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.
Some commentators have described this provision as a "license to lie," because it arguably protects companies from liability based on even deliberately false forward-looking statements. The U.S. Court of Appeals for the First Circuit agrees. In In re Stone & Webster, Inc., Sec. Litig., 2005 WL 1654040 (1st Cir. July 14, 2005), the court evaluated an allegedly misleading statement that the company "has on hand . . . sufficient sources of funds to meet its anticipated [needs]." The district court found the statement to be forward-looking based on its reference to an anticipated futher need for funds and dismissed the claim based on the PSLRA's safe harbor. On appeal, the First Circuit found "that the meaning of this curious statute, which grants (within limits) a license to defraud, must be somewhat more complex and restricted."
In the instant case, the statement was "composed of elements that refer to estimates of future possibilities and elements that refer to present facts." The court found that the specific claim of fraud related to whether the defendants were "lying about the Company's present access to funds," not whether the defendants "were underestimating the amount of their future cash needs." Under these circumstances, the "mere fact that a statement contains some reference to a projection of future events cannot sensibly bring the statement within the safe harbor."
Holding: Judgment affirmed in part and vacated in part. (The decision contains holdings on a number of other pleading issues. It also creates an interesting bit of nomenclature, referring to the PSLRA's heightened pleading standards for false statements as the "clarity-and-basis" requirement.)
The New York Times reports that Representative Chris Cox, the President's nominee to head the SEC, had a confirmation hearing today before the Senate Banking, Housing and Urban Affairs Committee. He is expected to be confirmed, but did face questions about his role in sponsoring the PSLRA.
Quote of note: "Mr. Cox said many advocates for and against him were wrongly assuming that he would be lax in protecting shareholders because of his work on the 1995 securities law. 'I view that legislation today as I did then - and as Senator Stevens described in his introduction of me - it's a vital part of the regime to protect shareholders,' Mr. Cox said."
As part of the Securities Litigation Uniform Standards Act of 1998 ("SLUSA"), Congress mandated that "a court may stay discovery proceedings in any private action in state court, as necessary in aid of its jurisdiction, or to protect or effectuate its judgments, in an action subject to a stay of discovery pursuant to [the PSLRA]." One of the primary goals of this provision was to prevent plaintiffs from using a simultaneous state court action to circumvent the mandatory discovery stay imposed by the PSLRA in federal securities fraud cases. There is a growing judicial debate over when courts should exercise this power.
A court in the D. of Conn. has taken a broad view of the provision's applicability. In a decision handed down last Friday in In re Crompton Corp. Sec. Litig., 3:03-CV-1293 (D. Conn. July 22, 2005), the court held that discovery should be stayed in a parallel state court derivative action. The defendants only needed to show "a likelihood that the federal Plaintiffs will obtain state Plaintiff's discovery." In this regard, the court found that a substantial portion of the federal and state complaints were identical and that the derivative plaintiff was "a putative class member in the federal action, and her receipt of discovery without a showing that it is necessary to preserve evidence or prevent undue prejudice violates the PSLRA." The court also noted that it would be burdensome to the defendants to produce the same discovery that had been stayed, the risk of inconsistent rulings between the federal and state courts was high, and the derivative plaintiff would not be prejudiced by the stay. (The 10b-5 Daily will post an electronic cite to the decision when available.)
Holding: Motion for protective order granted.
Addition: The decision can be found electronically here - In re Crompton Corp. Sec. Litig., 2005 U.S. Dist. LEXIS 23001 (D. Conn. July 25, 2005).
Two interesting articles on securities fraud issues:
(1) This month's issue of the Wall Street Lawyer (Vol. 9, No. 2 - July 2005) has an article on two circuit splits concerning the Securities Litigation Uniform Standards Act of 1998 ("SLUSA"). In "Showdown Over SLUSA," the authors (Greg Harris and Christian Word) discuss the splits between the Second Circuit and Seventh Circuit over: (a) whether SLUSA preempts "holder" cases in which the plaintiff class consists entirely of investors who neither bought nor sold securities during the alleged class period; and (b) whether a district court's decision to remand an action removed to federal court under SLUSA is appealable. The authors speculate that this double-split "raises the prospect of Supreme Court intervention and the high court's first decision addressing SLUSA." (The 10b-5 Daily's discussion of the splits can be found here and here.)
(2) This month's issue of the Securities Reform Act Litigation Reporter (Vol. 19, No. 4 - July 2005) has an article providing an overview of the securities class actions that have gone to trial since the enactment of the PSLRA. In "Ten Years After the Reform Act: Trends in Securities Class Action Trials," the author (Michael Tu) finds that a total of seven cases have been brought to a trial verdict during this period, with only four cases involving claims based on post-Reform Act conduct. The Securities Litigation Watch has been following this issue closely and has both a handy list of the cases and a link to the article.
Judge Scheindlin of the S.D.N.Y., who is presiding over the IPO allocation cases, continues to publish notable securities law decisions. This time the issue is lead plaintiff selection. 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). In creating this provision, Congress sought to encourage the participation of institutional investors as lead plaintiffs. There is an ongoing debate over 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.
