On Jan. 18, 2023, the U.S. Court of Appeals for the Fifth Circuit in Oklahoma Firefighters Pension and Retirement System v. Six Flags Entertainment Corp. reversed and remanded a district court's order dismissing a securities fraud action with prejudice.
Of particular importance is the Fifth Circuit's walking back of the "discounting" of confidential witness claims, finding that the allegations provided by the plaintiff's anonymous witness "FE1" were sufficient to establish the elements of falsity and scienter.1
The decision — which represents a significant change in course from the Fifth Circuit's past confidential witness jurisprudence — will have significant ramifications for parties litigating securities fraud cases in the circuit, specifically as it relates to the use of anonymous witnesses at the investigation and pleading stage of the case.
The appeals court's ruling serves as a message from the Fifth Circuit to district courts that confidential witness allegations should be credited despite their anonymity, so long as the complaint articulates sufficient bases for crediting the anonymous witness's claims. Going forward, plaintiffs should feel more confident including confidential witness allegations in complaints, and defendants should expect less traction when arguing that anonymous witness allegations should be discounted because they were made by anonymous sources.
In 2014, the defendant Six Flags Entertainment Corp. announced a partnership with Riverside Investment Group, a Chinese real estate developer, to develop multiple Six Flags theme parks in China, with projected opening dates of 2019 through 2021.2 According to the complaint, Six Flags, its then-CEO James Reid-Anderson and its then-Chief Financial Officer Marshall Barber misled investors by touting unrealistic or even impossible timelines for these park openings.3
The complaint relies heavily on FE1, who was Six Flags' director of international construction and project management and was responsible for overseeing the construction of the parks in China and reporting on their progress internally at Six Flags.4 It alleges that FE1 believed it was "obvious" that the parks could not open on schedule because Riverside was unable or refused to fund the theme park rides, had not commissioned the necessary blueprints and had barely begun construction.5
The Fifth Circuit Sets Out Limited Instances Where "Discounting" Confidential Witness Testimony Is Appropriate
The Six Flags opinion, penned by U.S. Circuit Judge Leslie H. Southwick, begins by explaining why the "discounting" standard still exists in the Fifth Circuit.6
Specifically citing the 2008 Fifth Circuit decision in Indiana Electrical Workers' Pension Trust Fund IBEW v. Shaw Group Inc., the court held that the reason this "discounting" process exists is that under the appellate court's reading of the Private Securities Litigation Reform Act and the U.S. Supreme Court's 2007 ruling in Tellabs Inc. v. Makor Issues & Rights, courts must "weigh the strength of plaintiffs' favored inference in comparison to other possible inferences," adding that this weighing-of-the-scales methodology is "obstructed when the witness is anonymous."7
With that backdrop, the opinion takes an unexpected turn. Instead of upholding the district court's heavy discounting of the confidential witness allegations, the Fifth Circuit walked back the discounting analysis, holding that "discount does not mean unfettered discretion to discard."8
In fact, the opinion goes on to set forth a test for anonymous witness credibility more similar to that of the Second and Ninth Circuits, holding that the "degree of discounting depends on the circumstances involved" and that "courts may rely on assertions from confidential sources if the person is 'described in the complaint with sufficient particularity to support the probability that a person in the position occupied by the source would possess the information alleged.'"9
In doing so, the Six Flags court clarified and distinguished its prior "discounting" jurisprudence. Specifically, the court set forth the reasoning behind its prior decisions, noting that heavy confidential witness discounting usually occurs "in circumstances where the person's credentials are less clear, or the relevance of the person's job is more attenuated to the allegations, than is the case here."10
The Fifth Circuit pointed to its prior Shaw case because there, the plaintiff "generally fail[ed] to provide sufficient details about their sources to credit their statements" and since the Shaw court discounted one anonymous witness's statement because he was "not identified sufficiently by his title, work location, or dates of employment."11 The Fifth Circuit also distinguished its 2019 Municipal Employees' Retirement System of Michigan v. Pier 1 Imports Inc. decision, explaining that in that case, the court discounted confidential witness's statements because the plaintiffs "fail[ed] to tie the statements to the alleged fraud" and because the witnesses "[did] not relate any interaction with [the defendants]."12
Following this road map, the Fifth Circuit in Six Flags emphasized the fact that FE1 was clearly described as having a high-level and relevant position as "Six Flags International's Director of International Construction and Project Management" from May 2018 through September 2019 and that the complaint clearly set forth his applicable — and relevant — work responsibilities, including that he attended meetings with Six Flags and Riverside personnel, traveled to construction site inspections to inspect progress and worked onsite at one of the construction locations.13
Thus, FE1's role would put him "in a position to know at first hand the facts" relevant to the case, including the timeline for the construction projects in China.14 Accordingly, in reversing the dismissal on anonymous witness grounds, the court held, "our conclusion that the discount here should be minimal is consistent with not only our court's precedent, but also with other circuits' conclusions when details about the confidential sources support reliability."15
The Six Flags decision represents a significant change in the Fifth Circuit's confidential witness jurisprudence. The appeals court now appears to be more closely aligned with its sister circuits, especially when compared to previous Fifth Circuit decisions implicating anonymous witnesses that took a far more rigid approach to the fact-intensive confidential witness analysis, for example, Shaw and Pier 1.16
Indeed, beyond paring back the "discounting" analysis, the Six Flags decision contains many holdings crediting anonymous witness allegations in a way the Fifth Circuit has previously resisted.
