D&O Liability - Seventh Circuit Discounts Allegations Attributed to Confidential Witnesses, Citing Tellabs
On July 27, 2007, in Higginbotham v. Baxter International Inc., No. 06-1312 (7th Cir.), the United States Court of Appeals for the Seventh Circuit affirmed the district court’s dismissal with prejudice of a purported
securities class action on the basis that plaintiffs had failed adequately to plead scienter. Although the appeal had been fully briefed and argued before the United States Supreme Court granted certiorari in Tellabs, Inc., et al. v. Makor Issues & Rights, Ltd., et al.,
the Higginbotham court deferred action on the appeal pending the Supreme Court’s June 21, 2007 Tellabs decision.
According to the Seventh Circuit, “[o]ne upshot of the approach that Tellabs announced is that we must discount allegations that the complaint attributes to five ‘confidential witnesses.’” The
court reasoned:
It is hard to see how information from anonymous sources could be deemed “compelling” or how we could take account of plausible opposing inferences. Perhaps these confidential sources have axes to grind. Perhaps they are lying. Perhaps they don’t even exist.
Tellabs requires judges to weigh the strength of a plaintiff’s favored inferences against other possible inferences, the court reasoned, and “anonymity frustrates that process [and] does nothing but obstruct the judiciary’s ability to implement the PSLRA” because, among other things, it “conceals information that is essential to the sort of comparative evaluation required by Tellabs.”
The court rejected any analogy to the use of unnamed informants in affidavits for search warrants, noting that Tellabs set forth a higher standard than “probable cause” in its dictate that a complaint will survive
“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.”
Finally, although the court acknowledged that anonymous sources could conceivably corroborate or “disambiguate” evidence from disclosed sources and, therefore, allegations attributed to confidential witnesses should
be “discounted” rather than ignored, the court cautioned that “[u]sually that discount will be steep.”