The use of securities class actions is gaining favor in other legal systems. In an interesting article entitled "The Rise of Shareholder Class Actions in Australia" (via mondaq.com - free regist. req'd), an Australian attorney discusses the legal, regulatory, and environmental changes that have led to a spate of recent cases against Australian companies. He also compares the U.S. and Australian systems.
Quote of note: "There is an ever popular view among regulators and academics that shareholder class actions should be encouraged in order to supplement the often slow-moving cogs of government enforcement with much speedier private actions. Private enforcement is frequently more intimidating to corporations, particularly in the case of shareholder class actions which can aggregate the claims of thousands or even millions of shareholder and thereby significant increase a corporation’s legal exposure in comparison with the relatively meagre statutory fines that attach to corporate misfeasance."
In an interesting decision from earlier this month, the U.S. Court of Appeals for the Third Circuit has held that deference should be given to a lead plaintiff's decision not to compensate non-lead counsel. The case stems from the $3.2 billion settlement in the Cendant Corp. securities litigation. Lead counsel for the plaintiffs obtained $52 million in legal fees, which it shared with twelve other law firms that had been authorized to work on the case. An additional forty-five firms that represented individual plaintiffs, however, were frozen out of any fees. Three of these firms appealed the lower court's rejection of their fee applications.
In In re Cendant Corp. Sec. Litig., 2005 WL 820592 (3rd Cir. April 11, 2005), the Third Circuit held that the PSLRA "significantly restricts the ability of plaintiffs' attorneys to interpose themselves as representatives of a class and expect compensation for their work on behalf of that class." As a result, the lead plaintiff's "refusal to compensate non-lead counsel will generally be entitled to a presumption of correctness." The court did find that non-lead counsel can ask the court to compensate them for work done before the appointment of a lead plaintiff, but they must "demonstrate that their work actually benefited the class."
The Legal Intelligencer has an article (via law.com - free regist. req'd) on the decision.
Quote of note: "After the lead plaintiff is appointed, however, the PSLRA grants that lead plaintiff primary responsibility for selecting and supervising the attorneys who work on behalf of the class. We conclude that this mandate should be put into effect by granting a presumption of correctness to the lead plaintiff's decision not to compensate non-lead counsel for work done after the appointment of the lead plaintiff. Non-lead counsel may refute the presumption of correctness only by showing that lead plaintiff violated its fiduciary duties by refusing compensation, or by clearly demonstrating that counsel reasonably performed work that independently increased the recovery of the class."
Arthur Andersen LLP, the last remaining defendant in the WorldCom securities class action, has agreed to settle the case. The settlement ends the the ongoing trial in the S.D.N.Y. According to a New York Times article, the settlement is for $65 million plus "20 percent of any amount [Arthur Andersen] paid to distribute its remaining capital to its present and former partners." The settlement also reportedly includes a "most favored nation clause" that guarantees the plaintiffs "the difference between the $65 million and any larger settlement in any other lawsuit [Arthur Andersen] may settle in the future."
More on the Dura decision:
(1) The Legal Times has an article (via law.com - free regist. req'd) discussing the reaction of the parties to the decision.
(2) Forbes has a column stating that the decision was a "no-brainer" and providing some academic commentary.
(3) The Wall Street Journal has an editorial (subscrip. req'd) citing the decision as another reason why criminal sentencing in the Enron "barge" case should not be based on the alleged inflation of the company's stock price.
The U.S. Supreme Court has issued an opinion in the Dura Pharmaceuticals v. Broudo case. It is a unanimous decision authored by Justice Breyer. As predicted, the court rejected the Ninth Circuit's price inflation theory of loss causation. Instead, the court held that a plaintiff must prove that there was a causal connection between the alleged misrepresentations and the subsequent decline in the stock price.
Loss causation (i.e., a causal connection between the material misrepresentation and the loss) is an element of a securities fraud claim. In the Dura case, the Ninth Circuit had held that to satisfy this element a plaintiff only need prove that "the price at the time of purchase was inflated because of the misrepresentation." (See this post for a full summary of the Ninth Circuit's decision.)
