June 11, 2010

Time Bombs

In Freudenberg v. E*TRADE Financial Corp., 2010 WL 1904314 (S.D.N.Y. May 11. 2010), the plaintiffs alleged that E*TRADE had fraudulently concealed the high risk nature and deterioration of the company's mortgage portfolio. The court's decision, which denies the defendants' motion to dismiss, addresses a couple of interesting topics.

(1) Rule 10b5-1 stock trading plans - The utility of a Rule 10b5-1 stock trading plan in defeating the inference of scienter caused by large stock sales varies widely. (The 10b-5 Daily's most recent post on the topic, with links to other relevant posts, can be found here.) In the E*TRADE case, the individual defendants had entered into their plans during the class period. In other words, they allegedly "were already aware of the Company's mortgage exposure time bombs" when they decided to sell shares. Under these circumstances, the court declined to find that any inference of scienter created by the stock sales was dispelled.

(2) Announcement of SEC investigation - On the last day of the class period, E*TRADE announced additional mortgage losses , withdrew its guidance, and disclosed that the SEC has commenced an investigation. The company's stock price declined significantly. The court found that the announcement of the SEC investigation, which was "linked to the purportedly fraudulent misconduct," was within the "zone of risk" concealed by E*TRADE's alleged misrepresentations. As a result, it was "akin to a corrective disclosure" and could be used to adequately plead loss causation. (A post by The 10b-5 Daily on a contrary decision can be found here.)

Holding: Motion to dismiss denied.

Posted by Lyle Roberts at June 11, 2010 11:30 PM | TrackBack
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