The Supreme Court’s Impact on Securities Class Actions: An Empirical Assessment of Tellabs

Abstract

How does Supreme Court precedent affect lower court decisions when there is asymmetric probability of appellate review? Using securities fraud class actions filed between 2003 and 2007, we study the impact of a widely-followed Supreme Court decision from that period, Tellabs, Inc. v. Makor Issues & Rights, Ltd. Tellabs clarified the law with respect to one of the most contested issues in securities litigation: pleading scienter. The Tellabs decision reversed a lenient Seventh Circuit reasonableness standard for pleading scienter, but replaced it with a standard that is nonetheless relatively generous to plaintiffs. Would the Supreme Court’s directive cause the dismissal rates in the lower courts to converge? Looking at opinions resolving motions to dismiss decided before and after that decision, we find that Tellabs correlates with a significantly lower dismissal rate on scienter grounds in circuits previously applying a higher preponderance standard for scienter, particularly the Ninth Circuit. By contrast, we find no significant shift in the courts previously applying the lower reasonableness standard in our basic model. Looking at judicial characteristics that might explain the higher dismissal rates in the preponderance circuits, we find that judges who have substantial business caseloads or who were nominated by Republican presidents became substantially less likely to dismiss on scienter grounds after Tellabs. Consistent with the greater difficulty involved in obtaining dismissal, Tellabs correlates with an increase in low value settlements in the Ninth Circuit. Conversely, Tellabs also correlates with a decrease in low value settlements in circuits that previously applied the more lenient Seventh Circuit standard. Overall, we conclude that Tellabs led to increased uniformity in how lower courts apply pleading standards, but its effect is muted by the asymmetry of the right to appeal.

Keywords: Private Securities Litigation Reform Act of 1995 (PSLRA), Tellabs, Inc., Supreme Court

JEL Classification: K22, K41