On appeal, the Supreme Court made three key findings in rejecting the price inflation theory of loss causation. First, the court dismissed the idea that price inflation is the equivalent of an economic loss. The court noted that "as a matter of pure logic, at the moment the transaction takes place, the plaintiff has suffered no loss; the inflated purchase payment is offset by ownership of a share that at that instant possesses equivalent value." Moreover, it is not inevitable that an initially inflated purchase price will lead to a later loss. A subsequent resale of the stock at a lower price may result from "changed economic circumstances, changed investor expectations, new industry-specific or firm-specific facts, conditions, or other events, which taken separately or together account for some or all of that lower price."
Second, the court found that the price inflation theory of loss causation has no support in the common law. The common law has "long insisted" that a plaintiff in a deceit or misrepresentation action "show not only that if had he known the truth he would not have acted but also that he suffered actual economic loss." Accordingly, it was "not surprising that other courts of appeals have rejected the Ninth Circuit's 'inflated purchase price' approach."
Finally, the court noted that the price inflation theory of loss causation was arguably at odds with the objectives of the securities statutes, including the PSLRA. The statutes make private securities fraud actions available "not to provide investors with broad insurance against market losses, but to protect them against those economic losses that misrepresentations actually cause." In particular, the PSLRA "makes clear Congress' intent to permit private securities fraud actions for recovery where, but only where, plaintiffs adequately allege and prove the traditional elements of causation and loss."
As clear as the opinion is on the issue of the price inflation theory, it fails to provide much guidance on what a plaintiff must allege on loss causation to survive a motion to dismiss. The court assumed, without deciding, "that neither the [Federal Rules of Civil Procedure] nor the securities statutes impose any special further requirements in respect to the pleading of proximate causation or economic loss." Even under the notice pleading requirements, however, the complaint's bare allegation of price inflation was deemed insufficient. As stated by the court, "it should not prove burdensome for a plaintiff who has suffered an economic loss to provide a defendant with some indication of the loss and the causal connection that the plaintiff has in mind."
Holding: Reversed and remanded for proceedings consistent with opinion.
Addition: A few initial thoughts on the Dura opinion:
(1) The case is a significant victory for defendants in the Eighth and Ninth Circuits, which were the only two courts to adopt the price inflation theory of loss causation.
(2) Although the Supreme Court has put the price inflation theory to rest, its opinion raises some complicated questions about recoverable loss. For example, the Supreme Court notes that many factors other than misrepresentations can cause a stock price decline, but does not provide any guidance on how plaintiffs can meet their burden of proof for loss causation in cases where some or all of these other factors are present.
(3) The opinion is unclear on an issue that was raised on appeal: does the stock price decline need to be the result of a corrective disclosure that reveals the "truth" to the market? The Supreme Court makes some opaque references to when "the relevant truth begins to leak out" and "when the truth makes its way into the market place," but does not squarely address whether there is any need for plaintiffs to establish the existence of a corrective disclosure.
(4) Finally, as noted above, the Supreme Court expressly leaves open the question of whether F.R.C.P. 9(b) or the PSLRA requires plaintiffs to plead loss causation with particularity. The lower courts will need to decide whether these statutes are applicable.
Dynegy, Inc. (NYSE: DYN), a Houston-based energy provider, has announced the preliminary settlement of the securities class action pending against the company in the S.D. of Texas. The case, originally filed in 2002, alleges fraud related to the accounting treatment and disclosures associated with a structured natural gas transaction know as "Project Alpha."
The settlement is for $468 million (including $150 million from the company's insurers, a $250 million cash payment, and the issuance of $68 million in common stock). Dynegy also agreed to the election of two new directors to its Board of Directors from a list of candidates supplied by the lead plaintiff in the case.
The Associated Press reports that in France a government-appointed panel has begun preparing the new class action law. One early debate is over whether France should adopt an "opt-out" or "opt-in" system for potential class members.
