Rakoff, Jed S.

English

Loyola University Chicago, School of Law: LAW eCommons

Loyola University Chicago Law Journal
Volume 45
Issue 3 2014 Spring Article 4
2014
Confidential Informants and Securities Class
Actions: Mixed Messages and Motives
Jed S. Rakoff
United States District Court for the Southern District of New York
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Recommended Citation
Jed S. Rakoff, Confidential Informants and Securities Class Actions: Mixed Messages and Motives, 45 Loy. U. Chi. L. J. 571 (2014).
Available at: http://lawecommons.luc.edu/luclj/vol45/iss3/4
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571 
Confidential Informants and Securities Class 
Actions: Mixed Messages and Motives  
Remarks of Judge Jed S. Rakoff* 
I want to take a step back and offer a broader perspective of federal 
securities class action litigation.  There are certain distinct aspects of this 
kind of litigation that cannot be overlooked and that really provide the 
backdrop to all these more nitty-gritty issues that we have been grappling 
with. 
The first is that it is lawyer-driven litigation.  I don’t say that 
pejoratively.  There are those who think that is a terrible thing; I think 
there are arguments both ways about it.  There’s a social function, a sort 
of private Attorney General function, that is being served by many of 
these cases that is socially beneficial.  On the other hand, these are 
lucrative litigations and there is a danger of champerty. 
But, for good or ill, the reality is that these cases tend to be initiated by 
the law firms who specialize in this area.  Before the Private Securities 
Litigation Reform Act (“PSLRA”),1 this was done through individual 
plaintiffs, “professional plaintiffs” if you will, who had ongoing 
relationships with certain law firms.  Now you have more often union and 
state pension funds, which enter into agreements with law firms whereby 
the law firms, free of charge, will “monitor” the funds’ investments and 
tell the trustees of the funds when they think a class action lawsuit should 
be brought.  I’m not necessarily criticizing any of this; I’m just saying 
that a clear-eyed view of it is that this is lawyer-driven litigation. 
The second thing that is worth noting is that, as was already mentioned 
today, these cases almost always settle.  Now, to some degree that is true 
of civil litigation in general in this country.  Given our system’s 
preference for expensive and time-consuming discovery, for slow 
 
* Honorable Jed S. Rakoff serves as a federal judge for the United States District Court for the 
Southern District of New York.  Judge Rakoff delivered these remarks at the Third Annual Institute 
for Investor Protection Conference, “Strategies for Investigating and Pleading Securities Fraud 
Claims,” held at Loyola University Chicago School of Law on October 25, 2013, and cosponsored 
by the Institute for Investor Protection and the Institute for Law and Economic Policy.  Judge 
Rakoff spoke on a panel titled, “The Effective and Ethical Use of Confidential Witnesses.” 
1. Private Securities Litigation Reform Act of 1995, Pub. L. No. 104-67, 109 Stat. 737 (codified 
as amended in scattered sections of 15 U.S.C.). 
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572 Loyola University Chicago Law Journal [Vol.  45 
decision making by trial judges who are themselves anxious to promote 
settlement, for multiple opportunities for appeals, and so forth, in many 
cases parties that file their lawsuits intent on going to trial come around 
after awhile to realizing that they might as well settle. 
But I think there are special features about class action securities 
litigation that create even a greater pressure to settle.  First, the stakes are 
very high in monetary terms because it is a class action.  And, second, I 
think most corporations fear juries: fear them greatly.  They fear, if you 
will, the increasing hostility that many everyday people feel towards 
corporate America.  We had that chart earlier about how much more 
CEOs are paid than anywhere else in the world.2  This may be rational, it 
may be irrational, but it invites anger and suspicion, which, in turn, makes 
corporate lawyers very reluctant to put a case before a jury. 
What is the result of all this pressure to settle?  The result is that, in 
real terms, a judge is deciding these cases when he or she decides early 
motions, such as a motion to dismiss or a motion for class certification.  
In other words, a corporate defendant will take, at most, two shots to get 
rid of the case: a motion to dismiss and, if that fails, an opposition to class 
certification.  If the corporation wins either of these motions, the case will 
either disappear or be settled cheaply.  If the corporation loses both 
motions, the corporation will settle for a big number. 
A corollary to this is that, increasingly, courts will take a “peek” at the 
merits in deciding these motions.  To some extent, moreover, this has 
been in effect embodied in statutory and case law through the heightened 
pleading requirements imposed by Congress under the PSLRA and by the 
Supreme Court in cases like Twombly3 and Iqbal.4  From a plaintiffs’ 
perspective, however, this creates a dilemma: how can you meet these 
pleading requirements before you have had any discovery?  This has 
driven plaintiffs’ lawyers to try to overcome these pleading hurdles 
through, among other things, increasing use of confidential informants.5  
This is an unintended, but natural result of the PSLRA, and as has already 
been pointed out, this means mostly contacting former employees and 
getting information from them.  In that regard, we’ve heard a lot about 
the dangers of retaliation, which I think is a genuine problem, even for 
 
