The Private Securities Litigation Reform Act of 1995 (the "Reform Act" or "Act")¹ adopted uniform requirements for pleading scienter in a private action under Section 10(b) of the Securities Exchange Act of 1934 ("Exchange Act").² This case raises the question of the proper interpretation of that provision. This Court's interpretation of the provision will have a significant impact on the Reform Act's effectiveness and on the federal securities laws' protection of investors. For that reason, the Securities and Exchange Commission, the agency principally responsible for the administration and enforcement of the federal securities laws, submits this brief as amicus curiae.

The Reform Act requires that the plaintiff's complaint in a private action³ "state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind."⁴ This "strong inference" formulation is modeled after the Second Circuit's standard for pleading scienter, which requires "plaintiffs to allege facts that give rise to a strong inference of fraudulent intent."⁵ The Second Circuit has construed that standard as being met, in the absence of direct evidence of the defendant's intent, by either (1) strong circumstantial evidence of conscious or reckless misbehavior, or (2) facts showing motive and opportunity to commit the fraud.⁶

The district court addressed the question whether the Reform Act eliminated recklessness, and motive and opportunity, as bases for pleading scienter. It concluded that both had been eliminated.

Recklessness. The Commission believes that the district court erred in holding that the new pleading standard eliminates recklessness as a basis for pleading scienter in private actions. It would make no sense to eliminate recklessness as a basis for pleading scienter if, as all courts of appeals to have considered the issue have held, recklessness suffices to establish liability. Neither the Reform Act nor its legislative history reflects any intention of eliminating recklessness as a basis for liability. The recklessness standard has long been recognized by the federal courts and is essential to investor protection.

Motive and Opportunity. The Commission also believes that the district court erred in holding that pleading motive and opportunity does not satisfy the Reform Act's requirement for pleading scienter. The Second Circuit's motive and opportunity test -- which requires a rational economic motive and an opportunity to achieve concrete benefits -- is an effective tool allowing courts to distinguish cases where fraud is likely to have occurred from non-meritorious cases. The motive and opportunity test is important to investor protection because it allows credible claims of securities fraud to proceed where strong circumstantial evidence of conscious behavior or recklessness may be lacking.

Congress recognized that the Commission would play an active role in the interpretation of the Reform Act. As Senator Bradley put it during the floor debate, "the Commission needs to make clear which part of the second circuit pleading standard is to be enforced and how."⁷ The Commission has long recognized that private antifraud actions are an essential supplement to the Commission's own enforcement efforts. At the same time, the Commission has recognized that investors are not well served by frivolous lawsuits. The Reform Act attempts to balance these interests by raising the threshold for pleading fraud in order to exclude nonmeritorious cases at an early point, thereby avoiding the often enormous costs that discovery can impose on defendants. At the same time, Congress did not intend to create a bar to meritorious claims. Setting the pleading threshold too high, however, would have precisely that effect.

The Commission believes that Congress intended that courts interpreting the Reform Act's "strong inference" standard would apply the tests that the Second Circuit has developed to implement that standard. Even if this Court determines that this result is not compelled by the Reform Act, the Second Circuit's well-developed tests for pleading scienter are consistent with the purposes of the Reform Act and adoption of those tests will help achieve Congress's goal of bringing greater uniformity to pleading standards.⁸

This case was brought as a class action on behalf of purchasers of shares of Comshare, Inc., during a class period in which, it is alleged, the price of the shares was artificially inflated because of false and misleading statements about the company's revenues made by the defendants. Relief is sought under Section 10(b) of the Exchange Act and Rule 10b-5.⁹

Defendants moved to dismiss the complaint largely on the ground that it did not meet the requirements of the Reform Act for pleading scienter. In ruling in favor of the defendants, the district court rejected the Second Circuit's tests for pleading scienter, under which plaintiffs may plead scienter by alleging facts (1) constituting circumstantial evidence of either reckless or conscious misbehavior, or (2) establishing a motive to commit fraud and an opportunity to do so.¹⁰ The district court instead held that "the legislative history makes explicitly clear that it is not enough to allege recklessness, or motive and opportunity, in order to establish a defendant's scienter in a securities fraud case" and that "under the requirements of the PSLRA plaintiffs must plead specific facts that create strong inference of knowing misrepresentation on the part of the defendants."

Although posed as a question of the proper standard for pleading under the Reform Act, the decision effectively eliminated recklessness as a standard for liability in private actions under Section 10(b) and Rule 10b-5, and it eliminated both recklessness and the motive and opportunity test as bases for pleading scienter. While some courts have accepted this holding of the district court,¹¹ most district courts to decide the question have held that the Second Circuit tests for pleading scienter, which include both recklessness and motive and opportunity to commit fraud, are appropriately applied under the Reform Act for pleading scienter.¹² No court of appeals has decided the question to date.¹³

Applying its knowing misrepresentation standard to the allegations of the complaint, the distict court found that the plaintiffs had not adequately alleged scienter and dismissed the complaint. This appeal followed.

