The PSLRA creates a safe harbor for forward-looking statements to encourage companies to provide investors with information about future plans and prospects. There are two prongs to the safe harbor. First, a defendant shall not be liable with respect to any forward-looking statement if it is identified as forward-looking and is accompanied by "meaningful cautionary statements" that alert investors to the factors that could cause actual results to differ. Second, a defendant shall not be liable with respect to any forward-looking statement, even in the absence of meaningful cautionary statements, if the plaintiff cannot establish that the statement was made with "actual knowledge" that it was false or misleading.
As noted by numerous commentators, the statutory scheme arguably gives companies a license to lie. If a company uses appropriate cautionary language, it can make a forward-looking statement that it knows to be false without fear of liability. Accordingly, courts have struggled with how to apply the first prong of the safe harbor where the plaintiffs allege that the defendants knew their forward-looking statements were false and merely offered cautionary language to create a smoke screen for their fraud.
In In re Seebeyond Technologies Corp. Sec. Litig., 2003 WL 21262498 (C.D. Cal. May 28, 2003), the court disagreed that the safe harbor permits knowing falsities. The key is the requirement that the cautionary language be "meaningful." The court found that "[i]f the forward-looking statement is made with actual knowledge that it is false or misleading, the accompanying cautionary language can only be meaningful if it either states the belief that it is false or misleading or, at the very least, clearly articulates the reasons why it is false or misleading."
This reading of the statute is subject to a number of objections, some of which the court itself raises. First, it appears to require a court to determine whether the statement was made with actual knowledge of falsity as a prerequisite for determining whether the cautionary language was meaningful. Congress did not impose a state of mind requirement in the first prong of the safe harbor; leaving that examination for forward-looking statements that are not accompanied by cautionary language. Second, other courts have held that to take advantage of the safe harbor, a defendant is not required to have identified the exact factor that ultimately rendered the statement untrue. It is enough to have cautionary language that reasonably alerted investors to the risks. The court's holding would appear to severely weaken this principle - as long as the plaintiff adequately alleges actual knowledge, the defendant's disclosure is never sufficient unless the exact factor that ultimately rendered the statement untrue is revealed. The bottom line: Congress is going need to solve this one.
Holding: Motion to dismiss granted in part and denied in part (plaintiffs were allowed to proceed with their claims based on forward-looking statements).
Quote of note: "Subsection (A) may still provide safe harbor where cautionary language is used, even if the defendant has actual knowledge that the statement is false or misleading. The idea that sufficient cautionary language may be used when the defendant has actual knowledge that a statement is somehow misleading (for instance, where the company is engaging in 'puffery' of some sort) is not so far-fetched."
As discussed previously in The 10b-5 Daily, Chrysler Corp.'s former shareholders have brought a class action in the D. of Del. alleging that Daimler-Benz misrepresented the acquisition of Chrysler as a "merger of equals" to avoid paying them a takeover premium for their shares. The court recently certified the class and things are continuing to go well for the plaintiffs. The Associated Press reports that Judge Farnan has denied the portion of Diamler-Benz's summary judgment motion based on the statute of limitations.
Quote of note: "In his ruling on DaimlerChrysler's statute of limitations argument, Farnan wrote: 'I agree with the plaintiffs' assertion that they could not have known that the merger-of-equals representations were false until Schrempp revealed his true intent in the Financial Times article.' Farnan has not yet ruled on other parts of DaimlerChrysler's motion for summary judgment."
There is already a securities class action and an ERISA class action seeking damages on behalf of Enron's employees who invested in Enron stock through the company's pension plan. Now the Department of Labor is joining the bandwagon. The Houston Chronicle reports that the DOL has brought its own ERISA claim on behalf of the employees for violations of the pension laws. The suit "accuses former Chairman Ken Lay, former CEO Jeff Skilling, the former board of directors and officers on a committee overseeing Enron's retirement plans with failing to fulfill their responsibilities." Reuters also has an article.
Just as in the securities and ERISA suits, however, the DOL's suit appears to focus on alleged false statements that induced employees to invest in the stock at artificially high prices. But isn't this circumventing the PSLRA? (See this post for a discussion of the conflict.) And aren't the public and private ERISA suits going after the exact same sources of recovery? (See this post about a similar overlap problem between the SEC and securities class actions.)
Quote of note (Houston Chronicle): "'Mr. Lay went so far as to tout Enron stock as a good investment for employees even after he had information on the accounting scandals,' said Elaine Chao, U.S. Secretary of Labor."
