CRYO-CELL Int'l, Inc. (OTC Bulletin Board: CCEL), a Florida-based stem cell banking firm, has announced the preliminary settlement of the securities class action pending against the company in the S.D. of Fla. The case, originally filed in 2003, alleges that there was improper recognition of revenue in the Company's consolidated financial statements. The settlement is for $7 million, including a payment of $4 million by CRYO-CELL's former auditors. CRYO-CELL states that the entire amount is covered, minus the applicable deductibles, by insurance.
In securities litigation, the wheels of justice can move slow. The Associated Press has an article on the securities class action against Cabletron Systems, Inc. in the D. of N.H. The complaint was originally filed in 1997 and alleges that Cabletron artificially inflated its stock price by overstating sales and failing to disclose problems with its products.
In a remarkable series of events, the case was dismissed in 1998 with leave to amend, reassigned several times after the original judge passed away, dismissed again in 2001, reinstated by the 1st Circuit in 2002 (in a well-known opinion), and has since been bogged down in discovery and procedural disagreements. In the interim, Cabletron has gone out of business.
Quote of note: "The two sides are currently waiting for a judge to settle procedural disagreements. Cabletron’s lawyers want to know the identity of the shareholders’ anonymous sources. . . . The shareholders want permission to question under oath several of Cabletron’s top executives, a group that hasn’t been identified but is expected to include [Craig] Benson [a former Cabletron officer and the current governor of New Hampshire]."
It turns out that the combination of a clear circuit split, the U.S.'s encouragement, and yet another opportunity to overturn the Ninth Circuit, is irresistible. (See this post.) The Associated Press reports that the Supreme Court has granted the cert petition filed by the defendants in the Dura Pharmaceuticals securities litigation, which should lead to a resolution of the circuit split over what is necessary to adequately plead loss causation in a securities fraud case.
A majority of circuit courts hold that a plaintiff must demonstrate a causal connection between the alleged misrepresentations and a subsequent decline in the stock price to adequately plead loss causation, while a minority of circuit courts hold that a plaintiff merely needs to demonstrate that the alleged misrepresentations artificially inflated the stock price. In Broudo v. Dura Pharmaceuticals, Inc., 339 F.3d 933 (9th Cir. 2003), the Ninth Circuit came down squarely in favor of the minority position.
The court found that loss causation "merely requires pleading that the price at the time of purchase was overstated and sufficient identification of the cause." Based on this holding, the Ninth Circuit reversed the lower court's dismissal and remanded the case for further proceedings. The defendants petitioned for a writ of certiorari to the Supreme Court. The U.S. (the SEC and the Solicitor General) later filed an amicus brief in support of the petition, arguing that the case was wrongly decided and the Supreme Court should adopt the majority position. Will it? Stay tuned.
There is a growing district court split over whether plaintiffs can bring a securities class action pursuant to the Securities Act of 1933 ("'33 Act") in state court. As a general matter, claims under the '33 Act may be brought in federal or state court.
Securities class actions, however, are subject to a number of special rules. The Securities Litigation Uniform Standards Act of 1998 ("SLUSA") is designed to prohibit the bringing of securities class actions in state court and provides for their removal to federal court. SLUSA only applies to class actions "based upon the statutory or common law of any State." The drafters were focused on plaintiffs who wanted to avoid the heightened pleading standards of the PSLRA by bringing the equivalent of Rule 10b-5 claims (for which federal courts have exclusive jurisdiction) in state court under state law.
In In re Tyco Int'l, Ltd. Multidistrict Litig., 2004 WL 1403009 (D.N.H. June 21, 2004), the court addressed motions to remand to state court seven of the 47 cases that had been consolidated for pretrial proceedings. The seven cases are all based exclusively on the '33 Act. The court found that although SLUSA would prohibit the bringing of a securities class action in state court alleging both '33 Act claims and state law claims, it does not, as a matter of statutory construction, apply to securities class actions based exclusively on the '33 Act. (For a discussion of a contrary opinion from the N.D. of Tex., see this post.)
