Court Opinion

ID: 3001243
Source: CourtListenerOpinion
Date Created: 2015-09-24 20:14:26.550827+00
Date Added: 2024-06-11T13:23:19.535482
License: Public Domain

In the
 United States Court of Appeals
               For the Seventh Circuit
                          ____________

No. 04-1687
MAKOR ISSUES & RIGHTS, LTD., et al.,
                                               Plaintiffs-Appellants,
                                  v.

TELLABS INCORPORATED, et al.,
                                               Defendants-Appellees.
                          ____________
             Appeal from the United States District Court
        for the Northern District of Illinois, Eastern Division.
                No. 02 C 4356—Amy J. St. Eve, Judge.
                          ____________
   ARGUED NOVEMBER 1, 2007—DECIDED JANUARY 17, 2008
                          ____________

  Before POSNER, WOOD, and SYKES, Circuit Judges.
   POSNER, Circuit Judge. This appeal is before the court
a second time, after our previous decision, 437 F.3d 588
(7th Cir. 2006), reversing the dismissal of the suit by the
district court on the defendants’ motion to dismiss, was
itself reversed by the Supreme Court. 127 S. Ct. 2499 (2007).
The Court remanded the case to us with directions to
consider whether the plaintiffs’ allegations of securities
fraud in violation of section 10(b) of the Securities Ex-
change Act of 1934, 15 U.S.C. § 78j(b), and SEC Rule 10b-5,
17 C.F.R. § 240.10b-5, create the “strong inference” of
scienter, as defined by the Supreme Court in its opinion,
2                                                 No. 04-1687

that the Private Securities Litigation Reform Act of 1995
requires for the complaint to survive a motion to dismiss.
  Rule 10b-5 forbids a company or an individual “to
make any untrue statement of a material fact or to omit to
state a material fact necessary in order to make the state-
ments made, in the light of the circumstances under which
they were made, not misleading.” 17 C.F.R. § 240.10b-5(b).
But liability requires proof of the defendant’s “scienter,”
which is to say proof that he either knew the statement
was false or was reckless in disregarding a substantial risk
that it was false. Higginbotham v. Baxter International, Inc.,
495 F.3d 753, 756 (7th Cir. 2007). A popular definition of
recklessness in this context is “an extreme departure from
the standards of ordinary care . . . to the extent that the
danger was either known to the defendant or so obvious
that the defendant must have been aware of it.” In re
Scholastic Corp. Securities Litigation, 252 F.3d 63, 76 (2d Cir.
2001), quoting Rolf v. Blyth, Eastman Dillon & Co., 570
F.2d 38, 47 (2d Cir. 1978). This looks like two criteria—
knowledge of the risk and how big the risk is—but as a
practical matter it is only one because knowledge is
inferable from gravity (“the danger was either known
to the defendant or so obvious that the defendant must
have been aware of it”). When the facts known to a per-
son place him on notice of a risk, he cannot ignore the
facts and plead ignorance of the risk. AMPAT/Midwest,
Inc. v. Illinois Tool Works Inc., 896 F.2d 1035, 1042 (7th Cir.
1990); SEC v. Jakubowski, 150 F.3d 675, 681 (7th Cir. 1998).
  A complication introduced by the Private Securities
Litigation Reform Act is that “actual knowledge” of falsity,
not merely indifference to the danger that a statement
is false, is required for liability for “forward-looking”
statements—predictions or speculations about the future.
No. 04-1687                                                3