Quote of note (Reuters): "Radzely [Labor Solicitor] later told Reuters that the department would seek to recover money where it could, including from each individual defendant and from an $85 million fiduciary liability insurance policy that covers some of them. But the court will determine the extent of each defendant's liability, he said. 'We're going to go wherever the money is,' he added."
Benefitsblog has collected links to related articles.
There is an interesting Reuters article on the nascent, but perhaps growing, movement to override the U.S. Supreme Court's decision in the Central Bank case and restore aiding and abetting liability in private Rule 10b-5 cases. While the absence of aiding and abetting liability does not completely shield a company's lawyers, accountants, and bankers from litigation risk, it does make it more difficult for investors to bring claims against them.
Legislation to restore aiding and abetting liability has been proposed in the House of Representatives (see this earlier post). Meanwhile, courts (notably in the Enron case) have begun to chip away at Central Bank's holding by creating a broad definition of "primary violator."
Quote of note: "Rolling back Central Bank of Denver to expose corporate advisers to more liability is favored by plaintiffs' lawyers who bring suits on behalf of shareholders. 'This rule is important ... Many, if not, most frauds involve participation of a whole network of assistors,' said Jon Cuneo, spokesman for the National Association of Shareholder and Consumer Attorneys."
The big news today is the proposed settlement for $1 billion of the more than 300 cases against companies who made initial public offerings of their shares in the high-tech boom years. The cases, known as the "IPO Allocation" cases, were previously consolidated in the S.D.N.Y. Plaintiffs have alleged, as summarized by Reuters, that the issuers and/or their underwriters "manipulated the market with optimistic research; ramped up trading commissions in exchange for access to IPO shares; and that investors allocated IPO shares were required to buy shares in the after-market to help push up the share price."
The key to the settlement, however, is that the companies and their insurers may never have to pay a dime. Indeed, they may even get to recoup their costs for defending against the litigation to date. A Bloomberg article on the proposed settlement explains that the companies are only liable for the difference between $1 billion and what the plaintiffs are able to collect from the underwriter defendants. In other words, if the plaintiffs recover more than $1 billion from the underwriter defendants, the companies will not have to make any payment. If the plaintiffs recover more than $5 billion from the underwriter defendants, the companies will actually be able to recover various expenses associated with the litigation. In return, the companies appear to have assigned any related claims they may have against the underwriters to the plaintiffs.
An article in the Financial Times examines the recent "Mass Torts Made Perfect" seminar held in Chicago. The trial lawyers in attendance appear to agree that Wall Street is a ripe target, with the $1.4 billion settlement by the investment banks for analyst fraud merely the beginning.
Quote of note: "Mike Papantonio, the head of the mass tort department at Florida law firm Levin, Papantonio who has a record of securing million-dollar awards, said: 'The money from Spitzer is a drop in the bucket. [Investment bank] reserves need to be in line with the major pharmaceutical companies.'"
Reuters reports that the S.D.N.Y. has denied Arthur Anderson's motion to dismiss a WorldCom-related securities class action pending against the defunct accounting firm. The suit "accuses Andersen of failing to properly review and investigate WorldCom's adjustments and journal entries in its books and argues the firm should have discovered the $11 billion accounting fraud at the telephone company."
Deloitte Touche Bermuda is accused of aiding and abetting the Manhattan Investment Fund's alleged $400 million fraud through audits it conducted for the 1996 and 1997 fiscal years. On Monday, the New York Law Journal reports, the S.D.N.Y. rejected a summary judgment motion by the accounting firm. Among other things, Deloitte had argued that the court lacked subject matter jurisdiction because the plaintiffs are not U.S. citizens.
Quote of note: "'All of the causes of action and defendants are tied together through their connection to the single scheme which was the fraud committed by Berger [who controlled the hedge fund] in New York,' [Judge] Cote said. 'It matters not, therefore, whether any beneficial owner of shares in the Fund or the two named plaintiffs are United States citizens.'"
A few weeks ago The 10b-5 Daily speculated that Oscar Wyatt, Jr., who was both helping to finance the attempt to oust the current board of El Paso Corp. and acting as the lead plaintiff in a shareholder class action against the company, would be in an interesting position if the dissident slate of directors won. Would his interests be sufficiently aligned with the the interests of the rest of the class if El Paso was controlled by individuals he had helped elect? We'll never know. The Houston Chronicle reported last week that the incumbent board of directors was reelected in a close vote.
