In 1995, Congress passed the Private Securities Litigation Reform Act to eliminate abusive practices in federal securities litigation.1 Among other things, the act raised plaintiffs’ burden in pleading federal securities fraud actions. First, the Reform Act heightened the standard to plead scienter (i.e., a fraudulent state of mind), requiring a federal securities fraud complaint to plead facts “giving rise to a strong inference that the defendants acted with the required state of mind.”2 Second, the Reform Act instituted an automatic discovery stay in securities cases until resolution of the defendant’s motion to dismiss.3 As a result, a federal securities plaintiff can no longer simply file a bare bones complaint and then serve pre-motion-to-dismiss discovery requests, hoping to obtain information to support a subsequent well-pleaded amended complaint. Instead, he must at the outset plead facts giving rise to a strong inference of scienter, without the benefit of formal discovery.
In many cases, plaintiffs attempt to meet this burden by relying on statements attributed to anonymous current or former company insiders, usually referred to as confidential witnesses or CWs. (For obvious reasons, many current and former employees of defendant corporations are reluctant to be identified by name in class action securities complaints). Since Congress passed the Reform Act, the courts have struggled with the proper treatment of such confidential witness statements under the act’s pleading standard.
