Comfort With the Majority: the Eighth Circuit Weighs in on the Proper Pleading Test for a Securities Fraud Claim in Florida State Board of Administration v. Green Tree Financial Corporation, 270 F.3d 645 (8th Cir. 2001)

• Publication year: 2021
• Citation: Vol. 82

82 Nebraska L. Rev. 1276. Comfort with the Majority: The Eighth Circuit Weighs in on the Proper Pleading Test for a Securities Fraud Claim in Florida State Board of Administration v. Green Tree Financial Corporation, 270 F.3d 645 (8th Cir. 2001)

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Note*

Erin M. O'Gara*

Comfort with the Majority: The Eighth Circuit Weighs in on the Proper Pleading Test for a Securities Fraud Claim in Florida State Board of Administration v. Green Tree Financial Corporation, 270 F.3d 645 (8th Cir. 2001)

TABLE OF CONTENTS

I. Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . 1277
II. Background . . . . . . . . . . . . . . . . . . . . . . . . . . . 1281
A. The Pre-Reform Act Pleading Standard . . . . . . . . . . . . . 1281
B. The Reform Act and Its Legislative History . . . . . . . . . . 1282
C. The Reform Act's Interpretation by the Courts and
the Resulting Circuit Court Split . . . . . . . . . . . . . . 1284
1. The Second Circuit Standard: The Motive-and-
Opportunity Test . . . . . . . . . . . . . . . . . . . . . 1284
2. The Ninth Circuit Standard: Allegations of
Motive and Opportunity Are Never Sufficient to
Plead Scienter . . . . . . . . . . . . . . . . . . . . . . 1285
3. The Middle Ground: Allegations of Motive and
Opportunity May Not Necessarily be Sufficient
to Plead Scienter . . . . . . . . . . . . . . . . . . . . . 1286
D. Green Tree . . . . . . . . . . . . . . . . . . . . . . . . . . 1287
1. Facts . . . . . . . . . . . . . . . . . . . . . . . . . . . 1287
2. Holding . . . . . . . . . . . . . . . . . . . . . . . . . . 1290
III. Analysis . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1292

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A. The Plain Language, Legislative History, and
Policies Underlying the Reform Act Indicate that
Congress Neither Codified Nor Rejected the Second
Circuit's Motive-and-Opportunity Test . . . . . . . . . . . . 1293
1. The Reform Act's Plain Language Indicates That
Congress Neither Codified, Nor Rejected the
Second Circuit's Motive-and-Opportunity Test . . . . . . . 1293
2. The Reform Act's Legislative History Indicates
That Congress Did Not Explicitly Reject the
Motive-and-Opportunity Test . . . . . . . . . . . . . . . . 1294
B. The Eighth Circuit Should Adopt the Motive-and-
Opportunity Pleading Test . . . . . . . . . . . . . . . . . . 1298
1. The Motive-and-Opportunity Test, Along with
the Second Circuit Case Law, Raises the
Procedural Pleading Requirement, Thus
Deterring Meritless Strike Suits . . . . . . . . . . . . . 1300
2. The Motive-and-Opportunity Test Best Protects
Investors in the Securities Market . . . . . . . . . . . . 1302
3. The Adoption of the Motive-and-Opportunity
Test, Along with the Second Circuit Case Law,
Establishes a Uniform Pleading System
Throughout the Circuits . . . . . . . . . . . . . . . . . . 1304
C. Some Guidance for Securities Fraud Plaintiffs in the
Eighth Circuit . . . . . . . . . . . . . . . . . . . . . . . . 1305
IV. Conclusion and Future of the Reform Act . . . . . . . . . . . . . 1307

I. INTRODUCTION

In this age of corporate scandals it is unlikely that one would view large profitable corporations such as Enron, WorldCom, and Global Crossing, as victimized, "deep-pocket" defendants-the unfair targets of frivolous shareholder lawsuits.(fn1) However, it was exactly this concern that motivated Congress to pass the Private Securities Litigation Reform Act of 1995 (the "Reform Act").(fn2) The Reform Act, which amended the Securities and Exchange Act of 1934, strengthened a variety of securities laws in favor of corporate defendants. In part, the Reform Act increased the minimum showing of scienter,(fn3) an essential element of both a section 10(b) claim of the Securities and Exchange

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Act of 1934(fn4) ("section 10(b) claim") and a Securities and Exchange Commission Rule 10b-5 claim(fn5) ("Rule 10b-5 claim"), necessary to survive a motion to dismiss.(fn6)