The debate over the Reform Act's requirement that a plaintiff "state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind"¹⁴ has its genesis in the Act's legislative history. The "strong inference" standard for pleading scienter originated in S. 240, a precursor to the bill that became the Reform Act. As reported by the Senate Banking Committee, S. 240 mandated that the complaint "specifically allege facts giving rise to a strong inference that the defendant acted with the required state of mind." The report accompanying S. 240 explained the basis for this standard:

The Committee does not adopt a new and untested pleading standard that would generate additional litigation. Instead, the Committee chose a uniform standard modeled upon the pleading standard of the Second Circuit. Regarded as the most stringent pleading standard, the Second Circuit requires that the plaintiff plead facts that give rise to a "strong inference" of defendant's fraudulent intent. The Committee does not intend to codify the Second Circuit's case law interpreting this pleading standard, although courts may find this body of law instructive.¹⁵

The Senate Banking Committee's report leaves little doubt that Congress modeled the Act's pleading standard on the Second Circuit's.

Senator Specter attempted to make this reliance on the Second Circuit standard even more explicit. He offered a floor amendment which would have provided that:

a strong inference that the defendant acted with the required state of mind may be established either --
(A) by alleging facts to show that the defendant had both motive and opportunity to commit fraud; or
(B) by alleging facts that constitute strong circumstantial evidence of conscious misbehavior or recklessness by the defendant.¹⁶

This amendment was based on the Second Circuit's formulation of the "strong inference" standard.¹⁷ The Senate adopted the Specter amendment,¹⁸ but it was deleted by the Conference Committee. The Conference Committee also changed the language of the standard from "specifically allege" to "plead with particularity" based on the recommendation of the Judicial Conference that the provision be amended to conform to the language of Rule 9(b) of the Federal Rules of Civil Procedure, which requires that "[i]n all averments of fraud or mistake, the circumstances constituting fraud or mistake shall be stated with particularity."¹⁹

The Conference Committee explained the standard it adopted in the Statement of Managers:

The Conference Committee language is based in part on the pleading standard of the Second Circuit. The standard also is specifically written to conform the language to Rule 9(b)'s notion of pleading with "particularity."

Regarded as the most stringent pleading standard, the Second Circuit requirement is that the plaintiff state facts with particularity, and that these facts, in turn, must give rise to a "strong inference" of the defendant's fraudulent intent. Because the Conference Committee intends to strengthen existing pleading requirements, it does not intend to codify the Second Circuit's case law interpreting this pleading standard.²⁰

To the last sentence of this passage was appended a footnote further explaining the Committee's decision to omit the Specter amendment: "For this reason, the Conference Report chose not to include in the pleading standard certain language relating to motive, opportunity, or recklessness."²¹ No further explanation is offered by the Statement of Managers.

In the floor debate, Senator Domenici, one of the Conference Committee Managers, stated that "the conference report adopts the pleading standard utilized by the second circuit court of appeals."²² Senator Dodd, another of the managers, agreed that the Conference Committee had "adopt[ed] the Second Circuit Court of Appeals standard."²³

Notwithstanding these statements from the bill's managers of their intent to adhere to the Second Circuit standard, the President cited the Statement of Managers as one of his reasons for vetoing the Reform Act. In his veto message, he stated:

I believe that the pleading requirements of the Conference Report with regard to a defendant's state of mind impose an unacceptable procedural hurdle to meritorious claims being heard in Federal courts. I am prepared to support the high pleading standard of the U.S. Court of Appeals for the Second Circuit -- the highest pleading standard of any Federal circuit court. But the conferees make crystal clear in the Statement of Managers their intent to raise the standard even beyond that level. I am not prepared to accept that.

The conferees deleted an amendment offered by Senator Specter and adopted by the Senate that specifically incorporated Second Circuit case law with respect to pleading a claim of fraud. Then they specifically indicated that they were not adopting Second Circuit case law but instead intended to "strengthen" the existing pleading requirements of the Second Circuit. All this shows that the conferees meant to erect a higher barrier to bringing suit than any now existing -- one so high that even the most aggrieved investors with the most painful losses may get tossed out of court before they have a chance to prove their case.²⁴

In the floor debate following the President's veto, Senator Dodd argued the President had "reversed course on the pleading standards" which the President had previously endorsed.²⁵ Senator Dodd explained that the Conference Committee had omitted the Specter amendment because it "did not really follow the guidance of the second circuit."²⁶ In Senator Dodd's view, the Specter amendment "omits that where a motive is not apparent, the strength of circumstantial evidence must be correspondingly greater."²⁷ In his view, the pleading provision, contrary to the President's belief, "met [the Second Circuit] standard. We have left out the guidance. That does not mean you disregard it."²⁸ Senator Domenici reiterated that the Reform Act's pleading standard "is the Second Circuit's pleading standard" and was a "codification of the Second Circuit rule."²⁹ He pointed out that President Clinton's reliance on the language from the statement of managers was misplaced because "[a] statement of managers is not law, everyone knows that."³⁰ Evidently rejecting President Clinton's arguments, Congress voted to override his veto.

