Congress, the Supreme Court, and the Proper Role of Confidential Informants in Securities Fraud Litigation
Michael J. Kaufman
Loyola University Chicago School of Law
John M. Wunderlich
Institute for Investor Protection
Securities Regulation Law Journal, Vol. 36, No. 2, Summer 2008
Confidential sources are critical to preventing financial harm and prosecuting corporate misconduct. In order to overcome the Private Securities Fraud Litigation Act's heightened pleading requirements, victims of securities fraud often have to rely on confidential sources for particularized facts regarding fraud. In its most recent decision regarding those pleading requirements, the United States Supreme Court held that plaintiffs must allege a strong inference of scienter; meaning the inference of culpability must be at least as likely as nonculpable competing inferences. The question left unanswered by the Court in Tellabs, however, is whether securities fraud victims can satisfy this pleading standard through the use of confidential sources.
This article will show that Tellabs cannot fairly be construed to preclude plaintiffs from relying on confidential sources to satisfy the PSLRA's securities fraud pleading requirements. Section II of this article will examine the federal courts' pre-Tellabs treatment of confidential sources for securities fraud cases based on the particularity provision of the PSLRA. This section also will discuss the Tellabs decision and its emergent rule. Section III of this article will analyze the circuits' post-Tellabs treatment of confidential sources. The lower federal courts thus far are split on the place of confidential sources in securities fraud pleading. A recent Seventh Circuit decision invoking Tellabs requires courts to discount allegations from confidential witnesses. This Section will show that the Tellabs rule does not justify such a discounting of confidential sources. Finally, this article will conclude that, while the federal courts previously assessed confidential informants from a particularity viewpoint, some federal courts after Tellabs are beginning to treat confidential sources under an erroneous strong inference standard. The continuation of that trend will disserve the Supreme Court's precedents, the will of Congress and the victims of securities fraud.
Keywords: Securities Fraud, Confidential Source, Confidential Witness, Scienter
Date posted: January 31, 2009