Quote of note: "Wyatt, who founded a company, Coastal Corp., that was later sold to El Paso, is the lead plaintiff in a shareholder lawsuit accusing El Paso of federal securities violations. Kuehn [El Paso's CEO] recognized Wyatt to speak [at the shareholders' meeting]. 'Mr. Kuehn, you don't really need to recognize me. I'm recognized by a lot of people, which is something you are not.'"
Quote of note: "Several dozen shareholders cast their ballots at the meeting, including those who were undecided heading in. Among them was Jacqueline Goettsche of Katy who said she bought shares of El Paso four months ago just so she could attend the meeting. 'It's more exciting than going to the opera,' Goettsche said."
In case anyone thought that the issues noted by The 10b-5 Daily here were merely theoretical, along comes the motion to dismiss decision in In re WorldCom Inc. ERISA Litigation (S.D.N.Y.). As reported yesterday in the New York Law Journal (via law.com), the court made two rulings of note: 1) it dismissed the ERISA claims against directors and employees who it found were not fiduciaries under ERISA; and 2) it held that ERISA claims could be brought against WorldCom's former CEO both for failing to disclose material facts about the company's financial condition and for making affirmative missrepresentations concerning the prudence of investing in the company's stock in SEC filings. The second ruling was made despite the former CEO's argument that his duty to disclose arose under the securities laws and not ERISA. Benefitsblog has a full summary of the opinion.
Quote of note (from the opinion): "When a corporate insider puts on his ERISA hat, he is not assumed to have forgotten adverse information he may have acquired while acting in his corporate capacity."
Quote of note (from the opinion): "Ebbers' potential liability to employees who invested in WorldCom stock through the Plan for violations of the federal securities laws cannot shield him from suit over his alleged failure to perform his quite separate and independent ERISA obligations."
The opinion in the Interpublic Group case (In re Interpublic Securities Litigation, 2003 WL 21250682, (S.D.N.Y. May 29, 2003)) is a must-read because it brings three strands of questionable law together to eviscerate the PSLRA's scienter (i.e., fraudulent intent) pleading requirement. It has taken The 10b-5 Daily a while to get around to addressing the opinion, but only because there is so much to say!
A little background is in order. Interpublic (“IPG”) is a New York holding company that ranks as the second-largest owner of advertising agencies in the world. The case is the result of a restatement IPG announced last August for the five years from 1997 to 2001, which corrected inter-company charges that had been wrongly declared as income for the European offices of one of IPG's agencies.
The three strands of questionable law are:
1) Section 20(a) liability has no scienter element- Section 20(a) of the '34 Act creates a cause of action against defendants alleged to have been "control persons" of those who engaged in securities fraud. Good faith may be asserted as an affirmative defense. Six circuit courts have held that plaintiffs do not have to show that the control persons acted with scienter (the 5th, 7th, 8th, 9th, 10th, and 11th Circuits); two have held that such a showing is required (the 3rd and 4th Circuits). The Second Circuit has not definitively answered the question, but has stated that to prove a Section 20(a) claim a plaintiff must show, inter alia, "that the controlling person was in some meaningful sense a culpable participant." Although some district courts in the Second Circuit have found that this creates a scienter pleading requirement, others have disagreed. The effect of no scienter requirement, however, is that the heightened pleading standards of the PSLRA do not apply. All plaintiffs need to show at the pleading stage is: (a) there was a primary violation by a controlled person; and (b) control of the primary violator by the defendant.
2) Corporate acquisitions for stock can be a motive for securities fraud - There is a line of cases, especially in the Second Circuit, which hold that a desire to acquire other companies through the use of stock as consideration may be a sufficient allegation that defendants had a motive to make misstatements for the purpose of artificially inflating the stock price. (Note that the question of whether the motive and opportunity to commit fraud is sufficient, on its own, to establish scienter for a Rule 10b-5 claim is a whole separate debate. The Second Circuit has held that it is, but other circuit courts have disagreed.) The relatively unexplored question is: motive for whom? The company may benefit from obtaining another entity at a cheap price, but the “concrete benefit” for the individual defendants (i.e., officers or directors) is in the value of their stock. So in the absence of stock sales by the individual defendants at an inflated price (with the acquisition presumably included), are corporate acquisitions really a motive for individual defendants to commit fraud?
