Although the media generally has praised the recent trend of requiring corporate governance reforms as part of the settlement of shareholder litigation (see, e.g., this post from last month), the response has not been uniform. Business Week has a column in its Sept. 6 edition that is critical of the real value of these reforms.
Quote of note: "It is just another example of how there's as much bluster as big bucks behind the recent wave of such therapeutic shareholder deals. Governance experts and the lawyers who push the lawsuits laud them for forcing boards closer to true independence and pressuring executives to be more accountable. But while some financial payouts have been impressive, the governance changes, with few exceptions, have not. Worse, the settlements are taking some of the pressure off companies to make more substantive changes."
A court in the W.D. of Wash. has dramatically cut the requested attorneys' fees in the InfoSpace securities class action settlement. The case settled prior to a decision on the motion to dismiss for $34,300,000. Plaintiffs' counsel sought attorneys' fees of 25% of the settlement fund (i.e., approximately $8.5 million). Interestingly, objections to the fee request were filed by three public pension funds.
In its decision (In re InfoSpace, Inc. Sec. Litig., 2004 WL 1879013 (W.D. Wash. Aug. 5, 2004)), the court noted that the Ninth Circuit has established 25% of a settlement fund as a "benchmark" award for attorneys' fees in common fund cases. Nevertheless, the court found that a "25 percent benchmark does not promote the objectives of the PSLRA."
In the InfoSpace case, there was "a modest risk to recovery" and if the requested fees were awarded the damaged investors would only receive about 14 cents per share. Under these circumstances, the court decided to apply a lodestar method (take the reasonable hours expended times a reasonable hourly rate and enhance with a multiplier) to determine the fee award. After various rate adjustments, and applying a multiplier of 3.5, the court awarded attorneys' fees of approximately $4 million.
Quote of note: "In contrast to the 14 cents per share (or 0.10 percent recovery) to the class member investors, the 25 percent fee requested by plaintiffs' counsel, $8,456,353, results in an almost seven-fold increase for plaintiffs' counsel based on the number of hours spent on this case and the very high billable hourly rates reported by the attorneys. Such a result is unfair and does not provide a sound basis for an award of attorneys' fees in this case. Such an award would also constitute a substantial windfall to the attorneys to the detriment of the class members who would only recover pennies on the dollar. The Court concludes that the lodestar method provides a more accurate basis for fees to be awarded in this case."
The 10b-5 Daily has been actively following the unusual dispute among the lead plaintiffs in the Halliburton securities class action over a proposed $6 million settlement. (The most recent post can be found here.) According to an Associated Press story today, the new judge presiding over the case will decide whether to approve the settlement next week.
Quote of note: "[Judge Barbara Lynn of the N.D. of Tex.] pointed out that the $6 million settlement, cut in half by attorney and administrative fees, would result in low payouts to thousands of plaintiffs in the class-action lawsuit. She said they wouldn't lose much if she rejected the settlement, allowed the case to move forward and it eventually failed."
The Wall Street Journal reported (subscrip. req'd) today that seventeen former WorldCom bond underwriters, as part of the pretrial "requests for admission" in the securities class action pending in the S.D.N.Y., refused to admit that any of WorldCom's financial reports were false. Judge Cote apparently expressed scepticism over this position at the hearing.
The WSJ also reported that ten of WorldCom's former directors have agreed to settle allegations that they did not properly oversee the company for $50 million. An official announcement of the settlement could come this week. Bloomberg has a story on the settlement.
Quote of note (WSJ): "Asked about its attorney's exchange with Judge Cote, J.P. Morgan spokeswoman Kristin Lemkau yesterday said the bank and its co-defendants 'do not contend that no financial fraud occurred at WorldCom.' While Judge Cote characterized the banks' responses as an across-the-board denial, Ms. Lemkau said that, in fact, is not the banks' position. 'The financial fraud and its concealment from us has been the centerpiece of the underwriters' defense for two years and is a substantial part of our motion for summary judgment to have the entire case dismissed,' Ms. Lemkau said. 'That is different from whether -- for purpose of responding to a request to admit -- a particular line item in a particular financial statement was false, an issue which involves, among other things, accounting judgment and a review of the discovery record, which is not complete.'"
