that

belief is formed.” 15 U.S.C. § 78u-4(b)(1). More impor-

tantly for present purposes, the Reform Act also requires that

any securities complaint:

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). In addition, the

Reform Act creates a “safe harbor” against liability for com-

J

panies that disclose valuable forward-looking information.

15 U.S.C. § 78u-5(c). The Reform Act further bars discov-

ery until a complaint is determined to meet the Act’s rigor-

ous pleading standards. 15 U.S.C. § 78u-4(b)(3). In so do-

ing, the Reform Act allows properly supported claims to

proceed, while screening out improper suits prior to discov-

ery, thus protecting innocent parties from the burdens that

had previously been used to force unmerited settlements.

See, e.g., H.R. Rep. No. 104-369, at 31-32; S. Rep. No. 104-

98, at 16.

As a result of these changes, cases governed by the Re-

form Act are treated differently than other federal court civil

litigation, where notice pleading under the Federal Rules of

Civil Procedure suffices. Ronconi v. Larkin, 253 F.3d 423,

437 (9th Cir. 2001) (Reform Act effects “an unusual devia-

tion from the usually lenient requirements of federal rules

pleading.”). The Reform Act expressly requires a securities

' plaintiff to identify specific facts in order to withstand a mo-

tion to dismiss. In most other settings, plaintiffs receive the

benefit of all favorable inferences at the pleading stage. Not

so under the Reform Act: the allegations must, when taken as

a whole, support a strong inference of wrongdoing, and can-

not stand merely because some rational inference exists that

favors plaintiffs. See, e.g, Gompper v. VISX, Inc., 298 F.3d

893, 896-97 (9th Cir. 2002). Accordingly, while facts al-

leged with specificity are still taken as true at the pleading

stage, see id. at 896, the Reform Act thus “alters the normal

operation of inferences under Fed. R. Civ. P. 12(b)(6).” Jn re

Digital Island Sec. Litig., 357 F.3d 322, 328 (3d Cir. 2004);

In re Cabletron Sys., Inc., 311 F.3d 11, 28 (ist Cir. 2002)

(same).

Despite the Reform Act’s pronouncement of a uniform

scienter standard against which allegations should be meas-

ured, courts have differed sharply in their application of that

8

standard. See Pet. at 17-25. The Ninth Circuit has recog-

nized that consideration of a “strong inference” necessarily

entails evaluating “all reasonable inferences to be drawn

from the allegations, including inferences unfavorable to the

plaintiffs.” VISX, Inc., 298 F.3d at 897. Under this standard,

which the First, Fourth, and Sixth Circuits have paralleled, a

complaint supports a “strong inference” of scienter only

where fraud is the most likely inference on the facts alleged.

See, e.g., id. (citing Helwig v. Vencor, Inc., 251 F.3d 540,

553 (6th Cir. 2001) (en banc), cert. dismissed, 536 U.S. 935

(2002) (“plaintiffs are entitled only to the most plausible of

competing inferences”). Other Circuits, however, have de-

clined to apply this rigorous test. The Tenth and Eighth Cir-

cuits, for instance, have refused to weigh competing infer-

ences at the pleading stage. See, e.g., Pirraglia v. Novell,

Inc., 339 F.3d 1182, 1188 (10th Cir. 2003). The Second Cir-

cuit has not directly addressed the issue, but has continued to

apply its pre-Reform Act scienter standard (which the Third

Circuit has also adopted). See, e.g., Novak v. Kasaks, 216

F.3d 300, 310 (2d Cir. 2000); Jn re Advanta Corp., 180 F.3d

525, 534-35 (3d Cir. 1999). Most recently, the Seventh Cir-

cuit held in the case at bar that a strong inference arises on

“facts from which, if true, a reasonable person could infer

that the defendant acted” with scienter. Makor Issues &

Rights, Lid. v. Tellabs, Inc., 437 F.3d 588, 602 (7th Cir.

2006) (emphasis added). These conflicting standards, and

particularly the Seventh Circuit’s approach, have prevented

the protections Congress created from being fully realized.’