Holding: Motions to remand granted.
Quote of note: "SLUSA's legislative history supports the view that Congress attempted to prevent plaintiffs from circumventing the PSLRA by 'enact[ing] national standards for securities class action lawsuits involving nationally traded securities,' rather than by making federal courts the exclusive forum for Securities Act class actions alleging fraud."
In an unusual opinion, the U.S. Court of Appeals for the Eleventh Circuit has clarified its position on the pleading of scienter (i.e., fraudulent intent) under the PSLRA. The district court in the Scientific-Atlanta securities litigation had denied the defendants' motion to dismiss, finding that "although individual allegations in the complaint, considered in isolation, may not have given rise to a strong inference of scienter, the allegations created such an inference when viewed collectively." The defendants petitioned for interlocutory appeal, which the district court certified on the narrow question of whether factual allegations may be aggregated to create the necessary strong inference.
In Phillips v. Scientific-Atlanta, Inc., 2004 WL 1382906 (11th Cir. June 22, 2004) the Eleventh Circuit affirmed the lower court's ruling. The PSLRA states that the complaint "shall, with respect to each act or omission alleged to violate this chapter, state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind." As a threshold matter, the court noted "the Defendants have largely conceded the narrow, certified question and have attempted to parlay the appeal into a much broader review of the district court." Under these circumstances, the court had little difficulty joining a number of other circuits in finding that nothing in the PSLRA suggests that scienter may only be inferred from individual facts.
The court also went beyond the certified question and found that scienter must be adequately plead with respect to each defendant and with respect to each alleged violation. In the instant case, however, "Plaintiffs' complaint sufficiently alleges facts giving rise to a strong inference of scienter on the part of each defendant alleged to have committed each violation of the statute."
Holding: Denial of motion to dismiss affirmed.
Quote of note: "We believe that the plain meaning of the statutory language compels the conclusion that scienter must be alleged with respect to each alleged violation of the statute. Although the plain language is less compelling with respect to alleging the scienter of each defendant, the statute does use the singular term 'the defendant,' and we believe that the most plausible reading in light of congressional intent is that a plaintiff, to proceed beyond the pleading stage, must allege facts sufficiently demonstrating each defendant's state of mind regarding his or her alleged violations."
Will the IPO allocation cases be granted class certification? It seems likely, but the S.D.N.Y. has asked the plaintiffs to provide the court with more information before it will let them proceed against the 55 investment banks named in the suits.
According to a Reuters report, Judge Scheindlin issued an order on Monday giving the plaintiffs two weeks to "redefine the class and convince the court that the definition is adequate." Moreover, one of the plaintiffs' primary claims is that the investment banks engaged in "laddering," a practice in which the banks allegedly handed out IPO shares to buyers who promised to buy more shares at higher prices once the stocks began trading publicly. The alleged goal was to put additional upward pressure on the stock prices. As to these claims, the court stated that the plaintiffs "should report within three weeks on how an expert would measure what effect, if any, was exerted on stock prices" by the alleged laddering.
Quote of note: "In her order, Judge Scheindlin said the court record on whether to grant class status is insufficient in two ways and set tight deadlines for plaintiffs to fill in the gaps. 'Plaintiffs' failure to adequately respond to either aspect of this order may result in denial of the pending motions' seeking class certification, the order said."
The decision in the Fogarazzo research analyst case in the S.D.N.Y. (previously posted about in The 10b-5 Daily here) is controversial on a number of pleading issues. Not only does the court apply a loss causation standard that, in contravention of the Second Circuit, appears to remove the need to draw any actual connection between the misrepresentations and the loss, it also runs roughshod over other S.D.N.Y. decisions on how to analyze the falsity and scienter (i.e., fraudulent intent) requirements for securities fraud claims based on statements of opinion.
