The Ninth Circuit And Tellabs — Ignoring The Supreme Court?
The Ninth Circuit Court of Appeals handed down a pair of decisions last week construing the Supreme Court’s decision in Tellabs, Inc. v. Makor Issuers & Rights, Ltd., 127 S.Ct. 2499 (2007). In that decision, the Supreme Court resolved a split among the circuits over the construction of the PSLRA Section 21D(b)(2) “strong inference” of scienter requirement. One of these decisions, Zucco Partners, LLC v. Digmarc Corporations, Case No. 06-35758 (9th Cir. Jan. 12, 2009), is discussed here. https://www.secactions.com/?p=738 The second, handed down one day after Digmarc Corporation, is Rubke, Trustee v. Capital Bancorp LTD, Case No. 07-15083 (9th Cir. Jan. 13, 2009). The court’s opinions raise a significant question regarding the application of Tellabs’ teachings in the Ninth Circuit.
In Capital Bancorp, plaintiffs filed a complaint alleging violations of Section 10(b) and 14(e) of the Exchange Act and Section 11 of the Securities Act. The defendants are Capital Bancorp, a bank holding company, and Joseph Reid, its CEO and Chairman. The suit was brought by minority shareholders of Napa Community Bank, whose shares were being acquired by Capital. The case centered on two groups of allegations. The first claimed that defendants knew the offer price of 150% of book value in a registration statement was unfair, rendering the offering circular false. The second group focused on phone calls board members made to shareholders claiming that they should sell or see their shares become worthless.
The district court dismissed the Section 11 claim for failing to plead fraud with particularity as required by Rule 9(b) and the Exchange Act claims for not meeting the PSLRA pleading requirements. Plaintiffs declined to amend their complaint and appealed.
The Ninth Circuit affirmed. The Section 11 claims, the court held, had to be pled in accord with the particularity requirements of Federal Civil Rule 9(b). The PSLRA standards however, do not apply to that claim. Those allegations were based on “information and belief.” Since defendants failed to specify the facts supporting their belief the court concluded that plaintiffs failed to meet the Rule 9(b) pleading requirements regarding their registration statement claim.
The court also found that the Exchange Act claims were not properly pled. These allegations must meet the pleading requirements of the PSLRA the court held. Since the allegations regarding the registration statement failed to meet the particularity requirements of Rule 9(b), it is clear that they also did not meet the requirements of the PSLRA.
The court then examined the Exchange Act fraud claims and the allegations regarding the telephone calls in view of the PSLRA pleading requirements. To determine whether a strong inference of scienter was pled the court reviewed the Supreme Court’s decision in Tellabs. Under that ruling, all of the allegations in the complaint must be considered, the circuit court concluded. This contrasts with the circuit’s prior jurisprudence which required that each allegation be considered separately and that the facts pled demonstrate that the statements or omissions were made either “intentionally” or with “deliberate recklessness” under In re Silicon Graphics Inc. Sec. Litig., 183 F.3d 970, 985 (9th Cir. 1999). To harmonize its prior jurisprudence, with Tellabs, the court held that both approaches should be used. This requires a two step analysis: First, the court must examine each allegation under Silicon Graphics; second, the holistic Tellabs approach will be used. This is the same conclusion the court reached in Digmarc Corporation – but that decision is not cited here.
The court concluded that plaintiffs failed to plead a strong inference of scienter under its two step analysis. The court characterized the claims in the complaint as little more than allegations regarding “motive and opportunity” which are insufficient to plead a strong inference of scienter.
The approach of the Ninth Circuit in Digmarc Corporation and Capital Bancorp appears at odds with Tellabs. In that case, the Supreme Court resolved a dispute among the circuits over what constitutes a strong inference of scienter within the meaning of the PSLRA. The split the court resolved focused on the meaning of the “strong inference” language incorporated in the Reform Act from the then-existing Second Circuit case law. Essentially the circuits adopted conflicting readings of the complex legislative history of the Section.
In the dispute among the circuits, the Second Circuit concluded that its “motive and opportunity” test was a type of proof which could establish a strong inference. The Ninth Circuit took a different approach. After reviewing the legislative history of the Section and the statutory language in Silicon Graphics, the court concluded that a strong inference is only pled if it constitutes intentional conduct or deliberate recklessness. Every other circuit which considered the Ninth Circuit test rejected this standard.
Tellabs resolved the split among the circuits, holding that all inferences must be considered and that the competing inferences must be compared. This holding is based squarely on the PSLRA statutory language.
By combining Silicon Graphics with Tellabs, the Ninth Circuit reaffirmed its pre-Tellabs reading of Section 21D(b)(2), which was part of the circuit split the Supreme Court resolved. This is clearly an incorrect reading of Tellabs. Digmarc Corporation and Capital Bancorp thus appear to be setting the stage for another split among the circuits over the proper pleading standard.