15 U.S.C. § 78u-5(c)(1)(B)(ii); see Helwig v. Vencor, Inc.,
251 F.3d 540, 554-55 (6th Cir. 2001). This has implications
for pleading, since the “strong inference” that must be
drawn to avoid dismissal cannot be an inference merely
of recklessness if predictions are challenged as fraudulent.
The fact that all the statements challenged in this case
that we found in our earlier opinion to be materially
false are in the present tense is not decisive on the ques-
tion whether the statements include predictions: “Our
earnings are certain to double” is in the present tense,
but is a prediction. But a mixed present/future state-
ment is not entitled to the safe harbor with respect to the
part of the statement that refers to the present. When
Tellabs told the world that sales of its 5500 system were
“still going strong,” it was saying both that current sales
were strong and that they would continue to be so, at least
for a time, since the statement would be misleading if
Tellabs knew that its sales were about to collapse. The
element of prediction in saying that sales are “still going
strong” does not entitle Tellabs to a safe harbor with
regard to the statement’s representation concerning cur-
rent sales.
   Section 21D(b)(2) of the Reform Act requires that the
plaintiff’s complaint “state with particularity facts giving
rise to a strong inference that the defendant acted with
the required state of mind,” 15 U.S.C. § 78u-4(b)(2), that
is, with scienter. But except with regard to “forward-
looking” statements, the Act does not specify “the re-
quired state of mind,” so it remains the concept of scienter
developed before the Act. Nathenson v. Zonagen Inc.,
267 F.3d 400, 407-09 (5th Cir. 2001); Helwig v. Vencor, Inc.,
supra, 251 F.3d at 550. In our previous opinion, we ruled
that the plaintiffs had adequately pleaded not only that
4                                               No. 04-1687

the defendants had made materially false statements
but also that they had acted with the required scienter.
The first ruling was not disturbed by the Supreme
Court and is the law of the case, controlling our present
consideration. The second ruling was not reversed, but
the Supreme Court disagreed with this court’s interpreta-
tion of “strong inference” of scienter and directed us 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.” 127 S. Ct. at 2510 (footnote omit-
ted). The plaintiff “must plead facts rendering an infer-
ence of scienter at least as likely as any plausible op-
posing inference.” Id. at 2513 (emphasis in original). So
first the inference must be cogent, and second it must be
as cogent as the opposing inference, that is, the inference
of lack of scienter.
  To judges raised on notice pleading, the idea of drawing
a “strong inference” from factual allegations is mysterious.
Even when a plaintiff is required by Rule 9(b) to plead
facts (such as the when and where of an alleged fraudu-
lent statement), the court must treat the pleaded facts as
true and “draw all reasonable inferences in favor of the
plaintiff.” Borsellino v. Goldman Sachs Group, Inc., 477 F.3d
502, 506-07 (7th Cir. 2007). To draw a “strong inference”
in favor of the plaintiff might seem to imply that the
defendant had pleaded facts or presented evidence that
would, by comparison with the plaintiff’s allegations,
enable a conclusion that the plaintiff had the stronger
case; and therefore that a judge could not draw a strong
inference in the plaintiff’s favor before hearing from the
defendant. But comparison is not essential, and obviously
is not contemplated by the Reform Act, which requires
dismissal in advance of the defendant’s answer unless
No. 04-1687                                               5

the complaint itself gives rise to a strong inference of
scienter. For a defendant will usually have evidence to
present in his defense; and so a complaint that on its face,
and without reference to the defendant’s case, creates only
a weak or bare inference of scienter, suggesting that the
plaintiff would prevail only if there were no defense
case at all, would be quite likely to fail eventually
when the defendant had a chance to put on his case,
which would normally be after pretrial discovery. Appar-
ently Congress does not believe that weak complaints
should put a defendant to the expense of discovery in a
securities-fraud case, which is likely to be complex—as
this case is.
  The complaint alleges the following: The corporate
defendant, Tellabs, manufactures equipment used in
fiber optic cable networks; its principal customers are
telephone companies. In December 2000, the beginning of
the period of alleged violations of Rule 10b-5, Tellabs’s
principal product, accounting for more than half its sales,
was a switching system called TITAN 5500. The product
was almost 10 years old when on December 11 Tellabs
announced that the 5500’s successor product, TITAN 6500,
was “available now” and that Sprint had signed a multi-
year, $100 million contract to buy the 6500, though in fact
no sales pursuant to the contract closed until after the
period covered by the complaint. The same announce-
ment added that despite the advent of the 6500, sales of
the 5500 would continue to grow. (Most of these and
other announcements quoted in the complaint were
made by Richard Notebaert, who was Tellabs’s chief
executive officer and, along with Tellabs, is the principal
defendant.)
  The following month, Tellabs announced that “customers
are buying more and more Tellabs equipment” and that
6                                                 No. 04-1687