In the research analyst cases, the issue is whether the defendants deliberately misrepresented their truly held opinion that the stock was not a good investment. Judges in the S.D.N.Y. (e.g., Judge Lynch in the Podany decision discussed here) have found that under these circumstances the falsity and scienter requirements are essentially identical. Since the statement (unlike a statement of fact) cannot be false at all unless the speaker is knowingly misstating his truly held opinion, the plaintiffs must allege inconsistent statements or actions by the defendants from which a factfinder could infer that a knowing misstatement was made. For example, the plaintiffs might allege that the defendants' made statements to others that the stock was overvalued or engaged in personal sales of the stock.
In Forgarazzo, Judge Scheindlin rejected this approach. After finding that falsity must be examined separately from scienter, the court held that the falsity of the analysts' buy recommendations was adequately plead based on allegations that the defendants: (1) wanted to obtain investment banking business from the underlying company; (2) had analysts that were subject to financial conflicts of interest; and (3) failed to maintain adequate controls to protect the objectivity of their public research. None of these allegations, however, suggests that the analyst reports were false (i.e., that the defendants actually regarded the underlying stock as a poor investment). In essence, the court found that the existence of a motive to commit fraud is enough to demonstrate that the opinions were false.
Holding: Motion to dismiss denied.
The 10b-5 Daily has posted previously about the interesting securities class action brought against Tyson Foods, Inc. in connection with the company's 2001 acquisition of IBP Inc. (see here and here).
The plaintiffs in the case are a group of hedge funds who were seeking to arbitrage the merger. They allege that on March 29, 2001, Tyson falsely stated that it was backing out of the merger with IBP due to a government investigation into accounting discrepancies at one of IBP's units. As a result, Tyson artificially deflated the price of IBP's stock. Tyson eventually completed the acquisition in September 2001, after being ordered to perform on the merger contract by a Delaware state court. The plaintiffs represent all IBP shareholders who bought on or before March 29, 2001, and then sold their shares following Tyson's announcement.
The Associated Press reports that the D. of Del. has granted summary judgment in favor of Tyson in the case. According to the article, the court found that the father-son team that ran Tyson at the time was "under no duty to tell shareholders the business reasons for their decision not to go forward with the deal."
On Tuesday, the U.S. Court of Appeals for the Third Circuit affirmed the dismissal, with prejudice, of the Alpharma securities class action. See In re Alpharma, Inc. Sec. Litig., 2004 WL 1326013 (3rd Cir. June 15, 2004). A few highlights from the opinion:
(1) Collective scienter - The court appeared to reject the idea that a corporate defendant's scienter (i.e., fraudulent intent) can be properly alleged on the basis of the collective knowledge of all of the corporation's officers and employees. The plaintiffs alleged that a sales manager in one of Alpharma's divisions notified employees in the main office of accounting irregularities. The court held that "the mere fact that the information was sent to Alpharma's headquarters and therefore was available for review by the individual defendants is insufficient to 'giv[e] rise to a strong inference that [defendants] acted with the required state of mind.'"
(2) Insider stock sales - The court held that the insider stock sales were not unusual in their scope or timing and, therefore, could not support a strong inference of scienter. The allegation that the defendants had not sold any stock during the preceding fifteen months was deemed insufficient. The defendants asserted they were precluded from selling any stock by a blackout period. Although the court could not technically consider this assertion, it found that the "plaintiffs failed to allege the absence of a blackout period or other facts which would demonstrate that the fifteen month period of inactivity was in any way unusual."
(3) Leave to amend - The court upheld the district court's denial of leave to amend where the plaintiffs had failed to proffer any proposed amendment. The denial was "further supported by the fact that plaintiffs (1) had already filed previous complaints and (2) were given an extension of time to assemble the amended consolidated complaint currently at issue."
Holding: Affirm grant of motion to dismiss with prejudice.
For every commentator who believes that Congress has gone too far in passing corporate reforms, there is another who believes that Congress needs to take immediate additional action. In this column from CBS MarketWatch, the author argues that the PSLRA should be overhauled to make it easier for investors to bring suit and new reforms should be passed to address the failings of lawyers, accountants, and Wall Street firms to prevent fraud.
