To satisfy PSLRA pleading requirements, securities fraud complaints frequently rely on confidential informants. A substantial body of law has grown up concerning whether, or how much, confidentiality is permissible. The Seventh Circuit’s decision on Friday, July 27, 2007, in Higgingotham v. Baxter Int’l, Inc., 2007 U.S. App. LEXIS 17918 (7th Cir. July 27, 2007), changes the discussion entirely. Judge Easterbrook interprets the Supreme Court’s recent decision in Tellabs, Inc. v. Makor Issues & Rights, Ltd., 127 S. Ct. 2499, 168 L. Ed. 2d 179 (2007) (see our posts of July 7 and 25, 2007) as requiring that judges discount allegations premised on information received from confidential informants because it is impossible to weigh them in Tellabs’ mandated cogency analysis.

Tellabs provides that a complaint survives a dismissal motion ‛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," and, in applying this standard, "the court must take into account plausible opposing inferences." 168 L. Ed. 2d at 193-94. From this, Judge Easterbrook reasons:

One upshot of the approach that Tellabs announced is that we must discount allegations that the complaint attributes to five "confidential witnesses"***. 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.

At oral argument, we asked when the identity of these five persons would be revealed and how their stories could be tested. The answer we received was that the sources' identity would never be revealed, which means that their stories can't be checked. Yet Tellabs requires judges to weigh the strength of plaintiffs' favored inference in comparison to other possible inferences; anonymity frustrates that process.

Some thoughts: (1) Tellabs applies only to scienter allegations. It does not mandate any different approach toward confidential informant-based allegations that go, e.g., to falsity. Those presumably are subject to Bell Atlantic. (2) The counter argument to Higgingotham includes that the allegations of the complaint are to be taken as true, and the court is not to be judging credibility on a 12(b)(6) motion, even after Bell Atlantic. In other words, neither ‛cogency“ nor ‛plausibility“ entails credibility determinations. (3) The better the description of the role of the confidential informant — in other words, the less confidential he or she is kept — the better for 12(b)(6) purposes.