Tellabs had “set the stage for sustained growth” with the
successful launch of several products. In February, the
company told its stockholders that its growth was “robust”
and that “customers are embracing” the 6500. In response
to a question frequently asked by investors—whether
sales of the 5500 had peaked—the company declared
that “although we introduced this product nearly 10 years
ago, it’s still going strong.” In March the company re-
duced its sales estimates slightly but said it was doing
so because of lower than expected growth in a part of its
business unrelated to the 5500 and 6500 systems, and
that “interest in and demand for the 6500 continues to
grow” and “we are satisfying very strong demand and
growing customer demand [for the 6500, and] we are as
confident as ever—that may be an understatement—about
the 6500.” And in response to a securities analyst’s ques-
tion whether Tellabs was experiencing “any weak-
ness at all” in demand for the 5500, Notebaert re-
sponded: “No, we’re not . . . . We’re still seeing that prod-
uct continue to maintain its growth rate; it’s still experienc-
ing strong acceptance.” Yet from the outset of the period
covered by the complaint Tellabs had been flooding its
customers with tens of millions of dollars worth of 5500s
that the customers had not requested, in order to create
an illusion of demand. The company had to lease extra
storage space in January and February to accommodate
the large number of returns.
  Just weeks after these statements Tellabs reduced its
sales projections significantly because its customers
were “exercising a high degree of prudence over every
dollar spent.” But it reiterated that the demand for the
6500 was “very strong.” In April it said “we should hit
our full manufacturing capacity [for the 6500] in May or
June to accommodate the demand we are seeing. Every-
No. 04-1687                                              7

thing we can build, we are building and shipping. The
demand is very strong.”
  In June, however, at the end of the period covered by
the complaint, Tellabs announced a major drop in reve-
nues, and its share price, which at its peak during the
period had been $67 and in the middle of the period had
varied between $30 and $38, fell to just under $16. (It
currently is below $7.00.) But the deterioration had been
well under way by December as a result of the bursting of
the fiber-optics bubble in the middle of the year. The
market for the 5500 was evaporating; the next month
(January 2001), Tellabs’s largest customer, Verizon, re-
duced its orders for the 5500 by 50 percent—having
already, the previous June, reduced them by 25 percent.
And not a single 6500 system was shipped during the
complaint period.
  Tellabs’s revenues in 2001 were 35 percent lower than
the year before and its profits 125 percent lower. The
drop in the second quarter (most of which was within the
period covered by the complaint) over the year before
was even steeper; revenues dropped 43 percent and profits
211 percent.
  The company’s statements that we have quoted or
paraphrased were, we ruled in our previous opinion—and,
to repeat, the ruling binds us as law of the case—ade-
quately pleaded as materially false. But is an inference of
scienter from these allegations cogent and at least as
compelling as the contrary inference—that there was no
scienter? It is easier to consider the second, the compara-
tive, question first, and also to separate the issue of the
company’s scienter from that of Notebaert’s. The em-
phasis throughout the litigation has been on the latter,
8                                               No. 04-1687

but the former is also alleged and (though briefly) argued;
and we begin with it.
  There are two competing inferences (always assuming
of course that the plaintiffs are able to prove the allega-
tions of the complaint). One is that the company knew
(or was reckless in failing to realize, but we shall not have
to discuss that possibility separately) that the state-
ments were false, and material to investors. The other is
that although the statements were false and material,
their falsity was the result of innocent, or at worst care-
less, mistakes at the executive level. Suppose a clerical
worker in the company’s finance department accidentally
overstated the company’s earnings and the erroneous
figure got reported in good faith up the line to Notebaert
or other senior management, who then included the
figure in their public announcements. Even if senior
management had been careless in failing to detect the
error, there would be no corporate scienter. Intent to
deceive is not a corporate attribute—though not because
“collective intent” or “shared purpose” is an oxymoron. It
is not. A panel of judges does not have a single mind,
but if all the judges agree on the decision of a case, the
decision can properly be said to represent the collective
intent of the panel, though the judges who join an opinion
to make it unanimous may not agree with everything
said in it.
  The problem with inferring a collective intent to de-
ceive behind the act of a corporation is that the hierar-
chical and differentiated corporate structure makes it
quite plausible that a fraud, though ordinarily a delib-
erate act, could be the result of a series of acts none of
which was both done with scienter and imputable to the
company by the doctrine of respondeat superior. Some-
No. 04-1687                                                  9

