Tellabs appeal could hinder investor suits
By James P. Miller, Staff Reporter
Wednesday, March 28, 2007
When the U.S. Supreme Court hears oral arguments Wednesday in a
case involving Naperville-based Tellabs Inc. securities
regulators and the investing community will be paying close
The justices are not expected to issue their ruling in the case
of Tellabs vs. Makor until June. But when it comes, the ruling
could make it significantly more difficult for investors to
pursue securities-fraud claims against U.S. corporations.
Whether such an outcome would be a good or a bad thing is a
matter of perspective.
Corporations, weary of having to defend themselves against
shareholder lawsuits that might or might not have any merit, are
hoping to see investors' ability to bring such litigation
But investor groups and legal interests that pursue such suits
are alarmed and suggest that investor protections put in place
after the Enron Corp. scandal are now in danger of being rolled
A ruling in favor of Tellabs and former chief executive Richard
Notebaert could result in "nearly insurmountable" barriers to
investors seeking to recover fraud losses, two investor-oriented
groups contended Tuesday.
"The Supreme Court will in effect be deciding whether or not the
securities fraud class-action remedy will survive as the primary
vehicle for investors to recover legitimate fraud losses," the
National Conference on Public Employee Retirement Systems and
the National Association of Shareholder and Consumer Attorneys
The fight involves an arcane-sounding legal concept known as "scienter."
In legal corporate-fraud cases, scienter generally means that
the company knew that its representations were false and that it
made the claims in order to deceive.
The issue generally arises in instances when a company's profits
prove disappointing, its share price drops, and stockholders
rush to file a class-action lawsuit claiming the company
deceived them. The key question in such legal fights is whether
company officials knew trouble was brewing but withheld the
information from investors, or whether they were as surprised as
stockholders when sales suddenly slumped and profits swooned.
If plaintiffs cannot prove scienter -- cannot demonstrate, in
other words, that company executives knew about and concealed
the bad news that drove the share price lower -- they generally
cannot prove a fraud claim.
For years the law generally granted investors significant
leeway, but in 1995 federal lawmakers, hoping to stem a rising
number of abusive shareholders suits, raised the hurdle that
plaintiffs must clear to prove scienter in fraud cases.
The new law holds that in the face of competing claims between
the company and the plaintiffs the court must be able to make a
"strong inference" that officials were knowingly holding back
information. If the evidence for such a conclusion is not there,
the judge is free to throw out the case before it goes to trial.
There is still confusion among different federal appeals courts,
however, as to just what legal yardstick should apply. The
Tellabs case now before the Supreme Court is expected to clarify
In the Tellabs case, shareholders who bought Tellabs shares
between late 2000 and mid-2001 filed suit after the company's
once highflying stock took a near-catastrophic tumble when the
Internet bubble burst.
As potential problems with a key product grew more obvious, they
say, then-CEO Notebaert knew he was not being truthful when he
offered upbeat pronouncements about the telecom
The federal district court that heard the case dismissed the
plaintiffs' lawsuit before it went to trial, ruling that Tellabs
investors had not met the threshold for proving the company
knowingly deceived the public.
When the investors appealed the case to the Chicago-based 7th
U.S. Circuit Court of Appeals the court ruled that the case
should be able to proceed to trial. The U.S. Court of Appeals in
Chicago offered an interpretation of the 1995 law less
restrictive than many other courts have applied.
As the case gathered momentum, the Securities and Exchange
Commission filed a friend-of-the-court document backing Tellabs'
The 1995 law that required a "strong inference" of scienter
before a case could go to trial was designed to raise the bar
from the earlier law's requirement of a "reasonable" inference,
the SEC argued, but the 7th Circuit's ruling does not reflect
that tougher requirement.
While solid claims from private investors are an "essential
supplement" to criminal and civil enforment actions brought by
the Justice Department and the SEC, it said, "Congress has
recognized the potential for such actions to be abused" to the
detriment of U.S. companies.
The Tellabs investors told the Supreme Court in a filing that
"the foundations of the government are not about to crumble
because defrauded investors seek relief from the companies that
have cheated them."