A unique feature of securities litigation is the frequent reliance placed by plaintiff's counsel on confidential witnesses. Nowhere else does one regularly encounter detailed complaints that cite as many as 20 or more confidential witnesses (listed in order as C.W. 1, C.W. 2, C.W. 3, etc.), most describing damaging admissions allegedly made to these unnamed witnesses by individual defendants and/or senior executives at the principal corporate defendant. The origins of this anomaly are clear: Necessity was the mother of invention, as plaintiff's counsel had to find some means to satisfy the high pleading standards imposed by the Private Securities Litigation Reform Act (PSLRA), which requires (in a Rule 10b-5 case) that the plaintiff plead facts with particularity that give rise to a strong inference of fraud before the plaintiff can obtain discovery.¹ Some defense counsel regard confidential witnesses as generating more fiction than fact, in order to help the plaintiffs surmount the PSLRA's high hurdle at the motion to dismiss stage and enter the subsequent stage where costly discovery induces defendants to settle. No case reveals anything this cynical, but several cases (discussed below) do show substantial distortion in the information transmission, as the witness's testimony is aggressively rephrased, as it passes from an initial investigator, to a junior associate, and finally to senior counsel.

At present, the circuits are divided in their tolerance for unidentified “confidential witnesses,” with the Seventh Circuit holding that the statements of confidential witnesses should be “substantially discounted”² while the Second and Third Circuits permit the use of confidential witnesses “provided they are described with sufficient particularity to support the probability that a person in the position occupied by the source would possess the information.”³

In this light, what can or should be done with respect to the use of confidential witnesses? One real possibility is the development of “best practices” standards. The Federal Rules Committee is interested in this possibility, and, in support thereof, Duke University Law School sponsored a program this summer in New York City to discuss possible such standards with a specially invited group of federal judges and prominent practitioners. I served as moderator for the panel dealing with confidential witnesses but, because “Gresham House” rules applied, I cannot discuss the views of any specific participant. Still, it will surprise few to learn that plaintiff and defense counsel disagreed. The former thought that defense counsel “were inventing a solution for a problem that does not exist,” and defense counsel believed that the PSLRA was being outflanked by creative pleading that was only thinly grounded in fact. Equally significant, judges had a different problem: At the motion to dismiss stage, judges are not authorized to find facts, but must accept the well-pleaded allegations in the complaint. What, then, do they do when defendants produce affidavits from a confidential witnesses asserting they have been misquoted? Some cases have found ways to permit some fact-finding at this stage, but the legitimacy of these decisions was questioned by some of the participants.