3) Personifying the company - It is generally understood that a company acts through its officers and directors. As a result, courts uniformly hold that allegations of scienter as to the individual defendants in a securities fraud case can be used to plead a claim against the company. In other words, the scienter of the individual defendants is imputed to the company. But is the reverse true? Can a securities fraud case continue against a company if there are insufficient allegations of scienter as to the individual defendants? For some courts, the corporate acquisitions motive appears to be the answer to this question. In In re IPO Securities Litigation, 241 F.Supp.2d 281 (S.D.N.Y. 2003), for example, the court separately examined the motive allegations against the companies and the individual defendants that had been sued. For the companies, the court considered whether there had been stock-based acquisitions or add-on offerings during the class period. For the individual defendants, the court looked at stock sales during the class period. In other words, the motive of a company to commit fraud was evaluated without reference to the motive of the company's officers or directors.
All of which leads to the holdings in the IPG opinion, the perfect storm that happens when these three strands of questionable law come together. As to the Rule 10b-5 claims in the case, the court made the following rulings: (a) the series of stock-for-stock acquisitions made by IPG during the class period created a strong inference that IPG had acted with scienter; and (b) there were insufficient allegations concerning the individual defendants' stock sales and knowledge of the accounting problems to create a strong inference that the individual defendants had acted with scienter. As a result, the Rule 10b-5 claims were allowed to continue against IPG, but were dismissed against the individual defendants.
The individual defendants were not, however, free to go. Since they controlled IPG and the court had found that a Rule 10b-5 claim was adequately pled against IPG, the Section 20(a) claims for controlling person liability against the individual defendants still remain.
This is a troubling result on two levels. By analyzing the scienter of IPG separately, the court, in essence, ends up holding that IPG acted with fraudulent intent, but its officers and directors did not. How can a company do anything if not through its officers and directors? Moreover, the PSLRA was designed to protect individuals from unsubstantiated securities fraud claims. By applying Section 20(a) in this manner, the court allowed the plaintiffs to bypass the heightened pleading requirements for scienter in the PSLRA. Based on the IPG holding, plaintiffs merely have to establish that the company had a motive for fraud (or, one supposes, that some unnamed person at the company knew of the misstatements or was reckless with respect to them), and can then continue to bring their securities fraud claims against both the company and its officers and directors (in the form of Section 20(a) claims) without having to make any specific scienter allegations concerning the individual defendants. That does not comport with the PSLRA’s requirement that scienter be sufficiently alleged as to each defendant.
This post covers a lot of ground. Readers comments, as always, are welcome.
The Associated Press has an article discussing the financial costs associated with the problems at Rite-Aid Corp. The 10b-5 Daily has previously posted about the related securities class action here. Interestingly, both plaintiffs' counsel and an independent expert appear to agree that it is very difficult to determine the actual damages suffered by Rite-Aid's shareholders as a result of the alleged fraud.
The Wall Street Journal (subscription required) reports today that Tyco International Ltd. will "restate its financial results back to 1998 to correct $696.1 million that it mistakenly classified as pretax charges in recent quarters." It is the fifth time in seven months that Tyco has announced accounting problems. The restatement will not change the overall financial results for the Company during the period in question.
As discussed here in The 10b-5 Daily, Tyco is a defendant in a securities class action in the D. of N.H.
Quote of note: "The restatements also complicate Tyco's legal situation in shareholder lawsuits it is facing over scandals that have battered its share price. Once companies restate, plaintiffs no longer have to prove past financial statements were wrong."
It is axiomatic that bad facts make for bad law. One area of the law that is changing rapidly in response to the recent corporate scandals is Employee Retirement Income Security Act of 1974 ("ERISA") litigation. ERISA creates a right of action against company executives overseeing employee stock ownership plans who violate their fiduciary duties to the plan participants.
The recent trend, however, is for employees who lost retirement savings as a result of their investment in company stock to file an ERISA class action against the company that parallels the pending securities class action on behalf of all investors. In other words, the employees allege the company and its officers violated their fiduciary duties under ERISA by making false statements that induced employees to invest in the stock at artificially inflated prices. These parallel ERISA class actions have been filed, for example, against Enron, Qwest, WorldCom, and Global Crossing.
ERISA class actions based on false statements to the market are problematic for two reasons. First, the suits attempt to significantly expand the scope of ERISA liability to include officers not responsible for the management of plan assets and statements that are not related to plan benefits. David Gische and Jo Ann Abramson of Ross, Dixon & Bell have an excellent overview of these issues in an article entitled "Corporate Fiduciary Liability Claims in the Post-Enron Era" that was written last year. (Thanks to the Securities Law Beacon for the link.) Second, the suits allow plaintiffs to make an end run around the procedural safeguards of the PSLRA. Because they are brought under ERISA, rather than the federal securities laws, plaintiffs can obtain early discovery and seek to force a quick settlement. An article in Monday's edition of The Recorder discusses the growth of these suits and their overlap with securities class actions.