In In re eSpeed, Inc. Sec. Litig., 2005 WL 1653933 (S.D.N.Y. July 13, 2005), the court addressed whether a group of individual investors (which included a family and one other individual) or a single insititutional investor should be named lead plaintiff. After surveying the relevant case law in the S.D.N.Y., the court found:
"[A] group of unrelated investors should not be considered as lead plaintiff when that group would displace the institutional investor preferred by the PSLRA. But where aggregation would not displace an institutional investor as presumptive lead plaintiff based on the amount of losses sustained, a small group of unrelated investors may serve as lead plaintiff, assuming they meet the other necessary requirements."
Based on this standard, the relevant question was whether the family members (i.e., the related members of the individual investor group) had greater losses than the institutional investor. In making that evaluation, the court was forced to address another controversial issue: whether the "first-in, first-out" (FIFO) or "last-in, first-out" (LIFO) methods for estimating losses should be used. The court decided to apply the LIFO method, which matches the last purchases made during the class period with the first sales made during the class period, noting that "it takes into account gains that might have accrued to plaintiffs during the class period due to the inflation of the stock price." Under the LIFO method, the family members had greater losses than the institutional investor. Accordingly, the court named the entire individual investor group as the presumptive lead plaintiff.
The New York Law Journal has an article (via law.com - free regist. req'd) on the decision. Another recent decision applying the LIFO method is Arenson v. Broadcom Corp., 2004 WL 3253646 (C.D. Cal. Dec. 6, 2004), where the court granted summary judgment against certain plaintiffs who could not establish damages under this method.
NERA Economic Consulting has released a study entitled "Recent Trends In Shareholder Class Action Litigation: Are WorldCom and Enron the New Standard?" The study reaches the following notable conclusions:
(1) In the first half of 2005, the median settlement value of securities class action cases jumped nearly 30% to $6.8 million from $5.3 million last year. The study states that the driving factor behind this increase is a sharp reduction in "nuisance" settlements of under $3 million.
(2) While bigger settlements have yielded lower percentage fees for plaintiffs' counsel, the average settlement in 2005 will result in over $6 million in fees (as compared to $3.6 million five years ago).
(3) Securities class action filings are down by 17 percent in the first half of 2005. The study finds that the slowdown is attributable to a drop in filings in the 9th Circuit, where plaintiffs' firms may have delayed filing cases pending the Dura decision.
(4) Dismissal rates have nearly doubled after the passage of the PSLRA and account for 39.3% of dispositions of securities class actions filed 1996-2002. This increase offsets the increased likelihood that a public company will be sued in a securities class action. As a result, the annual probability of a company facing a suit that survives a motion to dismiss has remained roughly constant at 1.2%.
The statistics on dismissal rates are surprising, especially since an earlier NERA study found that the PSLRA had not significantly increased the likelihood of a securities class action being dismissed.
The 10b-5 Daily has previously posted 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 is seeking the discovery collected in the case and argues that the firms have breached their fiduciary duty to him by not granting access to the materials because, as a CA shareholder, he was effectively a client of the firms until he declined to participate in the settlement.
The plaintiffs' law firms removed the case to federal court, arguing that the petition raised numerous federal questions, including "whether under the PSLRA lead counsel represents the class as a whole or individual class members." In Wyly v. Milberg Weiss Bershad & Schulman, 2005 WL 1606034 (S.D.N.Y. July 8, 2005), the court disagreed, finding that none of the cited reasons were sufficient to find federal jurisdiction, and remanded the case back to state court. The court declined, however, to award Wyly any attorneys' fees for fighting the removal, noting "the dubious nature of petitioner's cause of action and the surrounding circumstances."
Why has the Supreme Court declined to hear cases that would clarify the PSLRA? Business Week has a "news analysis" on the Supreme Court's reluctance to take cases in "vital areas such as antitrust, environmental, intellectual-property, securities, and tax law." In particular, the article cites the varied application of the PSLRA's heightened pleading standards as a "prime example of the legal confusion that the Supreme Court has allowed to fester."
The article does not state how many cert petitions involving interpretations of the PSLRA the Supreme Court has rejected. That said, anecdotal evidence abounds. A recent example is the Supreme Court's decision not to hear the Baxter case, an appeal from a Seventh Circuit decision that created a circuit split over the PSLRA's safe harbor for forward-looking statements.
Judge Scheindlin (S.D.N.Y.) has issued two loss causation decisions in an offshoot of the IPO allocation cases.
In the case in question, the plaintiffs alleged a scheme by an investment bank and several issuers to systematically set the issuers' announced earnings forecasts below internal forecasts. When earnings consistently beat the announced forecasts, the resulting excitement in the market allegedly drove the issuers’ stock prices up. According to the complaint, the scheme was ultimately revealed to the market through a series of announcements disclosing that earnings were below expectations or warning that future earnings would not meet expectations. These announcements allegedly ended "the fraudulently induced expectation of continuing upside surprises."
