Higginbotham v. Baxter International Inc.
2007 WL 2142298, 495 F.3d 753, 2007 U.S. App. LEXIS 17918 (2007)
Rule of Law:
Under the Private Securities Litigation Reform Act (PSLRA) and the standard set in Tellabs, a complaint alleging securities fraud must plead facts creating a 'strong inference' of scienter, meaning the inference of fraudulent intent must be cogent and at least as compelling as any opposing inference, and allegations from anonymous sources must be discounted as they cannot be adequately tested.
Facts:
- On July 22, 2004, Baxter International announced it would restate its earnings for the preceding three years due to fraud at its Brazilian subsidiary.
- Managers at the Brazilian subsidiary created the illusion of growth by reporting sales earlier than actual dates, reporting fictitious sales, and failing to create appropriate reserves for bad debts.
- On the day of the announcement, Baxter's common stock fell $1.48 per share, or 4.6% of its market price.
- The formal restatement later showed that the overstatement of profits amounted to approximately $33 million over a three-year period, representing about 1.5% of Baxter's operating profits.
- Baxter's 2004 10-K report (March 12, 2004) and 10-Q report (May 10, 2004) contained false financial information submitted by the Brazilian subsidiary.
- In April 2004, Brian P. Anderson, Baxter’s Chief Financial Officer, and Carlos del Salto, a senior vice president, sold company shares for approximately $1.5 million and $4.4 million, respectively.
- The Brazilian government publicly accused Baxter’s Brazilian subsidiary of participating in an antitrust cartel on April 29, 2004.
- Baxter’s headquarters in the United States were notified of the fraud by an employee in Brazil "sometime in the May time frame" 2004, prompting an internal investigation.
Procedural Posture:
- Multiple lawsuits invoking § 10(b) of the Securities Exchange Act of 1934 and SEC Rule 10b-5 were filed.
- The claims were consolidated, and a lead plaintiff was selected under the Private Securities Litigation Reform Act of 1995 (PSLRA).
- The district court (N.D.Ill.) initially dismissed the action on May 25, 2005.
- The district court subsequently reinstated the action on September 23, 2005.
- The district court ultimately dismissed the action again with prejudice on December 22, 2005, ruling that the complaint failed to establish the required 'strong inference' of scienter.
- Plaintiffs appealed the dismissal to the United States Court of Appeals for the Seventh Circuit.
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Issue:
Does a complaint alleging securities fraud satisfy the Private Securities Litigation Reform Act's 'strong inference of scienter' requirement when it primarily relies on allegations from anonymous sources and presents other evidence that is not as compelling as plausible opposing inferences of innocent conduct?
Opinions:
Majority - Easterbrook, Chief Judge
No, a complaint alleging securities fraud fails to satisfy the Private Securities Litigation Reform Act's 'strong inference of scienter' requirement if it relies heavily on anonymous sources and lacks other compelling evidence of fraudulent intent when considered against plausible opposing inferences. The Supreme Court's Tellabs decision requires that a complaint establish an inference of scienter that is "cogent and at least as compelling as any opposing inference one could draw from the facts alleged," and that courts must consider plausible opposing inferences. Allegations attributed to 'confidential witnesses' must be significantly discounted because their anonymity prevents assessing credibility and weighing their stories against other possibilities, making it hard to deem them 'compelling'. The court found no concrete evidence that Baxter's headquarters knew of the fraud before March 12, 2004, or were recklessly indifferent to its accuracy before May 10, 2004. The stock sales by two executives in April 2004 were not a 'compelling' or 'cogent' inference of scienter, especially since the fraud represented only 1.5% of profits, and there was no evidence of abnormally high sales by other managers. Accusations of an antitrust cartel, being public knowledge and unrelated to financial fraud, did not demonstrate scienter or require disclosure. Furthermore, post-fraud remedial measures cannot be used as evidence of prior knowledge. Finally, Baxter was entitled to a reasonable period to investigate the reported problems before making a public disclosure, as the securities laws mandate periodic, not continuous, disclosure.
Analysis:
This case significantly reinforces the high pleading standard for scienter in securities fraud cases following the Supreme Court's Tellabs decision, particularly regarding the treatment of anonymous sources. It clarifies that such sources are to be heavily discounted, making it more challenging for plaintiffs to meet the 'strong inference' requirement. The ruling emphasizes balancing the need to deter fraud against the desire to prevent 'strike suits,' placing a substantial burden on plaintiffs to present concrete, verifiable evidence of fraudulent intent early in the litigation, without relying on speculation or hindsight. This approach likely limits discovery in securities litigation by requiring stronger initial complaints.
