Note to companies headquartered in Kansas: be careful when telling investors that you are eager to retain your senior officers.
In a securities class action against Sprint Corp., the plaintiffs based their claims on Sprint's March 26, 2001 statement that it had entered into new employment contracts with its CEO and COO that were "designed to insure their long-term employment with Sprint." According to the plaintiffs, this statement was misleading because Sprint knew that it might have to fire these officers as the result of a tax avoidance issue. In its motion to dismiss, Sprint argued that it had no duty to disclose this information because its statement did not "foreclose the possibility" that the CEO and COO might later be terminated.
The court disagreed with this characterization of the statement. See State of New Jersey and its Division of Investment v. Sprint Corp., 2004 WL 1960130 (D. Kan. Sept. 3, 2004). In finding that a duty to disclose existed, the court held that "Sprint's statements that the contracts were 'designed to insure' the long-term employment of [the CEO and COO] could reasonably have led an investor to conclude that the termination of [their] employment (at least in the near future) was simply not an option from Sprint's perspective."
Although the court may have correctly found that a duty to disclose existed, the rationale it used is curious. Did Sprint really need to say, "then again, we might fire them," for a reasonable investor to realize that it is always possible for the employment of a CEO or COO of a corporation to be terminated? Guess so.
The Halliburton settlement just got even messier. Not only has the N.D. of Tex. rejected the proposed $6 million settlement, but the court now has appointed a trustee to protect the interests of the preliminary class members. The Houston Chronicle reports that Judge Lynn "made the decision to appoint the trustee, called a 'guardian ad litem,' Thursday, according to legal documents obtained Friday."
Section 308 of Sarbanes-Oxley, the "Fair Funds" provision, 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. The Los Angeles Times has a feature article (free regist. req'd) today discussing the SEC's use of its restitution powers. The article states that although accounts have been set up in 96 cases, amassing $2.6 billion in funds, the disbursement of those funds has proven to be a "logistical challenge" for the SEC and relatively little of the money has found its way to investors to date.
As for the impact on private litigation, the article notes that many of the supporters of the Fair Funds strategy "like the fact that the funds gave investors a means beyond class-action lawsuits to reclaim their losses." In passing the legislation, however, Congress failed to specifically address whether these funds were supposed to supplement or offset funds obtained as the result of private litigation. The practical effect of large SEC civil penalties may be the reduction of private settlements (see, for example, this post about the mutual fund trading practices cases), but it is not clear that they can be used as a direct offset.
The SEC, for its part, has not given defendants much comfort on this issue, suggesting that civil penalties should still be viewed as a punitive measure despite the Fair Funds provision. As the SEC's Director of Enforcement stated earlier this year: "That harmed investors can benefit directly from these efforts is icing on the case, so to speak." The courts may have to have the final say.
The Wall Street Journal reports (subscrip. req'd) today that Lehman Brothers is "close to reaching a deal to pay about $220 million to settle a class-action lawsuit alleging that it and other big brokerage firms participated in a scheme with Enron Corp. executives to mislead shareholders."
Whether a defendant corporation has acted with scienter (i.e., fraudulent intent) is determined by looking "to the state of mind of the individual corporate official or officials who make or issue the statement . . . rather than generally to the collective knowledge of all the corporation's officers and employees acquired in the course of their employment." Southland Sec. Corp. v. INSpire Ins. Solutions, Inc., 365 F.3d 353 (5th Cir. 2004). In other words, courts reject a "collective scienter" theory.
Eager to get at corporate wrongdoing, however, some courts have been ignoring this principle. In In re NUI Sec. Litig., 314 F.Supp.2d 388 (D.N.J. 2004), the court found that the plaintiffs had adequately alleged a strong inference of scienter for the corporate defendant because NUI's associate general counsel (who was not a defendant in the case and made none of the alleged misstatements) 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. (See this post for a discussion of the case.)
