Gauging the Hurdle to Strike Suits: Reconciling the Circuit Split over the Proper Interpretation of the Heightened Pleading Standard under the Private Securities

I. INTRODUCTION In December 1995, Congress passed the Private Securities Litigation Reform Act of 1995 (the Reform Act)1 in an effort to curb abuse in securities fraud litigation, particularly the filing of strike suits.2 Often, a drop in a company's stock price may trigger a strike suit.3 The abuse of strike suits unduly burdens corporate defendants4 and consequently hurts investors and the stock markets by increasing the cost of capital.5 To prevent this abusive practice, the Reform Act imposes significant new limitations and requirements on private securities fraud actions brought under the federal securities law.6 One such requirement is the Reform Act's heightened pleading standard.7 A stringent pleading requirement can make it more difficult for plaintiffs to pursue securities fraud claims. Under a strict pleading requirement, a corporate defendant may be able to successfully move for dismissal of a securities fraud lawsuit by challenging the plaintiffs' pleading of fraud. Therefore, designing an appropriate standard for pleading fraud would be an effective method of discouraging abusive securities litigation. However, the heightened pleading standard set forth in the Reform Act has failed to achieve the purposes conceived by Congress. This failure was first reflected in the sharp division among federal district courts concerning the proper interpretation of the new pleading standard of the Reform Act.8 Over the past year, this division has permeated up to the circuit court level. Six federal courts of appeals have issued conflicting decisions interpreting the Reform Act's pleading standard provision.9 These conflicting decisions apply different pleading standards, and consequently, whether a securities fraud action will survive a motion to dismiss will largely turn on the particular court in which the plaintiff files the action.10 The differing treatment leads to forum-shopping11 by plaintiffs lawyers and disturbs the balance that Congress intended to maintain between the competing interests of preventing frivolous securities fraud litigation and protecting shareholders against fraud.12 Thus, it is necessary to clarify the Reform Act's pleading standard and promote a uniform interpretation of the pleading standard. This Note will first present the legal landscape for the recent circuit split over the Reform Act's pleading standard.13 Then, it will review those circuit cases interpreting the pleading standard.14 Finally, the Note will critique those circuit decisions, reconcile their differences, and propose a uniform interpretation of the pleading standard. 15 II. THE LEGAL LANDSCAPE A. Section 21D(b)(2): The Heightened Pleading Standard The Reform Act sets forth the heightened pleading standard in section 21D(b)(2). Section 21 D(b)(2) provides that a plaintiff filing a securities fraud action must with particularity facts giving rise to a that the defendant acted with the required state of mind.16 This standard is different from the pre-Reform Act standards applied by courts with regard to pleading scienter.17 Prior to the passage of the Reform Act, plaintiffs in securities fraud litigation had to comply with the requirements of Rule 9(b) of the Federal Rules of Civil Procedures.18 Under Rule 9(b), plaintiffs may aver scienter generally, but the circumstances constituting fraud must be stated with particularity.19 However, federal courts were widely divided over the proper interpretation of Rule 9(b).20 The Ninth Circuit, for example, merely required plaintiffs to plead scienter with conclusory allegations,21 while the Second Circuit required plaintiffs to plead specific facts sufficient to establish a strong inference of scienter.22 Congress introduced the heightened pleading standard in section 211)(b)(2) of the Reform Act as an attempt to create uniformity among the circuits.23 However, it has become a fertile source of dispute, spawning a flood of litigation regarding its proper interpretation. …