Quote of note: "The real problem is the lack of 'vicarious liability,' whereby institutional gatekeepers are held accountable for misdeeds as much as the organizations from which they supposedly protect the public."
The argument that loss causation must be plead by showing a stock price decline related to the alleged fraud, articulated in the Second Circuit by the Emergent Capital decision, is meeting with increased resistance by the S.D.N.Y. judges handling the research analyst cases. Judges have argued that the stock market crash that occured between the issuance of the allegedly biased research and the revelation of the analysts' conflicts of interest (and, therefore, arguably caused any loss) was irrelevant, either because of allegations that the research analyst directly participated in a fraudulent scheme perpetrated by the issuer of the underlying stock or because the revelation of the analysts' conduct caused a subsequent stock price drop. (See these posts on the WorldCom and Robertson Stephens cases).
In Fogarazzo v. Lehman Brothers, Inc., 2004 WL 1151542 (S.D.N.Y. May 21, 2004), however, the entire concept of the price decline approach to pleading loss causation comes under attack. The complaint, brought by shareholders of RSL Communications, Inc. (“RSL”), alleged that analysts at three firms had falsified their opinions of RSL. Specifically, while RSL issued a series of negative announcements in 1999 and 2000 – and its stock price dropped – the analysts continued to provide RSL with positive ratings. Ultimately, RSL’s stock declined to the point that it was delisted, and each of the three firms then dropped analyst coverage. The court was careful to note that there were no allegations that the defendants concealed any facts concerning RSL. Instead, the plaintiffs merely alleged that despite publicly available negative information, the analysts expressed falsely positive opinions.
Although the facts are similar to those in the Merrill Lynch cases, Judge Scheindlin appears to create a new loss causation standard and concludes that loss causation was adequately plead. The court explained that loss causation is shown when "(1) the misrepresentation artificially inflated the value of the security, or otherwise misrepresented its investment quality, and (2) the subject of the misrepresentation caused the decline in the value of the security." Here, the subject of the misrepresentations was "the financial health and future prospects of RSL," and though no facts were concealed, that subject still caused plaintiffs' losses. "[E]ven though the true facts were available to the world to see, by affirmatively opining on the meaning of those facts, the Banks obscured the logical conclusion that RSL was failing." This standard would appear to remove the need to draw any actual connection between the misrepresentations and the loss; the mere fact that the company's stock price declined creates liability for anyone who issued false statements about the company into the market.
Moreover, although Judge Scheindlin expressed uncertainty as to whether the Second Circuit’s price decline approach requires a corrective disclosure, the court concluded that dropping analyst coverage of RSL was a corrective disclosure. "[W]hen the Banks dropped coverage, they essentially conceded (in the eyes of the investing public) that their previous recommendations were mistaken." Even accepting this characterization of the banks' actions (and it is hard to see how dropping coverage can be equated with a disclosure about the previous recommendations), the court did not find that there was a price decline after coverage was dropped.
As noted previously, clarification of these issues may come in the near future. The Second Circuit is scheduled to hear the appeal of the first few Merrill Lynch decisions on August 12, 2004.
Holding: Motion to dismiss denied. (The 10b-5 Daily may do an additional post about the other holdings in the opinion.)
The shakeup in the plaintiffs' securities bar continues with today's announcement that Lerach Coughlin Stoia & Robbins will combine with Geller Rudman. The merger will expand Lerach Coughlin's presence on the east coast, adding offices in New York and Florida.
As of August 1, 2004, the combined firm will be known as Lerach Coughlin Stoia Geller Rudman & Robbins LLP and will have approximately 140 lawyers. Both firms are the products of recent splits. (See this post on the Milberg/Lerach split and this post on the Cauley/Geller split.)
As noted in The 10b-5 Daily's discussions of the Intergroup and NUI decisions, the idea that corporate acquisitions for stock are a sufficient motive for securities fraud is controversial. A contrary view can be found in the recent decision in In re Corning Sec. Litig., 2004 WL 1056063 (W.D.N.Y. April 9, 2004).
