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Stanford University Law School - Securities Class Action Clearinghouse
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BRUCE G. VANYO, State Bar # 060134
SUSAN A. CREIGHTON, State Bar # 135528
JEROME F. BIRN, JR., State Bar # 128561
LLOYD WINAWER, State Bar # 157059
DAVID PRIEBE, State Bar # 148679
WILSON SONSINI GOODRICH & ROSATI
Professional Corporation
650 Page Mill Road
Palo Alto, California 94304-1050
Telephone: (415) 493-9300
Attorneys for Defendants
EDWARD R. McCRACKEN, MICHAEL RAMSAY,
ROBERT K. BURGESS, FOREST BASKETT,
WILLIAM M. KELLY, TERUYASU SEKIMOTO,
and SILICON GRAPHICS, INC.
UNITED STATES DISTRICT COURT
NORTHERN DISTRICT OF CALIFORNIA
In re SILICON GRAPHICS, INC. ) LEAD CASE NO.: C-96-0393 FMS
SECURITIES LITIGATION )
) Consolidated Cases:
__________________________________ ) C-96-0393
) C-96-0631
) C-96-1111
This document relates to the )
consolidated securities class ) CLASS ACTION
actions: )
) DEFENDANTS' MEMORANDUM
Brody v. McCracken, C-96-0393 ) IN RESPONSE TO
Reiner v. McCracken, C-96-0631 ) CONTENTIONS REGARDING
Krim v. McCracken, C-96-1111 ) PLEADING STANDARDS IN
) PLAINTIFF'S MOTION FOR
) INTERLOCUTORY APPEAL,
) PLAINTIFF'S OPPOSITION TO
) MOTION TO DISMISS, AND
) AMICUS BRIEF OF THE
) SECURITIES & EXCHANGE
) COMMISSION
)
) Date: April 25, 1997
) Time: 10:00 a.m.
) Ctrm: Honorable
____________________________________) Fern M. Smith
DEFS' MEMO RE: PLEADING STANDARDS
C-96-0393 FMS
TABLE OF CONTENTS
INTRODUCTION .................................................... 1
ARGUMENT ........................................................ 4
I. FROM HOCHFELDER THROUGH CENTRAL BANK, THE SUPREME
COURT DECLINED TO ENDORSE SECTION 10(b) LIABILITY
FOR LESS THAN KNOWING OR INTENTIONAL BEHAVIOR ......... 5
II. SECTION 21D(b)(2) OF THE REFORM ACT REQUIRES THE
PLEADING OF FACTS SUFFICIENT TO SUPPORT A STRONG
INFERENCE OF KNOWING OR INTENTIONAL MISCONDUCT ........ 7
A. In the Second Circuit, a Line of Pre-Reform
Act Decisions Had Imposed a Pleading
Requirement Consistent With Hochfelder ........... 8
B. The Conference Committee Expressly Rejected
Allegations of Mere Recklessness as a Basis
for Pleading Under Section 10(b) ................ 11
C. The Remainder of the Reform Act's Legislative
History Also Shows that Congress Had Rejected
a Pleading Standard of Mere Recklessness ........ 15
CONCLUSION ..................................................... 18
DEFS' MEMO RE: PLEADING STANDARDS
C-96-0393 FMS i
TABLE OF AUTHORITIES
CASES
Aaron v. Securities & Exchange Comm'n,
446 U.S. 680 (1980) ........................................ 5
Acito v. IMCERA Group,
47 F.3d 47 (2d Cir. 1995) ............................. 10, 11
Beck v. Manufacturers Hanover Trust Co.,
820 F.2d 46 (2d Cir. 1987) ............................ passim
Boley v. Pineloch Assocs., Ltd.,
[1990 Tr. Binder] Fed. Sec. L. Rep. (CCH) ¶ 95,407
(S.D.N.Y. Aug. 2, 1990) .................................... 9
Central Bank v. First Interstate Bank,
511 U.S. 164 (1994) .............................. 2, 6, 9, 14
Derry v. Peek,
14 App. Cas. 337 (U.K. 1889) ............................... 6
D'Orange v. Feeley,
877 F. Supp. 152 (S.D.N.Y. 1995) .......................... 10
Ernst & Ernst v. Hochfelder,
425 U.S. 185 (1976) ................................... passim
Finkel v. Stratton Corp.,
754 F. Supp. 318 (S.D.N.Y. 1990),
dismissal of other claims reversed,
962 F.2d 169 (2d Cir. 1992) ............................... 10
Friedberg v. Discreet Logic Inc.,
___ F. Supp. ___, 1997 WL 109228
(D. Mass. Mar. 7, 1997) .................................... 1
Goldman v. McMahan, Brafman, Morgan & Co.,
706 F. Supp. 256 (S.D.N.Y. 1989) ........................... 8
Herman & MacLean v. Huddleston,
459 U.S. 375 (1983) ........................................ 5
In re Fischbach Corp. Sec. Litig.,
[1995 Tr. Binder] Fed. Sec. L. Rep. (CCH) ¶ 98,665
(S.D.N.Y. Jan. 15, 1992) ............................... 8, 13
In re Leslie Fay Companies, Inc. Sec. Litig.,
835 F. Supp. 167 (S.D.N.Y. 1993) ........................... 9
In re Leslie Fay Companies, Inc. Sec. Litig.,
871 F. Supp. 686 (S.D.N.Y. 1995) ................... 2, 3-4, 9
In re Silicon Graphics, Inc. Sec. Litig.,
[1996-97 Tr. Binder] Fed. Sec. L. Rep. (CCH) ¶ 99,325
(N.D. Cal. Sept. 25, 1996) ............................. 4, 15
In re Time Warner Inc. Sec. Litig.,
9 F.3d 259 (2d Cir. 1993), cert. denied,
511 U.S. 1017 (1994) .................................. passim
Keenan v. D.H. Blair & Co.,
838 F. Supp. 82 (S.D.N.Y. 1993) ............................ 9
Kimmel v. Labenski,
[1990-91 Tr. Binder] Fed. Sec. L. Rep. (CCH) ¶ 95,869
(S.D.N.Y. Dec. 13, 1990) .................................. 10
Kohn v. American Metal Climax, Inc.,
458 F.2d 255 (3d Cir. 1972) ............................. 6, 7
Laro, Inc. v. Chase Manhattan Bank,
866 F. Supp. 132 (S.D.N.Y. 1994), aff'd,
60 F.3d 810 (1995) ........................................ 10
Mayer v. Oil Field Sys. Corp.,
803 F.2d 749 (2d Cir. 1986) ................................ 9
DEFS' MEMO RE: PLEADING STANDARDS
C-96-0393 FMS ii
Ochs v. Shearson Lehman Hutton Inc.,
768 F. Supp. 418 (S.D.N.Y. 1991) ........................... 9
Plaut v. Spendthrift Farms,
514 U.S. 211, 115 S. Ct. 1447 (1995) ....................... 2
Powers v. British Vita,
P.L.C., 57 F.3d 176 (2d Cir. 1995) ........................ 10
Reiss v. Pan American World Airways, Inc.,
711 F.2d 11 (2d Cir. 1983) ................................. 9
Salzmann v. Prudential-Bache Secs.,
[1993 Tr. Binder] Fed. Sec. L. Rep. (CCH) ¶ 97,608
(S.D.N.Y. Mar. 12, 1993) ................................... 9
San Leandro Emergency Med. Profit Sharing Plan v.