one low in the corporate hierarchy might make a
mistake that formed the premise of a statement made at
the executive level by someone who was at worst care-
less in having failed to catch the mistake. A routine in-
vocation of respondeat superior, which would impute the
mistake to the corporation provided only that it was
committed in the course of the employee’s job rather
than being “a frolic of his own,” Joel v. Morrison, 6 C. & P.
501, 172 Eng. Rep. 1338 (1834), would, if applied to a
securities fraud that requires scienter, attribute to a cor-
poration a state of mind that none of its employees had. To
establish corporate liability for a violation of Rule 10b-5
requires “look[ing] to the state of mind of the individual
corporate official or officials who make or issue the state-
ment (or order or approve it or its making or issuance,
or who furnish information or language for inclusion
therein, or the like) rather than generally to the collective
knowledge of all the corporation’s officers and employees
acquired in the course of their employment.” Southland
Securities Corp. v. INSpire Ins. Solutions, Inc., 365 F.3d 353,
366 (5th Cir. 2004) (footnote omitted). A corporation is
liable for statements by employees who have apparent
authority to make them. See, e.g., American Society of
Mechanical Engineers, Inc. v. Hydrolevel Corp., 456 U.S. 556,
568 (1982), and for the application of the principle to
securities fraud In re Atlantic Financial Management, Inc., 784
F.2d 29, 31-32 (1st Cir. 1986).
  Suppose the false communication by the low-level
employee to his superiors had been deliberate. Suppose
he was embezzling tens of millions of dollars, and by
concealing the embezzlement greatly exaggerated his
corporation’s assets. Suppose he even knew that as a
result the corporation would misrepresent its assets to
10                                                No. 04-1687

investors. Nevertheless, even if his superiors were care-
less in failing to detect the embezzlement, the corpora-
tion would not be guilty of fraud, since the malefactor’s
acts of embezzling and concealing the embezzlement
would not be acts on behalf of the corporation; deliberate
wrongs by an employee are not imputed to his employer
unless they are not only within the scope of his employ-
ment but in attempted furtherance of the employer’s
goals. Hunter v. Allis-Chalmers Corp., 797 F.2d 1417, 1421-22
(7th Cir. 1986); Fitzgerald v. Mountain States Tel. & Tel. Co.,
68 F.3d 1257, 1262-63 (10th Cir. 1995); Home Life Ins. Co. v.
Equitable Equipment Co., 680 F.2d 1056, 1059-60 (5th Cir.
1982).
  The Supreme Court has declined to incorporate com-
mon law principles root and branch into section 10(b) of
the Securities Exchange Act (and hence into Rule 10b-5),
and specifically has rejected aider and abettor liability.
Central Bank of Denver, N.A. v. First Interstate Bank of
Denver, N.A., 511 U.S. 164 (1994). But the doctrines of
respondeat superior and apparent authority remain
applicable to suits for securities fraud. AT&T v. Winback &
Conserve Program, Inc., 42 F.3d 1421, 1429-33 (3d Cir. 1994).
Tellabs does not argue the contrary.
  The court in the Southland Securities case said that corpo-
rate scienter could be based on the state of mind of some-
one who furnished false information that became the
basis of a fraudulent public announcement. Suppose he
had knowingly supplied the false information intending
to help the company. His superiors would not be liable
for failing to catch the mistake, but Southland implies that
the corporation would be liable, just as it would be in a
common law tort suit. W. Page Keeton et al., Prosser and
Keeton on the Law of Torts § 70, pp. 505-06 (5th ed. 1984).
No. 04-1687                                                 11

