Conditions of Mind

Conditions of Mind

Rule 9(b) splits a fraud claim into two kinds of facts and treats them differently. The first sentence requires a party to “state with particularity the circumstances constituting fraud or mistake,” and the second adds that “[m]alice, intent, knowledge, and other conditions of a person’s mind may be alleged generally.”¹ The first kind of fact is what happened: what was said, on what occasion, and why it was untrue. The second is what the speaker had in mind: whether the speaker knew the statement was false or meant to induce reliance on it.

This unit asks three questions about the second sentence. Why does the rule relax the demand for state of mind alone? How far does “generally” stretch once Twombly and Iqbal require facts behind every claim? And must a fraud plaintiff still plead facts from which fraudulent intent can be inferred, and how strong must the inference be? The courts of appeals have split on the last question, and Congress has answered it by statute for private securities fraud suits.

Intent May Be Alleged Generally

The rule’s different treatment of the two halves tracks what a fraud plaintiff can be expected to know. The typical fraud claim alleges that a seller made an incorrect statement to induce a buyer’s reliance. Because the buyer was a party to the transaction, she can be expected to know the statement that induced her reliance and why it was incorrect by the time she sues. She cannot be expected to have any direct information about the seller’s state of mind.² The pleading burdens under Rule 9(b) rest on the assumption that, for at least some kinds of facts, plaintiff and defendant have equal access to the relevant information.³ Detail about the statement is required because the plaintiff has it, and detail about the seller’s mind is not, because she does not.

The particular half of the claim is still demanding. A plaintiff must state the time, place, and specific content of the false representations as well as the identities of the parties to the misrepresentation.⁴ Time, place, and content only identify the statement, however; they do not “constitute” fraud, because the statement must be false to be fraudulent, so courts require that circumstances indicating falseness be set forth.⁵ Within those requirements, particularity can be supplied simply. In Barinaga v. JP Morgan Chase & Co. the court acknowledged that the allegations “may not be as specific as Chase would like,” held them sufficient under Rule 9(b), and quoted the Ninth Circuit’s observation that “the requisite particularity might be supplied with great simplicity.”⁶

The two halves therefore work as a pair. The pleaded circumstances give notice of which statement is attacked and why it was false, and the allegation of knowledge or intent can then be brief.

Students err in two opposite directions on the second sentence. Some read it as relaxing the whole fraud claim, so that any complaint reciting fraudulent intent survives, when the permission reaches only the way the mental element is pleaded and leaves the particulars of the misrepresentation fully required. Others overcorrect and demand dates, meetings, and documents revealing what the defendant was thinking, which is the very detail the sentence excuses. The permission also has an outer edge, because Rule 8 still governs a pleaded state of mind, and the next part takes up that limit.⁷

Limits on General Allegation

The word “generally” limits itself. The Supreme Court read it as a relative term in Ashcroft v. Iqbal: in the context of Rule 9, it is to be compared to the particularity requirement applicable to fraud or mistake. Rule 9 merely excuses a party from pleading discriminatory intent under an elevated pleading standard, and it does not give him license to evade the less rigid, though still operative, strictures of Rule 8.¹⁰ Rule 8 therefore does not allow a plaintiff to plead the bare elements of his cause of action, affix the label “general allegation,” and expect the complaint to survive a motion to dismiss.¹¹ A pleader may not need to plead state of mind with particularity, but even general pleading must be well pleaded, meaning not entirely conclusory, and plausible.¹²

That holding is the first step of the Iqbal approach applied to Rule 9. A court may begin by identifying pleadings that are no more than conclusions and so are not entitled to the assumption of truth, and it then assumes the truth of the well-pleaded facts and asks whether they plausibly give rise to an entitlement to relief.¹³ The Court did exactly that in Iqbal. The majority discarded the allegations against Ashcroft and Mueller as conclusory and was left with two statements: that the FBI under Mueller arrested and detained thousands of Arab Muslim men, and that the policy of confining detainees in highly restrictive conditions until they were “cleared” was approved by the two officials in discussions in the weeks after September 11. Those statements suggested only that the officials sought to keep suspected terrorists in the most secure conditions available until the suspects could be cleared of terrorist activity.¹⁴

Rule 9 cannot work as an exemption from that screen, because so many claims turn on a mental state. Intent, malice, and knowledge are elements of many causes of action, and each can be recited in a single word. If the recital satisfied Rule 8, a complaint could survive by adding the word knowingly or intentionally, and no event bearing on the defendant’s mind would ever have to be alleged. The two rules coexist because they operate at different levels. Rule 9’s second sentence takes a mental state off the particularity level, so the pleader need not supply dates, meetings, or documents exposing what the defendant was thinking. Rule 8 keeps it on the plausibility level, so the complaint must still contain facts that make the claimed state of mind a plausible inference.¹⁵ Requiring those facts does not create a heightened standard for a category of claims, because plausibility applies to every claim, and Twombly itself said it was not abandoning the principle that pleading standards are not heightened for different types of cases.¹⁶

Fraud cases add a second limit, because the first sentence of Rule 9(b) is also in play. In Greenstone v. Cambex Corp. the complaint alleged, in conclusory fashion, that Cambex “knew” that IBM Credit’s leases forbade Cambex’s memory trade-ins and that the defendants “knowingly or recklessly” published misleading financial statements.¹⁷ The plaintiff argued that the first assertion at least satisfied Rule 9(b), which permits averments of knowledge in general terms. The First Circuit answered that Rule 9(b) also requires the circumstances constituting fraud to be pleaded with particularity, and that a plaintiff cannot avoid that requirement through a general averment that defendants “knew” earlier what later turned out badly.¹⁸ The courts, it reported, have uniformly held a general averment of knowledge of material falsity inadequate, unless the complaint also sets forth specific facts that make it reasonable to believe that the defendant knew the statement was materially false or misleading.¹⁹