Philip Morris Cos.,
75 F.3d 801 (2d Cir. 1996) ............................ 10, 11
Santa Fe Indus., Inc. v. Green,
430 U.S. 462 (1977) ..................................... 5, 6
Securities & Exchange Comm'n v. Texas Gulf Sulphur Co.,
401 F.2d 833 (2d Cir. 1968) ............................. 7, 9
Seidenberg v. Drexel Assocs.,
[1990 Tr. Binder] Fed. Sec. L. Rep. (CCH) ¶ 95,477
(S.D.N.Y. Sept. 5, 1990) .................................. 10
Shields v. Citytrust Bancorp, Inc.,
25 F.3d 1124 (2d Cir. 1994) ........................... 10, 11
Stander v. Financial Clearing & Serv. Corp.,
718 F. Supp. 1204 (S.D.N.Y. 1989) .......................... 9
Thornburgh v. Gingles,
478 U.S. 30 (1986) ........................................ 15
Three Crown Ltd. Partnership v. Caxton Corp.,
817 F. Supp. 1033 (S.D.N.Y. 1993) .................. 9, 15, 16
Tribune Co. v. Purcigliotti,
869 F. Supp. 1076 (S.D.N.Y. 1994) ......................... 10
Wechsler v. Steinberg,
733 F.2d 1054 (2d Cir. 1984) ............................... 9
White v. Abrams,
495 F.2d 724 (9th Cir. 1974) ............................... 7
STATUTES
Securities & Exchange Act of 1934 § 10(b),
15 U.S.C. § 78j(b) .................................... passim
Securities & Exchange Act of 1934 § 21D(b)(2),
15 U.S.C.§ 78u-4(b)(2) ................................ passim
RULES
Fed. R. Civ. P. 9(b) ........................................... 11
Securities & Exchange Comm'n Rule 10b-5,
17 C.F.R. § 240.10b-5 .................................. 6, 7
DEFS' MEMO RE: PLEADING STANDARDS
C-96-0393 FMS iii
CITATIONS TO THE CONGRESSIONAL RECORD
141 Cong. R. H2818, H2820 (Mar. 8, 1995) ....................... 12
141 Cong. R. S8966, S8973 (June 23, 1995) ...................... 12
141 Cong. R. S9032, S9084 (June 26, 1995) ...................... 12
141 Cong. R. S9032, S9085 (June 26, 1995) ...................... 12
141 Cong. R. S9150, S9170 (June 27, 1995) ...................... 14
141 Cong. R. S9150, S9171 (June 27, 1995) ...................... 15
141 Cong. R. H13699, H13699 (Nov. 28, 1995) .................... 11
141 Cong. R. H13699, H13702 (Nov. 28, 1995) .................... 12
141 Cong. R. H13699, H13702 & n.23 (Nov. 28, 1995) ............. 14
141 Cong. R. S17933, S17938 (Dec. 5, 1995) ..................... 17
141 Cong. R. S17933, S17959-60 (Dec. 5, 1995) .................. 16
141 Cong. R. S17933, S17960 (Dec. 5, 1995) ..................... 16
141 Cong. R. S17933, S17960 (Dec. 5, 1995) ..................... 17
141 Cong. R. S17965, S17976 (Dec. 5. 1995) ..................... 17
141 Cong. R. S17965, S17980 (Dec. 5. 1995) ..................... 17
141 Cong. R. H14039, H14040 (Dec. 6, 1995) ..................... 13
141 Cong. R. S19034, S19035 (Dec. 21, 1995) ................ 14, 17
141 Cong. R. S19034, S19067 (Dec. 21, 1995) .................... 17
141 Cong. R. S19034, S19071 (Dec. 21, 1995) ................. 3, 15
141 Cong. R. S19145, S19149 (Dec. 22, 1995) .................... 17
MISCELLANEOUS
Harold S. Bloomenthal,
Private Securities Litigation Reform Act,
(Clark Boardman Callaghan 1996) ........................... 13
Fowler V. Harper & Fleming James, Jr.,
The Law of Torts § 7.3 (1956) .............................. 6
Louis Loss, Summary Remarks,
30 Bus. Law. 163, 165 (Special Issue Mar. 1975) ............ 7
DEFS' MEMO RE: PLEADING STANDARDS
C-96-0393 FMS iv
Defendants respectfully submit this brief in opposition to the
arguments raised by plaintiff's motion for interlocutory appeal,
plaintiff's opposition to defendants' motion to dismiss, and the
amicus brief of the Securities and Exchange Commission ("SEC"),
regarding the standards for pleading a claim under Section 10(b) of
the Securities and Exchange Act of 1934 ("Exchange Act"), 15 U.S.C.
§ 78j(b). Plaintiff and the SEC ask the Court to reconsider its
ruling that Section 21D(b)(2) of the Private Securities Litigation
Reform Act of 1995 ("Reform Act"), requires plaintiff to plead
facts that would support an inference of conscious wrongdoing.
This Court's interpretation of Section 21(D)(b)(2), however, which
now has been followed in Friedberg v. Discreet Logic Inc., ___ F.
Supp. ___, 1997 WL 109228 (D. Mass. Mar. 7, 1997), is correct, and
warrants no reconsideration.
INTRODUCTION
Plaintiff contends that all of those who participated in the
enactment of the Reform Act simply were wrong in believing that the
legislation imposes a higher pleading standard than mere
recklessness. Notwithstanding the Conference Committee Report, the
President's Veto Message, the statements of the bill's managers,
and the views of both the bill's proponents and detractors during
the lengthy debate preceding Congress' veto override, plaintiff
insists that this Court should interpret the Reform Act as adopting
a recklessness pleading standard that Congress expressly considered
and rejected. In so doing, plaintiff in effect asks this Court to
reverse Congress' determination on these issues, and to embrace
positions that were urged, without success, at the time the Reform
Act was enacted over the President's veto.
Plaintiff's argument rests on unsound premises, two of which
are particularly important to its effort to rewrite history.
First, plaintiff contends that, prior to the enactment of the
Reform Act, precedent was "unanimous" in interpreting Section 10(b)
as imposing liability upon a showing of recklessness.1 She
therefore poses the question raised in this case as whether the
Reform Act "overruled" the Exchange Act's scienter standard. In
fact, however, in decisions from Ernst & Ernst v. Hochfelder, 425
____________________
1 See Plaintiff's Brief In Support of Motion for
Interlocutory Appeal ("Pltf. Brief") at 13-14.