° Litigation patterns have shifted in response. In the Ninth Circuit, once

the most common securities venue, the percentage of suits filed there has

declined. See, e.g., Perino, 2003 U. Ill. L. Rev. at 916 (noting “statisti-

cally significant” decline in Ninth Circuit filings). In parallel, the Second

Circuit—until Tellabs, the most plaintiff-friendly post-Reform Act

venue—has become the most common forum for such suits. See, e.g.,

Cornerstone Research, 2006: A Year in Review, at 15, available at

http://securities.stanford.edu/clearinghouse_research/2006_Y1R/2007010

2-01 .pdf. (Second Circuit had the most filings in 2005 and 2006). This

9

SUMMARY OF ARGUMENT

To preserve valid claims while combating “significant

abuses” in securities cases, the Reform Act requires, among

other things, that facts alleged with particularity support a

“strong inference” of scienter. 15 U.S.C. § 78u-4(b)(2).

This plain language compels reversal here. An inference of

fraud is not “strong” if it is less plausible than other infer-

ences arising from the same facts. A court can only deter-

mine whether an inference is “strong” by evaluating “all rea-

sonable inferences to be drawn from the allegations, includ-

ing inferences unfavorable to the plaintiffs,” and allowing

cases to proceed to the costly discovery phase only where

particularized facts support fraud as the most plausible sce-

nario. VISX, 298 F.3d at 897. Any lesser standard is flatly

inconsistent with the text Congress has chosen, and with the

Reform Act’s purpose of screening out improper claims at an

early stage.

The legislative history confirms that Congress intended

to bar suits at the pleading stage where the facts alleged do

not strongly suggest fraud. Congress passed the Reform Act

precisely because Fed. R. Civ. P. 9(b) had not prevented

highly speculative complaints from reaching the discovery

stage. The Reform Act expressly elevates the pleading stan-

dard above Rule 9(b), and beyond the standards imposed by

prior law. Standards that allow securities fraud suits to pro-

ceed on inferences that, compared to others available, are

implausible, would not accomplish that goal, and would ef-

fectively revive the pre-Reform Act regime.

The “strong inference” requirement embodies a careful

balance between the goals of protecting against litigation

abuses and allowing valid claims to proceed. This balance

correlation between suit frequency and pleading standard laxity high-

lights the continued existence of abuse.

10

requires that courts consider all logical inferences from par-

ticularized facts, and allow cases to proceed only where (at

the very least) fraud is a more plausible inference than inno-

cence. The decision below failed to effectuate that balance,

and thus should be reversed.

ARGUMENT

I. THE PLAIN LANGUAGE OF THE RE-

FORM ACT’S “STRONG INFERENCE”

REQUIREMENT COMPELS REJEC-

TION OF THE SEVENTH CIRCUIT’S

STANDARD.

The aim of the Reform Act is to more reliably screen out

frivolous securities class actions and prevent them from im-

posing burdens on the American economy. It accomplishes

this by requiring, inter alia, that plaintiffs allege particular-

ized facts supporting their claims, and that those facts sup-

port a “strong inference” of scienter. 15 U.S.C. §78u-4(b).

By providing the standard that the required detailed facts

must satisfy, the “strong inference” component of the Re-

form Act forms an indispensable part of this mechanism.

The plain text of the statute requires more than “a per-

missible inference” or a “reasonable inference.” It requires a

“strong inference.” 15 U.S.C. § 78u-4(b)(2); VISX, 298 F.3d

at 897 (rejecting inference that is “reasonable and war-

ranted”). A “strong inference” by definition must be more

than the “reasonable” inferences that allowed securities

plaintiffs to proceed prior to the Reform Act. See, e.g., In re

Read-Rite Corp. Sec. Litig., 335 F.3d 843, 848-49 (9th Cir.

2003) (rejecting claims even to the extent facts supported

“reasonable” inference of fraud); Jn re VISX, Inc. Sec. Litig.,

Nos. C 00-0649 CRB, C-00-0815 CM, 2001 WL 210481 at

*3 (N.D. Cal. 2001) (Breyer, J.) (“{S]trong must mean some-

thing more than merely ‘reasonable.’”).

il

“Strong inferences’ . . . involve deductive reasoning;

their strength depends on how closely a conclusion of mis-

conduct follows from a plaintiff's proposition of fact.”

Helwig, 251 F.3d at 553. To evaluate the strength of the

connection between facts and a conclusion of fraud that

plaintiffs seek to draw from those facts, a court necessarily

must review the entirety of the permissible inferences and

determine, at a bare minimum, that an inference of fraud is

more plausible than those suggesting innocence. See, e.g.,

VISX, 298 F.3d at 897. An inference of fraud cannot be

“strong” if the most likely scenario on the facts alleged, and

the conclusion that flows most closely from those facts, is

non-fraudulent conduct. See, e.g, id. (rejecting claims

where fraud was less likely than unsuspicious inference).