2. See CEO-to-Worker Pay Ratios Around the World, EXECUTIVE PAYWATCH, 
http://www.aflcio.org/Corporate-Watch/CEO-Pay-and-You/CEO-to-Worker-Pay-Gap-in-the-
United-States/Pay-Gaps-in-the-World (last visited Mar. 30, 2014) (“On average, U.S. CEOs . . . 
make far more than CEOs of comparably sized companies in other developed countries.”). 
3. Bell Atl. Corp. v. Twombly, 550 U.S. 544 (2007). 
4. Ashcroft v. Iqbal, 556 U.S. 662 (2009). 
5. See Gideon Mark, Recanting Confidential Witnesses in Securities Litigation, 45 LOY. U. CHI. 
L.J. 575, 576 (2014). 
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2014] Mixed Messages and Motives 573 
former employees; but we need to balance that with the danger that a 
former employee often has a strong motive to gripe, and to exaggerate, 
and to say nasty things that may or may not be true about his or her former 
employer.  It’s a two-edged sword.  So how does a judge deal with that? 
I give as a modest example the City of Pontiac case that was referred 
to earlier, a case in my court, where I wrote the relevant opinion this past 
July.6  The plaintiff was a municipal pension fund that had invested in 
Lockheed stock and claimed it had been defrauded; and the complaint, in 
order to meet the requirements of the PSLRA, relied heavily on the 
statements of six unidentified confidential informants.7  Incidentally, I 
totally agree with Professor Mark: I see no reason why such statements 
should be inherently discounted at the pleading stage just because the 
informants are unidentified.8  And in this case, I denied a motion to 
dismiss and upheld the complaint largely on the basis of the allegations 
attributed to the confidential informants.9 
In due course, the identities of the informants were disclosed, so that 
their depositions could be taken, which I do not think is a bad thing either: 
they need to be tested like any other witnesses.10  But, perhaps because 
of the special pressures that may be brought to bear when a former (let 
alone present) employee is involved, five of the six either denied the 
statements attributed to them in the complaint or recanted their 
accuracy.11  I do not agree with those courts that say that that mere fact 
should kill the lawsuit, because again, these witnesses have motivations 
going in both directions.  They have motivations to overstate misconduct 
by the companies, but they also have motivations to recant: you cannot 
have a bright-line rule, in my view, in these situations. 
So, what I did was hold a hearing, an evidentiary hearing, and five of 
the six, the five who had denied ever making the statements or had 
recanted, were required to testify in my court, subject to examination and 
cross-examination—exactly the way our system posits that the truth will 
come out.12  In the end, the plaintiffs had the better of it.  For example, 
several of the informants who had said things at their depositions like “we 
never even spoke to the investigator for the plaintiff for more than two or 
 
6. City of Pontiac Gen. Emps.’ Ret. Sys. v. Lockheed Martin Corp., 952 F. Supp. 2d 633 
(S.D.N.Y. 2013). 
7. Id. at 635. 
8. Mark, supra note 5, at 601. 
9. City of Pontiac Gen. Emps.’ Ret. Sys. v. Lockheed Martin Corp., 875 F. Supp. 2d 359, 375 
(S.D.N.Y. 2012). 
10. City of Pontiac Gen. Emps’ Ret. Sys., 952 F. Supp. 2d at 636. 
11. Id. 
12. Id. 
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574 Loyola University Chicago Law Journal [Vol.  45 
three minutes,” were confronted with phone records that showed that they 
had had conversations for fifty, sixty, or more minutes with the plaintiffs’ 
investigator.13  They had lied at their deposition because they feared 
retaliation, and I had a certain sympathy for the plight that they were 
placed in; nevertheless, they had lied. 
The plaintiffs’ investigator, on the whole, had pretty good notes about 
everything that was said.  In my written decision following the hearing, I 
faulted him for some of his methods; it would have been much better, for 
example, as Professor Mark just suggested, if there had been a written 
statement taken from the witnesses.14  Some of the statements used by 
the investigator were clearly out of context.15  And there were other 
problems: he had no one else with him when he did the interviews, they 
were telephone interviews, and he was making his notes at the very same 
time he was talking to the witnesses.16  Nevertheless, on the whole, what 
he had said and reported to plaintiffs’ counsel as the witnesses having 
said was far more accurate than the recantations that they had given in 
their depositions. 
Of course, in other cases, it might be the statements to the investigator 
that are the lies.  My point is simply that issues involving confidential 
informants should not be decided by legal presumptions or paper wars: 
you need to have an evidentiary hearing if you are going to decide 
whether in any given case the confidential informants are sufficiently 
reliable to enable the case based on their statements to continue. 
 
 
13. Id. at 637. 
14. Id. 
15. Id. at 637–38. 
16. Id. at 637. 


Confidential Informants and Securities Class Actions: Mixed Messages and Motives

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