In a decision noteworthy both for the prominence of the case and for the implications of its analysis, the Seventh Circuit, hearing the Makor Issues & Rights Ltd. v. Tellabs Incorporated case on remand from the U.S. Supreme Court, has once again reversed the district court’s dismissal of the case.

The Supreme Court, in its June 21, 2007 opinion in the Tellabs case (about which refer here) had directed the Seventh Circuit to dismiss the complaint "unless a reasonable person would deem the inference of scienter cogent and at least as compelling as any opposing inference one could draw from the facts alleged."

In a January 17, 2008 opinion (here) written by Judge Richard Posner, the Seventh Circuit concluded that "the plaintiffs have succeeded…in pleading scienter" and therefore the court decided to "adhere to our decision to reverse the judgment of the district court in dismissing the suit."

In determining whether or not the plaintiffs’ allegations supported a "strong inference" that the defendants acted with scienter (as required in the heightened pleading requirements in the Private Securities Litigation Reform Act), the Seventh Circuit said that it was "exceedingly unlikely" that the alleged false statements "were the result of merely careless mistakes at the management level based on false information fed it from below, rather than of an intent to deceive or a reckless indifference to whether the statements were misleading."

In considering whether or not the plaintiffs’ allegations were sufficient to establish that the corporation itself acted with scienter, the court articulated a broad concept of "collective scienter"; the court said

it is possible to draw a strong inference of corporate scienter without being able to name the individuals who concocted and disseminated the fraud. Suppose General Motors announced that it had sold one million SUVs in 2006, and the actual number was zero. There would be a strong inference of corporate scienter, since so dramatic an announcement would have been approved by corporate officials sufficiently knowledgeable about the company to know that the announcement was false.

The court then turned to the question whether the plaintiffs had presented sufficient scienter allegations in connection with defendant Richard Notebaert, Tellabs’ former CEO, about whom the court noted that "almost all of the false statements that we have quoted emanated directly from him." The court asked

Is it conceivable that he was unaware of the problems of his company’s two major products and merely repeating lies fed to him by other executives of the company? It is conceivable, yes, but it is exceedingly unlikely.

Finally, the court noted that the complaint’s reliance on confidential sources "does not invalidate the drawing of a stong inference from the informants’ assertions." While acknowledging that there are circumstances when the accusations of anonymous informants would not be sufficient to meet the pleading requirements, the court distinguished the allegations in this complaint, observing that "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."

The Seventh Circuit’s decision is not only a victory for the plaintiffs in that case, it is also a refutation of the position, advanced by some at the time, that the Supreme Court’s Tellabs decision represented a watershed victory for securities litigation defendants. As I wrote at the time about the Supreme Court’s Tellabs opinion (here) "neither side has been handed a strategically decisive weapon, and so the battle will rage on, in many ways as before."

The Seventh Circuit’s recent opinion also represents a victory for plaintiffs in two other important respects as well. First, it represents a strong affirmation that plaintiffs can, at least in certain circumstances and with sufficiently detailed support, fulfill the threshold pleading requirements in reliance on anonymous sources and informants.

Second, the Seventh Circuit’s opinion represents an important recognition of the ability of plaintiffs to fulfill the pleading requirements as to corporate defendants by relying on allegations of "corporate" or "collective scienter." (My observations here about the corporate scienter portion of the Seventh Circuit’s opinion draw on comments about the case by one of the leading members of the plaintiffs’ bar whom I am sure would prefer anonymity – I emphasize this point just to acknowledge my gratitude for and to disclaim the originality of these observations.)

The court’s holding that "it is possible to draw a strong inference of corporate scienter without being able to name the individuals who concocted or disseminated the fraud," is a vigorous endorsement of the "collective scienter" approach to pleading a corporation’s state of mind. The question of plaintiffs’ ability to satisfy the requirements for pleading scienter with allegations of collective or corporate scienter is precisely the issue that will be argued before the Second Circuit on January 30, 2008, in the Dynex Capital securities lawsuit.

In the district court proceedings in the Dynex Capital case, Judge Harold Baer, Jr. held in a February 10, 2006 opinion (here) that a plaintiff "may, and in this case has, alleged scienter on the part of the corporate defendant without pleading scienter against any particular employees of the corporation." In a June 2, 2006 ruling (here), Judge Baer denied the defendants’ motion for reconsideration but granted the defendant’s petition for leave to take an interlocutory appeal on the collective scienter issue. A wide variety of litigants and interested parties have filed amicus briefs in the case, the consideration of which will undoubtedly be influenced by the Seventh Circuit’s most recent decision in the Tellabs case.

The final note about the Seventh Circuit’s Tellabs decision has to be that while the plaintiffs have had some significant recent setbacks in the U.S. Supreme Court, they have not by any means been put out of businsess, and indeed, even the string of defense-oriented Supreme Court decisions clearly still allows plaintiffs room to maneuver.