That theory of liability is not argued in this case, however,
and so we need not explore it. Nor do the plaintiffs seek to
use section 20(a) of the Securities Exchange Act, 15 U.S.C.
§ 78t(a), to impose “control person” liability on the corpora-
tion, which would require the plaintiffs to overcome
defenses of good faith and noninducement. Tellabs does
not make the argument, which has been rejected by most
courts, that section 20(a) supersedes liability based on
apparent authority or respondeat superior. Hollinger v.
Titan Capital Corp., 914 F.2d 1564, 1576-78 (9th Cir. 1990) (en
banc); Commerford v. Olson, 794 F.2d 1319, 1322-23 (8th Cir.
1986); In re Atlantic Financial Management, Inc., supra, 784
F.2d at 32-35; Fey v. Walston & Co., 493 F.2d 1036, 1051-53
(7th Cir. 1974).
   The critical question, therefore, is how likely it is that
the allegedly false statements that we quoted earlier in
this opinion 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. It is exceedingly unlikely. The 5500 and the
6500 were Tellabs’s most important products. The 5500
was described by the company as its “flagship” product
and the 6500 was the 5500’s heralded successor. They
were to Tellabs as Windows XP and Vista are to Microsoft.
That no member of the company’s senior management
who was involved in authorizing or making public state-
ments about the demand for the 5500 and 6500 knew that
they were false is very hard to credit, and no plausible
story has yet been told by the defendants that might
dispel our incredulity. The closest is the suggestion that
while “available” no doubt meant to most investors that the
6500 was ready to be shipped to customers rather than that
12                                              No. 04-1687

the new product was having teething troubles that would
keep it off the market for many months, this may have been
a bit of corporate jargon innocently intended to indicate
that the company was ready to take orders. If so, then
while it was false as reasonably understood by investors
the false impression was a result of mutual misunderstand-
ing rather than of fraud. See Banque Arabe et Internationale
D’Investissement v. Maryland National Bank, 57 F.3d 146, 153-
54 (2d Cir. 1995). But this is highly implausible when
“available” is set among the company’s alleged lies about
the 6500—that “customers are embracing” the 6500, that
“interest in and demand for the 6500 continues to grow,”
that “we are satisfying very strong demand and growing
customer demand [for the 6500 and] we are as confident as
ever—that may be an understatement—about the 6500,”
and that “we should hit our full manufacturing capacity in
May or June to accommodate the demand [for the 6500] we
are seeing. Everything we can build, we are building and
shipping. The demand is very strong.”
  Another possible, though again very unlikely, example
of innocent misunderstanding is the charge of “channel
stuffing.” The term refers to shipping to one’s distributors
more of one’s product than one thinks one can sell. A
certain amount of channel stuffing could be innocent
and might not even mislead—a seller might have a real-
istic hope that stuffing the channel of distribution would
incite his distributors to more vigorous efforts to sell
the stuff lest it pile up in inventory. Channel stuffing
becomes a form of fraud only when it is used, as the
complaint alleges, to book revenues on the basis of goods
shipped but not really sold because the buyer can return
them. They are in effect sales on consignment, and such
sales “cannot be booked as revenue. Neither condition of
revenue recognition has been fulfilled—ownership and
No. 04-1687                                              13

