Can a securities class action be too easy to settle? The answer may be "yes," if you are plaintiffs' counsel and plan to request a significant fees award.
The Bristol-Myers securities class action filed in the S.D.N.Y. alleged violations of federal securities laws in connection with the company’s investment in and relationship with ImClone Systems and issues related to wholesaler inventory and sales incentives, the establishment of reserves, and accounting for certain asset and other sales. The case was settled in July 2004 for $300 million, even though the district court had previously dismissed the claims with prejudice (the decision was under appeal). A few days after the class action settlement, the company also settled a case brought by the SEC.
Plaintiffs' counsel in the securities class action sought $22 million in legal fees (about 7.5% of the funds) as part of the settlement. Last week, however, Judge Preska cut that amount nearly in half, awarding plaintiffs' counsel $12 million. According to a New York Law Journal article (via law.com - free regist. req'd) on the decision, the judge described the case as relatively low risk for plaintiffs' counsel and noted that the "simultaneous settlement of the SEC action suggests that it was the Company's desire, prompted by the SEC, to put its house in order that caused the settlement, not any action on the part of Lead Counsel." This is the second case in the last six months where a court has significantly reduced a proposed fee award based on a determination that the case was low risk (see this post on the earlier decision).
Quote of note: "'[I]t is not thirty times more difficult to settle a thirty million dollar case as it is to settle a one million dollar case,' Southern District Judge Lorretta A. Preska wrote."
Novell, Inc. (NASDAQ: NOVL), a Massachusetts-based information solutions provider, has obtained preliminary court approval for a settlement of the securities class action pending against the company in the D. of Utah. The case was filed nearly five years ago and alleges that Novell engaged in accounting fraud. Although the case was initially dismissed, the U.S. Court of Appeals for the 10th Circuit partially overturned the decision in 2003 (see this post). The settlement is for $13.9 million.
Securities class actions rarely go to trial, but that does not mean they never go to trial. The Recorder reports (via law.com - free regist. req'd) that Ernst & Young has achieved a trial victory in a securities class action brought in the N.D. of Cal. and based on the accounting firm's work for Clarent Corp. The plaintiffs filed the class action after accounting irregularities at Clarent came to light in 2001. Although the jury found no liability for Ernst & Young, Clarent's former CEO was found liable for an accounting misrepresentation. Plaintiffs' counsel has issued a press release stating that the trial was only the third trial of a securities class action in the last ten years.
The litigation arising out of the “research analyst” scandals (where major investment banks have been accused of disseminating overly optimistic research and investment recommendations to garner investment banking business) continues to raise interesting legal issues. Both the Second and Third Circuits, for example, have recently addressed whether the Securities Litigation Uniform Standards Act of 1998 (“SLUSA”) mandates the dismissal of class actions based upon state law seeking to recover various types of damages related to the allegedly biased research.
SLUSA preempts certain class actions based upon state law that allege a misrepresentation in connection with the purchase or sale of nationally traded securities. In Dabit v. Merrill Lynch, 2005 WL 44434 (2d Cir. Jan. 11, 2005), the Second Circuit addressed two state class actions (brought on behalf of Merrill Lynch brokers and brokerage customers respectively) alleging losses based on biased research. In both cases, the plaintiffs generally did not dispute that the lawsuits were “covered class actions” and concerned “covered securities.” The issue was whether Merrill Lynch’s alleged misrepresentations were “in connection with the purchase or sale” of those securities. The court held that to be prohibited under SLUSA “an action must allege a purchase or sale of covered securities made by the plaintiff or members of the alleged class.” As for the brokers, the court found that the proposed class of brokers who were injured by holding the recommended stocks included purchasers and therefore, in part, satisfied the “in connection with requirement.” Because the court could not “distinguish any non-preempted subclass, SLUSA requires that the claim be dismissed.” A separate claim regarding commissions lost by the brokers when their customers left Merrill Lynch due to the scandal, however, was allowed to proceed in state court.