The U.S. Court of Appeals for the Sixth Circuit has upheld the dismissal of a securities class action originally brought against Ford Motor Co. in 2000. The plaintiffs alleged that Ford failed to disclose safety problems with the tires on its Ford Explorer vehicles (prior to a tire recall) and failed to account for the possibility of future recall costs as a loss contingency.
In its decision (In re Ford Motor Co. Sec. Litig., 2004 WL 1873808 (6th Cir. August 23, 2004)), the court found that none of the alleged misrepresentations were actionable. Most of the statements were "either mere corporate puffery or hyperbole" and did not specifically address the safety of Ford Explorers. As for the few statements that did talk about the safety of Ford Explorers, the court held that the plaintiffs failed to establish that these statements were knowingly or recklessly false. Ford also warned investors about potential recall costs and the plaintiffs did not "allege any facts that establish that anyone at Ford thought or anticipated a massive recall of tires was necessary in the United States before the recall was announced."
Holding: Motion to dismiss with prejudice affirmed.
The Associated Press has an article on the decision.
CBS MarketWatch.com has a column on the mutual fund fee cases, which allege "that the operational savings that a fund company accrues when its issues reach the multibillion-dollar level never get passed to individual investors." The columnist argues that the cases will ultimately benefit investors by either resulting in fee cuts or creating an environment in which mutual fund companies will be reluctant to raise fees.
The Wall Street Journal has an editorial (subscrip. req'd) in today's paper on the relationship between public pension funds and the securities plaintiffs' bar. The editorial is entitled "Pension Fund Shenanigans" and discusses what the authors describe as "a couple of recent cases show[ing] that some public pension funds are not only failing their own beneficiaries, they are making mischief for well-run corporations."
Stephen Choi, a law professor at Berkeley, has published an article entitled "Do the Merits Matter Less After the Private Securities Litigation Reform Act?" Choi finds that the PSLRA has reduced nuisance litigation, but may discourage some meritorious suits.
Notably, Choi's research suggests that two classes of cases are less likely to be brought post-PSLRA: (1) cases against "companies engaged in smaller offerings or with a lower secondary market volume (and therefore reduced potential damage awards);" and (2) cases against "companies engaged in fraud where no hard evidence of the fraud is announced pre-filing of a suit." Choi concludes that the PSLRA "has operated less like a selective deterrence against fraud and more as a simple tax on all litigation (including meritorious suits)."
ProfessorBainbridge.com has a post on the article. Thanks to George Best for sending in the link.
Judge Milton Pollack (S.D.N.Y.) passed away last week. During his long career on the bench, Judge Pollack decided a number of well-known financial fraud cases, including the Drexel Burnham Lambert bankruptcy case and the Merrill Lynch research analyst cases (currently on appeal in the Second Circuit). The New York Times ran an obituary in Monday's edition.
Following its enormous settlement in the WorldCom case, Citigroup received a bit of relief last week when Judge Swain (S.D.N.Y.) dismissed a related securities class action against the company. In In re Citigroup, Inc. Sec. Litig., 2004 WL 1794465 (S.D.N.Y. August 10, 2004), the court addressed claims that Citigroup had failed, with respect to transactions with Enron, Dynegy, and WorldCom, to conduct its business in accordance with its risk management policies. The plaintiffs also alleged that Citigroup had permitted Solomon Smith Barney (a Citigroup subsidiary) analysts to color their public assessments of those companies to aid Citigroup's investment banking business.
In its decision, the court found that the claims regarding the transactions with Enron, Dynegy, and WorldCom merely alleged "that Citigroup's business would have been conducted differently had the company adhered to the management principles disclosed in its public filings." The court held that under established law, "allegations of mismanagement, even where a plaintiff claims that it would not have invested in the an entity had it known of the management issues, are insufficient to support a securities fraud claim under section 10(b)."