Nor is an inference of fraud “strong” “when, viewed in light

of the complaint as a whole, there are legitimate explanations

for the behavior that are equally convincing.” Jn re Credit

Suisse First Boston Corp. Analyst Reports Sec. Litig., 431

F.3d 36, 49 (Ist Cir. 2005); see also e.g. Ottmann v. Hanger

Orthopedic Group, Inc., 353 F.3d 338, 350 (4th Cir. 2003)

(“Strong inference” did not exist where negligence was as

likely as fraud). Accordingly, as a logical matter, a com-

plaint supports a “strong” inference of scienter only where

deliberate fraud is the more likely scenario flowing from the

facts alleged—as four Circuits have recognized. Credit

Suisse, 431 F.3d at 49; Ottman, 353 F.3d at 350; Helwig, 251

F.3d at 553; VISX, 298 F.3d at 896-97.

The structure of the Reform Act confirms this reading of

the “strong inference” provision. See, e.g., Exxon Mobil

Corp. v. Allapattah Servs., 125 S. Ct. 2611, 2620 (2005) (to

determine what Congress enacted, court “must examine the

Statute’s text in light of context, structure, and related statu-

tory provisions”). The Reform Act’s discovery stay, its com-

mand that plaintiffs supply “all facts” supporting their

12

claims, and its “strong inference” requirement combine to

serve a carefully balanced gatekeeping function. See 15

U.S.C. §§ 78u-4(b)(1), (2), (3). Together, these provisions

allow claims to proceed only where they are founded on par-

ticularized allegations showing a strong likelihood of fraud,

while preventing speculative claims from being used to sup-

port potentially abusive discovery. The purpose of this

screening mechanism would be defeated if Congress’s lan-

guage were interpreted to allow plaintiffs to impose discov-

ery burdens based upon fraud inferences that are barely plau-

sible. See, e.g., VISX, 298 F.3d at 896-97 (“Congress made

it crystal clear that the [Reform Act]’s pleading requirements

were put in place so that only complaints with particularized

facts giving rise to a strong inference of wrongdoing survive

a motion to dismiss .. . .”’)

The Seventh Circuit’s formulation of the standard is im-

possible to reconcile with the text and structure of the Re-

form Act. The Seventh Circuit’s command that plaintiffs

supply “facts from which, if true, a reasonable person could

infer that the defendant acted with the required intent,” see

Tellabs, 437 F.3d at 602, effectively applies the pre-Reform

Act approach of sustaining claims when any reasonable in-

ference of fraud could support a suit. See, e.g. In re Time

Warner Inc. Sec. Litig., 9 F.3d 259, 270 (2d Cir. 1993)

(drawing all inferences in plaintiffs’ favor), superseded by

statute as stated in Bryant v. Avado Brands, Inc., 187 F.3d

1271, 1286 (11th Cir. 1999). Several other circuits, includ-

ing the Tenth and Eighth, have similarly declined to weigh

competing inferences, and have invoked pre-Reform Act

12(b) jurisprudence in support of a lenient standard. See,

e.g., Novell, 339 F.3d at 1188 (continuing to draw inferences

in plaintiffs’ favor based in part on application of traditional

12(b)(6) standard). These approaches are incorrect on multi-

ple grounds. Setting aside the Reform Act’s alteration of the

framework for pleading challenges, see supra at 5, these

13

constructions “eviscerate the PSLRA’s strong inference re-

quirement by allowing plaintiffs to plead in a vacuum.”

VISX, 298 F.3d at 896; see also, e.g., Credit Suisse, 431 F.3d

at 51 (courts should not “turn a blind eye to the universe of

possible conclusions stemming from a given fact or set of

facts”). Under these standards, plaintiffs do not even need to

supply the full range of particularized facts the Reform Act

demands, because they can use improbable but technically

possible inferences to fill any gaps in their factual allega-

tions. These approaches invite the illogical conclusion that a

“strong inference” does not mean “strong,” as the text states,

but merely “not impossible.” By accepting “reasonable” in-

ferences uncritically, the standard set forth by the Seventh

Circuit, and other similarly lenient standards, effectively read

the “strong inference” language out of the statute, in direct

contravention of “cardinal principle[s] of statutory construc-

tion.” Bennett v. Spear, 520 U.S. 154, 173 (1997) (Court

will “give effect, if possible, to every clause and word of a

statute”) (citations omitted).

