To allege scienter (intent or knowledge of wrongdoing) in securities fraud cases, lawyers sometimes avow to the court that they have one or more confidential sources who tipped them off to the wrongdoing. If the court accepts this story, they may keep a case alive for which there would otherwise be no or inadequate evidence. Trouble is, the confidential informants can be, if not entirely a mirage, then flimsier on inspection than the court might have assumed. Cory Andrews of WLF tells of a recent ruling by Judge Richard Posner in a case called City of Livonia Employees’ Retirement System v. Boeing:
Seeking hundreds of millions of dollars in damages, plaintiffs filed a putative class action alleging that Boeing Company, along with its CEO and the head of its commercial aircraft division, committed securities fraud in violation of federal law. The district judge dismissed the complaint for failing to allege sufficient facts to properly plead the requisite scienter for fraud. Not to be deterred, plaintiffs promptly filed an amended complaint, but this time with detailed bombshell revelations from a confidential source. Ultimately, however, the allegations in the amended complaint could not withstand even the slightest scrutiny.
As Posner describes it:
The plaintiffs’ lawyers had made confident assurances in their complaint 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 acknowledged that she couldn’t verify what (according to her) he had told her.
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.
Noting that the same law firm [Robbins Geller Rudman & Dowd] had been accused of “similar conduct” in three other reported cases, Posner [on behalf of a unanimous panel] remanded the matter back to the district judge, who would be in a better position to calculate a dollar amount for Rule 11 sanctions.