DEFS' MEMO RE: PLEADING STANDARDS
C-96-0393 FMS
U.S. 185 (1976), to Central Bank v. First Interstate Bank, 511 U.S.
164 (1994), the Supreme Court consistently imposed a higher
standard, finding that the language of Section 10(b) "clearly
connotes intentional misconduct." Hochfelder, 425 U.S. at 201.
Although Hochfelder left open the question whether reckless
behavior "in some circumstances" could amount "to be a form of
intentional conduct," id. at 194 n.12, the Court never adopted such
an extension of Section 10(b)'s scienter standard, despite numerous
opportunities to do so. The fact that many lower courts in the
interim applied a recklessness standard does not change the fact
that the Court had not.2
Plaintiff's second contention is equally infirm. According to
plaintiff, the Reform Act intended to adopt the pleading standard
of the Second Circuit, and the Second Circuit's standard was
satisfied by "alleging facts that suggest . . . reckless[ness]."3
In fact, however, there were two quite separate lines of authority
in the Second Circuit: one endorsed mere recklessness as a basis
for liability, while the other adhered to Hochfelder. The
"recklessness" line of cases culminated in In re Time Warner Inc.
Securities Litigation, 9 F.3d 259, 268-69 (2d Cir. 1993), cert.
denied, 511 U.S. 1017 (1994), which formulated the multi-part test
adopted in the Specter Amendment. As this Court recognized in its
Order of September 25, this Time Warner test was expressly rejected
by the Conference Committee.
As the court noted in In re Leslie Fay Companies, Inc. Sec.
Litig., 871 F. Supp. 686 (S.D.N.Y. 1995), however, there was a
second line of Second Circuit cases that did not endorse a
"recklessness" standard. Rather, like Hochfelder and Central Bank,
these decisions "indicated that Section 10(b) scienter requires
either allegations of actual intent or circumstances implying a
strong inference of actual intent." Id. at 692. For many years,
district courts in the Second Circuit applied this higher standard
at the pleading stage, drawing particularly on the standard for
____________________
2 See Central Bank, 511 U.S. at 177-78 (Stevens, J.,
dissenting) (noting that Court had declined to extend Section 10(b)
liability to aiding and abetting, another question left open in
Hochfelder, despite contrary holding of all eleven Courts of
Appeals that had addressed the issue); Plaut v. Spendthrift Farms,
514 U.S. 211, 115 S. Ct. 1447, 1458 (1995) (statute of limitations
for Exchange Act claims had never been addressed by the Court, and
it was "therefore an open question, no matter what the lower courts
had held at the time").
3 Pltf. Brief at 12-13.
DEFS' MEMO RE: PLEADING STANDARDS
C-96-0393 FMS 2
pleading fraud in civil RICO cases established by Beck v.
Manufacturers Hanover Trust Co., 820 F.2d 46 (2d Cir. 1987). The
court in Time Warner also purported to rely on Beck, which requires
the pleading of facts that would support a strong inference of
"conscious behavior." At the same time, however, it added a new
(and dramatically lower) standard not present in Beck or the
district court decisions that had applied it under Section 10(b):
the pleading of mere recklessness.
The legislative history is absolutely clear that when
proponents of the Reform Act referred to guidance from Second
Circuit authority, they were referring to Beck and its progeny, not
Time Warner. Indeed, even as to Beck, the Conference Committee
made clear that it was adopting the Second Circuit only "in part,"
lest there be any confusion that "motive and opportunity" -- which
are part of the Beck test -- be taken as an alternative to pleading
facts that would support an inference of conscious behavior, rather
than simply as evidence that might (or might not) support such an
inference. After striking "motive" and "opportunity" -- and, most
importantly, Time Warner's "recklessness" -- from the Second
Circuit standard, therefore, the Conference Committee had the
desired standard: the plaintiff must allege facts supporting a
strong inference of "conscious behavior," Beck, 820 F.2d at 50,
which is to say, "knowing or intentional misconduct." Hochfelder,
425 U.S. at 197-98.
In explaining why the Conference Committee had rejected the
Specter Amendment, Senator Dodd -- whom plaintiff emphasizes "knew
what [he was] talking about" as co-author of the bill and manager
on the Conference Committee4 -- was succinct. The Specter
Amendment was rejected because "it was an effort to get
recklessness in, which would have changed the standard from the
second circuit." 141 Cong. R. S19034, S19071 (Dec. 21, 1995).5 If
plaintiff's position were correct, Senator Dodd's statement would
be utterly inexplicable. It loses its mystery, however, if one
considers that only a few months before Senator Dodd made that
statement during the Senate veto debate, district courts in the
Second Circuit were continuing to question whether "mere
____________________
4 Pltf. Brief at 18.
5 Copies of this memorandum's citations to the
Congressional Record are enclosed as Exhibit A to the accompanying
Declaration of David Priebe.
DEFS' MEMO RE: PLEADING STANDARDS
C-96-0393 FMS 3
allegations of recklessness" were adequate to satisfy the scienter
requirement under Second Circuit law. Leslie Fay, 871 F. Supp. at
692-94.
Having failed to persuade Senator Dodd and the rest of the
Conference Committee -- and, ultimately, Congress as a whole --
that the Reform Act should authorize pleading based on
recklessness, rather the "knowledge or intent" standard used by the
Supreme Court and applied in a line of decisions in the Second
Circuit, plaintiff is making yet another effort "to get
recklessness in." This Court correctly has rejected plaintiff's
effort as inconsistent with the Reform Act's legislative history
and statutory purpose, and defendants respectfully submit that the
Court should do so again.
ARGUMENT
There is an old saying that "the wrong answer is what the
wrong question begets." Plaintiff has asked the wrong question
whether the Reform Act "overruled" the scienter standard for
Section 10(b) -- and her analysis therefore yields the wrong
answer. Congress did not "overrule" Section 10(b)'s requirement
that defendant's conduct must be "manipulative or deceptive."
Rather, in enacting a pleading standard for Section 10(b), Congress
adhered to the Supreme Court's position in Ernst & Ernst v.
Hochfelder, 425 U.S. 185, 197 (1976), that Section 10(b) proscribes
only "knowing or intentional conduct." As this Court found in its
Order of September 25, 1996, that is what the Reform Act now
requires to be pleaded: the complaint "must allege specific facts
that constitute circumstantial evidence of conscious behavior by
defendants." In re Silicon Graphics, Inc. Sec. Litig., [1996-97
Tr. Binder] Fed. Sec. L. Rep. (CCH) ¶ 99,325, at 99,962 (N.D. Cal.
Sept. 25, 1996).
The remainder of this memorandum proceeds in two parts.
Section I addresses how Section 10(b) had been interpreted by the
Supreme Court at the time the Reform Act was enacted. These
precedents provided the background against which Congress acted,
and are important in understanding the statute's legislative
history. Section II shows how Congress deliberately settled upon a
pleading standard, drawn partly from Second Circuit decisions, that
was consonant with its own -- and the Supreme Court's --
interpretation of Section 10(b). Plaintiff's arguments simply
DEFS' MEMO RE: PLEADING STANDARDS
C-96-0393 FMS 4
cannot be squared with the overwhelming weight of legislative
history, and seek to fight a battle that already has been fought,
and lost.
