Resolving the Continuing Controversy Regarding Confidential Informants in Private Securities Fraud Litigation

Abstract

Tellabs Inc. v. Makor Issues & Rights, Ltd., has injected considerable uncertainty into the securities fraud pleading game, particularly with the law of confidential informants. Before Tellabs, the circuits correctly addressed whether confidential sources satisfied the PSLRA’s particularity requirement. The essential inquiry was whether there was a probability that the source had the information pleaded. However, as we wrote in our prior article, Congress, the Supreme Court, and the Proper Role of Confidential Informants in Securities Fraud Litigation, after Tellabs some federal circuit courts reassessed this well-settled and well-founded assessment of confidential sources, requiring instead that allegations deriving from confidential sources be steeply discounted based on the PSLRA’s scienter requirement. This approach has been gaining ground as of late.

This emerging trend, however, is based on a fundamental misunderstanding of how allegations based on information provided by confidential informants relate to the PSLRA: confidential sources speak to the particularity of the allegation. These allegations are governed by the particularity aspect of the PSLRA and not the Tellabs decision nor the “strong inference” requirement. Rather, a proper assessment of allegations by confidential informants involves only an inquiry whether the plaintiff has established a probability that the confidential source contains the information claimed – and not an assessment whether the allegations give rise to a strong inference of scienter. This Article shows that assessing confidential source allegations only under the particularity prong of the PSLRA is consistent with the text of PSLRA, Supreme Court precedent, and the underlying purposes of the securities laws. Yet, this Article acknowledges that should courts continue to reassess the proper role of confidential informants under the scienter prong, such a reassessment does not require a steep discount or general skepticism of such allegations out of hand.