The language and legislative history of the Reform Act leave no doubt that Congress adopted the Second Circuit's "strong inference" formulation for pleading the Reform Act's "required state of mind." Because Congress adopted the Second Circuit's "strong inference" standard, absent contrary evidence, it may be presumed that it intended to adopt the judicial constructions of that standard.³¹ The settled judicial construction of that pleading standard includes both the circumstantial evidence of scienter test and the motive and opportunity test. Thus, Congress intended that courts would rely on the these Second Circuit tests in interpreting the pleading standard of the Reform Act.

Whether or not that result is compelled as a matter of legislative intent, Congress certainly did not foreclose the possibility of the use of the Second Circuit tests in applying the Reform Act's pleading standard. At a minimum, therefore, this Court has the discretion to adopt the Second Circuit's tests as its own under the Reform Act. Applying the Second Circuit's well-developed circumstantial evidence of scienter and motive and opportunity tests is consistent with the purposes of the Reform Act and will help achieve Congress's goal of bringing greater uniformity to pleading standards.³²

The Reform Act requires plaintiffs to plead with "particularity facts giving rise to a strong inference that the defendant acted with the required state of mind." The Act does not specify the "state of mind" required, leaving undisturbed the well-settled proposition that recklessness satisifies the scienter requirement of Section 10(b). Because this Court has accepted that proposition, the plain text of the Reform Act mandates that recklessness suffices to plead scienter, even if this Court declines to follow the Second Circuit tests.

I. EVIDENCE OF RECKLESSNESS SUFFICES TO PLEAD SCIENTER UNDER THE REFORM ACT AND TO ESTABLISH LIABILITY UNDER SECTION 10(b).

The Commission and the courts have long construed the scienter element of Section 10(b) as being satisfied by recklessness -- a construction necessary to protect investors and the integrity of the disclosure process. In Ernst & Ernst v. Hochfelder, although the Supreme Court left open the question of whether recklessness could satisfy the scienter requirement of Section 10(b) and Rule 10b-5, the Court explicitly recognized that "in certain areas of the law recklessness is considered to be a form of intentional conduct for purposes of imposing liability for some act."³³ In the 21 years since the Supreme Court's decision in Hochfelder, every court of appeals that has considered the question, including this Court, has held that recklessness is sufficient to establish liability under Section 10(b) and Rule 10b-5.³⁴

Except in the case of forward-looking statements, the Reform Act does not change the state of mind necessary to establish liability under Section 10(b) and Rule 10b-5. That the pleading standard provision does not do so is apparent from its very language, which refers to the "required state of mind," thus requiring reference to the substantive law to determine what is the required level of culpability.³⁵ Construing the Reform Act's pleading standard provision as eliminating recklessness would convert what was intended to be a procedural provision into a substantive change in the definition of scienter. It would, in effect, eliminate recklessness (in private actions) from the uniformly accepted definition of scienter. Because the substantive law allows liability for recklessness, it follows that plaintiffs must be allowed to plead that the defendants acted recklessly. If plaintiffs can state with particularity facts giving rise to a strong inference that defendants acted recklessly, their complaint is sufficient under the Reform Act.

The threshold for a finding of recklessness is quite high. Although the definition of recklessness varies somewhat in different courts, most of the federal courts of appeals, including this Court, follow the standard enunciated by the Seventh Circuit in Sundstrand Corporation v. Sun Chemical Corp.,³⁶ or some variant thereof.³⁷ In Sundstrand, the court defined a reckless omission as:

a highly unreasonable omission, involving not merely simple, or even inexcusable negligence, but an extreme departure from the standards of ordinary care, and which presents a danger of misleading buyers or sellers that is either known to the defendant or is so obvious that the actor must have been aware of it.³⁸

In short, the recklessness standard requires a high level of culpability -- a standard clearly distinguishable from negligence.

Recklessness is essential to the effective functioning of Section 10(b). Proving a defendant's actual knowledge of fraud in a securities case can be a daunting task, particularly when, as is frequently the case, the evidence relating to the defendant's state of mind is entirely circumstantial. Rarely will the defendant admit his fraudulent intent. As this Court stated in deciding that recklessness was the appropriate standard: "Requiring a plaintiff to show that the defendant acted with actual subjective intent to defraud could impose a great burden upon recovery, greatly limiting the § 10(b)/Rule 10b-5 claim."³⁹ The Commission itself often relies on the recklessness standard in its own law enforcement cases.