Where the facts alleged with particularity show alternate

inferences to be as or more likely than fraud, the plaintiff has

not satisfied its pleading burden of demonstrating a “strong

inference” of securities fraud. The rigorous application of

the “strong inference” requirement enables early rejection of

claims based on speculative inferences, see, e.g., VISX, 298

F.3d 893, while facilitating claims founded on strong infer-

ences drawn from particularized facts. Any more lenient

construction would fail to effectuate the Reform Act as writ-

ten. Given the Reform Act’s gatekeeping function, there is

no basis for interpreting its “strong inference” requirement to

permit plaintiffs to impose discovery burdens where the most

plausible inferences are inconsistent with fraud. This Court

therefore should reverse the decision below.

14

Il. THE LEGISLATIVE HISTORY CONFIRMS

CONGRESSIONAL INTENT TO SCREEN OUT

BARELY PLAUSIBLE CLAIMS OF SECURI-

TIES FRAUD

The legislative history confirms what the Reform Act’s

language compels: that Congress intended to heighten the

standard for pleading scienter. Even the Seventh Circuit

recognizes that the Reform Act “did unequivocally raise the

bar for pleading scienter.” Tellabs, 437 F.3d at 601.

Congress enacted the Reform Act precisely because Fed-

eral Rule of Civil Procedure 9(b) “ha[d] not prevented abuse

of the securities laws by private litigants.” H. R. Rep. No.

104-369, at 41 (1995) (Conf. Rep.) as reprinted in 1995

U.S.C.C.A.N. 730, 740 (quoted in Jn re Comshare Inc. Sec.

Litig., 183 F.3d 542, 548 (6th Cir. 1999)). Congress recog-

nized “a need” to establish “more stringent pleading re-

quirements” to restrict securities suits to meritorious claims,

and “to curtail the filing of meritless lawsuits.” /d To fulfill

that need, Congress expressly elevated the pleading standard

beyond Rule 9(b), and beyond anything in existing law. See

Message to the House of Representatives Returning Without

Approval the “Private Securities Litigation Reform Act of

1995,” 31 Weekly Comp. Pres. Doc. 2210 (Dec. 19, 1995).

To craft a new and more stringent standard, Congress

began with the then-strictest scienter requirement in the na-

tion, which was the Second Circuit’s “strong inference” ap-

proach. It then went a step further, cautioning that

“(because [it] intend{ed] to strengthen existing pleading re-

quirements, it [did] not intend to codify the Second Circuit’s

case law interpreting [the “strong inference”] pleading stan-

dard.” See H.R. Rep. No. 104-369, at 41, 48 n.23 (1995)

(Conf. Rep.), as reprinted in 1995 U.S.C.C.A.N. 730, 740,

747. Indeed, while the Senate precursor to the final statute

15

adopted a full version of the Second Circuit’s interpretation

of the “strong inference” requirement in substance, the Con-

ference Committee deliberately removed that language to

more expressly raise the Reform Act’s pleading standard

above that established in Second Circuit decisions. See H.R.

Rep. No. 104-369, at 48 n.23 (1995) (Conf. Rep.), as re-

printed in 1995 U.S.C.C.A.N. 730, 747. The Conference

Committee confirmed its decision to adopt a higher standard

in its final report, noting Congress’s choice “not to include . .

. language relating to motive, opportunity, or recklessness”

as set forth in Second Circuit opinions. /d.

President Clinton recognized the intention to make plead-

ing standards more rigorous than those in force in the Second

Circuit in his message to Congress vetoing the Reform Act.

See Message to the House of Representatives Returning

Without Approval the “Private Securities Litigation Reform

Act of 1995,” 31 Weekly Comp. Pres. Doc. 2210 (Dec. 19,

1995). He indicated that, while he was willing to support a

codification of the Second Circuit’s pleading standard, it was

“crystal clear” that the Reform Act was intended “to raise the

pleading standard even beyond that level.” /d Congress

overrode that veto, and passed the Reform Act—a direct

mandate to implement the stringent pleading standard Presi-

dent Clinton and the Conference Committee described.