In the Corning case, the plaintiffs alleged that the defendants were motivated to artificially inflate the company's stock price so that they could use it as currency for the acquisition of Tropel Corporation. The court found that "[p]aying a smaller price for the acquisition of Tropel [by using inflated stock] benefited Corning's common shareholders." Moreover, the desire to have a high stock price to be used in the purchase of Tropel "is a motive that could be attributed to virtually every company seeking to acquire another through the use of its own stock as part of the purchase." As a result, the court held that the acquisition failed to create a strong inference of scienter.
Holding: Motion to dismiss granted.
Providian Financial Corp. (NYSE: PVN), a San Francisco-based provider of consumer credit cards, has announced the preliminary settlement of the securities class action pending against the company in the N.D. of Cal. The suit, originally filed in 2001 and about to go to trial, alleges that the company made misrepresentations concerning its operations and prospects. The settlement is for $65 million, to be paid by Providian's insurance carriers.
Two large settlements from the end of last week:
Honeywell Int'l, Inc. (NYSE: HON), a New Jersey-based diversified manufacturer, has announced the preliminary settlement of the securities class action pending against the company in the D. of N.J. The suit, originally filed in 2002 and currently in discovery, alleges that Honeywell made false and misleading statements relating to the 1999 AlliedSignal/Honeywell merger and its financial performance. Under the terms of the settlement, Honeywell has agreed to pay $100 million into an escrow fund, with $85 million coming from its insurers.
Symbol Technologies, Inc. (NYSE: SBL), a New York-based manufacturer of bar scanner-integrated mobile and wireless information management systems, has announced the preliminary settlement of the securities class action pending against the company in the E.D.N.Y. (as well as settlements with the DOJ and SEC). The suit, originally filed in 2002, alleges that the company made false and misleading statements relating to accounting issues. The settlement is valued at $139 million, including $96.25 million in common stock, $5.75 million in cash (from the company and its ex-CEO), and $37 million in cash from the company as part of a joint compensation fund created in the DOJ settlement. Lead counsel for the class has also issued a press release.
Are two opinions a trend? Last year, The 10b-5 Daily posted about the denial of the motion to dismiss in the Interpublic Group securities litigation in the S.D.N.Y. The court's opinion in that case was based on the following controversial legal propositions: (1) Section 20(a) claims have no scienter pleading requirement; (2) corporate acquisitions for stock can be a motive for securities fraud; and (3) companies can be personified for scienter purposes (i.e., a finding of fraudulent intent). In a holding that was described here as "the perfect storm that happens when these three strands of questionable law come together," the Interpublic court found that even though the plaintiffs had failed to establish a strong inference of scienter for any of Interpublic's officers, the case could proceed against Interpublic and its officers based on the company's alleged motive to commit fraud and control person liability.
A year later, another court has issued a very similar decision. In In re NUI Sec. Litig., 2004 WL 895846 (D.N.J. April 23, 2004), the court found that the plaintiffs had adequately alleged a strong inference of scienter for the corporate defendant based on two sets of facts applicable to different parts of the class period. First, NUI's stock-for-stock acquisition of another company allegedly gave it a motive to inflate the price of its stock. Second, NUI's associate general counsel (who is not a defendant in the case) was alleged to have actual knowledge of the company's fraudulent conduct. As to the individual defendants (the CEO and CFO of NUI), however, the court held that there were insufficient allegations concerning their motive to commit fraud and knowledge of the alleged fraudulent conduct. Just as in Interpublic, the Rule 10b-5 claims were allowed to continue against NUI, but were dismissed against the individual defendants. The individual defendants were not, however, free to go. Since they controlled NUI and the court had found that a Rule 10b-5 claim was adequately pled against NUI, the Section 20(a) claims against the individual defendants based on control person liability still remain.
