Unprecedented Mass Layoffs May Trigger More Confidential Witnesses in Shareholder Actions: What Measures Can Companies Take to Mitigate These Risks?

February 08, 2021

The once-in-a-century pandemic has triggered not only market turbulence, but also unprecedented mass layoffs and furloughs. As the markets continue to fluctuate and public companies plan reductions in staff, companies—and their officers and directors—are not only at risk for shareholder actions associated with any significant stock drop, but plaintiffs’ firms will undoubtedly wield one of the most important tools in bringing those claims: the confidential witness. Company counsel should take a number of proactive measures to mitigate such potential risks. 

As the markets continue to react to the pandemic, securities fraud claims will continue to thrive. A plaintiff bringing a securities fraud claim under Section 10(b) of the Exchange Act of 1934, must plead a material misstatement or omission made with the requisite scienter (i.e. intent to deceive) in connection with the sale or purchase of securities, which causes the stock to drop. The Private Securities Litigation Reform Act (“PSLRA”) appropriately requires enterprising plaintiffs to plead such claims with the requisite particularity associated with the statute’s heightened pleading requirements.  

In an attempt to meet such high pleading standards, plaintiffs often attempt to find confidential witnesses, generally former employees of a company, through sources such as LinkedIn to bolster their allegations. Against the backdrop of large scale layoffs at many companies, we expect this trend to increase. The use and reliability of such witnesses, however, continues to be a contested issue. One court has even described plaintiffs’ counsel as “‘private eyes’ who would entice naive or disgruntled employees into gossip sessions that might help support a federal lawsuit.”1 These former employees may have “axes to grind” or could be “lying” --- and in some circumstances, may not “even exist.”2 They also may simply be dropped into a complaint, despite being a low level employee with limited access to top management, not even employed during the putative class period, or merely disseminating sheer gossip and rumor. 

In addition to the confidential witness, in August 2011, the SEC created the whistleblower program under the Dodd-Frank Act by adding Section 21F to the Exchange Act. Section 21F of the Exchange Act provides that the SEC shall pay eligible whistleblowers who voluntarily provide it with original information about a violation of the federal securities laws that leads to the successful enforcement of a covered judicial or administrative action, and any related action. Indeed, as set forth in the Dodd-Frank Act, the SEC protects the confidentiality of whistleblowers and does not disclose information that could reveal a whistleblower’s identity. In addition, Exchange Act Rule 21F-17 prohibits a company from “tak[ing] any action to impede an individual from communicating directly with the [SEC] about a possible securities law violation, including enforcing, or threatening to enforce, a confidentiality agreement . . . with respect to such communications.” The awards can be significant. On September 14, 2020, the SEC announced an award of more than $10 million to a whistleblower whose information and assistance were crucial to the SEC; the SEC has awarded approximately $520 million to 94 individuals since 2012.3  

On September 23, 2020, the SEC voted to adopt amendments to its whistleblower award program, designed to provide “greater clarity to whistleblowers and increase the program’s efficiency and transparency.” Such amendments include, in part, that the form of an action—e.g. settlement agreements, deferred prosecution agreements, and non-prosecution agreements—will not affect whether the action is a covered action or a related action. In addition, in response to the Supreme Court’s decision in Digital Realty Trust, Inc. v. Somers, 138 S. Ct. 767 (2018), the SEC modified Rule 21F-2 to establish a uniform definition of “whistleblower” that will apply to all aspects of Exchange Act Section 21F—i.e. the award program, the heightened confidentiality requirements, and the employment anti-retaliation protections.4 In light of these provisions, companies that use restrictive language in confidentiality agreements—such as agreements limiting communication with government agencies, requiring an employee to notify the company before disclosing information, overly broad non-disparagement clauses, and broad confidentiality provisions that contain significant liquidated damages provisions—may be viewed as potentially stifling the whistleblowing process.  

Because plaintiffs’ counsel may undoubtedly contact former employees impacted by the company’s next lay-off or reduction in force, or a former employee may become a whistleblower, company counsel should be aware of this issue, and care should be taken in exit interviews with employees. The following is a check list to consider in relation to confidential witness issues: 

  • Explain that it is very common for plaintiffs’ firms to reach out to former employees to try to obtain negative information about the company. While former employees may talk to anyone they choose, if a plaintiff firm or investigator reaches out to them post-employment, the former employees have no obligation to speak with such individuals. In fact, the company’s preference is that they do not speak with plaintiffs’ counsel or investigators. 

  • Remind employees to adhere to confidentiality agreements. Note, however, that provisions prohibiting an employee from criticizing or disparaging the company and/or its practices, or requiring employees to cooperate with the employer in any future litigation may be viewed unfavorably. Indeed, SEC rules prohibit employers from taking measures through confidentiality, employment, severance or other types of agreements that may silence potential whistleblowers before they can reach out to the SEC.  

  • Explain that investigators and plaintiffs’ firms examine former employees’ LinkedIn profiles and may add them into complaints or use them in subsequent depositions. Employees should take care to ensure that the descriptions on LinkedIn or other similar sites of former employees’ roles at the company are accurate. 

  • Explain that if an investigator reaches out to them, company counsel would appreciate knowing that they were contacted.   

