Supreme Court Raises Bar for Investors Bringing Securities Fraud Suits

The U.S. Supreme Court last Thursday imposed a strict standard that investors must meet to keep alive their lawsuits alleging securities fraud.

In an 8-1 decision, the justices said that courts must weigh possible innocent explanations for defendants’ conduct at the very start of a securities fraud case. Doing so can lead to early dismissal of investors’ lawsuits.

The ruling came in a shareholders suit against high-tech company Tellabs Inc.

The firm misled investors by engaging in a scheme to inflate Tellabs’ stock price from December 2000 to June 2001, according to the lawsuit. It said the company’s CEO provided false assurances of robust demand for the company’s products.

A lawsuit will survive only if the facts alleged in it are “cogent and compelling” in pointing to an intent to deceive, wrote Ruth Bader Ginsburg. Those factual allegations must be at least as compelling as “any opposing inference” suggesting innocence, she added.

The Supreme Court decision comes as the corporate world pushes regulators to roll back some safeguards put in place after the accounting scandals that brought down Enron Corp. and WorldCom Inc.

The business community says the Tellabs case is the kind of meritless claim that Congress intended to prohibit when it reformed securities law 12 years ago.

Under the 1995 reforms, a securities fraud complaint must allege facts giving rise to a “strong inference” that defendants acted with an intent to deceive investors.

The 7th U.S. Circuit Court of Appeals had ruled against Tellabs, saying the complaint should survive if a reasonable person could infer from the allegations that defendants’ conduct was intentionally deceptive.

“That one-sided approach, we hold, was erroneous,” Ginsburg said in court.

The justices sent the case back so that the lower courts can assess whether the lawsuit should survive.

Last Monday, the court dealt another setback to investors when it sided with Wall Street investment banks that allegedly colluded to drive up the price of 900 technology stocks in the late 1990s. Shareholders subsequently lost billions when the dot-com bubble burst.

Next fall, the court will consider a case that could make it impossible for Enron shareholders to recover money from Wall Street institutions that allegedly assisted the energy company in disguising its financial problems.