By James Hamilton, J.D., LL.M.
A Seventh Circuit appeals panel has rendered one of the first interpretations of the recent US Supreme Court opinion in Tellabs, Inc. v. Makor Issues and Rights, Ltd. No. 06-484, June 21, 2007. The case involved a securities fraud claim against a company that had to restate financial results in order to correct errors created by fraud at its Brazilian subsidiary.
In an opinion by Chief Judge Easterbrook, the court said that Tellabs stands for two propositions relevant to this case. First, a complaint will survive a motion to dismiss 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. Second, in applying this standard, the court must take into account plausible opposing inferences.
One upshot of the Tellabs approach is that the panel was forced to discount allegations that the complaint attributed to five confidential witnesses, three of whom were former corporate employees. It is hard to see, reasoned the panel, how information from anonymous sources could be deemed compelling or how the court could take account of plausible opposing inferences. Perhaps these confidential sources have axes to grind, suggested the panel, or perhaps they are lying.
Anonymity frustrates the Tellabs requirement that courts weigh the strength of plaintiffs’ favored inference in comparison to other possible inferences. But notice that the court said that it would discount allegations from confidential witnesses, not ignore them. However, the panel said that the discount will usually be steep.
The court also noted that a complaint passes muster under Tellabs 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, which the panel described as a higher standard than probable cause.