I. FROM HOCHFELDER THROUGH CENTRAL BANK, THE SUPREME
COURT DECLINED TO ENDORSE SECTION 10(b) LIABILITY
FOR LESS THAN KNOWING OR INTENTIONAL BEHAVIOR.
Section 21D(b)(2) of the Reform Act provides that in any
private action under the Exchange Act, the complaint must "state
with particularity facts giving rise to a strong inference that the
defendant acted with the required state of mind." The "required
state of mind" for Section 10(b) of the Act is determined by the
language of the statute, which expressly requires the defendant's
conduct to be "manipulative or deceptive." 15 U.S.C. § 78j(b).
Plaintiff has urged the Court to invoke the rule that where
the statutory language is clear, there is no need to resort to the
statute's legislative history.6 In Hochfelder, the Court did find
the language of Section 10(b) to be clear -- but not in the way
plaintiff suggests. To the contrary, the Court in Hochfelder found
that the statute's language "strongly suggest[s] that § 10(b) was
intended to proscribe knowing or intentional conduct." The SEC
argued in Hochfelder that Section 10(b)'s language should not be
viewed as "limit[ing] its operation to knowing or intentional
practices." 425 U.S. at 197-98. The Court, however, disagreed.
Indeed, the language of the statute "so clearly connotes
intentional misconduct" that it seemed unnecessary to examine
Section 10(b)'s legislative history. Id. at 201.7
In subsequent decisions, the Court repeatedly reaffirmed
Hochfelder, and held that the "language of § 10(b) gives no
indication that Congress meant to prohibit any conduct not
involving manipulation or deception." Santa Fe Indus., Inc. v.
Green, 430 U.S. 462, 473 (1977).8 Most recently, in Central Bank
____________________
6 Pltf. Brief at 11-12.
7 Nonetheless, the Hochfelder Court proceeded to review the
legislative history of the Exchange Act, and found that it was
consistent with the Court's reading of the statutory language. 425
U.S. at 201-206.
8 See also Aaron v. Securities & Exchange Comm'n, 446 U.S.
680, 690, 694-95 (1980) (Hochfelder requirement of "knowing or
intentional misconduct" applies to SEC civil enforcement actions
under § 10(b)); Herman & MacLean v. Huddleston, 459 U.S. 375, 382
(1983) (§ 10(b) plaintiff "must prove that the defendant acted with
scienter, i.e., with intent to deceive, manipulate, or defraud").
DEFS' MEMO RE: PLEADING STANDARDS
C-96-0393 FMS 5
v. First Interstate Bank, 511 U.S. 164 (1994), decided only the
year before Congress' enactment of the Reform Act, the Court
affirmed once again its "refus[al] to allow 10b-5 challenges to
conduct not prohibited by the text of the statute." 511 U.S. at
173. In rejecting the SEC's argument that Section 10(b) supports
the imposition of liability for aiding and abetting, the Court
emphasized that Hochfelder and Santa Fe had limited Section 10(b)
to "manipulative or deceptive act[s]." Id. at 177. Accordingly,
it could not "amend the statute to create liability for acts that
are not themselves manipulative or deceptive within the meaning of
the statute." Id. at 177-78.
These post-Hochfelder decisions give no hint that the Court
believed it appropriate to extend Section 10(b) liability beyond
its previous holdings. To the contrary, in Hochfelder itself, the
Court had observed in a footnote that in certain areas of the
common law, recklessness was viewed "in some circumstances" as a
form of intentional conduct. Hochfelder, 425 U.S. at 194 n.12.
Such usage dated back to Derry v. Peek, 14 App. Cas. 337 (U.K.
1889), which recognized recklessness as a basis for deceit
liability under very limited circumstances. Under Derry and its
progeny, deceit liability attached only if the person asserted a
fact to be true, for the purpose of inducing reliance, where "he
knows that he does not know whether [the fact] is true or false --
in other words, with subjective recklessness."9 This formulation
of a claim for deceit made "honest belief in the truth [of the
statement] a complete defense, under all circumstances,"10 and
disallowed claims of "objective" recklessness, in which the
reasonableness of conduct is measured without regard to the
defendant's good faith.
In noting this common-law usage, Hochfelder did not suggest
that subjective recklessness in fact would be sufficient to satisfy
the statutory requirements of Section 10(b). To the contrary, in
concluding that Section 10(b) by its terms proscribed only "knowing
or intentional misconduct," Hochfelder cited to two concurring
opinions, one by Judge Adams (in Kohn v. American Metal Climax,
____________________
9 Fowler V. Harper & Fleming James, Jr., The Law of Torts §
7.3, at 534 (1956) (emphasis added).
10 Id.
DEFS' MEMO RE: PLEADING STANDARDS
C-96-0393 FMS 6
Inc., 458 F.2d 255 (3d Cir. 1972)), and one by Judge Friendly (in
Securities & Exchange Comm'n v. Texas Gulf Sulphur Co., 401 F.2d
833 (2d Cir. 1968)).11 In his opinion, Judge Adams had emphasized
that Section 10(b) should be strictly construed, stating that "it
is altogether proper, and indeed essential, for courts to cleave
close to the Congressional purpose by construing the statute
strictly." Kohn, 458 F.2d at 287 (Adams, J., concurring and
dissenting). Judge Friendly's separate opinion was even more to
the point. With respect to Section 10(b)'s scienter requirement,
he believed that Section 10(b) at most could be extended to
subjective recklessness -- in other words, to "the kind of
recklessness that is equivalent to wilful fraud." Texas Gulf
Sulphur, 401 F.2d at 868. Even then, however, he expressed concern
that Rule 10b-5, "even limited in the way just proposed," would "go
beyond the authority vested in the Commission by § 10(b)." Id.
By the time Congress took up debate on the Reform Act,
therefore, the Supreme Court only had applied Section 10(b) to
knowing and intentional misconduct, and had suggested some
skepticism -- but not yet resolved -- whether the statute could
reach conduct that was subjectively reckless. The lower courts, in
attempting to address this issue, had adopted a wide variety of
positions, ranging from adherence to Hochfelder's requirement of
knowing misconduct, to a recklessness standard far lower than that
governing common-law fraud. Congress drew upon one such line of
case -- a line from the Second Circuit which had adhered to the
Hochfelder standard -- in setting the pleading standard adopted in
the Reform Act.
II. SECTION 21D(b)(2) OF THE REFORM ACT REQUIRES THE
PLEADING OF FACTS SUFFICIENT TO SUPPORT A STRONG
INFERENCE OF KNOWING OR INTENTIONAL MISCONDUCT.
