The Dictates of Conscience

In Institutional Investors Group v. Ayaya, Inc., 2009 WL 1151943 (3rd Cir. April 30, 2009), the U.S. Court of Appeals for Third Circuit has issued a comprehensive opinion that addresses a number of important pleading topics.

(1) Safe Harbor for Forward-Looking Statements – Whether the first prong of the PSLRA’s safe harbor, which states that a defendant shall not be liable with respect to any forward-looking statement if it is accompanied by “meaningful cautionary statements,” insulates the defendant from liability for false statements made with actual knowledge of their falsity is an open issue (see this post). The Third Circuit found that Avaya’s cautionary language was “extensive and specific.” In particular, the company had warned against the adverse effects of “price and product competition,” which was exactly what the plaintiffs asserted “was responsible for Avaya’s missing its projections.” The court declined, however, to decide whether the cautionary language on its own was sufficient to avoid liability, instead finding that the plaintiffs had, in any event, failed to adequately plead actual knowledge of the projections’ falsity.

(2) Confidential Witnesses – The Third Circuit considered whether, as some courts have held, the Tellabs decision requires a court to discount allegations attributed to confidential witnesses. The court found that its earlier decision on the issue remained good law. To wit, confidential witness allegations must be evaluated by examining “the detail provided by the confidential sources, the sources’ basis of knowledge, the reliability of the sources, the corrobative nature of other facts alleged, including from other sources, the coherence and plausibility of the allegations, and similar indicia.” The statements should only be “discounted” if they are “found wanting with respect to these criteria.”

(3) Holistic Approach to Scienter Allegations – As predicted by The 10b-5 Daily following the Tellabs decision, the Third Circuit found that it can no longer allow plaintiffs to plead scienter by either alleging facts establishing motive and opportunity or by alleging facts that constitute evidence of reckless or conscious behavior. Instead, all of the plaintiffs’ scienter allegations must be considered collectively. (Along the same lines, the court rejected the Ninth Circuit’s recent embrace of a dual inquiry in which scienter allegations are evaluated individually and then, if insufficient on their own, collectively.)

Holding: Reversed in part, affirmed in part, and remanded.

Quote of note: “Our conclusion that ‘motive and opportunity’ may no longer serve as an independent route to scienter follows also from Tellabs’s general instruction to weigh culpable and nonculpable inferences. Individuals not infrequently have both strong motive and ample opportunity to commit bad acts-and yet they often forbear, whether from fear of sanction, the dictates of conscience, or some other influence. It cannot be said that, in every conceivable situation in which an individual makes a false or misleading statement and has a strong motive and opportunity to do so, the nonculpable explanations will necessarily not be more compelling than the culpable ones. And if that is true, then allegations of motive and opportunity are not entitled to a special, independent status.”

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