There will be no new posts on The 10b-5 Daily until after Labor Day (Sept. 4).
Whether a plaintiff can establish the scienter (i.e., fraudulent intent) of a defendant corporation based on the collective knowledge of the corporation's employees (commonly referred to as the "collective scienter" theory), is a topic that has been simmering in the courts for a number of years. When The 10b-5 Daily last checked in on the status of the issue back in 2004, the Sixth Circuit had issued an opinion in the Bridgestone securities litigation that appeared to apply a collective scienter theory. Although the opinion did not specifically discuss the issue, the court's holding clearly was incompatible with the Fifth and Ninth Circuits' previous rulings that a defendant corporation only can be deemed to have acted with scienter if the individual officer making the alleged false statement acted with scienter.
Fast forward a couple of years and the collective scienter theory is gaining traction in certain district courts. There are two distinct versions of the theory being applied.
Under the weaker version, it is sufficient for a plaintiff to establish that a management-level employee of the corporation acted with fraudulent intent, even if that employee is not a defendant and did not make any alleged false statement. Two recent decisions from the D. of Mass. and the S.D.N.Y. have adopted this version. In re Sonus Networks, Inc. Sec. Litig., 2006 WL 1308165 (D. Mass. May 10, 2006) (scienter of former controller attributable to corporation); In re Marsh & McLennan Companies, Inc. Sec. Litig., 2006 WL 2057194 (S.D.N.Y. July 20, 2006) (scienter of "particular management-level employees identified in the Complaint" attributable to corporation).
Under the stronger version, a plaintiff can establish that the corporation acted with fraudulent intent without any reference to a particular employee. Not only has this version been adopted by a court in the S.D.N.Y., but that court has certified the issue for interlocutory appeal to the Second Circuit. In re Dynex Capital, Inc. Sec. Litig., 2006 WL 1517580 (S.D.N.Y. June 2, 2006) (finding that relevant prior decisions from Second Circuit do not clearly decide issue).
So stay tuned. The Second Circuit will have the opportunity to decide a question that The 10b-5 Daily posited years ago: if an officer makes the statement and a janitor knows the statement is false, has the corporation acted with fraudulent intent? If the answer is "yes," there will be an open circuit split on corporate scienter.
Cisco Systems, Inc. (NASDAQ: CSCO), a San Jose-based Internet networking company, has announced the preliminary settlement of the securities class action pending against the company in the N.D. of Cal. The case was originally filed in 2001.
The settlement is for $91.75 million, which will be paid by Cisco's insurers. Unusually, the press release contains a statement from plaintiffs' counsel describing the settlement as "fair" given the "litigation risks," including "a lack of insider trading, and Cisco was not required to make a financial restatement."
The New York Law Journal has an article (via law.com) in its August 14 edition discussing the dismissal of the federal securities claims in the Salomon Smith Barney mutual fund fees litigation. The plaintiffs had "accused the investment firm of offering undisclosed incentives to brokers and financial advisers, extracting improper fees from investors in its proprietary funds and encouraging its propriety funds to invest in poorly performing companies because of their status as Smith Barney investment banking clients." In its decision - In re Salomon Smith Barney Mut. Fund Fees Litigation, 2006 WL 2085979 (S.D.N.Y. July 26, 2006) - the court dismissed both the '34 Act (Rule 10b-5) and '33 Act (Sections 11 and 12) claims based on the failure to adequately plead loss causation.
Quote of note (opinion): "Here, Plaintiffs have not only not alleged why they lost money on their purchase of the mutual fund stock, they have not alleged even that they in fact lost money on their purchase of the mutual fund stock (i.e., that the mutual fund share price dropped and that it dropped for the precise reason complained of)."
Three unusual recent decisions addressing the PSLRA's discovery stay, appeals from the denial of a motion to dismiss, and prolixity in complaints:
(1) While the primary securities class action against Time Warner was settled last year, a consolidated action consisting of suits by institutional investors that opted out of the main case continues on. Moreover, the plaintiffs in the consolidated action have access to the approximately 14 million documents that Time Warner produced in the primary securities class action and related state court litigation. In re AOL Time Warner, Inc. Sec. Litig., 2006 WL 1997704 (S.D.N.Y. July 13, 2006), the court addressed a "unique" request by the defendants to lift the PSLRA's discovery stay to allow them to obtain discovery from the plaintiffs. Time Warner argued, and the court agreed, that the discovery stay should be lifted because "prohibiting Time Warner's discovery of Plaintiffs while Plaintiffs are able to formulate their litigation and settlement strategy on the basis of the massive discovery Time Warner has already produced constitutes undue prejudice."
(2) The denial of a motion to dismiss is not a final judgment in a securities class action and is normally not subject to appeal. Although a district court might certify an interlocutory appeal based on the existence of a novel and dispositive legal issue, whether the district court correctly found that the plaintiff met the heightened pleading standards of the PSLRA is not usually thought to meet that criteria. In Thompson v. Shaw Group, Inc., 2006 WL 2038025 (E.D. La. July 18, 2006), however, the district court certified its denial of the defendants' motion to dismiss for appeal, finding that "reasonable minds might disagree on the issue of whether the Plaintiffs have satisfied their pleading burden under the heightened standards for securities claims." The court noted that an immediate appeal was justified because "a ruling favorable to Defendants on this issue would render years of discovery, enormous expenses incurred by the parties, and a trial on the merits unnecessary."
(3) The modern securities class action complaint can be a massive tome, primarily because of the need to meet the PSLRA's heightened pleading standards. That said, not every court appreciates getting so much reading material. In In re Leapfrog Enterprises, Inc. Sec. Litig. 2006 WL 2192116 (N.D. Cal. Aug. 1, 2006), the court addressed a 147-page consolidated complaint that it believed was unnecessarily long. After clarifying the issues in the case at oral argument, the court granted leave to amend with the express condition that the amended complaint "not exceed fifty (50) pages in length."
King Pharmaceuticals, Inc. (NYSE: KG) has announced the preliminary settlement of the securities class action pending against the company in the E.D. of Tenn. The case was originally filed in 2003 and alleges securities violations in connection with the Company’s underpayment of rebates owed to Medicaid and other governmental pricing programs.
The settlement is for $38 million. Long-time readers of The 10b-5 Daily may remember the King Pharmaceuticals case as the source for one of the more amusing descriptions of the lead plaintiff selection process ever put forward by a court.
El Paso Corp. (NYSE: EP), a Houston-based energy company, has announced the preliminary settlement of the securities class action (and a related derivative case) pending against the company in the S.D. of Tex. The case was originally filed in 2002 and alleges securities law violations in connection with alleged wash trades, mark-to-market accounting, off-balance sheet debt, the overstatement of natural gas and oil reserves, and manipulation of the California energy market. The settlement is for $273 million, with El Paso contributing $48 million and the balance being paid by its insurers.