As to the claims based on analyst statements, the court noted that the plaintiffs had failed to allege that any misleading statements were made "in connection with the market for Citigroup's own securities." The allegation that Citigroup's failure to disclose the false nature of the analyst statements had the effect of misleading investors concerning the profitability of Citigroup's investment banking activities was summarily rejected. First, the court found the "securities laws do not require a company to accuse itself of wrongdoing." Second, the court found that to the extent the claims were "premised on the assertion that Citigroup breached a duty to disclose that its revenues were 'unsustainable," no such duty existed in the absence of any projections concerning those revenues.
Holding: Motion to dismiss granted with leave to amend.
The New York Law Journal has an article (via law.com - free regist. req'd) on the decision.
In May, some of the individual defendants in the AOL/Time Warner securities class action were dismissed from the case. According to a report in yesterday's Washington Post, however, Judge Kram of the S.D.N.Y. has reinstated the case against most of these defendants (including former AOL Chairman Steve Case) based on the plaintiffs' second amended complaint.
Quote of note: "The opinion said: 'According to the second amended complaint, on October 17, 2000, Case said, 'I do not think people generally are concerned about Internet advertising. Our results show that there's no reason to be concerned when it comes to AOL.' In light of Case's alleged knowledge as early as November 1999 that the advertising revenue was facing a 'stark reversal of fortune,' the above statement may form the basis of a [securities fraud] claim against Case.'"
The September/October issue of Corporate Board Member has a column on the increased litigation risk faced by corporate directors.
Quote of note: "The legal buzzwords for directors to remember here are 'business judgment' and 'good faith.' Courts traditionally won’t allow the former to be questioned so long as they are assured that board members acted in the latter."
As reported in The 10b-5 Daily last year, there is a dispute among the lead plaintiffs in the Halliburton securities class action over a proposed $6 million settlement. Scott + Scott (which represents one of the four lead plaintiffs) refused to sign onto the settlement and continues to challenge the appropriateness of the proposed payment. On June 7, 2004, Judge Godbey of the N.D. of Tex. gave his preliminary approval of the settlement. Since then, however, there have been two notable developments.
First, Scott + Scott moved the court to file a new class action complaint against Halliburton. The proposed complaint included allegations from anonymous former employees and got widespread publicity (in a number of newspapers under the erroneous headline "Ex-Employees Sue Halliburton For Fraud"). Second, Judge Godbey discovered this week that he may have sold Halliburton stock during the class period and recused himself from the case. CBSMarketwatch.com has thorough coverage of the story - see here and here. Scott+Scott has stated that it will renew its motions before the new judge.
One way to rebut the fraud-on-the-market theory is to demonstrate that the alleged misrepresentations could not have affected the market price of the stock because the truth of the matter was already known to investors. The "truth-on-the-market" defense is fact-specific, and courts have only rarely found it to be an appropriate basis for dismissing a securities fraud complaint for failure to adequately plead that the alleged misrepresentations were material.
As the court in White v. H.R. Block, Inc., 2004 WL 1698628 (S.D.N.Y. July 28, 2004) recently noted, however, "'rarely appropriate' is not the same as 'never appropriate.'" In that case, the plaintiffs alleged that H.R. Block had concealed important facts about more than 20 class action lawsuits filed against the company over its refund anticipation loan program. The court found that the "litigation involved public lawsuits brought by public filings in public courts, and the litigation was the subject of extensive press coverage . . . as well as press releases and SEC filings from Block itself." Not surprisingly, the court rejected the plaintiffs' argument that this information did not enter the market with sufficient intensity to counter-balance any alleged misrepresentations. "In short, the truth was all over the market."
Holding: Motion to dismiss granted with prejudice.
Quote of note: "Plaintiffs claim that investors should not be obligated to 'scour county court houses across the country.' But, as defendants point out, the market is comprised of more than ordinary investors; it is also comprised of market professionals, such as Avalon, and Avalon apparently had little trouble scouring those courthouses to gather information for its report on the RAL litigation which sparked this lawsuit against Block."
Charter Communications, Inc. (Nasdaq: CHTR), a cable television provider headquartered in St. Louis, has announced the preliminary settlement of the securities class action (as well as related federal and state derivative actions) pending against the company in the E.D. of Missouri. The case was originally filed in 2002 and alleges that Charter utilized misleading accounting practices and issued false and misleading financial statements and press releases concerning its operations and prospects.
