On August 21, 2014, Ruben Castillo, Chief Judge of the U.S. District Court for the Northern District of Illinois, issued an 18-page opinion on the sole issue on remand from the Seventh Circuit Court of Appeals of “whether to impose sanctions on Plaintiffs’ attorneys, pursuant to Federal Rule of Civil Procedure 11 and the Private Securities Litigation Reform Act of 1995 (“PSLRA”).” In that case, City of Livonia Employees’ Retirement Systems v. Boeing Co., Case No. 1:09-cv-07143, Plaintiffs’ counsel had relied on interviews conducted by two of their investigators of a single “confidential witness” in drafting and filing their first and second amended securities class action complaints. While the use of confidential witnesses is commonplace among the securities class action plaintiffs’ bar, the Boeing case reveals the dangers of such use where the plaintiffs’ attorneys have not conducted their own “reasonable investigation concerning the credibility and reliability of a purported key witness” upon whose statements serious allegations (i.e., of scienter) are based in a securities class action complaint.
Pertinent Background Facts
The case began in November of 2009 with the filing of the original securities class action complaint, which alleged claims of securities fraud under the federal securities laws. The Plaintiffs alleged that the Company had made false and misleading statements about the timeline for its new airliner when the Defendants purportedly knew that certain tests would cause the “first flight” of the plane to be delayed, and which, when revealed to the marketplace, caused the stock price of the Company to drop by more than 10 percent.
Plaintiffs’ counsel had not yet interviewed its sole confidential witness when the original complaint was filed. Three months later, an investigator for Plaintiffs’ counsel interviewed the confidential witness (“CW”) over the telephone, during which CW told the investigator that he had worked for the Company from 2004 through January of 2010 and that he had reported to a vice president. He also told the investigator that he worked on the test planes at issue and that he had knowledge of the testing. Three days later, another investigator interviewed CW, this time in person. After that meeting, Plaintiffs’ counsel’s investigator summarized her interview in an e-mail memorandum to the lead attorney for the Plaintiffs. Significantly, in that e-mail, the investigator indicated that her follow-up research “revealed that CW’s information was not reliable.” Nonetheless, the next day, Plaintiffs filed an amended complaint with “vague references to internal e-mails” suggesting the Defendants knew about the results of the tests.
Shortly thereafter, CW told the second investigator that he “no longer wished to cooperate with Plaintiffs’ investigation,” but, at that time, he allegedly did not refute or deny the information he had shared with the investigators in his prior interviews. Thereafter, the court dismissed the First Amended Complaint for failure to adequately plead scienter, and, in particular, the court commented on the Plaintiffs’ failure to plead any particularized facts about the “confidential sources.” In response, Plaintiffs filed a second amended complaint in which they added four new paragraphs detailing information about CW, the content of which came from the investigator’s e-mail memorandum. Based upon those new allegations, the trial court denied the Defendants’ second motion to dismiss.
When the Plaintiffs disclosed the identity of CW, Defendants promptly investigated and learned that, not only had CW never been an employee of the Company (rather, he had been a low-level independent contractor), but that also he had never worked on any project associated with the plane at issue in this case. Based upon this new information, the Defendants filed a renewed motion to dismiss, and additionally argued that Plaintiffs’ counsel had committed a fraud on the court. However, the court denied the renewed Motion.
Defendants then obtained a sworn declaration from CW in which he “repudiated each of the allegations attributed to him in the second amended complaint,” and deposed CW during which he again denied the allegations attributed to him by the Plaintiffs. Thereafter, Defendants moved for reconsideration of the court’s orders denying their motions to dismiss. Only then, when presented with irrefutable evidence of the lack of support for the allegations in the Second Amended Complaint that had been attributed to CW, did the trial court grant Defendants’ motion to dismiss the case with prejudice.
The Result and the Aftermath
On March 26, 2013, the Seventh Circuit Court of Appeals affirmed the dismissal of the case with prejudice, and in a Judge Posner-authored opinion, remanded the sanctions determination to the district court. Despite deferring that determination to the trial court, Judge Posner went into some detail regarding the procedural and factual history of the case, not mincing words in describing Plaintiffs’ counsel’s conduct. For instance, he stated:
[Plaintiffs’ counsel’s] failure to inquire further [following the investigator’s inability to confirm CW’s alleged position, among other things] puts one in mind of ostrich tactics—of failing to inquire for fear that the inquiry might reveal stronger evidence oftheir scienter regarding the authenticity of the confidential source than the flimsy evidence of scienter they were able to marshal against [the Company].
He went on to point out that Plaintiffs’ counsel has been criticized for asserting “misleading allegations, concerning confidential sources, made to stave off dismissal of a securities-fraud case much like this one” in three other cases (all cited by the court). He concluded with the comments that “[r]ecidivism is relevant in assessing sanctions” and that the “district court is in a better position than the court of appeals to calculate the dollar amount of the sanctions.”
Thus, upon remand, Judge Castillo was tasked with the determination of whether to assess sanctions and, if so, in what amount. In his analysis, Judge Castillo sternly rejected Plaintiffs’ assertions that “publicly available information is the traditional source of investigative material, and confidential witnesses are not required to state a claim,” noting that “[t]his kind of ‘shoot first, aim later’ practice, whereby (Plaintiffs’) attorneys wait until after the complaint is filed to ‘conduct an investigation that [they] should have conducted before filing [the] lawsuit,’ has already been criticized in this District.” Judge Castillo concluded that counsel’s failure to interview CW before filing the original complaint constituted a “failure to conduct a reasonable pre-filing investigation as required by the PSLRA.”
With respect to the allegations in the complaints that relied on the interviews of CW, Plaintiffs’ counsel argued that they were legally permitted to rely on their investigators and were not required to have participated in the interviews or to have shown the witness the complaint. In response, the court stated “there must be reasonable cause to trust the accuracy” of such information and that “a lawyer may not simply put his head in the sand and forgo any attempt to verify information.” Indeed, despite the “red flag” pointed out by the investigator as to the unreliable nature of CW’s statements, the court noted that counsel “nevertheless included that unverified information in the second amended complaint and persistently defended the truth of that information.” The court concluded that “Defendants are entitled to their reasonable attorneys’ fees and other expenses incurred in defending this lawsuit,” but the court ordered the parties to mediate the matter of what that amount should be.
Perhaps not surprisingly, other defendants and defense counsel have paid very close attention to Judge Castillo’s ruling. In fact, given the three previous cases cited by both Judge Posner and Judge Castillo in which Plaintiffs’ counsel was criticized for similar behavior, followed by the actual issuance of sanctions in Boeing, it would be surprising if opposing counsel did not seek to pounce on any hint of similar issues in other cases. Just such an approach was taken in another case pending in New York federal court, in which defense counsel opposed class certification, among other reasons, on the basis that Plaintiffs’ counsel is not suitable to serve as class counsel in light of its confidential witness shenanigans in the past and, purportedly, in that case as well. Regardless of these particular cases and facts, a reasonable take-away from these decisions for any counsel that may utilize investigators and confidential witnesses is that the “ostrich” approach can be sanctionable, and that more is required, including direct, reasonable diligence by the attorney, in making affirmative representations in pleadings.