Contrary to the views of the district court, the footnote in the Statement of Managers about choosing "not to include in the pleading standard certain language relating to motive, opportunity, or recklessness" does not mean that recklessness has been eliminated either as a basis for liability or as a pleading standard. Congress also declined to include language relating to conscious behavior in the pleading standard, but no one would suggest that conscious behavior no longer suffices for pleading. The Statement of Managers' footnote related to the Conference Committee's deletion of the Specter amendment, which would have specifically incorporated recklessness as a pleading standard. The Commission believes that the district court court misread that footnote when it rejected recklessness.

The Specter amendment failed to reflect the fact that recklessness was no longer sufficient for liability under certain circumstances. While Congress did not eliminate recklessness generally as a basis for liability under Section 10(b) and Rule 10b-5, it did do so in cases based upon fraudulent forward-looking statements. Under the Reform Act's safe harbor provision, a plaintiff must prove that a forward-looking statement was made with actual knowledge that it was false or misleading.⁴⁰ Since plaintiffs must prove actual knowledge in the case of allegedly misleading forward-looking statements that are covered by the safe harbor, it follows that plaintiffs are now required to plead with particularity facts giving rise to a strong inference that the defendant acted with actual knowledge in such cases. With respect to other allegedly misleading statements, however, the Reform Act makes no attempt to prescribe a new and stricter standard for liability. A recklessness standard for pleading that would apply in all cases would be inconsistent with the Reform Act provision for forward-looking statements, which requires actual knowledge in certain cases.

II. MOTIVE AND OPPORTUNITY SUFFICES TO PLEAD SCIENTER UNDER THE REFORM ACT.

The district court relied on the Statement of Managers in holding that the motive and opportunity test does not satisfy the Reform Act's pleading standard. A close reading of the Reform Act's legislative history and the Second Circuit's case law demonstrates that the district court erred in so holding. Congress declined to include the Specter amendment's language relating to motive and opportunity, not because it wanted to discard the motive and opportunity test, but rather, because the Specter amendment did not reflect two essential features of that test: (1) the motive and opportunity test imposes a different burden upon plaintiffs than does the circumstantial evidence test; and (2) it requires a rational economic motive and an opportunity to achieve concrete benefits. These features are necessary to ensure that the motive and opportunity test serves Congress's dual goals in adopting the Reform Act's pleading requirement: allowing meritorious cases to proceed, and weeding out meritless claims at an early stage.

1. The Specter amendment's attempted codification of the motive and opportunity test and the circumstantial evidence test for pleading scienter failed to reflect the different burdens imposed on plaintiffs by each of the tests. As Senator Dodd noted, the Specter amendment "omits that where a motive is not apparent, the strength of circumstantial evidence must be correspondingly greater."⁴¹ While Senator Specter disputed that this was an element of the Second Circuit test,⁴² Second Circuit case law supports Senator Dodd's view.⁴³

The motive and opportunity test establishes a lower threshold in cases where fraud is most likely to have occurred, such as where the misrepresentation was allegedly made to induce an investment, or where inflation of revenues is accompanied by large-scale insider trading.⁴⁴ Thus, the motive and opportunity test serves an important function by allowing the most credible claims of securities fraud to proceed when they might be derailed by the higher burden imposed by the circumstantial evidence test.

By contrast, the circumstantial evidence test requires a stronger showing in cases where the motive for committing fraud is not evident, such as where a company has restated its financial statements without any apparent gain by the corporation or the insiders responsible for the misrepresentations. Where the plaintiff cannot plead a rational economic motive, the circumstantial evidence test appropriately sets a higher threshold in order to deter meritless suits based solely on a drop in stock price.⁴⁵ As Senator Dodd's focus on this issue illustrates, Congress believed that it was important to retain the greater burden that Second Circuit case law imposes on plaintiffs who cannot adequately allege motive.⁴⁶ By failing to reflect the higher burden imposed on plaintiffs alleging only circumstantial evidence of scienter, the Specter amendment would have opened the door for claims of fraud based purely on hindsight, and would have weakened significantly the Second Circuit standard.

