all actions brought under title I of the Securities Exchange Act of 1934 or title I of the Securities Act of 1933, that are commenced after December 22, 1995. Since Plaintiffs filed their action on February 23, 1996, two months after the effective date, the Reform Act applies to their suit.
2.) Allegations Made on Information and Belief
Defendants assert that the FAC contains numerous allegations that are implicitly based on information and belief because, due to the nature of the allegations, they cannot be based on either Plaintiffs' or their counsels' personal knowledge. Further, Defendants contend that the FAC does not comply with the Reform Act because it fails to state with particularity all the facts on which these "beliefs" are formed.
Prior to the Reform Act, courts permitted plaintiffs asserting fraud to make allegations based on information and belief as to matters peculiarly within the defendant's knowledge. Neubronner v. Milken, 6 F.3d 666, 672 (9th Cir. 1993). Further, since plaintiffs could not be expected to have knowledge of such matters, courts relaxed the pleading requirements of Rule 9(b) when assessing the sufficiency of these allegations. Id. However, to warrant application of a relaxed standard, plaintiffs were required to state the facts that formed the basis for their allegations made on information and belief. Id.
As part of the pleading requirements established by the Reform Act, Congress codified the rule for pleading on information and belief. The Reform Act provides that "if an allegation regarding the statement is made on information and belief, the complaint shall state with particularity all facts on which that belief is formed." 15 U.S.C. § 78u-4(b)(1). Thus, under the Reform Act, plaintiffs may continue to make allegations based on information and belief so long as the complaint at issue sets forth the facts that form the basis of the allegations.
Here, the FAC does not state that any allegations are based on "information and belief" but rather, it asserts that Plaintiffs obtained the facts through "investigation of counsel." FAC P 123. In other words, even though some of the facts appear to be peculiarly within Defendants' knowledge, Plaintiffs contend that they have, through investigation, acquired sufficient facts to state a claim for fraud without relying on allegations made on information and belief.
As such, Plaintiffs need not state with particularity all facts on which their beliefs are formed. However, since Plaintiffs' allegations are not based on information and belief, they must meet the strict, rather than relaxed, pleading requirements of Rule 9(b) and the Reform Act. Accordingly, Plaintiffs cannot rely on conclusory allegations or tenuous inferences but instead, must allege with particularity: (1) each statement, (2) why each statement is false, and (3) as to each statement, facts giving rise to a strong inference that Defendants acted with scienter.
3.) Pleading Scienter1
Scienter is a necessary element of every 10-b(5) claim. Ernst & Ernst v. Hochfelder, 425 U.S. 185, 193, 96 S. Ct. 1375, 1380, 47 L. Ed. 2d 668 (1976). The Supreme Court has defined scienter as "a mental state embracing intent to deceive, manipulate or defraud." Id. at 194 n.12.
Prior to enactment of the Reform Act, the Ninth Circuit permitted plaintiffs to aver scienter generally. In re Glenfed, Inc. Sec. Litig., 42 F.3d 1541, 1545-47 (9th Cir. 1994). Congress then amended the standard for pleading scienter in all circuits by including a provision in the Reform Act which states: "the complaint shall, with respect to each act or omission alleged to violate this chapter, state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind." 15 U.S.C. § 78u-4(b)(2). This "strong inference" language was modeled upon the pleading standard of the Second Circuit. H.R. Conf. Rep. No. 369, 104th Cong., 1st Sess. 41 (1995).
In the Second Circuit, to adequately plead scienter, the facts alleged in a complaint must "give rise to a 'strong inference' of fraudulent intent." O'Brien v. National Property Analysts Partners, 936 F.2d 674, 676 (2d Cir. 1991). In applying this standard, the Second Circuit recognizes two distinct ways in which a plaintiff may plead scienter without having direct knowledge of the defendant's intent. In Re Time Warner Inc. Securities Litigation, 9 F.3d 259, 268-69 (2d Cir. 1993). First, the plaintiff can allege facts "establishing a motive to commit fraud and an opportunity to do so." Id. at 269. Second, the plaintiff can allege "facts constituting circumstantial evidence of either reckless or conscious behavior." Id.
Even though the Reform Act makes use of the "strong inference" language, the statute's legislative history creates some uncertainty as to whether Congress intended to adopt all, some or none of the Second Circuit case law interpreting the standard. The Senate Committee on Banking, Housing and Urban Affairs stated in its report on the initial bill, S. 240:
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 giving 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.