There have been some new developments in a pair of old disputes.
(1) Newsday reports that after a long-running legal battle, a California state court has granted a motion brought by Texas billionaire Sam Wyly and "order[ed] three class action law firms to turn over years' worth of evidence they collected as part of their lawsuits alleging accounting fraud by former [Computer Associates] executives." Wyly, who was a class member in the suits, alleges that the litigation was improperly settled for a low amount just prior to Computer Associates' public disclosures of accounting fraud. (For earlier posts on this story - click here and here)
(2) The court presiding over the Halliburton securities class action has granted a motion by the Archdiocese of Milwaukee Supporting Fund, which is acting as lead plaintiff in the case, to remove Lerach Coughlin and Scott + Scott as lead counsel. Legal Pad has a post. (For an earlier post on this story - click here.)
The U.S. Court of Appeals for the Fourth Circuit has issued a decision that addresses two pressing securities litigation issues. In Teachers' Retirement System of Louisiana v. Hunter, 2007 WL 509787 (4th Cir. Feb. 20, 2007), the court considered: (a) whether the plaintiffs could establish the scienter of the corporate defendant using a collective scienter theory; and (b) what is the proper pleading standard for loss causation. (For a discussion of the lower court decision, see this post.)
Collective scienter - The court rejected the idea that a corporate defendant's scienter can be established based on the collective knowledge of its employees. Specifically, the court held that "if the defendant is a corporation, the plaintiff must allege facts that support a strong inference of scienter with respect to at least one authorized agent of the corporation, since corporate liability derives from the actions of its agents." Although the court did not expressly determine whether the agent also must be alleged to have made a misstatement, the court's citation to the Southland decision (5th Cir.) offers some support for that interpretation.
Loss causation - The court noted that in Dura the U.S. Supreme Court expressly did not decide whether the pleading of loss causation is governed by Fed. R. Civ. P. 9(b). In examining the issue, the court found that a "strong case can be made that because loss causation is among the 'circumstances constituting fraud' for which Rule 9(b) demands particularity, loss causation should be pleaded with particularity." Based on this observation and the public policy concerns outlined in Dura, the court concluded that loss causation must be plead "with sufficient specificity to enable the court to evaluate whether the necessary causal link exists." In the instant case, the court found that the plaintiffs did not adequately plead loss causation. Although the disclosure that caused the stock price decline accused the corporate defendant of fraud, it did not provide any "new facts" that "revealed [the corporate defendant's] previous representations to have been fraudulent."
Holding: Dismissal affirmed (based on the failure to adequately plead falsity, scienter, and loss causation).
Disclosure: The author of The 10b-5 Daily represented the defendants in this litigation.
The Los Angeles Times had an article in yesterday's edition questioning whether Chairman Cox "is pushing for restrictions on investors' ability to sue." The SEC's brief has given critics a excuse to break out the "fox guarding the henhouse" analogies (again) based on Chairman Cox's sponsorship of the PSLRA when he served in Congress.
Meanwhile, the New York Law Journal has a lengthy preview (subscrip. req'd) of the Tellabs argument. The authors conclude: "At a minimum, it seems likely that the Court will agree with the majority of circuits that innocent inferences must at least to some extent by taken into consideration as part of the context necessary to judging whether a plaintiff's allegations give rise not merely to some inference of scienter but to a 'strong' inference."
A recent decision by the U.S. Court of Appeals for the Second Circuit offers some interesting clarifications on the scope of accountant liability for securities fraud. In Lattanzio v. Deloitte & Touche LLP, 2007 WL 259877 (2d Cir. Jan. 31, 2007), the court addressed whether Deloitte could be held liable for statements in audited and unaudited financial filings.
As to the company's unaudited financial filings, the court found that Deloitte's regulatory obligation to review the company's quarterly statements did not turn those statements into accountant's statements. Even if the public understood that Deloitte was engaging in these reviews, the accountant's "assurances were never communicated to the public." The court also rejected plaintiffs' argument that the reviews created a duty to correct the quarterly financial statements if false and that a breach of this duty amounted to a misstatement by Deloitte. The court noted that there is a distinct difference between the duties and liabilities created by a review of interim financial statements and those created by an audit of annual financials.