2. The Specter amendment was inconsistent with the Second Circuit's test for scienter in another way. In its most recent cases, the Second Circuit has demanded that the plaintiff plead a motive consistent with "informed economic self-interest" and an opportunity to "achiev[e] concrete benefits by the means alleged."⁴⁷ Moreover, "generalized motive, one which could be imputed to any publicly-owned, for-profit endeavor, is not sufficiently concrete for purposes of inferring scienter."⁴⁸ For this reason, conclusory allegations that defendants were attempting to inflate the stock price because they held shares in the company, to boost their compensation, or to retain their positions, do not suffice to plead a rational economic motive.⁴⁹ Nor do allegations that auditors were motivated to conduct a fraudulent audit in order to secure fees.⁵⁰ For the same reason, allegations that defendants sought "to maintain the appearance of corporate profitability, or of the success of an investment" do not establish a "concrete benefit."⁵¹

This test is considerably more demanding than the language of the Specter amendment. Unlike the Specter amendment, which could have been interpreted as permitting any allegation of motive and opportunity, this test requires plaintiffs to show a particularized economic benefit that the defendants could rationally expect to achieve through the fraudulent scheme alleged. The Conference Committee presumably believed that the codification offered by Senator Specter would have effectively watered down the Second Circuit standard, and thus, that the more general formulation adopted in the Reform Act would provide a more effective barrier for screening out non-meritorious lawsuits.

A rational economic motive and opportunity to achieve concrete benefits test better reflects the requirements of the most recent Second Circuit cases than the codification offered by the Specter amendment that the Conference Committee rejected. A formulation of the motive and opportunity test that includes these qualifications is more consistent with Congress's intent in adopting the pleading standards of the Reform Act than the Specter amendment's codification would have been.⁵² Absent these qualifications to the motive and opportunity test, any speculative allegation of motive conceivably could suffice to plead scienter, a result that would weaken the standard for pleading scienter in those circuits that previously had adopted a demanding test. By omitting the Specter amendment, the Conference Committee "strengthened" pleading standards.⁵³

Congress explicitly adopted the Second Circuit's formulation for pleading scienter when it enacted the Reform Act. Courts construing the Reform Act should apply that standard by using the proven tests that the Second Circuit has developed in the course of deciding many cases. The presumption that Congress intended this result is not overcome by the statute's legislative history, which is at best ambiguous, and in any event is not inconsistent with the motive and opportunity test. The key Congressional vote was not that taken pursuant to the Conference Report, but rather the subsequent vote taken after the President's veto. Statements made by the Reform Act's managers during the debate over whether to override the President's veto confirm that the pleading standard adopted by Congress was a "codification of the 2nd Circuit rule."⁵⁴ Because the bill's sponsors rejected the President's view that the Reform Act's pleading standards departed from the Second Circuit's standards, the view advocated by the sponsors in urging an override of the veto should govern in interpreting the Reform Act as enacted.⁵⁵ The Reform Act allows scienter to be pled either by alleging circumstantial evidence of scienter, or by alleging a rational economic motive and an opportunity to achieve concrete benefits through the fraud.

For the foregoing reasons, the Commission urges the Court to conclude that the pleading standard for scienter in the Reform Act is satisfied by recklessness or conscious behavior and that recklessness remains a basis for liability under Section 10(b); and that, alternatively, a plaintiff can plead scienter by showing a rational economic motive and an opportunity to achieve concrete benefits by committing fraud.

¹ Pub. L. No. 104-67, 109 Stat. 737 (1995).

² 15 U.S.C. 78j(b).

³ The decision in this case will have no effect on court actions and administrative proceedings instituted by the Commission because the Reform Act's pleading requirements apply only to private actions. Exchange Act § 21D(b)(2), 15 U.S.C. 78u-4(b)(2).

⁴ Exchange Act § 21D(b)(2).

⁵ Shields v. Citytrust Bancorp, Inc., 25 F.3d 1124, 1128 (2d Cir. 1994).

⁶ Id.

⁷ 141 Cong. Rec. S19,149 (1995).

⁸ The Commission only addresses the appropriate legal standard. It takes no position on the proper application of the Second Circuit tests to the allegations in the complaint, or any other issue presented in the case.

⁹ 17 C.F.R. 240.10b-5.

¹⁰ Shields, 25 F.3d at 1128.

¹¹ Havenick v. Network Express, Inc., No. 96-CV-74627-DT, 1997 U.S. Dist. LEXIS 16687, at *154-157 (E.D. Mich. Sept. 30, 1997) Voit v. Wonderware Corp., No. 96-CV. 7883, 1997 U.S. Dist. LEXIS 13856 (E.D. Pa. Sept. 8, 1997); Powers v. Eichen, No. 96-1431-B (AJB), 1997 U.S. Dist. LEXIS 11074 (S.D. Cal. Mar. 13, 1997); Norwood Venture Corp. v. Converse Inc., 959 F. Supp. 205, 208 (S.D.N.Y. 1997); Friedberg v. Discreet Logic, Inc., 959 F. Supp. 42, 48-49 (D. Mass. 1997); In re Silicon Graphics, Inc. Sec. Litig., No. C 96-0393, 1996 WL 664639, at *6, 7 (N.D. Cal. Sept. 25, 1996), modified in part, 970 F. Supp. 746 (N.D. Cal. 1997).