  • Ask whether the employee has any electronic or hard copy company documents at home, and whether they used personal emails or phones to communicate regarding substantive work issues. If so, steps should be taken to address such documents in accordance with the company’s confidentiality and document retention policies, whether that involves retrieving such information or ensuring it is destroyed (assuming no document hold is in place). To the extent there is an ongoing lawsuit, the company may be obligated to preserve certain relevant information and documents, regardless of where such information may be located.  

Such steps may help to ward off even inadvertent confidential witness allegations that may support plaintiffs’ next shareholder litigation claim.  

To the extent the company faces a securities litigation suit which contains assertions by alleged confidential witness(es), the mere existence of such assertions is not fatal to the company’s defense. Under the PSLRA, courts take issue with the reliability of confidential witness allegations and require certain indicia of reliability before such allegations will be factored into the court’s analysis. For example, (i) “the [CWs] whose statements are introduced to establish scienter must be described with sufficient particularity to establish their reliability and personal knowledge;” and furthermore, (ii) those CW statements “must themselves be indicative of scienter.”5 The Ninth Circuit, for example, requires courts to discount allegations of CWs who have “no firsthand knowledge,” “base their knowledge on vague hearsay” or “report only conclusory assertions” because they demonstrate that the CW is not reliable.”6 As such, assertions attributed to confidential witnesses can—and should—be analyzed carefully to test the veracity and reliability of such allegations.  Upon understanding the allegations asserted by confidential witnesses in a complaint, defense counsel should work with in-house counsel to identify, if possible, the confidential witness and determine who may have worked with the confidential witness to better understand the scope of the witnesses’ duties and access to higher level management. For example: 

  • What are the confidential witness’s dates of employment? Were they employed during the putative class period? 

  • What was the confidential witness’s role at the company? Did the confidential witness work in a department which relates to the alleged misconduct?  

  • Did the confidential witness have access to higher level management, or any insight into decisions made by higher level management (including executive officers or the board)?  

  • When would the confidential witness have had access to any higher level management decisions? At a monthly meeting? In preparing documents for the monthly meeting? Anything else? 

  • What documents would the confidential witnesses have prepared and/or had access to which relate to the alleged misconduct? 

  • Are there records of the confidential witnesses’ departure? What were the circumstances? 

If company counsel determines that the confidential witness may be willing to speak with outside counsel, defense counsel may evaluate potentially reaching out to the witness, possibly through an introduction by someone at the company. It goes without saying that outside counsel may not speak to the purported confidential witness without confirming that he or she is not represented by counsel (and if represented, work solely through his or her counsel to schedule any meeting with all counsel present). To the extent that outside counsel has an opportunity to speak with the alleged confidential witness, counsel should clarify that they represent the company and other defendants in the relevant action (not the confidential witness), and should not in any way coerce or intimidate the confidential witness into changing the assertions set forth in the complaint. Instead, counsel should attempt to establish a rapport, be open about the purpose of the meeting, and attempt to learn first-hand how the confidential witnesses views the allegations attributed to them in the complaint. In some circumstances, confidential witnesses may not even know that their words have been taken out of context and added into a complaint. As defense counsel, we have seen numerous circumstances in which confidential witnesses have recanted incorrect allegations attributed to them in the complaint in the form of a voluntary affidavit before even being deposed. Indeed, many confidential witnesses we have spoken to were asked to guess or speculate relating to certain issues and then that speculation was asserted in the complaint as concrete allegations.  

If the confidential witness cannot be identified by the employer, an interrogatory may be served after the PSLRA stay is lifted. In Campo v. Sears Holding Corp., the Second Circuit upheld a trial court’s order to depose a plaintiff’s confidential witness during a pending motion to dismiss to determine whether the witnesses made statements attributed to them.7 The Court stated that “Because Fed. R. Civ. P. 11 requires that there be a good faith basis for the factual and legal contentions contained in a pleading, the district courts use of the confidential witnesses’ testimony to test the good faith basis of plaintiffs’ compliance . . . was permissible.”8

In the end, while the future remains uncertain in a constantly shifting economic landscape and conducting layoffs may be inevitable, public companies must thoughtfully anticipate the risks associated with confidential witnesses and should consider the above steps to mitigate such risks. 


1) City of Pontiac Gen Emps. Ret. Sys. v. Lockheed Martin Corp., 952 F. Supp. 2d 633, 638 (S.D.N.Y. 2013).  

2) Higginbotham v. Baxter Intern., Inc., 495 F. 3d 753, 757 (7th Cir. 2007).  

3) SEC Awards More Than $10 Million to Whistleblower (Sept. 14, 2020), available at https://www.sec.gov/news/press-release/2020-209

4) SEC Adds Clarity, Efficiency and Transparency to Its Successful Whistleblower Award Program, https://www.sec.gov/news/press-release/2020-219

5) See, e.g., Zucco Partners, LLC v. Digimarc Corp., 552 F.3d 981, 995 (9th Cir. 2009) (affirming securities class action dismissal with prejudice).  

6) Id. 

7) Campo v. Sears Holdings Corp., 371 F. App’x 212, n.4 (2d Cir. 2010). 

8) Id.

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