Quote of note (The Recorder): "One of the reasons companies don't always mount the most aggressive defense to ERISA suits is that any settlement comes from a fiduciary liability insurance fund -- separate from insurance for securities litigation -- that's often untapped. Consequently, the mainstream securities fraud bar usually has no problem with the ERISA suits."
Quote of note II (The Recorder): "Courts are still working out the limits of fiduciary duties in these cases . . . For example, what if an executive has inside information that the company's financial picture isn't as good as touted? As fiduciaries, shouldn't they divest employee stock? Sure. But wouldn't that be insider trading?"
The U.S. Court of Appeals for the Fourth Circuit has upheld the dismissal of a securities class action against Duratek, Inc., a Columbia, Md.-based company that disposes of radioactive waste materials for nuclear facililties. The opinion can be found here.
Any securities litigation opinion from the Fourth Circuit has the potential to be big news, because the court has never decided whether recklessness suffices to meet the scienter requirement for 10b-5 actions and, correspondingly, what a plaintiff must plead to satisfy the PSLRA's heightened pleading standards for scienter. But no luck today. Duratek is a per curiam opinion and simply holds that "even under the lenient Second Circuit standard" the complaint failed to adequately plead scienter.
According to an article in the Houston Chronicle, the federal judges overseeing Enron's bankruptcy and securities class action suits have appointed a new mediator for the settlement negotiations. As noted here in The 10b-5 Daily, the judges previously gave the job to U.S. District Judge Kevin Duffy of the S.D.N.Y. Judge Duffy's name was withdrawn, at his request, a week later. They did not go far to find Judge Duffy's replacement -- the new mediator will be Senior U.S. District Judge William Conner, also of the S.D.N.Y.
Nanophase will pay $2.5 million to settle claims arising from the Company's public disclosures in 2001 regarding its dealings with Celox, a British customer.
Cutter & Buck will pay $4 million in cash, plus an additional $3 million based on a formula applied to any recovery of funds from its ongoing suit against its D&O insurer (who has evidently sought to rescind its policy). The settlement also covers a separate derivative suit and includes the implementation of certain corporate governance policies.
Well, it's not exactly about Martha Stewart, but it's related. Judge Owen of the S.D.N.Y. apparently has denied the motions to dismiss in the two securities class actions against ImClone Systems, Inc. (Nasdaq: IMCLE).
Over the weekend, the Washington Post editorial page came out in favor of the Class Action Fairness Act.
There was a comprehensive article on the topic of D&O insurance a few weeks ago in The Journal News (which covers Westchester, Rockland, and Putnam counties in N.Y.). The author finds that both insurers and companies are struggling in the current environment. While insurers have been forced to pay out huge claims over the past few years due to corporate fraud and understandably want to limit their risk, the rise in premiums hits companies just as they are trying to weather the weak economy. Annual premiums of $1 million or more have become commonplace, with large cap companies often paying much more.
Quote of note (1): "Companies in industries that have gained dubious publicity for corporate fraud, such as securities, health care, technology and telecommunications, are getting hit the hardest, says Pam Sedmak, a partner in Sedmak & Co., and executive search firm in Cleveland. Sedmak says executives that her firm recruits for clients now routinely ask for details on the coverage the company's insurance will offer them if they're named as defendants in a lawsuit or investigation by the U.S. Securities and Exchange Commission or other agency. 'They're putting their personal wealth at stake, not to mention their freedom,' she says of those who dare serve as a top executive or director of a public company."
Quote of note (2): "Besides the lawsuits that have already been filed, the uncertainty about how much liability directors and officers will have in future claims is also driving premiums up, says attorney Lance Kimmel, an author of the Foley & Lardner study. That's because it remains to be seen how courts rule on claims brought against officers and directors who are alleged to have violated the Sarbanes-Oxley law, which Congress passed last year to police corporate conduct."
Quote of note (3): A insurance broker states that "she has seen companies go from policies that provided $10 million in coverage with a $100,000 deductible to policies that provide $5 million in coverage and carry a $200,000 deductible. Even with the inferior coverage, the new policy costs more, she says."
