Installing Tellabs

The latest application of the Tellabs decision on the pleading of scienter (i.e., fraudulent intent) comes from the U.S. Court of Appeals for the Eleventh Circuit. In Mizzaro v. Home Depot, Inc., 2008 WL 4498940 (11th Cir. Oct. 8, 2008), the court considered two controversial issues.

Confidential Witnesses – The court declined to embrace the Seventh Circuit’s position that statements by confidential witnesses should be “heavily discounted.” On the other hand, the court acknowledged that there were reasons to be “skeptical of confidential sources cited in securities fraud complaints,” including that there are no harsh consequences if a witness lies to a plaintiff’s attorney. The court concluded: “Confidentiality . . . should not eviscerate the weight given if the complaint otherwise fully describes the foundation of the confidential witness’s knowledge, including the position(s) held, the proximity to the offending conduct, and the relevant time frame.”

Collective Scienter – The court agreed with the Fifth Circuit’s position that a defendant corporation’s scienter is determined by looking “to the state of mind of the individual corporate official or officials who make or issue the statement . . . rather than generally to the collective knowledge of all the corporation’s officers and employees acquired in the course of their employment.” (For more on the circuit split over collective scienter, see this post.) The plaintiffs did “not argue that any Home Depot officials were responsible for the company’s financial statements other than the named individual defendants.” Accordingly, the court found that it “need not pursue this issue further.”

Holding: Dismissal affirmed.

Quote of note: “To begin with, we indulge at least some skepticism about allegations that hinge entirely on a theory that senior management ‘must have known’ everything that was happening in a company as large as Home Depot, which operates over 2000 stores. The amended complaint, therefore, must at least allege some facts showing how knowledge of the fraud would or should have percolated up to senior management. The amended complaint does not come close to accomplishing that task. In particular, [plaintiff’s] ‘must have known’ theory fails because the alleged amount of the fraud is wholly speculative, the type of fraud alleged would be very difficult for senior management to detect, [plaintiff] alleges no suspicious stock sales by management, and Home Depot’s 2004 overhaul of its RTV processing system does not suggest knowledge of widespread fraud.”

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