Earlier this month, the New York Sun ran an interesting feature article on the Time Warner securities litigation. Although the securities class action settled for $2.5 billion last year, some institutional investors who decided to opt-out of the case appear to be doing even better than the class participants. The State of Alaska, for example, recently settled its related state court action against Time Warner for 83% of its estimated damages. Thanks to Point of Law for the link.
Quote of note: "While Alaska may be the most successful opt-out plaintiff thus far, others have also improved their lot by going it alone. A Dutch retirement fund, Stichting Pensioenfonds ABP, won a $20 million settlement from Time Warner earlier this year on what ABP said was $150 million in investment losses. ABP's chief counsel told a Dutch newspaper, Het Financieele Dagblad, that the fund would have gotten only $1 million to $3 million if it had stayed in the class."
Addition: Lies, Damn Lies, & Forward-Looking Statements has a post on this article that offers more details and links on the opt-out cases.
The fee-shifting imposed by the Enron court - related to claims brought against Alliance Capital - continues to make news. At the time of the decision, the Wall Street Journal (subscrip. req'd) published an editorial lauding the result. In today's edition, the plaintiff's attorney fights back with a letter that he challenges the paper to print (a bet he happily loses), while the newspaper's editorial board defends its analysis. The WSJ Law Blog has the blow-by-blow (free content).
If the market were aware during the class period of the allegedly omitted information, could the investors later argue that they were defrauded? Some courts have declined to consider a "truth on the market" defense raised as part of a motion to dismiss because it presents factual issues. Other courts, however, have been willing to examine public documents available to investors and conclude that any failure on the part of the defendants to disclose material information was excused by its availability from other sources. Two recent decisions have taken the latter approach and dismissed securities fraud claims.
In Ley v. Visteon Corp., 2006 WL 2559795 (E.D. Mich. Aug. 31, 2006), the court considered whether claims based on "Visteon's Ford-related operational issues" should be dismissed because these issues were discussed in analyst reports and newspaper articles during the class period. Although the plaintiffs argued that a truth on the market defense would be premature at the motion to dismiss stage of the case, the court disagreed, finding that it could "consider publications by market analysts in determining if the market had sufficient knowledge of Defendants' various deficiencies." The court concluded that it was clear from these publications that the market was aware of "Visteon's inability to shed unprofitable business lines inherited from Ford, high labor costs, price reductions owed to Ford, and general reliance upon Ford."
Similarly, in In re Discovery Laboratories Sec. Litig., 2006 WL 3227767 (E.D. Pa. Nov. 1, 2006), the court examined whether certain statements related to the FDA-approval process for a drug product were materially misleading in light of the public information available to the market. The court held that the "'truth on the market' defense does not require that any investor should be capable of finding the information and understanding its significance based on a single click for a simple Web search." Instead, the standard is "reasonable investors, those who we can assume exercise due investment diligence." Based on public reports of facility problems and the widely known fact that the company would need to comply with FDA regulations to obtain approval for the drug, the court found that the alleged misstatements related to those issues were inactionable.
CIGNA Corp. (NYSE: CI), a Philadelphia-based employee benefits provider, last week announced the preliminary settlement of the securities class action pending against the company in the E.D. of Pa. The case, which was filed in 2002 and scheduled for trial in March 2007, alleges that CIGNA made various false and misleading statements by providing unrealistically high income guidance to the market and failing to disclose that it had been under-reserving for certain reinsurance obligations. The 10b-5 Daily has posted on a decision in the case related to the disclosure of confidential sources. The proposed settlement is for $93 million.
In an opinion issued in the IPO allocation cases, the Second Circuit has held that in evaluating a motion for class certification under Federal Rule of Civil Procedure 23, district judges must receive and review enough evidence to be satisfied that each requirement of Rule 23 is met, even if there is some overlap between class certification and the merits of a case. The court cautioned that while district judges must reach a full "determination" (but not a finding) regarding fulfillment of the class certification requirements, they should avoid reviewing any aspects of case merits that are unrelated to those requirements. The decision brings the Second Circuit's jurisprudence on class certification into line with the majority of federal appellate courts (including the Fourth, Fifth, Seventh, Eighth and Eleventh Circuits).