The NUI decision, like the Interpublic decision, would appear to eviscerate the PSLRA's requirement that scienter be adequately plead as to each defendant (see the post on the Interpublic decision for a fuller discussion). Moreover, the NUI court adds a fourth strand of questionable law to the mix. As recently discussed at length in the Fifth Circuit's decision in Southland Sec. Corp. v. INSpire Ins. Solutions, Inc., 365 F.3d 353 (5th Cir. 2004) (see this post on the decision's group pleading holding), in determining whether a corporate defendant has acted with scienter, a court generally looks "to the state of mind of the individual corporate official or official who make or issue the statement (or order or approve it or its making or issuance, or who furnish information or language for inclusions therein, or the like) rather than generally to the collective knowledge of all the corporation's officers and employees acquired in the course of their employment." In other words, courts generally reject a "collective scienter" theory - for example, where a plaintiff attempts to impute the knowledge of the associate general counsel, who is not alleged to have made or issued any statements, to the corporation for scienter purposes. The perfect storm keeps going.
Holding: Motion to dismiss granted in part (as to a separate alleged fraudulent scheme and certain statements), and denied in part.
As predicted, Senate Majority Leader Bill Frist has been forced to table the Class Action Fairness Act until after the completion of the 2005 Department of Defense authorization bill. The Hill has this report.
Quote of note: "With several of the class-action bill’s co-sponsors opposing the cloture vote, Frist probably lacked the votes yesterday to limit debate on the defense bill. Frist said he remains committed to bringing the class-action bill to the floor and said he would move 'immediately' to it after the defense bill was complete."
Addition: A reader has sent in this link to the U.S. Senate Republican Policy Committee's "Legislative Notice" describing the bill and its history.
As The 10b-5 Daily has frequently discussed (indeed, this is the third post in a row on the topic), there is a circuit split over what is necessary to adequately plead loss causation in a securities fraud case. A majority of the courts hold that a plaintiff must demonstrate a causal connection between the alleged misrepresentations and a subsequent decline in the stock price to adequately plead loss causation, while a minority of courts hold that a plaintiff merely needs to demonstrate that the alleged misrepresentations artificially inflated the stock price.
In Broudo v. Dura Pharmaceuticals, Inc., 339 F.3d 933 (9th Cir. 2003), the Ninth Circuit came down firmly in the minority camp. The court found that loss causation "merely requires pleading that the price at the time of purchase was overstated and sufficient identification of the cause." Based on this holding, the court reversed the lower court's dismissal and remanded the case for further proceedings. (See this post discussing the opinion.) The defendants petitioned for a writ of certiorari to the Supreme Court.
On Friday, the U.S. (the SEC and the Solicitor General) filed an amicus brief in support of the defendants' petition. In the brief, the U.S. argues that there is "an acknowledged circuit conflict regarding the nature and scope of the plaintiff's burden to plead and prove loss causation in a fraud-on-the-market case under Rule 10b-5; the court of appeals decided that question incorrectly; the question is one of recurring importance; and this case is a suitable vehicle for resolving it."
Specifically on the issue of whether the case was incorrectly decided, the U.S. makes two main arguments. First, the U.S. argues that measuring the loss in these types of cases "as of the time of the purchase, and not requiring any allegations of a subsequent loss of value attributable to the fraud, would grant a windfall to investors who sold before the reduction or elimination of the artificial inflation, because they would recover the portion of the purchase price attributable to the fraud on resale, and then would be entitled to recover that same amount again in damages." Second, the U.S. argues that the decision improperly conflated the separate elements of transaction causation (i.e., the alleged misconduct induced the plaintiff to engage in the transaction in question) and loss causation (i.e., the alleged misconduct caused the plaintiff’s economic loss).
The Supreme Court rarely takes on securities litigation issues. But the combination of a clear circuit split, the U.S.'s encouragement, and yet another opportunity to overturn the Ninth Circuit, may well prove irresistible.
Thanks to David Tabak for sending a copy of the brief to The 10b-5 Daily.