Plaintiff takes solace from references in the legislative
history to Second Circuit pleading standards. Equating Second
Circuit precedent with Time Warner, she argues that Congress must
have intended to endorse the Time Warner standard, and accordingly
this Court should disregard the overwhelming evidence -- including
the express rejection of the Specter Amendment based on the Time
____________________
11 See also Louis Loss, Summary Remarks, 30 Bus. Law. 163,
165 (Special Issue Mar. 1975) (cited approvingly in Hochfelder)
(criticizing White v. Abrams, 495 F.2d 724 (9th Cir. 1974), for
failing to "consider the language of Section 10(b)," which
prohibits only a "manipulative or deceptive device or
contrivance").
DEFS' MEMO RE: PLEADING STANDARDS
C-96-0393 FMS 7
Warner test -- that Congress had rejected a pleading standard based
on allegations of mere recklessness. Unfortunately for plaintiff,
not only do the Conference Report and the President's Veto Message
rebut her argument, but so do the floor debates on which she most
relies. The legislative history is overwhelming, and overwhelming
in one direction: that Congress intended to impose a pleading
requirement based on Hochfelder's requirement of knowing or
intentional misconduct.
A. In the Second Circuit, a Line of Pre-Reform
Act Decisions Had Imposed a Pleading Requirement
Consistent With Hochfelder.
Notwithstanding the Court's reluctance to extend Section 10(b)
liability beyond "knowing or intentional misconduct," many lower
courts prior to the Reform Act readily gave Section 10(b) this
broader reach. One line of decisions in the Second Circuit,
culminating in In re Time Warner Inc. Securities Litigation, 9 F.3d
259 (2d Cir. 1993), concurred with other lower courts in imposing
Section 10(b) liability for recklessness. As formulated in Time
Warner, a Section 10(b) claim was adequately stated if the
plaintiff could plead facts that "establish[] a motive to commit
fraud and an opportunity to do so," or alternately that
"constitut[e] circumstantial evidence of either reckless or
conscious behavior." Id. at 269 (emphasis added).
Among the courts recognizing liability for recklessness, there
was considerable uncertainty whether such liability in the Second
Circuit extended to all reckless conduct, or only to deliberate
recklessness. Thus, for example, in Goldman v. McMahan, Brafman,
Morgan & Co., 706 F. Supp. 256 (S.D.N.Y. 1989), rather than require
a showing of bad faith, the court held that the plaintiff need only
plead facts that "give rise to an inference of gross negligence
which can be the functional equivalent of recklessness." Id. at
259. On the other hand, in In re Fischbach Corp. Securities
Litigation, [1995 Tr. Binder] Fed. Sec. L. Rep. (CCH) ¶ 98,665, at
92,091 (S.D.N.Y. Jan. 15, 1992), Judge Wood concluded that the
Second Circuit had not "held that recklessness per se is
sufficient," and viewed any such holding as inconsistent with
Hochfelder. Judge Wood noted that "[t]he question left open by
[Hochfelder] is not whether recklessness is always sufficient to
meet the scienter requirements of Section 10(b)." Id. Rather,
Hochfelder "leaves open the question of whether recklessness that
DEFS' MEMO RE: PLEADING STANDARDS
C-96-0393 FMS 8
is equivalent to intentional conduct is actionable." Id. Judge
Wood held that liability for recklessness in the Second Circuit
could not extend beyond the "willful blindness" considered to be
the equivalent of knowledge in the common law, and to which Judge
Friendly referred in Texas Gulf Sulphur. Id. at 92,092.
Separate from this line of cases (and ignored by plaintiff)
was another line of decisions in the Second Circuit adhering to the
Hochfelder standard.12 As the court noted in In re Leslie Fay
Companies, Inc. Sec. Litig., 871 F. Supp. 686 (S.D.N.Y. 1995),
these decisions required "either allegations of actual intent or
circumstances implying a strong inference of actual intent." Id.
at 692.13 In applying this higher standard at the pleading stage,
a long line of district court decisions had looked to the civil
RICO case of Beck v. Manufacturers Hanover Trust Company, 820 F.2d
46 (2d Cir. 1987), cert. denied, 484 U.S. 1005 (1988). In Beck,
the court had confronted the same question posed by Section 10(b)
under Hochfelder: what facts does a plaintiff have to allege at
the pleading stage to sustain an inference of intentional fraud.
The standard adopted in Beck for pleading intentional fraud in
civil RICO seemed well-suited to allegations of intentional fraud
under Section 10(b), and accordingly was widely followed in Section
10(b) pleading cases.14
____________________
12 See, e.g., Wechsler v. Steinberg, 733 F.2d 1054, 1058 (2d
Cir. 1984) ("To prove scienter in a § 10(b) case, a plaintiff must
demonstrate 'knowing or intentional misconduct' on the part of the
defendant, ... or an 'intent to deceive, manipulate, or defraud'
investors") (citation omitted); Mayer v. Oil Field Sys. Corp., 803
F.2d 749, 756 (2d Cir. 1986) ("Scienter requires at least knowing
misconduct...."); Reiss v. Pan American World Airways, Inc., 711
F.2d 11, 14 (2d Cir. 1983) ("To prove scienter ... there must be
proof that the non-disclosure was intended to mislead").
13 In Leslie Fay, the court noted that its own earlier
decision in In re Leslie Fay Companies, Inc. Sec. Litig., 835 F.
Supp. 167 (S.D.N.Y. 1993), adhered to this standard, which was the
same one that the Supreme Court had articulated in Hochfelder, and
reaffirmed in Central Bank. The court therefore did not need to
reconsider its ruling in light of Central Bank: consistent with
Second Circuit precedent, it had measured the adequacy of the
plaintiff's pleadings to determine whether it raised a strong
inference of "knowing or intentional" misconduct. 871 F. Supp. at
692-94.
14 See, e.g., Salzmann v. Prudential-Bache Secs., [1993 Tr.
Binder] Fed. Sec. L. Rep. (CCH) ¶ 97,608, at 96,757 (S.D.N.Y. Mar.
12, 1993) (citing and applying Beck as written); Keenan v. D.H.
Blair & Co., 838 F. Supp. 82, 86 (S.D.N.Y. 1993) (same); Three
Crown Ltd. Partnership v. Caxton Corp., 817 F. Supp. 1033, 1040-41
(S.D.N.Y. 1993) (same); Boley v. Pineloch Assocs., Ltd., [1990 Tr.
Binder] Fed. Sec. L. Rep. (CCH) ¶ 95,407, at 97,002 (S.D.N.Y. Aug.
2, 1990) (same); Stander v. Financial Clearing & Serv. Corp., 718
F. Supp. 1204, 1210 (S.D.N.Y. 1989) (same); see also Ochs v.
Shearson Lehman Hutton Inc., 768 F. Supp. 418, 427 (S.D.N.Y. 1991)
(applying Beck as written; plaintiff must "identify circumstances
DEFS' MEMO RE: PLEADING STANDARDS
C-96-0393 FMS 9
The Beck standard made no mention of "recklessness" as a basis
for pleading facts sufficient to support an inference of
intentional fraud. One could plead direct evidence ("motive and
opportunity") or circumstantial evidence, but in either case it had
to support a "strong inference" of conscious wrongdoing.15 A long
line of decisions in the Second Circuit applied this same standard
to Section 10(b) claims. In Time Warner, the court changed that,
and made the standard for pleading a Section 10(b) case expressly
lower than for pleading a civil RICO case.