The brokerage customers also received a mixed decision. The Second Circuit followed a number of other circuits in finding that the claims based on commissions paid to Merrill Lynch in reliance on the research were “preempted because they necessarily involve allegations of a purchase or sale ‘in connection with’ this alleged misconduct.” In contrast, the claims related to the annual fees paid by the customers were not preempted because the fees were “paid whether or not the customer transacts in the account, and the misrepresentations inherent in the alleged nonperformance and statutory violations therefore do not necessarily ‘coincide with’ a securities transaction.”
Last week, the Third Circuit addressed the same issues and came to similar conclusions. In Rowinski v. Salomon Smith Barney, Inc., 2005 WL 356810 (3rd Cir. Feb. 16, 2005) a putative class of Salomon brokerage customers brought a class action in Pennsylvania state court alleging that the company’s dissemination of biased investment research breached the parties’ service contract, unjustly enriched Salomon, and violated state consumer protection law. The plaintiffs sought “an amount equal to the amount of any and all fees and charges collected” from the class by Salomon. The court held that the “in connection with the purchase or sale” requirement under SLUSA must, as it is in the context of Rule 10b-5 actions, be broadly interpreted. Looking at a number of factors, including whether the fraudulent scheme coincided with the purchase or sale of securities and whether the nature of the parties’ relationship was such that it necessarily involved the purchase or sale of securities, the court found that the class action fell “well within the bounds of SLUSA” and upheld its dismissal.
Quote of note (Rowinski): “Plaintiff also contends that as master of his own complaint, he is entitled to plead around SLUSA. But SLUSA stands as an express exception to the well-pleaded complaint rule, and its preemptive force cannot be circumvented by artful drafting. In this context – where Congress had expressly preempted a particular class of state law claims – the question is not whether a plaintiff pleads or omits certain key words or legal theories, but rather whether a reasonable reading of the complaint evidences allegations of ‘a misrepresentation or omission of a material fact in connection with the purchase or sale of a covered security.’”
As expected, the U.S. House of Representatives approved the Class Action Fairness Act today. Bloomberg reports that the final vote was 279 to 149. President Bush has said he will sign the legislation.
The plaintiffs and the issuer defendants in the IPO allocation cases have obtained preliminary court approval of their $1 billion settlement, originally agreed to back in June 2003. The cases were brought against nearly 300 companies and 55 investment banks involved in initial public offerings during the tech boom. The plaintiffs generally allege that the defendants ramped up trading commissions in exchange for providing access to IPO shares and required investors allocated IPO shares to buy additional shares in the after-market to help push up the share price. The Washington Post has an article on the court's decision.
Quote of note (Washington Post): "'Despite the apparent magnitude of the billion-dollar guarantee, this settlement is not solely -- or even primarily -- about monetary recovery,' Scheindlin said. The judge said the real value is in the companies' agreement to aid the investors' suits against the banks. The start-ups also agreed to allow investors to file suits to pursue the companies' claims that the banks didn't raise enough money in the IPOs. 'The value of each of these benefits should not be understated,' Scheindlin wrote. The Internet companies 'know far better than the plaintiff classes precisely what occurred in the period leading up to and including their IPOs.'"
The February issue of the Securities Reform Act Litigation Reporter includes The 10b-5 Daily's summary of the Supreme Court argument in the Dura case. A pdf of the issue, which also contains an article on the PSLRA, detailed case summaries, and copies of recent decisions, can be found here.
Disclosure and an Offer: The author of The 10b-5 Daily is on the Board of Advisors for the Securities Reform Act Litigation Reporter. The publisher has authorized a 33% discount on initial subscriptions to this useful periodical for readers of this weblog. For subscription information and to obtain the discounted price, call (202) 462-5755.
NERA Economic Consulting has released a study entitled "Recent Trends In Shareholder Class Action Litigation: Bear Market Cases Bring Big Settlements." The study reaches the following notable conclusions:
(1) There was a 33% increase in the mean settlement value of securities class actions in 2004 ($27.1 million in 2004, up from $20.3 million in 2003). NERA found that this increase was fueled by cases dealing with higher investor losses and is likely to continue for the next several years.
(2) On average, a 1% increase in investor losses results in a .4% increase in the size of an expected settlement.
