Tellabs on Remand — Complaint Upheld — Confidential Sources Generally OK

On remand from the Supreme Court, the Seventh Circuit upheld the complaint in Makor Issues & Rights Ltd. v Tellabs Inc., 2008 U.S. App. LEXIS 975 (7th Cir. 2005). In the course of doing so, it sharply circumscribed its prohibition against plaintiffs’ relying on confidential sources in their complaints (see our post of July 29, 2007, discussing Higgingotham v. Baxter Int’l, Inc., 2007 U.S. App. LEXIS 17918 (7th Cir. July 27, 2007)). Among Judge Posner’s observations:

1. Strong Inference. “To judges raised on notice pleading, the idea of drawing a ‘strong inference’ from factual allegations is mysterious. Even when a plaintiff is required by Rule 9(b) to plead facts (such as the when and where of an alleged fraudulent statement), the court must treat the pleaded facts as true and ‘draw all reasonable inferences in favor of the plaintiff.’”

2. Collective Intent. “The problem with inferring a collective intent to deceive behind the act of a corporation is that the hierarchical and differentiated corporate structure makes it quite plausible that a fraud, though ordinarily a deliberate act, could be the result of a series of acts none of which was both done with scienter and imputable to the company by the doctrine of respondeat superior.... To establish corporate liability for a violation of Rule 10b-5 requires ‘look[ing] to the state of mind of the individual corporate official or officials who make or issue the statement (or order or approve it or its making or issuance, or who furnish information or language for inclusion therein, or the like) rather than generally to the collective knowledge of all the corporation's officers and employees acquired in the course of their employment.’”

3. The Demise of Channel-Stuffing. “Channel stuffing becomes a form of fraud only when it is used, as the complaint alleges, to book revenues on the basis of goods shipped but not really sold because the buyer can return them.” (See also our post of July 7, 2007, for a further note on the demise of channel-stuffing after the Supreme Court’s decision in Tellabs.)

4. Confidential Sources Largely OK. “The confidential sources listed in the complaint in this case, in contrast [to the earlier Higgengotham decision], are numerous and consist of persons who from the description of their jobs were in a position to know at first hand the facts to which they are prepared to testify.... The information that the confidential informants are reported to have obtained is set forth in convincing detail, with some of the information, moreover, corroborated by multiple sources. It would be better were the informants named in the complaint, because it would be easier to determine whether they had been in a good position to know the facts that the complaint says they learned. But the absence of proper names does not invalidate the drawing of a strong inference from informants' assertions” (citations omitted).

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