Notably, the Second Circuit itself rapidly retreated from Time
Warner's gloss on Beck. Subsequent decisions focused on whether a
complaint pleaded a strong inference that the defendants actually
knew that their statements were false when made, and not that the
defendants were merely reckless in issuing the statements. See,
e.g., Shields v. Citytrust Bancorp, Inc., 25 F.3d 1124, 1129 (2d
Cir. 1994) (although the complaint "strongly suggests that the
defendants should have been more alert and more skeptical," it did
not plead a strong inference of fraudulent intent because "nothing
alleged indicates that management was promoting a fraud"); Acito v.
IMCERA Group, 47 F.3d 47, 53 (2d Cir. 1995) (theory that company
knew and should have disclosed that key manufacturing plant would
fail FDA inspection did not plead scienter); San Leandro Emergency
Med. Profit Sharing Plan v. Philip Morris Cos., 75 F.3d 801, 812-13
____________________
indicating conscious behavior by the defendant from which an intent
to defraud may be inferred"); Finkel v. Stratton Corp., 754 F.
Supp. 318, 329-30 (S.D.N.Y. 1990) (applying Beck as written;
dismissing complaint that did not "adequately allege circumstances
from which defendants' knowledge of falsity and intent to defraud
may be inferred"), dismissal of other claims reversed, 962 F.2d 169
(2d Cir. 1992); Kimmel v. Labenski, [1990-91 Tr. Binder] Fed. Sec.
L. Rep. (CCH) ¶ 95,869, at 99,306-07 (S.D.N.Y. Dec. 13, 1990)
(applying Beck as written and dismissing complaint); Seidenberg v.
Drexel Assocs., [1990 Tr. Binder] Fed. Sec. L. Rep. (CCH) ¶ 95,477,
at 97,501 (S.D.N.Y. Sept. 5, 1990) (applying Beck as written;
dismissing complaint that did not identify "circumstances
indicating conscious behavior ... that would support the inference
of knowledgeable participation in the alleged fraud"). Second
Circuit courts continue to apply Beck as written -- i.e., without
recognizing "recklessness" as a means of pleading the requisite
intent -- in RICO cases. See, e.g., Powers v. British Vita,
P.L.C., 57 F.3d 176, 184 (2d Cir. 1995); D'Orange v. Feeley, 877 F.
Supp. 152, 159 (S.D.N.Y. 1995); Tribune Co. v. Purcigliotti, 869 F.
Supp. 1076, 1091 (S.D.N.Y. 1994); Laro, Inc. v. Chase Manhattan
Bank, 866 F. Supp. 132, 137 (S.D.N.Y. 1994), aff'd, 60 F.3d 810
(1995).
15 The Beck court had stated: "A common method for
establishing a strong inference of scienter is to allege facts
showing a motive for committing fraud and a clear opportunity for
doing so. Where motive is not apparent, it is still possible to
plead scienter by identifying circumstances indicating conscious
behavior by the defendant, though the strength of the
circumstantial allegations must be correspondingly greater." See
820 F.2d at 50.
DEFS' MEMO RE: PLEADING STANDARDS
C-96-0393 FMS 10
(2d Cir. 1996) (because the defendants' statements were not
falsified by any specifically pleaded adverse information available
to them at time, plaintiffs had failed to allege facts showing
scienter). Thus, as defendants showed in their opening brief,
Shields, Acito, and Philip Morris more accurately reflected the
Second Circuit standard than did Time Warner at the time the Reform
Act was enacted.16
In any event, Congress (like the Second Circuit) had no
intention of following Time Warner's gloss on Beck. As discussed
in the following section, Congress explicitly declined to adopt
this lower pleading standard for Section 10(b) cases, and adhered
instead to a standard that had proved workable both for civil RICO
and Section 10(b) claims.
B. The Conference Committee Expressly Rejected
Allegations of Mere Recklessness as a Basis
for Pleading Under Section 10(b).
Congress' purpose in enacting the Reform Act was unmistakable:
it believed that private securities litigation under Section 10(b)
had come to be dominated by the filing of "abusive and meritless
suits," and it intended to bring that practice to a halt.17 One of
the central means by which the Reform Act sought to do so was to
heighten the pleading standards required to state a claim. As the
Conference Committee observed, Rule 9(b) had not "prevented abuse
of the securities laws by private litigants," and "[t]he House and
Senate hearings on securities litigation reform included testimony
on the need to establish uniform and more stringent pleading
____________________
16 The Second Circuit trilogy also questioned Time Warner's
liberality in construing allegations of motive and opportunity. In
Time Warner, the majority had strained to resolve the admittedly
"close question" posed by plaintiffs' convoluted motive theory in
plaintiffs' favor, 9 F.3d at 269-70 -- while raising the
possibility that "some focused preliminary discovery" would resolve
the issue adversely to plaintiffs, id. at 272 -- over the dissent's
vigorous contention that the theory was "inconsistent with
assumptions underlying securities law, statements in the complaint,
and any plausible understanding of the operation of capital
markets." 9 F.3d at 273-75 (Winter, J., dissenting). In Shields,
in contrast, the court easily rejected plaintiff's motive and
opportunity allegations. 25 F.3d at 1130-31. Acito and Philip
Morris also rejected plaintiffs' attempt to plead scienter via
motive and opportunity, even though in both cases, plaintiffs
pointed to a corporate officer who had sold stock near the end of
the class period. Acito, 47 F.3d at 54; Philip Morris, 75 F.3d at
813-14.
17 141 Cong. R. H13699, H13699 (Nov. 28, 1995).
DEFS' MEMO RE: PLEADING STANDARDS
C-96-0393 FMS 11
requirements to curtail the filing of meritless lawsuits."18 The
Reform Act sought to remedy this deficiency by adding such "uniform
and more stringent pleading requirements" to claims brought under
the Exchange Act.
In strengthening these pleading requirements, proponents of
the Reform Act were well aware that the Supreme Court never had
sanctioned the imposition of liability for other than intentional
or knowing misconduct.19 They also recognized how liability for
recklessness had failed to provide any protection against the
filing of unwarranted claims. For example, in explaining the
impetus behind the Reform Act's modification of proportionate
liability provisions, Senator Dodd stated:
In practice, the [recklessness] legal standard
does not provide protection against unjustified
and abusive claims, because juries can -- and as
a practical matter do -- misapply the standard.
