Corporate Governance

The Tellabs Excuse (A Recap)(Part 3)

By J. Robert Brown

We noted that one of the discipling effects of Tellabs was to require courts to consider all inferences raised by plaintiffs in determining whether they had produced a "strong inference" of scienter.  The analysis has already caused some courts to reconsider their approach to allegations that defendants, by virtue of their position, were aware of the company's core operations.

The approach has also clarified to some degree the necessary approach with respect to confidential sources.  The Seventh Circuit in Higginbotham suggested that, under Tellabs, confidential sources ought to be ignored or at least deeply discounted.  The Seventh Circuit subsequently backed off this approach.  See Makor v. Tellabs, 513 F.3d 702, 712 (7th Cir. 2008). 

Similarly, the position was rejected by the First Circuit in N.J. Carpenters Pension & Annuity Funds v. Biogen IDEC Inc., 537 F.3d 35 (1st Cir. 2008).  As the court noted:

• Tellabs requires that all information in plaintiffs' complaint be evaluated. We think that includes confidential source information, subject to the restrictions stated in our case law. We have never said a complaint would survive if it were based only on confidential source allegations. Indeed, we have said there must be a hard look at such allegations to evaluate their worth.

The language in Higginbotham still has the capacity to cause problems.  See Ind. Elec. Workers' Pension Trust Fund Ibew v. Shaw Group, Inc., 537 F.3d 527 (5th Cir. 2008)("That these allegations derive from confidential sources further detracts from their weight in the scienter analysis. Following Tellabs, courts must discount allegations from confidential sources.  Higginbotham v. Baxter Int'l Inc., 495 F.3d 753, 756-57 (7th Cir. 2007).  Such sources afford no basis for drawing the plausible competing inferences required by Tellabs.").  

Nonetheless, the command from Tellabs seems clear enough.  Anonymous sources can be a factor in creating an inference of scienter although the strength of the inference will in part depend upon the credibility of the sources, something that will often depend upon the level of detail that accompanies their statements.

We will finish with one more post on this subject tomorrow.

Full post as published by The Race to the Bottom on November 12, 2008 (boomark / email).