After a week that included the Stoneridge decision, the jury verdict in the Apollo Group case and the Seventh Circuit’s opinion on remand in the Tellabs case, it has to be asked –has there ever been a week as eventful as this past week in the annals of securities litigation? It is getting difficult for even the most diligent blogger to keep up…

Rick Bortnick and Emilio Boehringer at the Cozen O’Conner firm has written a good summary of and commentary on the 7th Circuit’s opinion in the Tellabs case, here.

Tenth Circuit Says Further Details About Qwest Settlement Required: The appellate proceedings in another prominent case, the Qwest Communications securities lawsuit, were also in the news this past week (refer here and here). The case was before the Tenth Circuit on an appeal brought by Joseph Nacchio and Robert Woodruff, Qwest’s former CEO and CFO. Nacchio and Woodruff were not included on the $400 million class settlement, but they appealed from the district court’s rejection of their objections to the settlement.

Nacchio and Woodruff allegedly were informed that they would be included in the settlement only if they would pay personally into any settlement fund, which they refused to do, as a result of which they were excluded from the settlement. The settlement documents nevertheless contained a number of different features designed to preclude the two individuals’ assertion of any rights to indemnification or contribution. The two individuals objected to the settlement based on these features, but the district court overruled their objections, specifically holding that the settlement was "fair, reasonable and adequate" as to Nacchio and Woodruff.

In a January 16, 2008 opinion (here), the Tenth Circuit found that the two individuals had standing to challenge the settlement, holding that they had suffered "legal prejudice," because the provisions of the settlement agreement "essentially strip, and in any event, palpably interfere with Mr Nacchio and Mr. Woodruff’s preexisting rights and potential legal claims." The Tenth Circuit went on to hold that the district court’s explanation of its reasons for overruling the individual defendants’ objections were "insufficient." The Tenth Circuit said that "we are unwilling to guess at the path the district court followed in resolving serious legal issues….We need something to show how and on what basis the court analyzed Mr. Nacchio and Mr. Woodruff’s objections." The Tenth Circuit remanded the case for the district court to provide further analysis of the individuals’ objections to the settlement.

Even though the Tenth Circuit’s ruling is purely procedural, the tenor of its decision strongly suggests the court’s discomfort with the settlement agreement’s elimination of Nacchio’s and Woodruff’s indemnification and contribution rights. Of course, it remains to be seen whether the district court can present an explanation sufficient to pass muster in the Tenth Circuit. The Tenth Circuit’s opinion does underscore the complications that can arise when litigants attempt to compel individuals to contribute toward settlements without recourse to indemnification or insurance.

Securities Litigation Teleconference: On Friday January 25, 2008 at 11 a.m. I will be participating in a conference call sponsored by Risk Metrics entitled "Securities Litigation: What You Need to Know for 2008." The call will be moderated by Adam Savett, the author of the Securities LitigationWatch blog, and the panelists will also include Stuart Grant, Managing Partner of Grant & Eisenhofer, and Lyle Roberts, a partner at Dewey & LeBoeuf and author of The 10b-Daily blog. Registration for the conference call, which is free, can be accessed here.

Now This: We here at The D & O Diary have particular respect for Judge Posner, the author of the recent Tellabs opinion in the Seventh Circuit, not only because he is one of the most highly regarded jurists in the country, but also because he is a blogger. Posner writes widely read The Becker-Posner Blog (here), which he co-authors with Gary Becker, the Nobel prize-winning economist from the University of Chicago. Their presence raises the tone of the entire blogosphere. Judge Posner is also the only Circuit judge of whom I am aware who has a website containing a searchable database devoted exclusively to his opinions.

Judge Posner was also recently the subject of a profile on the Law Blog (here), which included this excerpt from another opinion Judge Posner wrote, containing good advice for all of us involved in any way with the insurance industry:

A note, finally, on advocacy in this court. The lawyers’ oral arguments were excellent. But their briefs, although well written and professionally competent, were difficult for us judges to understand because of the density of the reinsurance jargon in them. There is nothing wrong with a specialized vocabulary–for use by specialists. Federal district and circuit judges, however, with the partial exception of the judges of the court of appeals for the Federal Circuit (which is semi-specialized), are generalists. We hear very few cases involving reinsurance, and cannot possibly achieve expertise in reinsurance practices except by the happenstance of having practiced in that area before becoming a judge, as none of us has. Lawyers should understand the judges’ limited knowledge of specialized fields and choose their vocabulary accordingly. Every esoteric term used by the reinsurance industry has a counterpart in ordinary English, as we hope this opinion has demonstrated. The able lawyers who briefed and argued this case could have saved us some work and presented their positions more effectively had they done the translations from reinsurancese into everyday English themselves.