As to the company's audited financial filings, the court dismissed the relevant claims based on a failure to adequately plead loss causation. The court held that the "plaintiffs had to allege that Deloitte's misstatements [in the company's annual reports concerning accounts payable and inventories] concealed the risk of [the company's] bankruptcy." Given that Deloitte had issued a going concern warning - along with the disclosed (if understated) collapse in the company's value - the risk of bankruptcy was apparent. Accordingly, the court found that the plaintiffs had not alleged facts showing that Deloitte's misstatements were the "proximate cause of plaintiffs' loss; nor have they alleged facts that would allow a factfinder to ascribe some rough proportion of the whole loss to Deloitte's misstatements."
Holding: Dismissal affirmed.
Quote of note: "Public understanding that an accountant is at work behind the scenes does not create an exception to the requirement that an actionable misstatement be made by the accountant. Unless the public's understanding is based on the accountant's articulated statement, the source for that understanding - whether it be a regulation, an accounting practice, or something else - does not matter."
Addition: Retired Supreme Court Justice Sandra Day O'Connor sat on the panel.
The U.S. Supreme Court's decision to hear a case on the pleading standards for scienter (i.e., fraudulent intent) has received little media attention . . . until today. The New York Times has an article on the SEC's recent activities related to private securities litigation, including the agency's decision to file an amicus brief in the Tellabs case in support of the defendants.
In their brief, the SEC/DOJ rejected the "reasonable person" test applied by the U.S. Court of Appeals for the Seventh Circuit in evaluating whether the "strong inference" of scienter pleading standard was met (see this post under "Competing Inferences"). Instead, "a court should determine whether, taking the alleged facts as true, there is a high likelihood that the conclusion that the defendant possessed scienter follows from those facts." If the same facts both support and negate an inference of scienter, "the court should consider the relative strength of both inferences, because, where there is a substantial possibility that the defendant acted without scienter, the inference of scienter will not be 'strong.'"
Quote of note (New York Times): "Critics said that the moves signaled a major retrenchment from the post-Enron changes and showed that a lobbying push by big companies, Wall Street firms and the accounting industry was gaining traction as they seek to roll back what they see as onerous regulation and excessive investor litigation. But Christopher Cox, the chairman of the commission, said in an interview Monday that both efforts were in the best interests of investors because they aimed at preventing the accounting industry from further consolidation and at limiting what he called 'fraudulent lawsuits,' including some he said were filed by 'professional plaintiffs.'"
Forget about reforming securities class actions, let's just get rid of them. Or so suggests Professor Joseph Grundfest in a provocative Wall Street Journal op-ed (subscrip. req'd) in yesterday's edition. Professor Grundfest is a former SEC commissioner, so his decision to kick securities class actions when they are down (based on number of filings) cannot be dismissed lightly.
The op-ed puts forward a simple, but debatable, theory: "fewer companies are being sued for fraud because there is less fraud." The reason for the decline in corporate fraud is the rigorous post-Enron enforcement activity of the SEC and DOJ, which provides a much greater "deterrent effect" than private securities litigation. Moreover, Sarbanes-Oxley has given the SEC the ability to compensate investors without the high attorneys' fees associated with securities class actions. (A topic the author of The 10b-5 Daily has covered elsewhere.) Accordingly, investors would be better off if they "simply allowed the SEC to control the process."
Quote of note: "As long as the government's enforcement activities remain sufficiently vigorous, the private class-action securities fraud lawsuit can be viewed as an expensive, wasteful and unnecessary sideshow that generates little deterrence and offers questionable levels of compensation. The question then is not why these lawsuits have been shrinking so rapidly in recent months, but when and whether they should exist at all."
A few items from around the web.
(1) The Financial Times had an article yesterday on the status of "scheme liability" in the U.S. courts. The article notes that the issue is currently before the Fifth Circuit in the Enron case and that the U.S. Supreme Court is considering whether to hear an appeal from the Ninth Circuit's decision in the Homestore case.
(2) Lies, Damn Lies, & Forward-Looking Statements (back from hiatus) has a post on the settlement of the opt-out case brought by the California State Teachers' Retirement System (CalSTRS) against Qwest Communications. CalSTRS claims to have recovered "approximately 30 times what it would have received had it participated in the federal class action as a class member." (The 10b-5 Daily's post on the class action settlement can be found here.)
(3) Best in Class has a post on "passive voice" press releases from plaintiffs' firms seeking clients.
(4) The Wall Street Journal had a column (subscrip. req'd) in Friday's edition discussing the effect of options backdating disclosures on a company's stock price (quick answer: generally not much of an effect). Of course, no significant stock price drop usually means no securities class action.