¹² Wiekel v. Tower Semiconductor Ltd., No. 96-3711 (D.N.J. Oct. 2, 1997); Gilford Ptnrs. L.P. v. Sensormatic Elec. Corp., 1997 U.S. Dist. LEXIS 13724 (N.D. Ill. Sept. 10, 1997); Galaxy Inv. Fund, Ltd. v. Fenchurch Capital Management, Ltd., 1997 U.S. Dist. LEXIS 13207 (N.D. Ill. Aug. 29, 1997); Pilarczyk v. Morrison Knudsen Corp., 965 F. Supp. 311, (N.D.N.Y. 1997); OnBank & Trust Co. v. FDIC, 967 F. Supp. 81, 88 & n.4 (W.D.N.Y. 1997); Page v. Derrickson, 1997 WL 148558, at *9 (M.D. Fla. 1997); Fugman v. Aprogenex, Inc., 961 F. Supp. 1190, 1195 (N.D. Ill. 1997); Rehm v. Eagle Fin. Co., 954 F. Supp. 1246, 1252 (N.D. Ill. 1997); In re Health Management Inc., 970 F. Supp. 192, 201 (E.D.N.Y. 1997); STI Classic Fund v. Bollinger Indus., Inc., 1996 WL 885802 (N.D. Tex. Oct. 25, 1996); Zeid v. Kimberley, 930 F. Supp. 431 (N.D. Cal. 1996); Marksman Partners, L.P. v. Chantal Pharmaceutical Corp., 927 F. Supp. 1297, 1309 n.9 (C.D. Cal. 1996). Other courts, while not rejecting recklessness, have held that motive and opportunity do not necessarily suffice to create a strong inference of fraud for the purposes of the Reform Act. See In re Baesa Securities Litig., 969 F. Supp. 238 (S.D.N.Y. 1997); Press v. Quick & Reilly Group, Inc., No. 96 Civ. 4278 (RPP) 1997 U.S. Dist. LEXIS 11609, at *5 (S.D.N.Y. Aug. 8, 1997) (following Baesa); In re Silicon Graphics Sec. Litig., No. C 96-0393 FMS, 1997 U.S. Dist. LEXIS 7551, at *29 (N.D. Cal. May 23, 1997) (rejecting the motive and opportunity test, but accepting pleading of "deliberate recklessness"); In re Glenayre Tech., Inc. Sec. Litig., No. 96 Civ. 8252 (HB), 1997 U.S. Dist. LEXIS 17313, at *6-10 (S.D.N.Y. Nov. 5, 1997) (rejecting the motive and opportunity test, but accepting pleading of "conscious recklessness").

¹³ The issue is pending, however, in the Ninth Circuit. See Zeid v. Kimberley, No. 97-16070; In re Silicon Graphics, Inc. Sec. Litig., No. 97-16240. The Commission has filed amicus briefs in both Zeid and Silicon Graphics, taking the same position as that taken here.

¹⁴ Exchange Act § 21D(b)(2).

¹⁵ S. Rep. No. 98, 104th Cong., 1st Sess. 15 (1995) (footnotes omitted).

¹⁶ 141 Cong. Rec. S9,222 (1995).

¹⁷ Shields, 25 F.3d at 1128.

¹⁸ 141 Cong. Rec. S9,200 (1995).

¹⁹ 141 Cong. Rec. S19,066-67 (1995).

²⁰ 141 Cong. Rec. H13,702 (1995)

²¹ 141 Cong. Rec. H13,704 n.23 (1995).

²² 141 Cong. Rec. S17,969 (1995).

²³ 141 Cong. Rec. S17,959 (1995).

²⁴ 141 Cong. Rec. H15,214 (1995).

²⁵ 141 Cong. Rec. S19,067 (1995).

²⁶ 141 Cong. Rec. S19,068 (1995).

²⁷ Id.

²⁸ Id.

²⁹ 141 Cong. Rec. S19,150 (1995).

³⁰ 141 Cong. Rec. S19,045 (1995).

³¹ See Cottage Savings Ass'n v. Commissioner, 499 U.S. 554, 562 (1991) ("Because these decisions were part of the 'contemporary legal context' in which Congress enacted [the statute] . . . we may presume that Congress intended to codify these principles"); Lorillard v. Pons, 434 U.S. 575, 581 (1978) ("[W]here, as here, Congress adopts a new law incorporating sections of a prior law, Congress normally can be presumed to have had knowledge of the interpretation given to the incorporated law, at least insofar as it affects the new statute."); Capital Traction Co. v. Hof, 174 U.S. 1, 36 (1899) ("By a familiar canon of interpretation, heretofore applied by this court whenever Congress, in legislating for the District of Columbia, has borrowed from the statutes of a state provisions which had received in that state a known and settled construction before their enactment by Congress, that construction must be deemed to have been adopted by Congress together with the text which it expounded, and the provisions must be construed as they were understood at the time in the State."); Employers' Liability Assur. Corp. v. Monahan, 91 F.2d 130, 133 (1st Cir. 1937) (where Congress adopts state law, federal court will follow interpretations of the state law by state court).

