The Private Securities Litigation Reform Act of 1995 (the "PSLRA") requires a plaintiff asserting securities fraud claims under Section 10(b) of the Securities Exchange Act of 1934 (the "Exchange Act") to "state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind." The PSLRA, however, does not define the "required state of mind" or set forth any test or standard for determining whether a "strong inference" of that state of mind has been pled adequately. Consequently, federal courts have differed on the proper application of the PSLRA's scienter pleading requirements. A series of recent circuit court decisions highlights the growing split.
Second and Third Circuits
In Press v. Chemical Investment Service Corporation, the Second Circuit Court of Appeals held without analysis that its pre-PSLRA standard satisfied the scienter pleading requirement under the PSLRA. Thus, a plaintiff could establish a "strong inference" of scienter by pleading either motive and opportunity to commit fraud, or strong circumstantial evidence of recklessness or conscious misbehavior.
The Third Circuit Court of Appeals in In re Advanta Corporation Securities Litigation adopted the same formulation espoused by the Second Circuit. In so doing, the Third Circuit specifically considered whether Congress intended to codify the Second Circuit standard described in Press or to impose a more stringent standard when it enacted the PSLRA.
The Third Circuit first sought to resolve these issues by resort to the legislative history of the PSLRA, but found it to be "contradictory and inconclusive." On the one hand, the court noted that the bill originally proposed in the House of Representatives would have substantively changed the scienter element for a Section 10(b) claim by eliminating recklessness, thereby establishing a more stringent standard than that applied by the Second Circuit. The court also noted, however, that the Senate Conference Committee stated that the pleading standard included in its version of the PSLRA was "modeled upon the pleading standard of the Second Circuit," though the Committee did "not intend to codify the Second Circuit's case law interpreting this pleading standard."
Unable to glean clarity from the legislative history, the Third Circuit considered and then rejected a Senate Report related to enactment of the Securities Litigation Uniform Standards Act of 1998 (the "Standards Act"), wherein it was stated that the PSLRA "establishe[d] a heightened uniform Federal standard on pleading requirements based upon the pleading standard applied by the Second Circuit Court of Appeals." According to the Third Circuit, this after-the-fact attempt to bolster the legislative history of the PSLRA was unavailing, since "the interpretation given by one Congress (or a committee or Member thereof) to an earlier statute is of little assistance in discerning the meaning of that statute."
Having found the legislative history of the PSLRA to be inconclusive, the Third Circuit next looked to the plain language of the statute. The court opined that the language of the PSLRA closely mirrored the Second Circuit's scienter pleading standard. The court reasoned, therefore, that the PSLRA "establishe[d] a pleading standard approximately equal in stringency to that of the Second Circuit." In addition, the Third Circuit noted that the PSLRA modified procedural law, not substantive law. Accordingly, the Third Circuit held that plaintiffs could still satisfy the scienter requirement by alleging motive and opportunity or recklessness or conscious behavior as long as the allegations were supported by particularized facts that gave rise to a "strong inference" of intent.
In support of its conclusion, the Third Circuit noted that if Congress intended to eliminate motive and opportunity or recklessness as a basis for scienter, it would have expressly done so in the text of the statute. Further, the court opined that retaining recklessness was consistent with the language of the PSLRA and furthered the policy of "discouraging deliberate ignorance and preventing defendants from escaping liability solely because of the difficulty of proving conscious intent to commit fraud."
In a significant departure from the holdings of the Second and Third Circuits, the Ninth Circuit Court of Appeals in In re Silicon Graphics Incorporated Securities Litigation held that "a private securities plaintiff proceeding under the PSLRA must plead, in great detail, facts that constitute circumstantial evidence of deliberately reckless or conscious misconduct." According to the Ninth Circuit, allegations of motive and opportunity or of mere recklessness will not suffice.
In arriving at its conclusion, the Ninth Circuit noted that the plain language of the statute required two separate determinations: "(1) what is the required state of mind; and (2) what constitutes a strong inference of that state of mind." As to the first question, the court stated that the required state of mind under Section 10(b) is intent. The court therefore read the PSLRA "to mean that the evidence must create a strong inference of fraudulent intent."
Because the PSLRA was silent as to what would satisfy the "strong inference" requirement, the Ninth Circuit next examined the legislative history. The Ninth Circuit reasoned that Congress sought to raise the pleading standard above that of the Second Circuit when it declined to enact an amendment that would have adopted the Second Circuit rule. Moreover, the Ninth Circuit noted that President Clinton vetoed the PSLRA because of the concern that the PSLRA elevated the standard above that of the Second Circuit, and that Congress overrode that veto. Relying heavily on the same legislative history that the Third Circuit found contradictory and inconclusive, the Ninth Circuit stated that "[i]t follows that plaintiffs can no longer aver intent in general terms of mere 'motive and opportunity' or 'recklessness,' but rather, must state specific facts indicating no less than a degree of recklessness that strongly suggests actual intent."