Juries today, quite frankly, have considerable
difficulty in distinguishing innocent mistakes,
negligence, or even gross negligence -- none of
which . . . is actionable under rule 10(b)(5)
-- from recklessness.20
To protect against misuse of the recklessness standard, one
alternative considered by the Reform Act's proponents was to codify
recklessness but expressly limit it to the extreme subjective
recklessness referred to in Hochfelder. Indeed, that was the
approach initially taken in the legislation that passed in the
House of Representatives. In H.R. 1058, the House provided for
liability for recklessness, but only the kind of subjective
recklessness recognized under the common law. The bill stated:
"Deliberately refraining from taking steps to discover whether
one's statements are false or misleading constitutes recklessness,
____________________
18 Id. at H13702.
19 See, e.g., 141 Cong. R. H2818, H2820 (Mar. 8, 1995) (Rep.
Cox) (liability for recklessness is "judge-made law that the
Supreme Court has never agreed to").
20 141 Cong. R. S8966, S8973 (June 23, 1995) (Sen. Dodd).
See also 141 Cong. R. S9032, S9084 (June 26, 1995) (Sen. Dodd,
discussing Sen. Bryan's amendment to create aiding and abetting
liability) ("[T]he recklessness standard here is a standard that is
so difficult to apply that it in effect would destroy the attempts
of this legislation to mitigate against this explosion of
unwarranted litigation in the area of securities"); id. at S9085
("The vagueness of the recklessness standard is one of the
principal reasons that joint and several liability should be
modified, and that is what we do in this bill").
DEFS' MEMO RE: PLEADING STANDARDS
C-96-0393 FMS 12
but if the failure to investigate was not deliberate, such conduct
shall not be considered to be reckless."21 In other words, the
House bill would have codified the result in Fischbach: liability
under Section 10(b) would be extended in the way that Hochfelder
had left open, but no further.
In the Conference Committee, however, H.R. 1058's extension of
Section 10(b) liability to recklessness was deleted. As
Representative Bliley, the co-manager of the Reform Act in the
House, explained: "The conference report is careful not to change
standards of liability under the securities laws. Unlike the bill
passed by the House, the conference report does not codify
recklessness as a standard of liability under the securities
laws."22 The managers of the Reform Act thus were well aware of a
fact that plaintiff seemingly overlooks -- that it was recklessness
that constituted the "change" to standards of liability under
Section 10(b). Congress was unwilling to expand Section 10(b)
liability beyond the bounds recognized by the Supreme Court, and
accordingly the recklessness provision was deleted from the bill.
The Conference Committee took similar steps with respect to
the Senate version of the reform legislation. As reported out of
the Banking Committee, Senate bill S. 240 had provided that "the
plaintiff's complaint shall, with respect to each act or omission
alleged to violate this title, specifically allege facts giving
rise to a strong inference that the defendant acted with the
required state of mind."23 Senator Specter proposed an amendment
that would have changed this pleading standard to permit Section
10(b) liability based on allegations of mere recklessness. The
Specter Amendment, which was adopted by the Senate in its initial
passage of the bill, provided:
[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
____________________
21 Harold S. Bloomenthal, Private Securities Litigation
Reform Act, appendix 4 at App. 4-7 (Clark Boardman Callaghan 1996)
(text of H.R. 1058 as passed on Mar. 8, 1995) (Priebe Decl., Ex.
B).
22 141 Cong. R. H14039, H14040 (Dec. 6, 1995) (Rep. Bliley)
(emphasis added).
23 Bloomenthal, appendix 3 at App. 3-9 (text of S. 240 as
presented to Senate) (Priebe Decl., Ex. C).
DEFS' MEMO RE: PLEADING STANDARDS
C-96-0393 FMS 13
facts that constitute strong circumstantial
evidence of conscious misbehavior or
recklessness by the defendant.24
The Conference Committee eliminated the Specter Amendment, and
substituted instead language that required the plaintiff to "state
with particularity facts giving rise to a strong inference that the
defendant acted with the required state of mind."25 In explaining
the change, the Conference Report stated that "[t]he Conference
Committee language is based in part on the pleading standard of the
Second Circuit."26 The Conference Report continued:
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 intends to strengthen existing
pleading requirements, it does not intend
to codify the Second Circuit's case law
interpreting this pleading standard.[23]
[23]: For this reason, the Conference Report
chose not to include in the pleading standard
certain language relating to motive,
opportunity, or recklessness.27
In the words of President Clinton, the Conference Committee's
intent in the Report was "crystal clear."28 The Committee was not
codifying the Time Warner test, because it would have permitted
Section 10(b) claims absent facts giving rise to a strong inference
of "conscious misbehavior." Motive, opportunity, and extreme
recklessness might provide evidence of intentional wrongdoing, but
they are not a substitute for it. To go forward with a Section
10(b) claim, the Conference Committee made clear that the plaintiff
would have to plead particular facts supporting a strong inference
of "conscious misbehavior" -- in other words, an inference of
scienter under the standard of Hochfelder and Central Bank.
____________________
24 141 Cong. R. S9150, S9170 (June 27, 1995) (Sen. Specter)
(introducing amendment) (emphasis added).
25 15 U.S.C. § 78u-4(b)(2).
26 141 Cong. R. H13699, H13702 (Nov. 28, 1995) (emphasis
added).
27 Id. & n.23.
28 141 Cong. R. S19034, S19035 (Dec. 21, 1995).
DEFS' MEMO RE: PLEADING STANDARDS
C-96-0393 FMS 14
C. The Remainder of the Reform Act's Legislative
History Also Shows that Congress Had Rejected
a Pleading Standard of Mere Recklessness.
Despite the seemingly unequivocal rejection of the Specter
Amendment and its recklessness standard, plaintiff urges that
allegations of recklessness still should be sufficient to meet the
pleading requirements of the Reform Act. Pltf. Brief at 4; see
also SEC Brief at 2 (except for forward-looking statements, "it is
sufficient under Section 21D(b)(2) to state with particularity
facts giving rise to a strong inference that the defendant acted
recklessly"). In doing so, plaintiff urges the Court to disregard
the Conference Report -- the most authoritative source regarding
the Reform Act's meaning29 -- on the ground that Senators Dodd,
Domenici, and others described the reform legislation as following
the Second Circuit's pleading standards. Pltf. Brief at 17-19.
The floor debates on which plaintiff relies, however, do not
support her reading of the Reform Act. Indeed, Senator Dodd, whom
plaintiff claims supported a recklessness pleading standard, could
hardly have been clearer in rejecting plaintiff's position. Thus,
for example, when asked why the Specter Amendment had been deleted
by the Conference, he stated: "[T]he Specter amendment was -- I
think it was an effort to get recklessness in, which would have
changed the standard from the second circuit."30
To the same effect was Senator Dodd's debate on the Senate
floor with Senator Specter regarding the Conference's deletion of
his amendment. In initially offering the amendment, Senator
Specter had described the amendment as based on Beck, which Time
Warner also had cited as authority for its four-part test.31 As
noted previously, however, the Beck case did not make any mention
of recklessness, and district courts in the Second Circuit for many
years had applied the Beck standard in assessing the adequacy of
the pleading of Section 10(b) claims, without the "recklessness"
gloss added by Time Warner. These cases included Three Crown Ltd.