³² The Statement of Managers explains Congress' concern that the pleading requirements of Rule 9(b) of the Federal Rules of Civil Procedure had "not prevented abuse of the securities laws by private litigants" and that the courts of appeals had "interpreted Rule 9(b)'s requirement in conflicting ways." 141 Cong. Rec. H13,702 (1995); H.R. Rep. 369, 104th Cong. 1st Sess., at 88 (1995). The Statement of Managers also notes that Congressional hearings had "included testimony on the need to establish uniform and more stringent pleading requirements." Id.

³³ 425 U.S. 185, 193-94 n.12 (1976).

³⁴ See, e.g., Mansbach v. Prescott, Ball & Turben, 598 F.2d 1017, 1024 (6th Cir. 1979).

³⁵ See Baesa, 969 F. Supp. at 240 ("Since the Reform Act nowhere defines what the 'required state of mind' is for any of the kinds of actions that might be brought under this title, the definition must necessarily be found either elsewhere in the Exchange Act itself or (if the action is judicially implied) in the existing case law.").

³⁶ 553 F.2d 1033 (7th Cir.), cert. denied, 434 U.S. 875 (1977).

³⁷ See Hollinger v. Titan Capital Corp., 914 F.2d 1564, 1569 & n.8 (9th Cir. 1990), cert. denied, 499 U.S. 976 (1991) (citing cases).

³⁸ 553 F.2d at 1045 (citation omitted).

³⁹ Mansbach v. Prescott, Ball & Turben, 598 F.2d 1017, 1025 (6th Cir. 1979). See also Rolf v. Blyth, Eastman Dillon & Co., 570 F.2d 38, 46-47 (2d Cir.), cert. denied, 439 U.S. 1039 (1978)("To require in all types of 10b-5 cases that a factfinder must find a specific intent to deceive or defraud would for all intents and purposes disembowel the private cause of action under § 10(b)."); Hackbart v. Holmes, 675 F.2d 1114, 1118 (10th Cir. 1982) ("requiring the plaintiff to show [conscious] intent would be unduly burdensome"); G.A. Thompson & Co. v. Partridge, 636 F.2d 945, 962 n.32 (5th Cir. 1981); cf. Herman & MacLean v. Huddleston, 459 U.S. 375, 390-91 n.30 (1983)("If anything, the difficulty of proving the defendant's state of mind supports a lower standard of proof" [i.e., a preponderance of the evidence rather than clear and convincing evidence].).

⁴⁰ Exchange Act § 21E(c)(1)(B), 15 U.S.C. 78u-5(c)(1)(B).

⁴¹ 141 Cong. Rec. S19,150 (1995).

⁴² The exchange between Senator Dodd and Senator Specter on this point is found at 141 Cong. Rec. S17,960 (1995).

⁴³ See Beck v. Manufacturers Hanover Trust Co., 820 F.2d 46, 50 (2d Cir. 1987), cert. denied, 484 U.S. 1005 (1988).

⁴⁴ See, e.g., Cohen v. Koenig, 25 F.3d 1168, 1172 (2d Cir. 1994) (finding adequate motive where defendants' misrepresentations of the company's assets and revenues allegedly induced plaintiff to extend credit).

⁴⁵ See Tuchman v. DSC Comm. Corp., 14 F.3d 1061, 1068 (5th Cir. 1994) ("Where a defendant's motive is not apparent, a plaintiff may adequately plead scienter by identifying circumstances that indicate conscious behavior on the part of the defendant, though the strength of the circumstantial allegations must be correspondingly greater."); Zucker v. Sasaki, 963 F. Supp. 301, 309 (S.D.N.Y. 1997) ("[W]here motive is not alleged and plaintiff relies entirely on allegations of recklessness in asserting scienter, the evidence presented must be proportionally greater.").

⁴⁶ Some courts have suggested that motive and opportunity should be used simply as factors to be considered in evaluating circumstantial evidence of conscious behavior or recklessness. See In re Baesa Sec. Litig., 969 F. Supp. at 242 ("[T]he mere pleading of motive and opportunity does not, of itself, automatically suffice to raise a strong inference of scienter. This, of course, does not mean that particulars regarding motive and opportunity may not be relevant to pleading circumstances from which a strong inference of scienter may be inferred. In some cases, they may even be sufficient by themselves to do so. But, under the Reform Act, and in contrast to prior Second Circuit precedent, they are not presumed sufficient to do so. Rather, under the Reform Act formulation, the pleadings must set forth sufficient particulars, of whatever kind, to raise a strong inference of the required scienter."). The Commission disagrees with this approach because such a test is likely to produce varying applications of the pleading standards, a result contrary to Congress's goal of uniformity. Properly construed, the motive and opportunity test gives rise to a strong inference of scienter.