The settlement is for $144 million in cash and equity. Charter's insurance carriers will pay $64 million in cash and the "balance will be paid in shares of Charter Class A common stock having an aggregate value of $40 million and ten year warrants to purchase shares of Class A common stock having an aggregate value of $40 million." The St. Louis Business Journal has an article on the settlement.
Bausch & Lomb (NYSE: BOL), an eye health company based in Rochester, N.Y., has announced the preliminary settlement of the securities class action pending against the company in the W.D.N.Y. The suit was originally filed in December 2001 and claims that the value of Bausch's stock "was artificially inflated by alleged false and misleading statements about expected financial results for the fiscal year 2000."
The settlement is for $12.5 million and will be paid by Bausch's insurance carrier. The Rochester Democrat & Chronicle has a story on the settlement.
(1) Of the 175 securities class actions filed in 2003, 107 were accounting-related. The primary allegation in accounting-related cases continues to be revenue recognition issues, alleged in over 50% of these cases.
(2) The percentage of cases with union/public pension funds as lead plaintiffs has grown steadily from 1996 (less than 3% of cases) to 2003 (28% of cases).
(3) Average settlement values for all cases settled in 2003 was $23.2 million, up 20% from 2002. There were an increasing number of large settlements, including 6 settlements of more than $100 million.
(4) PwC has begun to track "triple jeopardy" cases, where companies are subject to securities class actions along with SEC and DOJ investigations. There was an all-time high of over 40 of these cases in 2002, but last year saw this number fall to 8 cases (closer to historic norms).
The PSLRA created a safe harbor for forward-looking statements to encourage companies to provide investors with information about future plans and prospects. Under the first prong of the safe harbor, a defendant is not 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.
In a controversial decision, the U.S. Court of Appeals for the Seventh Circuit has held that it may be impossible, on a motion to dismiss, to determine whether a company's cautionary statements are "meaningful." In Asher v. Baxter Intern. Inc., 2004 WL 1687885 (7th Cir. July 29, 2004), the court addressed whether Baxter's published risk factors were sufficient to foreclose liability for its allegedly false financial projections. The court, in an opinion authored by Judge Easterbrook, made three important holdings:
(1) The plaintiffs relied on the fraud-on-the-market theory (i.e., reliance by investors on an alleged misrepresentation is presumed if the company's shares were traded on an efficient market) in bringing their claims. The court found that an "investor who invokes the fraud-on-the-market theory must acknowledge that all public information is reflected in the price." Accordingly, a company's cautionary statements, no matter where found, "must be treated as if attached to every one of its oral and written statements."
(2) A company does not have to have "prevision." It is enough for the cautionary statements "to point to the principal contingencies that could cause actual results to depart from the projection."
(3) Nevertheless, the court found that Baxter's cautionary statements, though company-specific and not boilerplate, may have fallen short because there "is no reason to think - at least, no reason that a court can accept at the pleading stage, before plaintiffs have access to discovery - that the items mentioned in Baxter's cautionary language were those thought at the time to be the (or any of the) 'important' sources of variance." The court noted that Baxter's cautionary language had remained fixed even as the risks faced by the company changed.
Prior to Baxter, numerous courts had dismissed cases pursuant to the first prong of the Safe Harbor (see, e.g., the Blockbuster decision discussed in this post). The Seventh Circuit's holding cuts sharply against the prevailing judicial trend and weakens the protections of the Safe Harbor. Will other circuit courts adopt the Seventh Circuit's reasoning?
Quote of note: "What [plaintiffs] do say is that the projections were too rosy, and that Baxter knew it. That charges the defendants with stupidity as much as with knavery, for the truth was bound to come out quickly, but the securities laws forbid foolish frauds along with clever ones."
Quote of note II: "[A] word such as 'meaningful' resists a concrete rendition and thus makes administration of the safe harbor difficult if not impossible. It rules out a caution such as: 'This is a forward-looking statement: caveat emptor.' But it does not rule in any particular caution, which always may be challenged as not sufficiently 'meaningful' or not pinning down the 'important factors that could cause actual results to differ materially'--for if it had identified all of those factors, it would not be possible to describe the forward-looking statement itself as materially misleading."