The Seventh Circuit’s standard is impossible to reconcile

with this compelling evidence of Congressional intent to en-

hance scienter pleading standards beyond existing law. See

VISX, 298 F.3d 893. As noted, the Seventh Circuit’s ap-

proach, by affording plaintiffs the benefit of all permissible

inferences, is no different than the regime that prevailed

prior to the Reform Act. See supra at 9. Such a construction

is thus improper, as are the standards of other Circuits that

apply pre-Reform Act law. See, e.g., Novak v. Kasaks, 216

16

F.3d 300, 310 (2d Cir. 2000); Jn re Advanta Corp., 180 F.3d

524, 534-35 (3d Cir. 1999).*

Il. THE REFORM ACT’S STRICT PLEADING

STANDARD COMPORTS FULLY WITH THE

CONSTITUTION

Perhaps recognizing the disconnect between its standard

for reviewing securities fraud pleadings and Congress’s ex-

press intent that federal courts play a more active gatekeep-

ing role, the Seventh Circuit suggests that a stringent con-

struction of “strong inference” might implicate jury trial

rights under the Seventh Amendment. See, e.g., Tellabs, 437

F.3d at 602. This concern is misplaced. There is nothing

unusual or problematic about requiring district courts to en-

force a stringent pleading standard of the sort set forth in the

Reform Act.

Judges routinely make decisions that either impact or

terminate litigation without jury input. Motions to dismiss,

motions for summary judgment, see Fed. R. Civ. P. 56, and

motions for judgment as a matter of law, see id. at Rule 50,

are all determined by judges without (and in some cases, de-

spite) jury findings. And as a general matter, crucial—even

“ The Novak and Advanta decisions, which applied the prior Second Cir-

cuit scienter standard, based their reasoning on the presence of the term

“strong inference” in earlier Second Circuit opinions, and on other com-

ments within the legislative history. See, e.g, Novak, 216 F.3d at 311-

12. The reasoning of these courts, however, is inconsistent with Con-

gress’s rejection of proposals designed simply to codify the Second Cir-

cuit’s test, with compelling legislative history that the Reform Act did

not simply adopt the Second Circuit test, and with the Clinton veto mes-

sage. The use of the “strong inference” language and surrounding com-

mentary simply shows that Congress found the then-existing highest

standard instructive in its attempt to craft a new, even more rigorous

standard. In light of the overwhelming evidence suggesting that Con-

gress created a standard higher than the Second Circuit's approach, con-

tinued application of pre-Reform Act standards is improper.

17

dispositive—evidentiary rulings, in criminal as well as civil

actions, are made by judges. See, e.g, Fed. R. Evid. 104

(providing for court to determine questions of admissibility),

403 (allowing court to exclude evidence where the risk of

undue prejudice outweighs the probative value of the evi-

dence). Such gatekeeping mechanisms are fundamental

parts of our judicial system.

It is thus not surprising that judicial enforcement of

pleading and other procedural requirements of the kind at

issue here have long been held to have no impact on jury

trial rights. See, e.g., Baltimore & Carolina Line, Inc. v.

Redman, 295 U.S. 654, 657 (1935). Every heightened plead-

ing standard is by definition intended to ensure that only se-

lected allegations are permitted to reach a jury for factfind-

ing. Challenges based on a plaintiffs inability to satisfy

congressionally-imposed (or even judge-made) pleading

standards do not implicate jury trial rights, as “the issue is

not whether a plaintiff will ultimately prevail but whether the

claimant is entitled to offer evidence to support the claims.”

Scheuer v. Rhodes, 416 U.S. 232, 236 (1974), overruled on

other grounds, Harlow v. Fitzgerald, 457 U.S. 800 (1982).

Elevated pleading standards are deeply rooted features of

existing law. See, e.g., Swierkiewicz v. Sorema, N.A., 534

U.S. 506, 512-13 (2002) (identifying example of heightened

pleading requirements under Rule 9(b)).