The court gave its reason: were the law otherwise, a complaint could evade too easily the particularity requirement in the rule’s first sentence.²⁰ The mechanism is easy to see. Fraud depends on what the speaker knew when speaking, yet a plaintiff always pleads from the vantage of a known bad outcome, and from that vantage nearly any disappointing result looks like something the defendant must have foreseen. If a bare statement that the defendant knew were enough, every failed forecast could be recast as a fraud known in advance. The court contrasted a complaint that charged that a company’s rosy mid-1986 predictions were misleading and pointed, to show knowledge, to the company’s poor financial results in 1987 through 1989 and to a company document reporting cash-flow problems that began in late 1986 or early 1987, only months after the prediction. Those allegations were not specific enough.²¹ They show how events turned out, and they show little about what the speakers knew when they spoke.

Because both limits ask whether facts stand behind a pleaded mental state, the allegation is best examined in a fixed order.

Two opposite errors recur here. One reads “generally” as permission to plead intent or knowledge in a bare clause and nothing more, a reading the Supreme Court rejected for every kind of claim and the First Circuit rejected for fraud claims in particular.²² The other demands dates, meetings, and documents that reveal what the defendant was thinking, which is the very detail the second sentence excuses. The cases require facts that make the belief reasonable. How strongly those facts must support the inference is where the courts of appeals divide, and the next part turns to that division.

Strong Inference Approaches

The text of Rule 9(b) does not say whether a fraud complaint must also offer facts from which fraudulent intent can be inferred. The Second Circuit says it must. Scienter “need not be alleged with great specificity,” but plaintiffs “are still required to plead the factual basis which gives rise to a ‘strong inference’ of fraudulent intent.”²⁵ Courts applying the test put it this way: although Rule 9(b) allows conditions of mind to be averred generally, plaintiffs must nonetheless allege facts which give rise to a strong inference that defendants possessed the requisite fraudulent intent.²⁶

The gloss answers the fact that a general allegation costs nothing. Writing that a defendant acted knowingly takes a moment and shows nothing about what the defendant actually knew. A requirement of supporting facts may deter groundless litigation, a benefit that even its critics acknowledge.²⁷ It does not ask for the particularity that attaches to the circumstances of the fraud. It asks for facts that make the mental state a reasonable inference.

A motive to deceive does not rescue a fraud complaint that never ties the defendant to a representation. In a ticketholder’s suit over a cancelled concert, the hotel was the only defendant with an apparent financial motive to withhold notice of the cancellation. The complaint nonetheless alleged no representation by the hotel on which the plaintiff relied, because the only alleged misrepresentations and omissions appeared, or failed to appear, on the ticket seller’s website.²⁸

The Ninth Circuit, sitting en banc in In re GlenFed, Inc. Securities Litigation, rejected any requirement that plaintiffs allege facts from which intent to commit fraud can be inferred. It reasoned that such a requirement is squarely at odds with the rule’s declaration that malice, intent, knowledge, and other conditions of mind “may be averred generally.” It acknowledged that a strong-inference requirement may deter groundless litigation, but it concluded that a court cannot, consistent with its judicial role, add a pleading requirement beyond those the Federal Rules mandate.²⁹ Rejecting the gloss leaves the first sentence untouched, because the statement must still be false to be fraudulent and the circumstances indicating falseness must still be set forth.³⁰ A district judge writing in the Third Circuit, noting that the Third Circuit had not spoken to the issue and that other courts had expressed reservations about the Second Circuit’s standard, was likewise not persuaded that Rule 9(b) calls for a strong inference. That ruling came in re ValueVision Int’l, Inc., Sec. Litig³¹

The circuits part ways on the first complaint and agree on the second. A court applying the Second Circuit’s test dismisses the first for want of facts supporting an inference of intent. A court following the Ninth Circuit accepts it under Rule 9(b), because the circumstances of falsity are pleaded and knowledge may be alleged generally. Rule 8’s plausibility requirement, which Iqbal held survives Rule 9’s allowance for conditions of mind, still asks even that court for facts that make the claimed state of mind plausible.³² Plausibility asks only whether the facts make the mental state reasonable to infer, while the Second Circuit asks that the inference be strong, so the approaches come closer without converging.

For private securities fraud suits, Congress settled the dispute by statute. The Private Securities Litigation Reform Act requires plaintiffs to “state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind.”³³ Scienter, the culpable state of mind that a securities fraud claim requires, such as knowledge of falsity or reckless disregard for the truth, therefore cannot be pleaded generally in those suits. Congress borrowed the phrase “strong inference” from the Second Circuit, but that borrowing did not incorporate the Second Circuit’s case law about what the words mean.³⁴ Outside those suits the split described above remains live.

The statutory test also asks for more than an ordinary motion to dismiss does. A court deciding a Rule 12(b)(6) motion normally draws reasonable inferences for the plaintiff, but in requiring a strong inference of scienter the statute alters that normal operation of inferences.³⁵ In Tellabs, Inc. v. Makor Issues & Rights, Ltd. the Supreme Court addressed what it takes to plead a strong inference of scienter under the statute.³⁶ The test requires courts to take into account plausible opposing inferences. A complaint adequately pleads scienter “only if a reasonable person would deem the inference of scienter cogent and at least as compelling as any opposing inference one could draw from the facts alleged,” and the court reviews all the allegations holistically.³⁷ The pleaded inference must therefore hold up against the innocent one. In Matrixx Initiatives, Inc. v. Siracusano the Court restated that test and rejected a bright-line rule requiring an allegation of statistical significance, calling that rule just as flawed as the company’s approach to materiality.³⁸

Because the right standard depends on the claim and the forum, the sorting comes before any weighing of facts.