Quote of note: "Eventually, experts say, the moves afoot in Britain, Sweden and France could lead to a European Union-wide class-action law - since governments generally prefer their neighbors' industries to be exposed to the same kinds of risk as their own. 'It's not for tomorrow, but if it gets off the ground in France, and since we already have it in Sweden, then maybe we'll see something at a European level,' said Peter Burbidge, a law professor at Britain's Westminster University. 'The French would want others to have it if they have it.'"
Westar Energy, Inc. (NYSE: WR), a Topeka-based electric utility, has announced the preliminary settlement of the securities class action (and a related derivative suit) pending against the company in the D. of Kansas. The case, originally filed in 2002, alleges that Westar misled investors concerning a proposed separation of its electric utility operations from its unregulated businesses. The settlement is for $32.5 million, with all but $1.25 million being paid by insurance.
The New York State Common Retirement Fund's (the "Fund") decision to act as lead plaintiff in the WorldCom securities class action has come under fire. The case has resulted in over $6 billion in settlements by the investment banks that underwrote WorldCom's bonds. Some commentators have argued, however, that the settlements actually lowered the value of the Fund's investments in those investment banks by more than the amount the Fund will receive from the settlements. In chronological order:
(1) Wall Street Journal editorial (subscrip. req'd) in the April 1 edition.
(2) Letter to the editor (subscrip. req'd) by Alan Hevesi, New York State Comptroller, in response to the Wall Street Journal editorial.
(3) New York Sun editorial in the April 12 edition.
(4) Forbes column in the April 25 edition.
Quote of note (Forbes): "Judging by a plaintiff expert's own estimate of shareholder losses, New York's claim of a $317 million hit would entitle it to 1.1% of the kitty, or a mere $11 million . . . . Hevesi's suit cost New York's pension fund by deflating the value of its investments in the banks it sued. The Hevesi fund owns stakes in J.P. Morgan, Citigroup and BofA. These three banks took aftertax charges totaling $3.2 billion for WorldCom settlement costs. The fund's pro rata share of these losses, and those of smaller-fry defendants, totes up to $13 million."
The use of confidential witnesses to support securities fraud allegations can be controversial, especially when the defense wants to test the accuracy of the statements attributed to these individuals. The Recorder has an article (via law. com - free regist. req'd) discussing two recent cases in the N.D. of Cal. where the handling of confidential witnesses has led to contempt and sanction motions.
Quote of note: "The plaintiff view is, 'My god, if we were to tell who they were, they'd sleep with the fishes.'"
When Judge Easterbrook of the U.S. Court of Appeals for the Seventh Circuit writes a securities law opinion, it is invariably going to be worth talking about. His latest is no exception.
The Securities Litigation Uniform Standards Act of 1998 ("SLUSA") preempts certain class actions based upon state law that allege a misrepresentation in connection with the purchase or sale of nationally traded securities. The defendants are permitted to remove the case to federal district court for a determination on whether the case is preempted by the statute. If so, the district court must dismiss the case; if not, the district court must remand the case back to state court.
In an earlier opinion in the Putnam Fund cases, Judge Easterbrook found that the district court's decision to remand the actions back to state court was appealable. This week's opinion, Kircher v. Putnam Funds Trust, 2005 WL 757255 (7th Cir. April 5, 2005), addressed the merits of that remand decision. In particular, Judge Easterbrook grappled with the question that has confronted the Second and Third Circuits recently (see this post): what is the scope of SLUSA's "in connection with the purchase or sale of securities" requirement?
In contrast to the Second Circuit, the Seventh Circuit found that SLUSA preemption is not limited to actions where the plaintiffs are purchasers or sellers of securities. One of the complaints filed in the Putnam Fund cases defined its class as "all investors who held the fund's securities during a defined period and neither purchased or sold shares during that period." The court held that the "in connection with" language in SLUSA merely "ensures that the fraud occurs in securities transactions rather than some other activity." Although private actions under Rule 10b-5 (from which SLUSA adopted the "in connection with" requirement) can only be brought by purchasers or sellers, it "would be more than a little strange" if this judicially-created limitation on private actions "became the opening by which that very litigation could be pursued under state law, despite the judgment of Congress (reflected in SLUSA) that securities class actions must proceed under federal securities laws or not at all." Accordingly, the complaint was subject to dismissal under SLUSA.