For instance, in finding that the defendants had actual knowledge of their false statements when they were made, the court credited FE1's claims that he prepared presentations for Six Flags' senior vice president of international park operations and president of Six Flags International, who in turn related the presentations' content to defendant Reid-Anderson and the board of directors, and that those allegations were sufficient to establish the defendants' scienter despite not alleging a direct connection to the defendants.17
In doing so, the court noted that a "confidential witness does not need to be a fly on every relevant wall — or directly deliver every relevant presentation — to plead allegations supporting an inference of scienter."18
Key Takeaways for Securities Practitioners
This notable change in tone from the Fifth Circuit should serve as a notice to securities practitioners that the circuit, and the district courts therein, will be taking a different approach to anonymous witness allegations moving forward.
Here are some key takeaways from the decision that could change how practitioners plead or challenge a securities fraud complaint with confidential witness allegations in the Fifth Circuit:
The Higher, the Better
The court credited the fact that FE1 was a senior-level employee or at least was in a senior role within the relevant business segment at issue in the case. Indeed, the Fifth Circuit specifically considers "the significance of FE1's reported role in the project," indicating that "while FE1 is only one source, the complaint's details about the responsibilities of his position are directly relevant to the events at issue in this case."19 Accordingly, just one high-level confidential witness, with particularized relevance to the fraud allegations, can be enough to allege an inference of scienter.
Details, Details, Details
The Fifth Circuit distinguished the facts of the Shaw case by analyzing the level of details alleged regarding the anonymous witness's reported role and the specific fraud allegations they provide. As such, and at a bare minimum, it is advisable to allege that the confidential witness's title, date of employment, work location and detailed narrative of responsibilities for each anonymous witness are being used in a complaint. As to the substance of the claims themselves, plaintiffs' litigants should make sure to include as much detail as possible, such as all relevant meetings, reports, communications, statements and other details that specifically tie to and highlight the nature of the fraud at issue.
Corroboration Is Persuasive
Corroborating evidence that further supports the confidential witness's allegations will be persuasive. The Six Flags court found that FE1's allegations were corroborated by a photo of one site in April 2018 showing that little construction progress had occurred, as FE1 had purported.20 The court cited this example of corroborative evidence in finding that FE1's allegations should only be minimally discounted.21
Read the article here.
1Oklahoma Firefighters Pension and Retirement System v. Six Flags Entertainment Corp.,
2023 WL 228268 (5th Cir. Jan. 18, 2023).
2Six Flags, 2023 WL 228268, at *1.
6Id. at *4.
7Six Flags, 2023 WL 228268, at *4 (citing Shaw, 537 F.3d at 535).
8Id. at *4 (emphasis added).
9Id. (citation omitted).
10Six Flags, 2023 WL 228268, at *4 n.9.
11Id. at *4 n.9 (quoting Shaw, 537 F.3d at 537–38).
12Id. at *4 n.9 (quoting Pier 1, 935 F.3d at 434).
13Id. at *5.
16As referenced in Six Flags, 2023 WL 228268, at *4 n.9.
17Six Flags, 2023 WL 228268, at *11.
18Id. at *11 n.18.
19Id. at *5.
20Id. at *5.