In In re Initial Public Offering Sec. Litig., No. MDL 1554(SAS), 2005 WL 1162445 (S.D.N.Y. May 13, 2005), the court responded to a motion for reconsideration of an earlier dismissal of the claims by rejecting the plaintiffs' reliance on the announcements because they were not "corrective disclosures." The court explained that "[t]o allege loss causation, plaintiffs must allege that, at some point, the concealed scheme was disclosed to the market." None of the disclosures relied on by the plaintiffs, however, implied that there had been a fraudulent scheme.
In response to a second motion for reconsideration, Judge Scheindlin issued another decision. In In re Initial Public Offering Sec. Litig., 2005 WL 1529659 (S.D.N.Y. June 28, 2005), the court noted that the Supreme Court's Dura opinion "did not disturb Second Circuit precedent regarding loss causation." After a lengthy discussion of how to reconcile this sometimes contradictory Second Circuit precedent, the court again found that loss causation had not been adequately plead.
The June 28 decision is the subject of a New York Law Journal article (via law.com - free regist. req'd).
The Wall Street Journal had a feature article (subscrip. req'd) last week on the SEC's efforts, pursuant to Section 308 of Sarbanes-Oxley (the "Fair Funds" provision), to pay out some of the large civil penalties it has collected to investors. The article focuses on the logistical challenges of the WorldCom case, where tracking down all of the injured investors and sorting out their claims is expected to take close to two years.
Quote of note: "Regulators are looking for cheaper and faster ways to get money back to investors. While the Fair Funds program was set up to be separate from private class-action lawsuits, the SEC is moving to work more closely with trial lawyers and has hitched several of its Fair Fund efforts to related class-action settlements that cover a similar set of investors. SEC funds have been combined with class-action settlements in about a half-dozen cases, including the agency's $150 million settlement with Bristol-Myers Squibb Co. and its $25 million settlement with Lucent Technologies Inc."
The June issue of The Review of Securities & Commodities Regulation (Vol. 38, No. 11) contains an excellent overview of the law surrounding the use of confidential sources. The article, entitled "Anonymous Sources in Securities Class Action Complaints," is authored by John Henn, Brandon White, and Matthew Baltay and provides a circuit-by-circuit analysis.
Whether trading under a Rule 10b5-1 trading plan can help shield corporate executives from securities fraud liability is a topic that courts continue to explore.
Rule 10b5-1, put into place in 2000, establishes that a person's purchase or sale of securities is not "on the basis of" material nonpublic information if, before becoming aware of the information, the person enters into a binding contract, instruction, or trading plan (as defined in the rule) covering the securities transaction at issue. To take advantage of this potential affirmative defense, many executives have implemented trading plans for their sales of company stock.
Insider trading, of course, is often used by plaintiffs in securities class actions to create an inference of scienter (i.e., fraudulent intent). The plaintiffs allege that the individual corporate defendants profited from the alleged fraud by selling their company stock at an artificially inflated price. In the latest decision to consider the impact of Rule 10b5-1 trading plans on insider trading scienter allegations, the court in In re Netflix, Inc. Sec. Litig., 2005 WL 1562858 (N.D. Cal. June 28, 2005) found that the fact that the trading in question took place pursuant to a trading plan mitigated against a finding of an inference of scienter.
The author of The 10b-5 Daily has written an article (with one of his colleagues) on this topic.
No sooner does France announce that it may permit class actions than the first securities class action appears. Reuters reports that a French lawyer has launched a class action against Vivendi Universal on behalf of small shareholders. The company already faces a similar suit in the U.S.
Quote of note: "'Until now, no one has had the courage to do this' in France, Canoy told Reuters. 'But why can the Americans do certain things and not the French?'"
The IPO allocation cases (brought against the underwriters of over 300 initial public offerings) 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. Last year, Judge Scheindlin (S.D.N.Y.) granted class certification in six "focus" cases that have been used to test the sufficiency of the overall allegations.
A reader points out that the Second Circuit has agreed to hear an appeal from that grant (by order dated June 30, 2005). Moreover, the court has specifically asked for briefing on two hot-button issues:
(1) Whether the Second Circuit's previous position that plaintiffs are only required to make "some showing" that the proposed class comports with all of the elements of Federal Rule of Civil Procedure 23 is consistent with the 2003 amendments to that rule.
(2) Whether the presumption of reliance established in Basic v. Levinson, 485 U.S. 224 (1988) (i.e., the fraud-on-the-market theory) was properly extended to plaintiffs' claims against the non-issuer defendants and to the market manipulation claims.
The Second Circuit has come close to addressing the scope of the fraud-on-the-market theory before, but was thwarted by a settlement. The resolution of this issue has wide-ranging implications for securities fraud litigation. Take a look, for example, at The 10b-5 Daily's discussion of two opposing district court decisions in cases brought against research analysts. Stay tuned.