⁴⁷ Shields v. Citytrust Bancorp, Inc., 25 F.3d 1124, 1130 (2d Cir. 1994).

⁴⁸ Chill v. General Electric Co., 101 F.3d 263, 268 (2d Cir. 1996).

⁴⁹ See Acito v. IMCERA Group, Inc., 47 F.3d 47, 54 (2d Cir. 1995) ("[T]he existence, without more, of executive compensation dependent upon stock value does not give rise to a strong inference of scienter."); Shields, 25 F.3d at 1130 ("[A] plaintiff must do more than merely charge that executives aim to prolong the benefits of the positions they hold."). See also In re Burlington Coat Factory Sec. Litig., 114 F.3d 1410, 1423 n.12 (3d Cir. 1997) ("Plaintiffs . . . allege, generally, that the individual officer-defendants sought to inflate the company's stock price so as to >protect, perpetuate and enhance their executive positions and the substantial compensation, prestige and other perquisites of executive employment obtained thereby.' . . . This general allegation, however, does not help plaintiffs in adequately alleging scienter because they fail to explain to us how a temporary inflation of BCF's stock price would help management increase its compensation or preserve its jobs. . . . As a general matter, . . . causing temporary inflations of price through the dissemination of false information hurts the long-term stock price of the company and thereby presumably hurts managerial compensation that may be tied to the long-term performance of the company. This is so because these disseminations of false information (that are eventually discovered by the market) increase the volatility of the company's stock and in turn increase its risk and long-term price."); Serabian v. Amoskeag Bank Shares, Inc., 24 F.3d 357, 368 (1st Cir. 1994) ("[A]llegations that defendants committed fraud to save their salaries or jobs ordinarily will not be enough to support a reasonable inference of scienter if the complaint lacks any other basis for inferring fraudulent intent."); Melder v. Morris, 27 F.3d 1097, 1102 (5th Cir. 1994) ("Accepting the plaintiffs' allegation of motive -- basically that the defendant officers and directors were motivated by incentive compensation -- would effectively eliminate the state of mind requirement as to all corporate officers and defendants.").

⁵⁰ See Melder, 27 F.3d at 1103.

⁵¹ Chill, 101 F.3d at 268. See id. at 268 n.5 ("If we accept this as sufficient motive, then we must accept as motive that every publicly-held corporation desires its stock to be priced highly by the market. At that point, the motive requirement becomes meaningless.").

⁵² While there are Second Circuit cases that do not appear to conform to this stringent formulation, see In re Time Warner Sec. Litig., 9 F.3d 259, 274, cert. denied, 511 U.S. 1017 (1994) (Winter, J., dissenting) (arguing that the majority opinion allowed the motive and opportunity test to be satisfied under circumstances that did not appear likely to produce concrete benefits), subsequent Second Circuit cases have been more restrictive in applying the motive and opportunity test. See, e.g., San Leandro Emergency Medical Group Profit Sharing Plan v. Philip Morris Cos., 75 F.3d 801, 813-814 (2d Cir. 1996). San Leandro (an opinion written by the author of Time Warner) rejected a generalized allegation that "a company's desire to maintain a high bond or credit rating" was sufficient to plead scienter "because if scienter could be pleaded on that basis alone, virtually every company in the United States that experiences a downturn in stock price could be forced to defend securities fraud actions." Id. at 814 (citations and internal quotation marks omitted). The court also held that: "the sale of stock by one company executive does not give rise to a strong inference of the company's fraudulent intent; the fact that other defendants did not sell their shares during the relevant class period sufficiently undermines plaintiffs' claim regarding motive." Id. Thus, the clear trend in the Second Circuit's decisions has been toward more searching scrutiny of allegations of motive and opportunity.

⁵³ See supra p. 11.

⁵⁴ 141 Cong. Rec. S19,150-151 (1995) (statement of Senator Domenici). See also 141 Cong. Rec. S19,068 (1995) (statement of Senator Dodd: "We have met the second circuit standard here").

⁵⁵ See NLRB v. Robbins Tire & Rubber Co., 437 U.S. 214, 235 (1978) (rejecting interpretation set forth in Presidential veto message where supporters of the legislation disagreed with the President's interpretation during post-veto debate).

On December 1, 1997, I caused to be served, by Federal Express overnight delivery, copies of the foregoing Brief of the Securities and Exchange Commission, Amicus Curiae, on Arthur Stock, Berger & Montague, P.C., 1622 Locust Street, Philadelphia, PA 19103-6365, counsel for Plaintiffs-Appellants, and on Donald Young, Dykema Gossett, PLLC, 400 Renaissance Center, Detroit, MI 48243, counsel for Defendants-Appellees.