The Associated Press has a report on yesterday's opening statements in the trial of the securities class action against Arthur Andersen based on WorldCom-related claims. As previously posted, the other defendants in the case have settled.
Although the U.S. Court of Appeals for the Fourth Circuit established its pleading standards for scienter (i.e., fraudulent intent) in securities fraud cases over a year ago, it has not had a subsequent opportunity to apply these standards. Moreover, the Hanger Orthopedic decision did not address the common scienter allegations of insider stock sales and violations of generally accepted accounting principles ("GAAP").
The Fourth Circuit's decision in In re PEC Solutions, Inc. Sec. Litig., 2005 WL 646070 (March 18, 2005), although unpublished, offers some guidance on how the court will evaluate the existence of a "strong inference" of scienter as required under the PSLRA. In PEC Solutions, plaintiffs alleged that scienter was demonstrated by, among other things, the stock trading of the individual defendants and a failure of the company to take a reserve against non-payment of a contract in violation of GAAP.
As to the stock sales, the court found that they were "nearly de minimus" given that the individual defendants only sold between 1.17% and 13% of their holdings during the class period. Moreover, the individual defendants exercised stock options during the class period, but did not sell the underlying stock, and actually lost hundreds of millions of dollars in stock value due to the price drop. The court concluded that "[i]f this all give rise to a 'strong inference' of anything, it is that no scienter exists."
Turning to the alleged GAAP violation, the court noted that "it is certainly possible that some egregious GAAP violations may help support an inference of scienter for pleading purposes." The supposed lack of a reserve, however, added "nothing new" to the scienter allegations because the complaint had failed to plead facts establishing that PEC believed it would not be paid for its work.
Holding: Dismissal affirmed.
Quote of note: ""But this alleged GAAP violation adds nothing new; rather it simply rides around in circles on the inadequate coattails of the scienter pleading. For if PEC was to take a reserve only when it believed non-payment was 'probable' . . . and that 'the amount of the loss can be reasonably estimated,' we are brought back to Appellants' previous problem that they have not pled facts that give rise to a strong inference that PEC ever believed it would not get paid by Pearson while making the public statements that the [Complaint] challenges."
Disclosure: The author of The 10b-5 Daily argued the case before the appellate court on behalf of the defendants. Note that the case has also received some attention for the results of the court's spell-checking.
OM Group, Inc. (NYSE: OMG), a Cleveland-based maker of metal-based chemicals, has announced the preliminary settlement of the securities class action pending against the company in the N.D. of Ohio. The suit was originally filed in 2002 following a dissapointing earnings announcement. The company subsequently engaged in a financial restatement. The settlement is for $84.5 million ($76 million in cash and $8.5 million in common stock).
Finding jurors that do not have strong feelings about the WorldCom corporate scandal may prove difficult for the company's former auditors. Arthur Andersen is the last remaining defendant in the WorldCom securities class action and the case is about to go to trial. According to a Bloomberg report, counsel for Arthur Andersen has informed the judge that many of the individuals in the jury pool "owned WorldCom stock while others displayed 'deeply felt' bias against Andersen and WorldCom." Jury selection begins on Monday and the trial is expected to last until the end of May.
It may have been too much to expect that the U.S. Supreme Court would grant cert in two securities litigation cases within the span of a year. Having just addressed the issue of loss causation, the court has passed on the opportunity to interpret the PSLRA's safe harbor for forward-looking statements.
The PSLRA created the safe harbor 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.
As discussed in a post in The 10b-5 Daily from last August, entitled "The Safe Harbor May Just Be A Safe Puddle," the U.S. Court of Appeals for the Seventh Circuit has weakened the protection afforded by the safe harbor. In Asher v. Baxter Int'l, the court found that it may be impossible, on a motion to dismiss, to determine whether a company's cautionary statements are "meaningful." Prior to this decision, however, numerous courts had dismissed cases pursuant to the first prong of the safe harbor. The defendants petitioned for a writ of certiorari to the Supreme Court to address the circuit split.
Quote of note: "Numerous business groups filed legal briefs in support of Baxter with the Supreme Court urging review of the case. The Business Roundtable, in its brief, argued that the 7th Circuit decision could affect how public companies across the country handle disclosures. 'The ramifications of the decision below could be enormous,' it wrote, adding that companies 'may choose to avoid making forward-looking disclosures rather than risk lawsuits like this one.'"
As of today, all of the former directors sued in the WorldCom securities class action pending in the S.D.N.Y. have agreed to settle the case. The twelve board members will pay $60.75 million ($24.75 million in personal payments and $36 million from their insurers), bringing the total settlements in the case to slightly over $6 billion. The last remaining defendant is Arthur Anderson. The Associated Press has a report.
Texas Lawyer has an article (via law.com - free regist. req'd) on the U.S. Court of Appeals for the Fifth Circuit's recent decision rejecting the use of "statistical" tracing to establish standing for Section 11 claims. The 10b-5 Daily posted about the case last week.