Congress unquestionably has the power to create (and

modify) the substantive standards for securities fraud claims,

just as in other areas of federal law. With this power comes

the concomitant power to impose heightened pleading stan-

dards. See, e.g., Jones v. Bock, _ S.Ct. __, Nos. 05-7058,

05-7142, 2007 WL 135890 at *9-10 (Jan. 22, 2007) (recog-

nizing that Congress possessed, but had not exercised, the

power to create specific pleading requirement of exhaustion

of remedies). What Congress has done here can be analo-

gized to the judge-made rule that permits certain antitrust

claimants to get to a jury only if their proffered evidence

“tend{s] to exclude the possibility” that the defendants’ con-

duct resulted from independent decision making. Matsushita

Elec. Indus. Co. v. Zenith Radio Corp. 475 U.S. 574, 597

(1986) (internal quotation omitted). By preventing such anti-

trust plaintiffs from proceeding with claims where the evi-

dence is equally consistent with lawful and unlawful behav-

ior, this rule helps prevent antitrust litigation from chilling

independent, and pro-competitive, behavior. See id. Simi-

larly, Congress here has required securities plaintiffs to iden-

tify specific facts that make an inference of scienter more

probable than competing inferences before proceeding in or-

der to prevent speculative fraud claims from imposing bur-

dens on behavior (such as good-faith forward-looking pro-

jections) that Congress wishes to encourage.

While there is, of course, a continuum of possible stan-

dards, there is no inherent constitutional difficulty with stan-

dards at the stringent end of the spectrum. If facts alleged

are insufficient to state a claim according to the standard

Congress selects, the case ends without any role for a jury or

any offense to jury trial rights. Indeed, Rule 9(b) itself re-

flects that structure: while it compels rejection of cases that

satisfy Rule 8’s notice pleading standard, it has never been

held to offend constitutional principles in doing so. See, e.g.,

Swierkiewicz, 534 U.S. at 513 (recognizing 9(b)’s heightened

standard).

The “strong inference” requirement that Congress has

imposed here is thus no less defensible than other legisla-

tively- or judicially-established pleading or evidentiary rules.

The Reform Act simply requires that to state a cause of ac-

tion for securities fraud, plaintiffs must allege facts that meet

a particularized pleading standard. To be sure, Congress has

selected a stringent standard, given the evidence of historical

19

abuse of the securities class action vehicle. Nevertheless,

there is no principled reason why the stringency of this stan-

dard (which no Circuit has held to violate due process rights)

would cause it to be any less constitutionally sound than

other heightened pleading standards.”

IV. THE FACTS OF THIS CASE DEMONSTRATE

THE NEED FOR STRINGENT APPLICATION

OF THE REFORM ACT

“The story in this complaint is familiar in securities liti-

gation. At one time the firm bathes itself in a favorable light.

Later the firm discloses that things are less rosy. The plaintiff

contends that the difference must be attributable to fraud.”

See, e.g., DiLeo v. Ernst & Young, 901 F.2d 624, 627 (7th

Cir. 1990) (dismissing case). Specifically, plaintiffs charge

Tellabs’ management with making falsely optimistic state-

ments while knowing that Tellabs would not meet expecta-

tions. See Tellabs, 437 F.3d at 592-593. Yet the complaint

lacks allegations placing knowledge of an upcoming miss in

the mind of any defendant. With the benefit of hindsight,

plaintiffs allege that the CEO overstated demand, and that

internal reports existed that identified the demand decline

that ultimately came to pass. See id. at 603. Plaintiffs do not

show that the CEO knew of those reports when he spoke,

however. The Seventh Circuit even acknowledges that he

may not have known of the decline when he spoke. /d. (“[I]t

is conceivable that [the CEO] had yet to see the reports sug-

gesting his company was in trouble”). The opinion simply

discounts that point on the grounds that “a reasonable person

could infer” that the CEO knew of the reports. /d. at 602.

Accordingly, this case is at its core a common accusation of

* Congress’s power to set a standard it deems proper is particularly broad

given that the Section |0(b) cause of action itself, as an implied right of

action under a federal statute, exists only due to Congressional acquies-

cence. See 15 U.S.C. § 78u-4.

20

“fraud by hindsight,” with no remarkable features in terms of

either theory or supporting fact.