Similarly, in the recent decision in In re Motorola Sec. Litig., 2004 WL 2032769 (N.D. Ill. Sept. 9, 2004), the court held that the plaintiffs had alleged a strong inference that Motorola "through its various officials, sought to mislead the investing public" about its vendor financing to a Turkish company. The direct fraud claims against the individual defendants (the CEO, CFO, and COO of Motorola) were dismissed, however, because the plaintiffs made no allegations that the individual defendants "had specific knowledge of the details concerning Motorola's loan" and the plaintiffs' motive allegations were insufficient.
In both cases, the claims against the individual defendants were not fully dismissed. Since the individual defendants controlled NUI and Motorola, and the courts found that a Rule 10b-5 claim was adequately pled against these companies, the Section 20(a) claims against the individual defendants based on control person liability for fraud still remained. By analyzing the scienter of NIU and Motorola separately, the courts, in essence, held that the companies acted with fraudulent intent, but their controlling officers or directors did not. This result both defies common sense (after all, a corporation can only act through its officers and directors) and, given that the individual defendants still have potential Section 20(a) liability, provides an end run around the PSLRA's requirement that scienter be adequately plead as to each defendant.
The Wall Street Journal reports (subscrip. req'd) that "the hefty penalties already levied by regulators in settlements with 11 fund firms make it less likely there will be a big payoff for investors in the private litigation." Meanwhile, the Boston Globe finds that the existing "settlement talks remain at initial stages" and some of the "fund firms appear to be in no mood to settle with plaintiffs."
The first set of briefs have been filed in Dura Pharmaceuticals v. Broudo, the loss causation case currently before the U.S. Supreme Court. Available on the web are Dura's brief, along with amicus briefs from the Department of Justice and the SEC, the Chamber of Commerce of the United States, the Securities Industry Association and Bond Market Association, the American Institute of Certified Public Accountants, and Technology Network. (The Washington Legal Foundation, Broadcom, and Merrill Lynch also filed amicus briefs and links will be posted when available.)
Dura and its supporters argue that, contrary to the Ninth Circuit's holding, a plaintiff must demonstrate a causal connection between the alleged misrepresentations and a subsequent decline in the stock price to adequately plead and prove loss causation. Broudo's time to respond has been extended until November 17.
The battle in the McKesson HBOC securities litigation over whether providing investigatory reports to the SEC and the DOJ constitutes a waiver of attorney-client privilege continues - now in federal court. Last February, the California Court of Appeal held in a case involving McKesson that providing investigatory reports to government entities was a waiver under California law.
Some of McKesson's former executives have been indicted by the DOJ and also want access to the reports. A federal district court agreed with the California Court of Appeal that the privilege had been waived, but McKesson wants to prevent the reports from going to the shareholder plaintiffs who have brought cases against it in federal court. McKesson appealed the decision and the SEC is supporting the company's position. The Recorder has an article (via law.com - free regist. req'd) on the recent hearing before the U.S. Court of Appeals for the Ninth Circuit.
Quote of note: "White-collar practitioners are closely watching the case, U.S. v. Bergonzi, 03-10511, because it highlights the collision of civil and criminal prosecutions in cases of alleged corporate wrongdoing. Companies share internal reports in order to win favor with government investigators. But if those reports end up exposing them to liability in securities fraud suits, they may not be as cooperative on the criminal side."
The PSLRA provides that "all discovery and other proceedings shall be stayed during the pendency of any motion to dismiss, unless the court finds upon the motion of any party that particularized discovery is necessary to preserve evidence or to prevent undue prejudice to that party." A district court split has developed over whether this provision allows for the discovery, prior to a decision on a motion to dismiss, of documents that have been produced to government entities. (See this post.)
In In re LaBranche Sec. Litig., 2004 WL 1924541 (S.D.N.Y. Aug. 27, 2004), Senior Judge Sweet agreed with those courts holding that not allowing plaintiffs access to documents previously produced to government entities would cause "undue prejudice." LaBranche had already settled with the SEC and NYSE and the court found that the plaintiffs needed the documents produced to those organizations "to make informed decisions about their litigation strategy in this rapidly shifting landscape." The New York Law Journal has an article (via law.com - free regist. req'd) discussing the decision.