____________________
29 See In re Silicon Graphics, Inc. Sec. Litig., [1996-97
Tr. Binder] Fed. Sec. L. Rep. (CCH) at 99,962 & cases cited
therein; see also Thornburgh v. Gingles, 478 U.S. 30, 43 n.7 (1986)
(conference committee reports are "the authoritative source for
[discerning] legislative intent").
30 141 Cong. R. S19034, S19071 (Dec. 21, 1995).
31 141 Cong. R. S9150, S9171 (June 27, 1995) (Sen. Specter).
DEFS' MEMO RE: PLEADING STANDARDS
C-96-0393 FMS 15
Partnership v. Caxton Corp., 817 F. Supp. 1033, 1041 (S.D.N.Y.
1993), which applied Beck's "conscious behavior" standard to a
Section 10(b) claim without modification.32
In the debate between Senators Dodd and Specter regarding the
deletion of Senator Specter's amendment in conference, Senator
Specter stated that the Conference Committee bill was
"significantly different" from his amendment because it "toughens
up the second circuit standard."33 Senator Dodd responded that it
was Senator Specter's amendment that "goes beyond" the Second
Circuit pleading standard.34 When Senator Specter challenged
Senator Dodd's contention, Senator Dodd referred him to two cases:
Beck, and the Three Crown Partnership decision applying Beck to a
Section 10(b) claim.35
The most obvious way in which the Specter Amendment went
beyond these two decisions, of course, was in its addition of an
expansive new basis for supporting liability -- the allegation of
facts showing mere recklessness.36 If Time Warner represented the
new Second Circuit standard, then the pleading standard that the
Reform Act adopted followed the Second Circuit only "in part" --
the part that proscribed "conscious behavior" by the defendant.
Courts could look to Second Circuit decisions for guidance, but
guidance on the pleading of intentional misconduct, not on the
adoption of a scienter standard lower than that authorized by
Hochfelder.
The significance of these changes were not missed by anyone.
Indeed, the President made the Reform Act's imposition of a
pleading standard higher than that approved in Time Warner one of
the three grounds on which he based his veto of the legislation.
He stated:
[T]he conferees make crystal clear in the
Statement of Managers their intent to raise
the standard even beyond [the Second Circuit's]
level. I am not prepared to accept that. The
conferees deleted an amendment offered by
Senator Specter and adopted by the Senate that
____________________
32 See also supra n.14 & cases cited therein.
33 141 Cong. R. S17933, S17959-60 (Dec. 5, 1995).
34 Id. at S17960.
35 Id.
36 The amendment also deleted an important qualification in
Beck, which was that the strength of circumstantial allegations
"must be correspondingly greater" to support an inference of
scienter. See Beck, 820 F.2d at 50.
DEFS' MEMO RE: PLEADING STANDARDS
C-96-0393 FMS 16
specifically incorporated Second Circuit 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.37
As with the Conference Report, plaintiff asks the Court to
disregard the President's Message.38 Yet the legislation's
opponents39 and supporters40 also had the same understanding of its
pleading requirements. Plaintiff cites to a number of individual
Senators or Representatives who stated that they viewed the
legislation as consistent with the Second Circuit's standard.
Senator Dodd's remarks, however, show what the legislation's
managers viewed as the Second Circuit standard: Beck, not Time
Warner. Indeed, even as to Beck, the Conference Committee had
deleted the references to "motive" and "opportunity," to emphasize
that there was only one way to state a sufficient Section 10(b)
claim -- the pleading of facts that showed conscious misbehavior.
Evidence of motive, opportunity, or even extreme recklessness might
support a "strong inference" of the intentional misconduct required
by Hochfelder, but they did not provide an alternative to it.
____________________
37 141 Cong. R. S19034, S19035 (Dec. 21, 1995).
38 Pltf. Brief at 19-20.
39 See 141 Cong. R. S17933, S17938 (Dec. 5, 1995) (Sen.
Sarbanes) ("The conference, however, added language that could call
liability for reckless conduct into question. The language of the
conference report could be read as inviting the courts to eliminate
all liability for reckless conduct under the securities fraud
provisions"); 141 Cong. R. S17965, S17976 (Dec. 5. 1995) (Sen.
Boxer) ("Even an excellent amendment by Senator Specter was
dropped, a very important amendment ... Close the door, you drop
the progressive provision that would have protected investors. That
was a very bad change in this bill. This bill is worse, much worse
now, than when it left here"); id. at S17980 (Sen. Heflin) ("In
another move away from the Senate bill the conferees dropped
proinvestor language which clarified the burdensome pleading
requirements of the bill. In a blow to investors, the proponents
have retained an extremely difficult pleading requirement").
40 See 141 Cong. R. S17933, S17960 (Dec. 5, 1995) (Sen.
Dodd) (the Conference Committee, "instead of trying to take each
case that came under the second circuit," adopted the core Second
Circuit "strong inference" pleading standard, and then allowed
courts to refer to specific cases from the Second Circuit and
elsewhere "to determine if these standards are based on facts and
circumstances in a particular case."); 141 Cong. R. S19034, S19067
(Dec. 21, 1995) (Sen. Dodd) (neither the original Senate bill nor
the Reform Act "codifies the entire case law of the second circuit,
as the administration says it wishes it did, and that is one of the
reasons it has expressed its objection"); 141 Cong. R. S19145,
S19149 (Dec. 22, 1995) (Sen. Bradley) ("even within the second
circuit, there are varying interpretations of the standard. That
is why the conference report deliberately rejects a complete
codification of the second circuit and adopts language which is
substantially similar to the language in the Senate-passed bill and
its report language").
DEFS' MEMO RE: PLEADING STANDARDS
C-96-0393 FMS 17
Finally, plaintiff has argued that the Conference Committee
cannot have meant what it said, because it would have rendered
unnecessary its requirement of actual knowledge for liability for
forward-looking statements. Pltf. Brief at 12. As this Court has
pointed out, however, that argument in fact cuts strongly in the
other direction. Where it was necessary for Congress to determine
the requisite scienter requirement, as it was with its new safe-
harbor provisions, it expressly adopted a "knowledge or intent"
standard. In setting the pleading standard for other Section 10(b)
claims, Congress had no need to legislate in the area. Section
10(b) already proscribed "manipulative or deceptive" acts -- and
the Supreme Court had held that this meant "knowing or intentional
misconduct."
CONCLUSION
The Court's analysis of the Reform Act's pleading requirements
is correct, and warrants no reconsideration. It is supported by
the statute's language, legislative history, and statutory purpose,
and plaintiff's (and the SEC's) contrary reading cannot be
sustained.
Dated: March 28, 1997 WILSON SONSINI GOODRICH & ROSATI
Professional Corporation
By: ____________________________
Bruce G. Vanyo
Attorneys for All Defendants
DEFS' MEMO RE: PLEADING STANDARDS
C-96-0393 FMS 10