Tellabs Applied

The first circuit court opinion to extensively apply the Tellabs decision has arrived and it contains a number of interesting holdings. Given that the opinion comes from the U.S. Court of Appeals for the Seventh Circuit and is authored by Judge Easterbrook, that will come as no surprise to any regular reader of this blog.

In Higginbotham v. Baxter Intern., Inc., 2007 WL 2142298 (7th Cir. July 27, 2007), the court addressed the impact of Tellabs on the use of confidential witnesses. Noting that the Supreme Court has required plaintiffs to plead an inference of scienter that is both cogent and at least as compelling as any opposing inference that can be drawn from the alleged facts, the court found that “anonymity frustrates that process.” In particular, the failure to name sources “conceals information that is essential to the sort of comparative evaluation required by Tellabs,” because the court is unable to fully evaluate the reliability of the witnesses. Accordingly, allegations from confidential witnesses must be “discounted” in determining whether a plaintiff has plead a strong inference of scienter and that discount will usually be “steep.”

The court went on to find that the plaintiffs had failed to plead a strong inference of scienter. In addition to discounting the statements of confidential witnesses, the court also poked holes in a number of other alleged inferences of scienter put forward by the plaintiffs. Notably, the court found that allegations of a publicly-announced antitrust investigation, stock sales by two company managers, and the company’s failure to disclose a fraud at its Brazilian subsidiary as soon as management was informed of its possible existence were insufficient to meet the plaintiffs’ pleading burden.

Holding: Dismissal affirmed.

Quote of note: “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.”

Quote of note II: “Prudent managers conduct inquiries rather than jump the gun with half-formed stories as soon as a problem comes to their attention. Baxter might more plausibly have been accused of deceiving investors had managers called a press conference before completing the steps necessary to determine just what had happened in Brazil. Taking the time necessary to get things right is both proper and lawful. Managers cannot tell lies but are entitled to investigate for a reasonable time, until they have a full story to reveal.”