JPMorgan Chase & Co. (NYSE: JPM) has announced the preliminary settlement of the claims brought against it as part of the WorldCom securities class action pending in the S.D.N.Y. JPMorgan is accused of failing to engage in proper due diligence while acting as an underwriter for WorldCom bond offerings and is the last of the defendant banks in the case to settle. The settlement is for $2 billion.
Bloomberg reports that JPMorgan will pay a significant premium (more than 17.5%) over the formula used to establish Citigroup's related settlement. Taken together, the WorldCom securities class action settlements now total approximately $6 billion.
Is it fraudulent to pay analysts to promote your company's stock? In a break from the run-of-the-mill securities class action, investors in Diomed Holdings, Inc. alleged that, in 2002, the company and its chairman "devised a plan to artificially inflate the price of Diomed's stock by secretly paying stock analysts to tout Diomed to unsuspecting investors." The plaintiffs argued that this was part of a "pump and dump" scheme and and unlawful pursuant to Rule 10b-5.
The court disagreed. In Garvey v. Arkoosh, 2005 WL 273135 (D. Mass. Feb. 4, 2005), the court held that "nothing in the securities laws bars the issuer of a regulated security from paying an analyst for a stock recommendation." While the applicable regulatory scheme requires the person who publishes the report to disclose a conflict of interest (see Section 17(b) of the '33 Act), there is no similar duty imposed on the issuer who paid for the promotion. Moreover, the analysts had clearly stated in their reports that they were being paid to tout the stock, even if the disclosures did not directly connect Diomed to the payments.
Holding: Motion to dismiss granted.
Quote of note: "Any reasonable investor told that the publisher of an investment report had received $700,000, $100,000, or even $50,000 to tout a particular stock would give the analyst's recommendation the proverbial grain of salt regardless of the source of the funds."
Amazon.com, Inc. (Nasdaq: AMZN), a Seattle-based Internet retailer, has announced the partial settlement of the securities litigation pending against the company in the W.D. of Wash. The plaintiffs brought '33 Act and '34 Act claims based on alleged false statements about the company's financial condition. The settlement is for $27.5 million and only covers the '34 Act claims. The Seattle Times has a report.
Under the PSLRA, the lead plaintiff in a securities class action is presumptively the party with the largest financial interest in the relief sought by the class (i.e., the movant who alleges the most potential damages). The presumption may be rebutted, however, by a showing that this party will not fairly and adequately protect the interests of the class or is subject to unique defenses not applicable to other class members. In creating this provision, Congress sought to encourage the participation of institutional investors as lead plaintiffs.
An open question is to what extent this legislative history, as opposed to the plain language of the "largest financial interest" presumption, should influence a court in its selection of a lead plaintiff. To put it another way, what happens when the mechanism created by Congress does not result in the preferred outcome? In two recent cases, courts appear to have been swayed heavily by Congressional intent.
In Malasky v. IAC/Interactive Corp., 2004 WL 2980085 (S.D.N.Y. Dec. 21, 2004), the court found that an individual investor had the largest financial stake in the case and was otherwise qualified to act as lead plaintiff. Nevertheless, the court held that because the individual investor was "not an institutional investor," he would be paired with an institutional investor as co-lead plaintiff.
Taking this analysis even a step further, in In re Cardinal Health, Inc. Sec. Litig., 2005 WL 238073 (S.D.Ohio Jan. 26, 2005), the court rejected an institutional investor, at least in part, because it was not a pension fund. Based on a statement in the House Conference Report on the PSLRA, the court found that the "PSLRA prefers pension funds."
There has already been one appellate decision, on a writ of mandamus, holding that "a straightforward application of the [PSLRA lead plaintiff] statutory scheme . . . provides no occasion for comparing plaintiffs with each other on any basis other than their financial stake in the case." See In re Cavanaugh, 306 F.3d 726 (9th Cir. 2002). More appellate courts may be asked to take up this issue in the future.
Three more banks have agreed to a preliminary settlement of the claims brought against them as part of the WorldCom securities class action pending in the S.D.N.Y. Deutsche Bank AG, WestLB AG, and Caboto Holding SIM Spa will pay a total of $437.5 million based on their roles as underwriters for WorldCom bond offerings.
Bloomberg reports that the premium over the formula used to establish Citigroup's settlement continues to rise as the case gets closer to trial. The current group of settling banks are paying a 13%-17.5% premium.
Taken together, the WorldCom securities class action settlements now total just under $4 billion.
Four more banks have agreed to a preliminary settlement of the claims brought against them as part of the WorldCom securities class action pending in the S.D.N.Y. ABN Amro, Mitsubishi Securities International, BNP Paribas Securities, and Mizuho International, who are accused of failing to engage in proper due diligence while acting as underwriters for WorldCom bond offerings, will pay a total of $428.4 million.