(3) Although a number of very large settlements caused the increase in the mean settlement value, the dollar value of the typical settlement is actually falling. Over 70% of the settlements in 2004 were valued at $10 million or less.
(4) Over a five-year period, a public corporation faces a 10% probability of facing a securities class action. This probability has risen since the passage of the PSLRA.
(5) The Sarbanes-Oxley Act of 2002 does not appear to have had an impact on the number of securities class action filings or the size of settlements.
NERA's press release on the study can be found here.
By a surprisingly large margin, the Senate passed the Class Action Fairness Act yesterday. The legislation applies some of the reform concepts in the PSLRA and SLUSA to all class actions. Notably, class actions meeting certain jurisdictional criteria would have to be heard in federal court. The Associated Press reports that the final vote in the Senate was 72-26. The House of Representatives, which had previously passed its own version of the legislation, is expected to take up the matter next week.
Addition: A reader has sent in this link to the U.S. Senate Republican Policy Committee's "Legislative Notice" describing the legislation and its history.
National Underwriter has an interesting article on remarks made at a directors and officers liability insurance conference by two prominent members of the plaintiffs' securities litigation bar. The topics included private actions vs. class actions, derivative cases, holding corporate officers accountable, and what industry is likely to see a flurry of new suits (hint: insurance).
Under the PSLRA, plaintiffs must plead facts creating a strong inference that the defendants acted with scienter (i.e., fraudulent intent) to survive a motion to dismiss. Several courts have found that the sheer size of an alleged financial fraud can support a finding of fraudulent intent. In a recent decision, however, the U.S. Court of Appeals for the Sixth Circuit has disagreed.
In Fidel v. Farley, 2004 WL 2901274 (6th Cir. Dec. 16, 2004), the plaintiffs argued that the magnitude of the financial fraud allegedly perpetrated by Fruit of the Loom, including a write-down of over $220 million of inventory in 1999, supported an inference that the company's auditors had acted with scienter. The court found that "[a]llowing an inference of scienter based on the magnitude of fraud 'would eviscerate the principle that accounting errors alone cannot justify a finding of scienter.'" Moreover, the fact that Fruit of the Loom took the write-offs in 1999, "in no way implied that [the auditors] acted with scienter while auditing the 1998 financial data."
Holding: Dismissal affirmed.
The PSLRA states that securities class action plaintiffs, within 20 days of filing a complaint, "shall cause to be published, in a widely circulated national business-oriented publication or wire service, a notice advising members of the purported plaintiff class." Although the standard practice is for the notice to be put out on a wire service, some plaintiffs/counsel have chosen to publish their notice in the print edition of a single publication (with the express intention, it has been argued, of limiting the number of lead plaintiff candidates).
A minor court split has developed over whether publishing notice in the print edition of a single publication is sufficient. Last year, a D. of Md. court found that the publication of a notice in the New York Times did not meet the PSLRA's requirements. A recent decision from the E.D. of Pa., however, has held that the publication of a notice in the Investor's Business Daily was sufficient.
Securities Litigation Watch has posted extensively on the subject and the Legal Intelligencer has an article on the E.D. of Pa. decision (which also found that the notice does not need to contain an extensive description of the case).
Less than a month after it was announced, the settlement by ten former WorldCom outside directors of the securities class action claims against them has collapsed. The settlement was for $54 million, but it was the fact that $18 million of that sum was to be paid personally by the directors that led to extensive media commentary. According to an article (subscrip. req'd) in the Wall Street Journal, District Judge Cote (S.D.N.Y.) "rejected a provision that relates to how much the remaining defendants in the suit might have to pay if they lose the case." Without that provision, the plaintiffs have chosen to withdraw from the settlement.
ConAgra Foods, Inc. (NYSE: CAG) has announced the preliminary settlement of the securities class action pending against the company in the D. of Neb. The complaint, originally filed in 2001, alleged that the company had engaged in fraud by permitting its United Agri Products subsidiary to prematurely recognize revenue from sales where the delivery of the goods had not yet taken place. The case is perhaps best known for generating a notable appellate decision on loss causation and materiality. The settlement is for $14 million and is "largely covered by insurance."