More importantly (at least for securities litigators), the court went on to decide whether class certification could be granted in the representative IPO allocation cases at issue. The Second Circuit held that, under the new, stronger standard, the plaintiffs were unable to satisfy the predominance of common questions over individual questions requirement for a Rule 23(b)(3) class action. Accordingly, the court vacated the district court's order granting class certifications and remanded the case for further proceedings.
Although the court's class certification analysis is short, it contains two interesting holdings.
Reliance: The court held that the "fraud on the market" presumption could not be applied because the market for IPO shares cannot be efficient under any circumstances. Interestingly, the court cited the Sixth Circuit's decision in Freeman v. Laventhol & Horwath, 915 F.2d 193, 199 (6th Cir. 1990) in support of this position, even though Freeman is a case about newly traded municipal bonds, not securities traded on a national exchange. The court went on to find that an efficient market cannot be established, for example, because during the 25-day "quiet period" analysts cannot report publicly concerning securities in an IPO and a “significant number of reports by securities analysts” is a "characteristic of an efficient market." Finally, the court reiterated its skepticism (also found in an earlier Second Circuit decision related to the WorldCom securities litigation) that the fraud on the market presumption can be applied in cases based on anything other than statements by an issuer or its agents.
Knowledge: For both Rule 10b-5 and Section 11 claims, plaintiffs must show that they traded without knowing that the stock price was affected by the alleged false or misleading statements. The Court held that lack of knowledge could not be established in the IPO allocation cases because many of the investors were fully aware of the alleged fraudulent scheme (due in large part to the unusual facts of the case). Thus, the court held that the plaintiffs were unable to fulfill the predominance requirement because lack of knowledge was not common throughout the class.
Reports on the decision and its potential impact on the proposed settlement by the issuer defendants can be found in the American Lawyer, Wall Street Journal (subscrip. req'd), and WSJ Law Blog. There is also a Bloomberg article on dissension among the plaintiffs' firms handling the litigation.
In an unusual decision, the S.D. of Tex. has ordered that a prominent plaintiffs' firm pay the attorneys' fees and expenses of Alliance Capital, a money management company sued for control person liability (under Section 15 of the 1933 Act) in the Enron securities class action. The plaintiffs had alleged that Alliance controlled one of its employees who also served as an Enron outside director. In his role as an Enron director, the employee signed a registration statement for a public offering that incorporated Enron's admittedly false financial statements for 1998-2000.
In In re Enron Corp. Securities, Derivative & "ERISA" Litigation, 2006 WL 3474980 (S.D.Tex. Nov. 30, 2006), the court found that the plaintiffs had failed to establish facts sufficient for a reasonable jury to conclude that Alliance was a control person. More interestingly, the court held that although the plaintiffs' firm could not be held liable for all of Alliance's fees and expenses from the outset of the case, once the director was deposed and sufficient evidence did not emerge, the plaintiffs' firm should have dropped the claim. Accordingly, the firm was required to pay Alliance's fees and expenses related to the summary judgment stage of the litigation.
Quote of Note: "Moreover, it appears to this Court more appropriate that an award of fees and costs under § 11(e) should be borne by counsel: non-attorney clients more likely than not would not have the ability to determine at what point, based on what evidence, an action becomes legally 'frivolous,' while its licensed counsel should and is held to such a standard."
The Committee on Capital Markets Regulation has issued its interim report. While there is no call for an abolition of private securities litigation (as had been suggested in the media), the report does contain a number of findings and recommendations regarding securities class actions that are likely to be controversial.