A split has developed among the circuit courts concerning which pleading requirement Congress adopted, if any, to satisfy the stronginference-of-scienter requirement mandated by the Reform Act. At one end of the spectrum, the Second and Third Circuits have adopted the "motive-and-opportunity" test, which finds that pleading facts demonstrating motive and opportunity is sufficient to give rise to a strong inference of scienter.(fn7) At the other end of the spectrum, the Ninth Circuit has held that Congress raised the pleading standard beyond that of "motive and opportunity," meaning that pleading facts detailing motive and opportunity will never satisfy the strong-inference-of-scienter requirement.(fn8) In the middle of the spectrum are the First, Fourth, Fifth, Sixth, Tenth, and Eleventh Circuits, holding that while pleading facts detailing motive and opportunity are important in pleading a securities fraud claim, ultimately the court must engage in a factual determination on a case-by-case basis to determine whether the strong-inference-of-scienter requirement has been met.(fn9)

The circuits are in agreement that the Reform Act does not alter the substantive requirement of scienter, which is recklessness, for a

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section 10(b) and a Rule 10b-5 claim.(fn10) Although the substantive scienter requirement is not the focus of this Note, it is important to understand that by increasing the minimum showing of scienter necessary to survive a motion to dismiss, "Congress has effectively, for policy reasons, made it substantively harder for plaintiffs to bring securities fraud cases."(fn11) Under the Reform Act, once a motion to dismiss is filed, all discovery, with certain narrow exceptions, is stayed while the motion to dismiss is pending.(fn12) Clearly, determining the proper pleading test that satisfies the strong-inference-of-scienter requirement has far reaching implications. The adoption of a lenient pleading test will fail to screen out frivolous securities fraud claims and will subject corporations to costly and time-consuming "strike suits."(fn13) Conversely, the adoption of an overly strict pleading test may deny securities fraud litigants with meritorious claims their day in court.

Interestingly, in the seven years since the passage of the Reform Act, it is not clear that the heightened pleading standards have decreased the number of strike suits. Initially, the passage of the Re

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form Act caused a significant drop in shareholder lawsuits,(fn14) but shareholder lawsuits quickly climbed back to previous levels, with a record number of suits filed in 2001.(fn15) One possible explanation is that the decline and subsequent rise in shareholder lawsuits had little to do with the heightened pleading standards and instead are attributable to the rise and fall of the stock market.(fn16) In a rising stock market, corporate directors and officers are less likely to manipulate their numbers or hide bad news, because investors are more likely to ignore this information.(fn17) In a down market, investors are more likely to act on this information, giving corporate directors and officers an incentive to try to hide the bad news from investors by manipulating the numbers reported to shareholders. Others argue, however, that because of the falling stock market, the number of suits filed in 2001 would have likely been higher without the heightened Reform Act pleading standards.(fn18)

This Note argues that the Reform Act neither codified nor rejected the Second Circuit's motive-and-opportunity pleading test and accompanying case law, instead leaving the matter to the courts. Left with this flexibility, the Eighth Circuit should have adopted the Second Circuit's motive-and-opportunity test and the accompanying Second Circuit case law. The motive-and-opportunity test, and the accompanying Second Circuit case law, best furthers the policies and considerations underlying the Reform Act, namely the deterrence of meritless strike suits, the protection of investors in the securities market, and the establishment of a uniform pleading system for securities fraud claims. The pleading test adopted by the Eighth Circuit, the case-bycase factual determination test, adds little to the deterrence of strike suits, fails to provide securities plaintiffs with guidance on how to satisfy the increased pleading requirements, and injects judicial flexibility into a situation where Congress clearly wanted it limited.

Section II of the Note examines (1) the pleading standard for scienter prior to the Reform Act; (2) the Reform Act's text and legislative history; and (3) the resulting circuit court split that has developed concerning the test for pleading scienter under the Reform Act. Section II also discusses the factual background and procedural history of Florida State Board of Administration v. Green Tree Financial Corpora

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tion ("Green Tree"),(fn19) the case in which the Eighth Circuit weighed in on the appropriate pleading test under the Reform Act. Section III argues that the legislative history and plain text of the Reform Act indicate that Congress neither codified nor rejected the Second Circuit's motive-and-opportunity test, and instead, left the matter to judicial determination. Section III also examines the policies and considerations underlying the Reform Act and concludes that to best further these policies and considerations, the Eighth Circuit should have adopted the motive-and-opportunity test and the accompanying Second Circuit case law.

II. BACKGROUND

A. The Pre-Reform Act Pleading Standard

Prior to the passage of the Reform Act, the pleading standard for a section 10(b) and a Rule 10b-5 claim was governed under Rule 9(b) of the Federal Rules of Civil Procedure ("Rule 9(b)"), which provided that "[i]n all averments of fraud or mistake, the circumstances constituting fraud or mistake shall be stated with particularity."(fn20) The Eighth Circuit interpreted Rule 9(b)...