In a separate opinion concurring in part and dissenting in part, Justice Browning resoundingly rejected the scienter pleading standard adopted by the Ninth Circuit. Justice Browning opined that by rejecting allegations of recklessness and motive and opportunity to commit fraud as bases for establishing scienter, "the majority raises the pleading bar higher than that envisioned by Congress, and places the Ninth Circuit at odds with both the Second and Third Circuits." Justice Browning reasoned that there was nothing in the plain language of the PSLRA to support the conclusion that allegations of recklessness or motive and opportunity to commit fraud were insufficient to establish the requisite "strong inference" of scienter. Because Justice Browning found the language of the PSLRA to be unambiguous on this point, he rejected the majority's consideration of and reliance on the PSLRA's legislative history.
Justice Browning also considered with approval the analysis contained in the amicus brief of the Securities and Exchange Commission (the "SEC"). Noting that the SEC was "uniquely qualified to assess the proper balance between the need to insure adequate disclosure and the need to avoid the adverse consequences of setting too low a threshold for civil liability," Justice Browning pointed out that the SEC "often relies on recklessness in its own law enforcement cases." Browning also quoted the SEC's contention that "eliminating recklessness would convert what was intended to be a procedural change into a substantive change in the definition of scienter." In conclusion, Justice Browning stated that the standard adopted by the majority was "a formulation not found in the text of the statute, in the legislative history, or in any case heretofore litigated, and rejected by the responsible administrative agency; it would eliminate recklessness as a basis for liability, and treat allegations of motive and opportunity to commit fraud as insufficient to allege scienter. It is 'new,' 'untested,' and certain to 'generate additional litigation.'"
Following closely on the heels of the Ninth Circuit's decision in Silicon Graphics, the Sixth Circuit Court of Appeals in In re Comshare Incorporated Securities Litigation articulated a scienter pleading standard that lies between those adopted by the Second and Third Circuits and the Ninth Circuit. In keeping with the Second and Third Circuits, the Sixth Circuit held that plaintiffs asserting Section 10(b) fraud claims may plead scienter by alleging facts giving rise to a strong inference of recklessness.
In keeping with the Ninth Circuit, however, the Sixth Circuit also held that a plaintiff may not plead scienter "by alleging facts merely establishing that a defendant had the motive and opportunity to commit securities fraud." The court reasoned that "[w]hile facts regarding motive and opportunity may be 'relevant to pleading circumstances from which a strong inference of fraudulent scienter may be inferred,' and may, on occasion, rise to the level of creating a strong inference of reckless or knowing conduct, the bare pleading of motive and opportunity does not, standing alone, constitute the pleading of a strong inference of scienter."
Thus, four appellate decisions have yielded three separate standards for satisfying the PSLRA's scienter pleading requirement, ranging from the Second Circuit's recklessness or motive and opportunity to commit fraud tests to the Ninth Circuit's stringent deliberate recklessness test. It is likely that such split in the circuit courts will continue until further clarification is provided by Congress or the United States Supreme Court. *
Press v. Chemical Inv. Servs. Corp., 166 F.3d 529 (2d Cir. 1999); In re Advanta Corp. Sec. Litig., 180 F.3d 525 (3d Cir. 1999); In re Comshare Inc. Sec. Litig., -- F.3d --, No. 97-2098, 1999 WL 460917 (6th Cir. July 8, 1999); In re Silicon Graphics Inc. Sec. Litig., -- F.3d --, Nos. 97-16204, 97-16240, 1999 WL 446521 (9th Cir. July 2, 1999).
- CIRCUIT SPLIT ON PLEADING SCIENTER UNDER THE PSLRA
- Second, Third
- Motive and opportunity to commit fraud; or
- Strong circumstantial evidence of conscious misbehavior; or
- Strong circumstantial evidence of recklessness.
- Strong circumstantial evidence of conscious misbehavior; or
- Strong circumstantial evidence of recklessness.
- Pleading motive and opportunity to commit fraud is insufficient in itself, but may support, or rise to the level of, a strong inference of recklessness or conscious misbehavior.
- Strong circumstantial evidence of conscious misconduct; or
- Strong circumstantial evidence of deliberately reckless.
- Must state specific facts indicating "no less than a degree of recklessness that strongly suggests actual intent".
- Allegations of motive and opportunity or of mere recklessness may provide some inference of intent, but will not suffice to establish "strong inference" of intent.