its attendant risks have not been transferred, and since
the goods might not even be sold, there can be no cer-
tainty of getting paid. But those strictures haven’t
stopped some managers from using consigned goods to
fatten the top line—that is, the revenue line—of the corpo-
rate income statement.” H. David Sherman et al., Profits
You Can Trust, Spotting & Surviving Accounting Landmines 30
(Financial Times Prentice Hall 2003); SEC v. McAfee, Inc.,
Civ. Action No. 06-009 (PJH) (N.D. Cal. Jan. 4, 2006),
http://sec.gov/litigation/litreleases/lr19520.htm (visited
Nov. 19, 2007). (Similarly, Tellabs could not properly
record revenue on its contract with Sprint before actually
transferring title to 6500 systems to Sprint.) The huge
number of returns of 5500 systems is evidence that the
purpose of the stuffing was to conceal the disappointing
demand for the product rather than to prod distributors
to work harder to attract new customers, and the pur-
pose would have been formed or ratified at the highest
level of management.
  All this is not to say that the plaintiffs could name
“management” as a defendant or, less absurdly, name
each corporate officer. That would be an example of “the
group pleading doctrine[, which] is a judicial presump-
tion that statements in group-published documents in-
cluding annual reports and press releases are attributable
to officers and directors who have day-to-day control or
involvement in regular company operations.” Winer Family
Trust v. Queen, 503 F.3d 319, 335 (3d Cir. 2007). As we held
in our first opinion, the doctrine is inconsistent with the
“strong inference” requirement. 437 F.3d 588, 602-03; see
also Winer Family Trust v. Queen, supra, 503 F.3d at 335-37.
But it is possible to draw a strong inference of corporate
scienter without being able to name the individuals
14                                                No. 04-1687

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 ap-
proved by corporate officials sufficiently knowledgeable
about the company to know that the announcement
was false.
  Against all this the defendants argue that they could
have had no motive to paint the prospects for the 5500 and
6500 systems in rosy hues because within months they
acknowledged their mistakes and disclosed the true
situation of the two products, and because there is no
indication that Notebaert or anyone else who may have
been in on the fraud profited from it financially. The
argument confuses expected with realized benefits.
Notebaert may have thought that there was a chance that
the situation regarding the two key products would
right itself. If so, the benefits of concealment might ex-
ceed the costs. Investors do not like to think they’re riding
a roller coaster. Prompt disclosure of the truth would
have caused Tellabs’s stock price to plummet, as it did
when the truth came out a couple of months later. Suppose
the situation had corrected itself. Still, investors would
have discovered that the stock was more volatile than
they thought, and risk-averse investors (who predominate)
do not like volatility and so, unless it can be diversified
away, demand compensation in the form of a lower price;
consequently the stock might not recover to its previous
level. The fact that a gamble—concealing bad news in the
hope that it will be overtaken by good news—fails is not
inconsistent with its having been a considered, though
because of the risk a reckless, gamble. See First Commodity
Corp. of Boston v. CFTC, 676 F.2d 1, 7-9 (1st Cir. 1982). It is
No. 04-1687                                                 15

like embezzling in the hope that winning at the track will
enable the embezzled funds to be replaced before they
are discovered to be missing.
   So the inference of corporate scienter is not only as likely
as its opposite, but more likely. And is it cogent? Well,
if there are only two possible inferences, and one is much
more likely than the other, it must be cogent. Suppose a
person woke up one morning with a sharp pain in his
abdomen. He thought it was due to a recent operation to
remove his gall bladder, but realized it could equally
well have been due to any number of other things. The
inference that it was due to the operation could not be
thought cogent. But suppose he went to a doctor who
performed tests that ruled out any cause other than the
operation or a duodenal ulcer and told the patient that
he was 99 percent certain that it was the operation. The
plausibility of an explanation depends on the plausibility
of the alternative explanations. United States v. Beard, 354
F.3d 691, 692-93 (7th Cir. 2004); Ronald J. Allen, “Factual
Ambiguity and a Theory of Evidence,” 88 Nw. U. L. Rev.
604, 611 (1994). As more and more alternatives to a
given explanation are ruled out, the probability of that
explanation’s being the correct one rises. “Events that
have a very low antecedent probability of occurring
nevertheless do sometimes occur (the Indian Ocean
tsunami, for example); and if in a particular case all the
alternatives are ruled out, we can be confident that the
case presents one of those instances in which the rare
event did occur.” Anderson v. Griffin, 397 F.3d 515, 521 (7th
Cir. 2005). Because in our abdominal-pain example all
other inferences had been ruled out except the 1 percent
one, the inference that the pain was due to the operation
would be cogent. This case is similar. Because the alter-
16                                              No. 04-1687