An important piece of the securities class action puzzle is directors and officers liability insurance ("D&O insurance"). Due in large part to the surge in shareholder claims severity over the past few years, the premiums paid by companies have skyrocketed. According to a 2002 survey by Tillinghast-Towers Perrin:
1) Companies paid nearly 30% more for D&O insurance in 2002 (a similar increase occurred in 2001);
2) Although claim frequency and severity for most type of claims has stabilized, the average indemnity paid for shareholder claims has increased to $23.35 million, compared with $17.8 million in 2001, and $9.62 million in 2000; and
3) There was a decrease in the D&O average policy limits for the first time in 8 years (which may be a result of the dramatic rise in costs).
Quote of note: "Rep. James Sensenbrenner, a Wisconsin Republican and chairman of the House Judiciary Committee, said forcing cases into federal court would stop lawyers forum-shopping for sympathetic state courts such as in Madison County, Illinois, where a judge recently granted a $10.1 billion verdict in a suit against cigarette maker Philip Morris. 'The class action judicial system itself has become a joke, and no one is laughing except the trial lawyers, all the way to the bank,' Sensenbrenner said."
Of course, there are always exceptions to the rule. The class certification appeal provision in the Class Action Fairness Act of 2003 (see below) might have played a role in the case by Chrysler Corp.'s former shareholders against DaimlerChrysler AG. The investors allege that Daimler-Benz AG misrepresented the acquisition of Chrysler as a "merger of equals" to avoid paying Chrysler shareholders a takeover premium for their shares. Bloomberg reports that District Judge Farnan of the D. of Del. has certified a class, over the defendants' objections, that includes both U.S. shareholders who exchanged their shares in the transaction and U.S. shareholders who purchased or acquired DaimlerChyrsler shares after the merger through November 2000 (when the fraud was allegedly revealed).
The U.S. House of Representatives will hold a vote today on the Class Action Fairness Act of 2003. As noted previously in The 10b-5 Daily, the legislation applies some of the reform concepts in the PSLRA and SLUSA to all class actions. Notably, the House bill (a) requires most class action suits with more that $2 million at issue to be heard in federal court (unless the substantial majority of the plaintiffs are from the same state as the principal defendants), (b) allows parties to appeal class certification rulings, and (c) attempts to limit "coupon" settlements. The House is expected to pass the bill.
The New York Times, in a lengthy article on the bill, states that the class certification appeal provision "could cause delays in pending federal-court cases that seek to recover money lost through the corporate scandals at Enron and other large companies." The newspaper evidently is not familiar with how securities class actions are usually resolved (i.e., before the class certification stage of the case). The Washington Post is also covering the story.
Quote of note (NY Times): "'Just about every industry group is on the bandwagon on this because every industry is affected,' said Lawrence Fineran, the vice president for regulatory and competition policy at the National Association of Manufacturers. For the business community, the bill is the most significant lawsuit-related legislation since Congress overrode President Bill Clinton's 1995 veto of a bill to limit private lawsuits for securities fraud. 'It's the biggest thing in years,' Mr. Fineran said."
Addition: The House bill specifically excludes securities class actions from its jurisdiction provisions, presumably to avoid any conflict with SLUSA.
Addition: The final House bill changed its jurisdiction provision to match the jurisdiction provision in the Senate bill. As a result, it now provides for class action suits to be heard in federal court when fewer than one-third of the plaintiffs are from the same state and when the plaintiffs' claims total at least $5 million.
A Reuters article provides additional information on the post-split structure.
Quote of note: "Weiss cautioned that details of the breakup plan were still being discussed and that timing was unknown. But if the plan plays out, he said, 'the present Milberg Weiss will continue as an entity. Another firm will be formed by Mr. Lerach.'"
Addition: A story in The Recorder confirms that Milberg Weiss is likely to split into East Coast and West Coast operations, with the firm's San Diego and San Francisco offices forming a separate entity. The article also speculates on the reasons behind the split.
Milberg Weiss Bershad Hynes & Lerach, widely recognized as the leading plaintiffs' securities class action firm, is breaking up. The Houston Chronicle reports today that the 200-lawyer firm will dissolve over the next few months, with the lawyers regrouping into smaller firms. Milberg Weiss has seven offices located throughout the country. The split, however, will not be "simply geographical."
Quote of note: "Lerach said he hopes that the resulting smaller firms will be 'friendly' competitors."
The Houston Chronicle reports (in last Friday's edition) that an amended complaint has been filed in the securities class action against Dynegy, Inc. (NYSE: DYN). The amended complaint alleges that Dynegy hid an $850 million loan from Citicorp, known as the "Black Thunder" transaction, in an off-balance-sheet company in 2000 to avoid a downgrade of Dynegy's debt. The Black Thunder loan is one of two transactions cited in the suit.