The basic premise of the "Civil Enforcement" section (pp. 74-84) is that the "public value of the securities class action litigation is questionable." The Committee cites three reasons for this conclusion. First, "virtually all of the costs" of securities class actions fall on the corporation and its insurers, which means they are ultimately borne by the shareholders. Second, securities class actions do a poor job of compensating investors (average settlement of "between two percent and three percent of the investors’ economic losses") and there are high transactions costs (attorney fees, business disruption, etc.). Finally, any recovery is "largely paid by diversified shareholders to diversified shareholders and thus represents a pocket-shifting wealth transfer that compensates no one in any meaningful sense." (More on the issue of diversified shareholders and securities litigation can be found here.)
In keeping with this assessment, the Committee recommends that the SEC: (1) resolve certain judicial conflicts over Rule 10b-5 liability; (2) limit the amount of damages recoverable in private litigation when it has already provided investor compensation; and (3) encourage courts (perhaps with the assistance of new legislation) to stop pay-to-play practices in which plaintiffs’ firms make political contributions in exchange for lead counsel positions. In particular:
Materiality - The SEC should clarify whether a misstatement can be material if its disclosure does not have an "effect on the market," thereby resolving a circuit split between the 9th Circuit (yes) and the 3rd Circuit (no).
Scienter – The SEC should clarify whether the fraudulent intent (i.e., scienter) element of a securities fraud claim can be demonstrated by "recklessness." At least, that is what the Committee appears to be suggesting. The discussion of the current state of the law in this section is simply wrong, with the report stating that there is a split between the Second Circuit’s more strenuous "strong inference of fraudulent intent" standard and the Ninth Circuit’s more lenient "deliberate recklessness" standard. The Committee confuses the Second Circuit’s description of the relevant pleading standard for fraudulent intent (which is mandated by the PSLRA and applicable in every circuit) with the court’s substantive standard for fraudulent intent. In fact, every federal circuit court (including the Second Circuit) has found that recklessness is sufficient to establish fraudulent intent. It is the Ninth Circuit’s "deliberate recklessness" standard, i.e., recklessness so severe that it "strongly suggests actual intent," that is generally believed to be the most strenuous version of this standard in the country. (For more on this issue, the author of The 10b-5 Daily has co-written an article that discusses the differences between the pleading and substantive standards for scienter applied by the various circuits.)
Efficient Market – The SEC should clarify what constitutes an efficient market for purposes of applying the fraud-on-the market theory. The Committee discusses the recent PolyMedica decision in the First Circuit. (The 10b-5 Daily’s summary of the decision and the subsequent history in the case can be found here).
Overlap between SEC and Private Lawsuits – The SEC should "prohibit double recoveries against defendants by requiring that private damages awards be offset by any Fair Funds collections [by the SEC] applied for victim compensation." Interestingly, the Committee suggests that the SEC has the authority to do this pursuant to Section 36 of the Securities Exchange Act, which states that the SEC can "unconditionally exempt any person, security, or transaction from any provision [of the Act]." Although the recommended reform seems like a stretch of the SEC's authority pursuant to Section 36, the Committee does not offer any further discussion of this point. (The author of The 10b-5 Daily provided his take on the overlap issue in a National Law Journal op-ed published last year.)
Prohibit Pay-To-Play – Either through legislation or SEC advocacy in the courts, lawyers that make political contributions to individuals in charge of a state of municipal pension fund "should not be permitted to represent the fund as a lead plaintiff in a securities class action." The Committee notes that the Municipal Securities Rulemaking Board has adopted a rule that prevents pay-to-play in municipal underwriting that could serve as a model for successful reform in this area.
Other recommendations in the interim report would impact securities class actions. They include recommendations that Congress should explore protecting auditing firms from catastrophic loss (p. 88), that the SEC should (a) clarify that an outside director's good-faith reliance on an audited financial statement or auditor report is conclusive evidence of good faith, and (b) reverse its position that indemnification of outside directors for Section 11 damages is against public policy (p. 91), and that public companies should be permitted to contract with their investors to provide for alternative dispute resolutions for securities litigations (p. 109).