native hypotheses—either a cascade of innocent mistakes,
or acts of subordinate employees, either or both resulting
in a series of false statements—are far less likely than
the hypothesis of scienter at the corporate level at which
the statements were approved, the latter hypothesis
must be considered cogent.
  And at the top of the corporate pyramid sat Notebaert,
the CEO. The 5500 and the 6500 were his company’s key
products. Almost all the false statements that we quoted
emanated directly from him. 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.
  The defendants complain, finally, about the com-
plaint’s dependence on “confidential sources.” The 26
“confidential sources” referred to in the complaint are
important sources for the allegations not only of falsity
but also of scienter. Because the Reform Act requires
detailed fact pleading of falsity, materiality, and scienter,
the plaintiff’s lawyers in securities-fraud litigation have
to conduct elaborate pre-complaint investigations—and
without the aid of discovery, which cannot be con-
ducted until the complaint is filed. Unable to compel
testimony from employees of the prospective defendant,
the lawyers worry that they won’t be able to get to first
base without assuring confidentiality to the employees
whom they interview, even though it is unlawful for an
employer to retaliate against an employee who blows
the whistle on a securities fraud, 18 U.S.C. § 1514A, and
even though, since informants have no evidentiary privi-
lege, their identity will be revealed in pretrial discovery,
though of course a suit might never be brought or if
No. 04-1687                                             17

brought might be settled before any discovery was con-
ducted.
   The problem with this argument—besides the seeming
flimsiness of the asserted need for anonymity—is that
allegations based on anonymous informants are very
difficult to assess. This concern led us to suggest in
Higginbotham v. Baxter International, Inc., supra, 495 F.3d
at 756-57, that such allegations must be steeply dis-
counted. But that was a very different case from this
one. The misconduct alleged consisted of frauds com-
mitted by Baxter’s Brazilian subsidiary, but because the
suit was against the parent, the plaintiffs had to show
that the parent knew about the Brazilian fraud. The
subsidiary had tried to conceal it from its parent as well
as from the Brazilian government. There was no basis
other than the confidential sources, described merely as
three ex-employees of Baxter and two consultants, for
a strong inference that the subsidiary had failed to con-
ceal the fraud from its parent and thus that the manage-
ment of the parent had been aware of the fraud during
the period covered by the complaint.
  The confidential sources listed in the complaint in
this case, in contrast, are numerous and consist of per-
sons who from the description of their jobs were in a
position to know at first hand the facts to which they are
prepared to testify, such as the returns of the 5500s, that
sales of the 5500 were dropping off a cliff while the com-
pany pretended that demand was strong, that the 6500 was
not approved by Regional Bell Operating Companies,
that it was still in the beta stage and failing performance
tests conducted by prospective customers, and that it was
too bulky for customers’ premises. The information that
the confidential informants are reported to have ob-
18                                                No. 04-1687

tained is set forth in convincing detail, with some of the
information, moreover, corroborated by multiple sources.
It would be better were the informants named in the
complaint, because it would be easier to determine wheth-
er they had been in a good position to know the facts
that the complaint says they learned. But the absence of
proper names does not invalidate the drawing of a strong
inference from informants’ assertions. See In re Daou
Systems, Inc., 411 F.3d 1006, 1015-16 (9th Cir. 2005); Califor-
nia Public Employees’ Retirement System v. Chubb Corp., 394
F.3d 126, 146-47 (3d Cir. 2004); ABC Arbitrage Plaintiffs
Group v. Tchuruk, 291 F.3d 336, 353-54 (5th Cir. 2002);
Novak v. Kasaks, 216 F.3d 300, 312-14 (2d Cir. 2000).
  We conclude that the plaintiffs have succeeded, with
regard to the statements identified in our previous opin-
ion as having been adequately alleged to be false and
material, in pleading scienter in conformity with the
requirements of the Private Securities Litigation Reform
Act. We therefore adhere to our decision to reverse
the judgment of the district court dismissing the suit.
                                 REVERSED AND REMANDED.
A true Copy:
        Teste:

                           _____________________________
                           Clerk of the United States Court of
                             Appeals for the Seventh Circuit

                    USCA-02-C-0072—1-17-08