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Supreme Court Raises Proof Thresholds on Shareholder Class Action Lawsuits

Supreme Court Raises Proof Thresholds on Shareholder Class Action Lawsuits

In Tellabs, Inc., et al. v. Makor Issues & Rights, LTD., et al., decided June 21, 2007, the United States Supreme Court resolved disagreement among lower courts regarding proof thresholds required under the 1995 Public Litigation Securities Reform Act.

In Tellabs, the Supreme Court heightened investors’ proof level in shareholder class action lawsuits, making it harder for class action securities lawsuits to make it to trial. By an 8-1 vote, the Justices ruled plaintiffs must show executives knew they were engaged in wrong doing.

The appeal to the Supreme Court involved a securities fraud complaint against Tellabs, Inc., a maker of equipment for fiber optic networks. Plaintiffs alleged Tellabs’ senior executives issued overly optimistic financial statements incentivising shareholders to invest.

Investors accused the company and its top executives of overstating projections of revenues. The lower federal court held the case could proceed to trial if “a reasonable person could infer that the defendant acted with the required intent.” The Supreme Court’s ruling sets the bar much higher.

Under Tellabs, the Court ruled shareholdings bringing class action securities lawsuits must supply evidence the corporate officers actually were engaged in, or had knowledge of, securities fraud to some degree. The Opinion, written by Justice Ruth Bader Ginsburg, makes it more difficult for investors to file successful lawsuits alleging they lost money because company officials violated U.S. securities laws.

Under the ruling, a shareholder class action lawsuit will survive only if the facts alleged in the complaint are “cogent and compelling” in establishing an intent to deceive investors. Those factual allegations must be as least as compelling as “any opposing inference” suggesting innocence.

The standard will be applied at the very start of securities fraud litigation, which means, many lawsuits face dismissal at the early battle stages.

June, 2007
Claudia L. Stringfield-Johnson

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