Quote of note: "The deadline for filing the amended complaint against Dynegy had been extended numerous times to enable the company and plaintiffs time to negotiate a settlement. A spokesman for the University of California [the lead plaintiff in the case] would not confirm whether those talks were still under way but said the school remains open to settlement talks."
The 10b-5 Daily previously noted that there has been a decision in the Interpublic Group case. The opinion (In re Interpublic Securities Litigation, 2003 WL 21250682, (S.D.N.Y. May 29, 2003)) turns out to be a must-read for a number of reasons. More on this later in the week.
There was an interesting Associated Press story on Friday about the ongoing proxy battle and securities class action involving El Paso Corp., a Houston-based provider of natural gas services. Oscar Wyatt, Jr. is the founder of Coastal Energy, which was sold to El Paso in 2001. As a result of the sale, Wyatt owns 5 million shares of El Paso. Currently, Wyatt is both helping to finance the attempt to oust the current board and acting as the lead plaintiff in a shareholder class action accusing "the company of hiding debt, reporting revenue from so-called 'wash' energy trades and defrauding investors." If the dissident slate of directors wins, however, can Wyatt continue as the lead plaintiff in the class action (even if he will not be a board member)? A court might find that Wyatt's interests are no longer sufficiently aligned with the interests of the rest of the class.
Addition: The Associated Press has a follow-up story about a full-page ad criticizing El Paso's management that Wyatt ran in the Sunday edition of the Houston Chronicle.
Addition: The June 9 edition of Fortune has a lengthy profile of Wyatt and El Paso. The story states: "People familiar with the matter say that even if Wyatt wins [the proxy battle], he'll continue to push forward with the lawsuit."
The securities class action news today is all about Tyco International, Ltd.
First, Reuters reports that the shareholder plaintiffs in the class action against Tyco in the D. of N.H. are alleging that "the conglomerate falsified financial reports and inflated pre-tax profits by more than $6 billion between December 1999 and June 2002." That is considerably more than the $2 billion in accounting-related problems that Tyco has disclosed. Interestingly, it is being reported as a new allegation that appears in the plaintiffs' opposition to Tyco's motion to dismiss (contrary to the normal assumption that the motion to dismiss briefing is based only on the factual allegations in the complaint).
Second, the Associated Press reports that Merrill Lynch & Co. and a former analyst are being sued by Tyco's shareholders in a separate class action alleging that the analyst "wrote and publicly issued research reports on Tyco claiming to be independent, when in fact he regularly sent drafts of his reports to Tyco's investor relations department for review."
As discussed in The 10b-5 Daily here, KPMG has settled its portion of the Rite-Aid Corp. securities class action. The Legal Intelligencer has an article summarizing the case's history and the final numbers on the settlements. (Thanks to the Securities Law Beacon for the link.)
Quote of note: "With settlements totaling more than $334 million and attorney fees of about $83 million, the class action shareholders' suit filed in the wake of an accounting scandal at Rite Aid Corp. now ranks among the nation's five largest shareholder settlements ever."
A subcomittee of the House Financial Services Committee is holding a hearing today on the Securities Fraud Deterrence and Investor Restitution Act. Stephen Cutler, the SEC's Division of Enforcement Director, is among those scheduled to testify.
The Atlanta Journal-Constitution has an article in today's edition reporting that an amended complaint has been filed in a securities class action against the Coca-Cola Company. The suit was originally brought in October 2000 in the N.D. of Ga. and alleges that Coca-Cola forced several of its major bottlers to buy excess beverage concentrate to boost the company's revenues. The court dismissed part of the case last year.
The proposed $500 million settlement to be paid by WorldCom to the SEC for distribution to the company’s injured shareholders raises questions about the role of private securities litigation in large corporate fraud cases.
The heart of the issue is the interaction between the Fair Funds for Investors provisions in the Sarbanes-Oxley Act of 2002 and securities class actions. Section 308 of Sarbanes-Oxley allows the SEC to combine civil penalties with the disgorgement obtained from a securities law violator into a fund for the benefit of the victims of the violation. Recent legislation proposed by Rep. Richard Baker (R-La.), the Securities Fraud Deterrence and Investor Restitution Act of 2003, would both increase the civil penalties the SEC could obtain and make it easier for the agency to disburse those funds to investors (the Corp Law Blog has an excellent summary of the proposed bill).
