Two years ago, I wrote about the difficulties defendants face when securities plaintiffs invoke confidential witnesses in their complaints. The case that prompted that discussion, City of Livonia Employee Retirement System v. Boeing Corp., now has a sequel. As it turns out, both parties appealed the opinion below: the plaintiffs because the court below had dismissed their case with prejudice, and the defendants because the court had not imposed sanctions consistent with the PSLRA.
Judge Posner wrote the opinion for the three-judge panel. He began with a brief (and very informative) summary of the relevant provisions of the PSLRA. In relaying the background of the case, Judge Posner specifically addressed the credibility of confidential witnesses head-on:
Allegations concerning–in the first amended complaint merely implying–unnamed confidential sources of damaging information require a heavy discount. The sources may be ill-informed, may be acting from spite rather than knowledge, may be misrepresented, may even be nonexistent–a gimmick for obtaining discovery costly to the defendants and maybe forcing settlement or inducing more favorable settlement terms.
(Emphasis added.) In this case, since the plaintiffs acknowledged at oral argument that they would not be relying on their formerly confidential witness, he quickly affirmed the dismissal with prejudice.
Then he moved on to sanctions, where he had some more severe things to say about the various amended complaints:
The plaintiffs’ lawyers had made confident assurances in their complaints about a confidential source–their only barrier to dismissal of their suit–even though none of the lawyers had spoken to the source and their investigator had acknowledged that she couldn’t verify what (according to her) he had told her. She had qualms: the names the source had given her of persons to whom he reported in the Boeing chain of command were inconsistent with what she was able to learn about the chain. This should have been a red flag to the plaintiffs’ lawyers. Their failure to inquire further puts one in mind of ostrich tactics–of failing to inquire for fear that the inquiry might reveal stronger evidence of their scienter regarding the authenticity of the confidential source than the flimsy evidence of scienter they were able to marshal against Boeing. Representations in a filing in a federal district court that are not grounded in an "inquiry reasonable under the circumstances" or that are unlikely to "have evidentiary support after a reasonable opportunity for further investigation or discovery" violate Rules 11(b) and 11(b)(3).
(Italics in original; bold added.) So the opinion affirmed the dismissal, and remanded the case the district court for a finding of whether sanctions were appropriate in this case, and, if so, how much.
There are two key takeaways here for defense lawyers. The first, as I wrote the last time I discussed Livonia, is that it is always worth probing deeply into the pleadings, especially in securities cases where there are heightened pleading standards. The second is a more general lesson for all lawyers: once you’ve been caught cutting corners, don’t push your luck with an appeal.