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

place” was “to put an end to the practice of pleading fraud by

hindsight” in this manner. VISX, 298 F.3d at 897. While

virtually every company falls short of expectations at some

point during its history, disappointment does not equate to

fraud. Even before the Reform Act, “[i]nvestors seeking re-

lief under Rule 10b-5 ha[d] to distinguish their situation from

that of many others who are adversely affected by business

reverses.” DiLeo, 901 F.2d at 627. In the post-Reform Act

era, without specific facts showing that fraud in fact oc-

curred, there is “no way of distinguishing [plaintiffs’] allega-

tions from the countless ‘fishing expeditions’ which the (Re-

form Act] was designed to deter.” In re Silicon Graphics

Inc. Sec. Litig., 183 F.3d 970, 988 (9th Cir. 1999) (dismiss-

ing claims).° Yet plaintiffs allege no such facts here. Be-

cause this case lacks facts that place knowledge of an immi-

nent miss in the mind of the CEO, it falls squarely within the

category of strike suits the Reform Act targets.

This case runs afoul of the Reform Act in an additional

respect in that it rests on exactly the kind of forward-looking

information that Congress sought to encourage companies to

disclose without fear of liability. Congress found that “a

company’s own assessment of its future potential would be

among the most valuable information shareholders and po-

tential investors could have about a firm.” H.R. Rep. No.

* Unsupported assertions that warnings in internal reports alerted execu-

tives to an imminent miss similarly do not distinguish strike suits from

instances of fraud. “[E]very sophisticated corporation uses some kind of

internal reporting system reflecting earlier forecasts, allowing [plaintiffs]

to go forward with a case based on general allegations of ‘negative inter-

nal reports’ would expose all those companies to securities litigation

whenever their stock prices dropped.” Silicon Graphics, 183 F.3d at 988

(citations and quotations omitted).

21

104-369, at 43 (1995) (Conf. Rep.), as reprinted in 1995

U.S.C.C.A.N. 730, 742. Congress concluded, however, that

issuers were declining to provide such information for fear

that a failure to meet forecasts would result in a lawsuit. /d.

The Reform Act was therefore calculated “to enhance market

efficiency by encouraging companies to disclose forward-

looking information” without fear of open-ended liability in

the event that forward-looking statements proved less than

prophetic. See id. This suit, which criticizes Tellabs for in-

accurate forecasting, would create just the kind of disincen-

tive to forthright discussions of future prospects that Con-

gress feared. The “strong inference” requirement, and its

ban on suits lacking compelling evidence of fraud, is part of

a carefully crafted plan to prevent such an outcome. For the

purposes of the Reform Act to be realized, that screening

mechanism must be applied according to its terms.

Because this case constitutes exactly the kind of hind-

sight criticism of forward-looking discussions that Congress

enacted the Reform Act to prevent, the consequences of al- —

lowing this suit to proceed are impossible to overstate. If the

Reform Act were found not to block such suits—despite

Congress’s clear intent to do so—companies would be effec-

tively returned to the pre-Reform Act regime with all of its

attendant abuses. Accordingly, if the goals of Congress are

to be achieved, the “strong inference” requirement must be

given its due force, and the allegations here must fail.

This is not to say that the Reform Act is so stringent as to

bar all claims. As Congress has concluded, anti-fraud pro-

tections serve a vital role in maintaining the integrity of the

capital markets on which the technology community de-

pends. See supra at 2. The Reform Act therefore does not

present a barrier to suits where adequate indicia of fraud ex-

ist. Even in Circuits that have strictly applied the Reform

Act’s strong inference requirement, complaints can and do

22

withstand motions to dismiss. The Reform Act is calculated

simply to ensure that the crucial anti-fraud mechanisms of

the Securities Exchange Act of 1934 are reserved for non-

speculative claims of fraud.

CONCLUSION

[t is vitally important for amici, for the innovation econ-

omy, and for the capital markets themselves, that the Reform

Act be implemented as Congress intended. The judgment of

the Court of Appeals should be reversed.

Respectfully submitted,

BRIAN D. BOYLE SETH ARONSON

Counsel of Record O’MELVENY & MYERS LLP

JULIA A. BERMAN 400 SOUTH Hope STREET

‘ Los ANGELES, CA 90071

O’MELVENY & MYERS LLP (213) 430-6000

1625 Eye Street, NW

Washington, DC 20006 MEREDITH LANDY

(202) 383-5300 DALE EDMONDSON

JOSHUA BAKER

O”’MELVENY & MYERS LLP

2765 Sand Hill Road

Menlo Park, CA 94025

(650) 473-2600

Attorneys for TechNet, the SIA, the ITAA, AeA, BayBio,

CHI, and NVCA as Amici Curiae

February 9, 2007