In the Baxter decision issued in July, the U.S. Court of Appeals for the Seventh Circuit severely limited the application of the PSLRA's safe harbor by holding that it may be impossible, on a motion to dismiss, to determine whether a company's cautionary statements are "meaningful." Baxter may turn out to be influential, but for the moment other appellate courts are continuing to affirm dismissals based on the safe harbor.
In Baron v. Smith, 2004 WL 1847751 (1st Cir. Aug. 18, 2004) the U.S. Court of Appeals for the First Circuit addressed claims based on forward-looking statements in a press release. The court cited the company's safe harbor language and found that to "the extent that plaintiffs seek to state a claim under the securities laws for a deceptive press release or as an indication that the company omitted material information from its filings, we agree with the district court that the press release contained forward-looking statements, as stated therein, and therefore comes under the protection of the statutory safe harbor."
Holding: Affirming grant of motion to dismiss.
The most recent edition of Forbes (Sept. 20) has a cover story on securities class action litigation. The authors are sharply critical of the effectiveness of public pension funds as lead plaintiffs.
Quote of note: "All told, public and union pension funds were lead plaintiffs in 28% of investor class actions last year; in 1996 they led just 3% of cases, says PricewaterhouseCoopers. Yet they have done nothing to improve shareholder recoveries or reduce significantly the lawyers' cut. 'We have a system where the courts consistently allow law firms to file cases on behalf of figureheads,' complains University of Arizona law professor Elliott Weiss. Translation: The lawyers still run the show. It is a pointed criticism, for Weiss did the research on class action settlements that helped shape the reform act."
After a year-long battle among the lead plaintiffs in the Halliburton securities class action (and the recusal of the original judge), the N.D. of Tex. has rejected a proposed $6 million settlement in the case. The court found that it was "not satisfied that the settlement proposed is fair, reasonable and adequate" and expressed concerns "about the manner in which settlement was reached." The New York Times has an article on the decision.
Quote of note: "The judge noted in her opinion that the $6 million payment proposed by the settlement would have been reduced by administrative costs of $1.5 million, lawyers' fees of $1.5 million and expenses of $117,239. Therefore, more than 800,000 potential claimants would share a settlement of less than $3 million. If all the potential class members submitted claims, the court calculated that an investor with 100 shares would recover about 62 cents."
The 10b-5 Daily will not be updated during the week starting September 6. Posting will resume the following week.
In a high-profile securities class action brought against Oracle Corp., the U.S. Court of Appeals for the Ninth Circuit has reversed the lower court's decision to dismiss the case with prejudice. The issue on appeal was whether the plaintiffs had plead a strong inference of scienter (i.e., fraudulent intent) as required by the PSLRA. The decision can be found here and The Recorder has an article (via law.com - free regist. req'd) summarizing the holding.
The Sarbanes-Oxley Act of 2002 extends the statute of limitations for federal securities fraud to the earlier of two years after the discovery of the facts constituting the violation or five years after such violation. Although the legislation clearly provides that it "shall apply to all proceedings addressed by this section that are commenced on or after the date of enactment of this Act [July 30, 2002]," left unresolved is whether Congress intended to revive claims that had already expired under the earlier one year/three years statute of limitations. District courts are split (although the trend appears to be against reviving time-barred claims) and the issue is currently before the U.S. Court of Appeals for the 11th Circuit.
In the midst of this debate, the Wall Street Journal reports (subscrip. req'd) that the SEC has filed an amicus brief in the U.S. Court of Appeals for the Second Circuit arguing that Sarbanes-Oxley did revive time-barred claims. The SEC's primary argument is that Congress was not required to specifically express its "retroactive intent" and the "natural meaning of the statutory language" supports its position. The underlying case, AIG Asian Infrastructure Fund, L.P. v. Chase Manhattan Asia Limited, et al., alleges Rule 10b-5 violations based on a 1998 purchase of securities.
Addition: In related news, the Legal Intelligencer has an article (via law.com - free regist. req'd) today on a district court decision (from the E.D. of Pa.) that rejects the revival of time-barred claims.