In the wake of Enron and other corporate scandals, Congress is clearly attempting to transfer some of the responsibility for the compensation of injured investors from private securities litigation to the SEC. As stated by Rep. Baker in his press release announcing the new legislation:
“If you're the victim of a crime, you might get some satisfaction out of knowing that the car thief has been caught and thrown in the slammer and that your stolen property has been recovered. But to watch the sheriff and a bunch of lawyers, after the trial, pile into your car and drive away with it just isn’t justice and isn’t an outcome you’re likely to consider fair.”The problem is that Sarbanes-Oxley and the Securities Fraud Deterrence Act address the “sheriff” (the SEC) but are silent on what to do about the “bunch of lawyers” (private securities litigation).
Which leaves the following question: If injured WorldCom investors receive $500 million from the SEC, what effect should this have on the pending securities class action? Thoughts and comments from readers are welcome.
The Washington Post reports today that a federal grand jury has indicted Martha Stewart and her broker on conspiracy, obstruction of justice, and false statement charges stemming from a federal investigation of alleged insider trading in ImClone Systems stock. Meanwhile, the securities class action against Ms. Stewart and her company, Martha Stewart Living Omnimedia, Inc., continues.
Quote of note: "Disgruntled shareholders have alleged in class-action lawsuits that Stewart violated securities laws by failing to disclose she was under investigation when she sold 3 million shares in a prearranged sale to a company run by another board member on Jan. 8, 2002."
The New York Law Journal reports that Judge Cote of the S.D.N.Y. (who is also the judge in the Worldcom case) has denied most of the motion to dismiss in the securities class action against Interpublic Group of Cos. Interpublic is a New York holding company that ranks as the second-largest owner of advertising agencies in the world. The case is the result of a restatement Interpublic announced last August for the five years from 1997 to 2001, which corrected inter-company charges that had been wrongly declared as income for the European offices of one of Interpublic's agencies. (Thanks to the Securities Law Beacon for the link.)
The 10b-5 Daily spans the globe to bring you the latest in securities litigation news. The JoongAng Daily has an interesting article on the political battle in South Korea over whether to permit investors to bring securities class actions against corporations. The current compromise is to allow class actions to be brought against any publicly-traded company, but to delay implementation of the new system until 2004.
Quote of note: "The business community fears that the impact of class-action suits would be devastating. Even though the class-action system would not be applied retroactively, tricky bookkeeping has been a long-established practice here. Indeed, even Shin Jong-ik, a senior official at the Federation of Korean Businesses, recently estimated that between half and 70 percent of Korean firms have been involved in accounting fraud."
Today's edition of The Daily Journal (subscription required) has a column by Thomas Klein, a Wilson Sonsini partner, entitled "Shareholders Who Keep Stock Have State Remedy." The column discusses the recent decision by a divided California Supreme Court in Small v. Fritz Cos. Inc., (Cal. April 7, 2003), in which the court ruled that a stockholder who held his stock, rather than purchased or sold his stock, in reliance on misrepresentations may bring suit for common-law fraud or negligent misrepresentation under California law. To adequately plead these claims, however, the stockholder must (a) plead with particularity; and (b) demonstrate actual reliance on the alleged misrepresentations (the "fraud-on-the-market" theory cannot be used). Note that the actual reliance requirement would appear to make it all but impossible for a plaintiff to bring a class action on behalf of holders.
Quote of note (from the opinion): "In a holder's action a plaintiff must allege specific reliance on the defendants' representations: for example, that if the plaintiff had read a truthful account of the corporation's financial status the plaintiff would have sold the stock, how many shares the plaintiff would have sold, and when the sale would have taken place. The plaintiff must allege actions, as distinguished from unspoken and unrecorded thoughts and decisions, that would indicate that the plaintiff actually relied on the misrepresentations."
The Associated Press reported on Friday that KPMG has agreed to a $125 million settlement in a securities class action in the E.D. of Pa. The case is based on KPMG's role in the events leading to Rite-Aid Corp.'s 1999 restatement of earnings. According to one of the plaintiffs' attorneys, it is the second-largest settlement by an accounting firm in a securities class action (after the Cendant case, in which Ernst & Young agreed to pay $335 million). U.S. District Judge Dalzell's ruling on the settlement is expected next week.
Quote of note: An individual investor objected to the request by the plaintiffs' law firms for 25% percent of the settlement in fees (or roughly $31 million). At the Friday hearing, however, Judge Dalzell seemed disinclined to find the proposed fees excessive, noting that it was a difficult case because "(KPMG) had the very obvious defense that they were victims too . . . It's not a sure thing."
Addition: Judge Dalzell approved the settlement.