These are the latest in a string of settlements by defendant banks just prior to trial. While the earlier settlements were all calculated using a formula pioneered by Citigroup's settlement, Bloomberg reports that this group of banks is paying a 5%-13% premium.
The Los Angeles Times has an article today on how disclosure issues can trigger shareholder litigation and SEC actions. The article focuses on the recent difficulties faced by many biotech companies. (The 10b-5 Daily has posted frequently on this topic.)
Quote of note: "Public demands that companies scale back secrecy have escalated since recent corporate scandals, and the SEC has supported more meaningful disclosure for public companies. Yet the pressures may raise particular issues in biotechnology because of the importance of test results and the profound effect that new products may have on the bottom line."
Section 11 of the '33 Act creates civil liability for misstatements in a registration statement. The class of persons who can sue under the statute, however, is limited to those who purchased shares issued pursuant to the registration statement in question. To have standing, an investor must have either acquired his shares in the offering or, if he purchased them in the aftermarket, be able to "trace" them back to the offering. As a general matter, the later introduction of non-offering shares into the market (e.g., via the sale of shares by insiders) generally defeats the ability of subsequent investors to trace their shares back to the offering because the intermingling of the shares makes it virtually impossible to establish that the purchased shares are offering shares.
In Krim v. pcOrder.com, 2005 WL 469618 (5th Cir. March 1, 2005), the plaintiffs tried a statistical approach to solving the problem of aftermarket standing for Section 11 claims. Although the plaintiffs conceded that they could not demonstrate that their shares were issued pursuant to the registration statement, they asserted the existence of standing based on expert testimony indicating that given the number of shares they owned and the percentage of offering stock in the market, the probability that they owned at least one share of offering stock was nearly 100%. The court rejected this statistical tracing theory, finding that "Congress conferred standing on those who actually purchased the tainted stock, not on the whole class of those who possibly purchased tainted shares - or, to put it another way, are at risk of having purchased tainted shares."
Holding: Dismissal affirmed.
Quote of note: "The fallacy of Appellants position is demonstrated with the following analogy. Taking a United States resident at random, there is a 99.83% chance that she will be from somewhere other than Wyoming. Does this high statistical likelihood alone, assuming for whatever reason there is no other information available, mean that she can avail herself of diversity jurisdiction in a suit against a Wyoming resident? Surely not."
On the eve of trial (set to begin on March 17), Bank of America (NYSE: BAC) has announced the preliminary settlement of the claims brought against it as part of the WorldCom securities class action pending in the S.D.N.Y. Bank of America is accused of failing to engage in proper due diligence while acting as an underwriter for WorldCom bond offerings. The settlement is for $460.5 million and was calculated, according to press reports, using the same formula applied by Citigroup in reaching its earlier settlement in the case.
Quote of note (New York Times): "A lawyer involved in the case said that a half-dozen smaller banks had expressed an interest in settling with the New York fund [which acts as lead plaintiff in the case]. This person said that the fund was likely to insist that at least some of the remaining banks pay a premium over the formula used by Citigroup and Bank of America in their settlements. J. P. Morgan Chase is perhaps the most vulnerable of the remaining defendants because it sold a large portion of the bonds offered by WorldCom in 2000 and 2001."
Addition: The settlements by defendant banks in the WorldCom case are now coming fast and furious. Today it was announced that Lehman Brothers Holdings, Inc., UBS AG, Goldman Sachs Group, Inc., and Credit Suisse Group have agreed to pay a combined $100.3 million to settle the claims against them. These settlements are also based on the Citigroup formula. Bloomberg has a report.
(1) The value of securities class action settlements in 2004 was a record $5.5 billion (the previous record was $4.5 billion in 2000). Even excluding Citigroup's $2.6 billion settlement of WorldCom-related claims, the year-to-year increase was substantial.
(2) For cases settled in 2004 (as compared to 2003), there was a 40% increase in the length of the class period and larger market capitalization losses. Cornerstone attributes this development to the fact that many cases settling in 2004 were originally filed during the bear market that began in 2000.
(3) Despite the increase in overall settlement values, more than 65% of all settlements in 2004 were for less than $10 million and approximately 80% were for less than $30 million.
Cornerstone's press release on the study can be found here.
Continuing to fulfill its pledge to "put the entire era behind us," Citigroup, Inc. (NYSE: C) has announced a preliminary settlement of the claims brought against it as part of the Global Crossing securities class action pending in the S.D.N.Y. According to a Reuters report, the company acted as one of Global Crossing's bankers and was accused "of issuing inflated research reports and failing to disclose conflicts of interest." The settlement is for $75 million (pre-tax), with two-thirds of the settlement scheduled to go to investors in underwritten public offerings of Global Crossing securities and one-third to other Global Crossing investors.