Holding: Cases remanded with instructions to undo the remand orders and dismiss plaintiffs' state-law claims.
Quote of note: "[M]ost of the approximately 200 suits filed against mutual funds in the last two years alleging that the home-exchange-valuation rule can be exploited by arbitrageurs have been filed in federal court under Rule 10b-5. Our plaintiffs’ effort to define non-purchaser-non-seller classes is designed to evade PSLRA in order to litigate a securities class action in state court in the hope that a local judge or jury may produce an idiosyncratic award. It is the very sort of maneuver that SLUSA is designed to prevent."
Interesting item in Newsday about a petition filed in New York state court against the plaintiffs' law firms that settled the Computer Associates securities class action. Texas billionaire Sam Wyly reportedly is seeking the discovery collected in the case and argues "that the documents 'rightfully belong to him' because, as a CA shareholder, he was effectively a client of the firms until he declined to participate in the class-action settlement."
Addition: Forbes has more on the story.
Two appellate decisions from earlier this year that are worth noting:
(1) In Barrie v. Intervoice-Brite, Inc., 2005 WL 57928 (5th Cir. Jan. 12, 2005), the Fifth Circuit considered a securities fraud claim based on revenue recognition issues at a software company. The defendants argued that a charge the company took against its revenues was caused by the SEC's issuance of new revenue recognition guidance. To counter this argument, the plaintiffs apparently attached a sworn expert analysis to their amended complaint stating that "Intervoice's reversal of revenue in the first quarter fiscal 2001 was not a result of SAB 101, but rather was required because Intervoice's prior revenue recognition practice did not comply with GAAP, specifically SOP 97-2." The Fifth Circuit reversed the dismissal of the revenue recognition claims, finding that the "accounting questions in this case are disputed" and that plaintiffs' position "was adequately supported by expert opinion."
(2) In In re Daou Systems, Inc. Sec. Litig., 2005 WL 237645 (9th Cir. Feb. 2, 2005), the Ninth Circuit clarified its position on confidential witnesses (by adopting the pleading standard used in the First and Second Circuits) and muddied its position on loss causation.
Confidential witnesses - The court held that "[n]aming sources is unnecessary so long as the sources are described 'with sufficient particularity to support the probability that a person in the position occupied by the source would possess the information alleged' and the complaint contained 'adequate corroborating details.'"
Loss causation - The court found that "if the improper accounting did not lead to the decrease in Daou's stock price, plaintiffs' reliance on the improper accounting in acquiring the stock would not be sufficiently linked to their damages." This position is the exact opposite of the one adopted by the Ninth Circuit in the Dura case and recently reviewed by the U.S. Supreme Court. Curious.
KPMG's settlement of the claims against it in the Rite Aid litigation has given rise to an interesting battle over attorneys' fees. In an opinion that came out two months ago, the U.S. Court of Appeals for the Third Circuit held that the district court should reconsider its fee award of $31 million (25% of the settlement). The Third Circuit found that although the district court correctly applied the percentage-of-recovery approach, it erred in its application of a lodestar 'crosscheck' by focusing only on the hourly rates for the top lawyers handling the case, making the fee award appear more reasonable.
On remand, however, the district court has once again awarded plaintiffs' counsel $31 million in fees. See In re Rite Aid Corp. Sec. Litig., 2005 WL 697461 (E.D. Pa. March 24, 2005). Although the district court conceded that the new calculation increased the lodestar mutliplier from 4.07 to 6.96 (i.e., plaintiffs' counsel will receive nearly 7 times the amount that they would have been paid if they had worked on an hourly basis), it nevertheless found that the award was still reasonable. In its decision, the district court noted that the "case appears to involve the largest class recovery on record against an auditor in a 10b-5 action, a fact no one at the hearing contested." Moreover, the settlement was achieved "without relying on the fruits of any official investigation."
The Legal Intelligencer has an article (via law.com - free regist. req'd) on the decision.