There has been a fair amount of media and blog coverage of the oral argument in the Tellabs case. Here is a partial roundup:
Click here for the transcript.
Oral argument in the Tellabs v. Makor Issues & Rights case took place in the U.S. Supreme Court this morning (links to most of the briefs can be found here). The question presented was: "Whether, and to what extent, a court must consider or weigh competing inferences in determining whether a complaint asserting a claim of securities fraud has alleged facts sufficient to establish a 'strong inference' that the defendant acted with scienter, as required under the Private Securities Litigation Reform Act of 1995."
All of the justices participated in the hearing. Argument was heard from Carter G. Phillips of Sidley Austin on behalf of petitioners Tellabs and Notebaert; Professor Arthur Miller of Harvard Law School on behalf of the respondent shareholders; and Assistant to the Solicitor General Kannon Shanmugam on behalf of the United States as an amicus in support of Tellabs.
Overall Impressions - Predicting how the Supreme Court will rule based on oral argument, especially where there are multiple possible approaches to the issue, is difficult. That said, the Court appeared likely to reject the Seventh Circuit's "reasonable person" standard as incompatible with the "strong inference" scienter pleading requirement. As noted by Justice Roberts and Justice Breyer, the "reasonable person" standard appears to allow for the possibility that the case will go forward even if the plaintiffs are only able to allege facts establishing a weak inference of scienter. There also appeared to be considerable support for the need to weigh competing inferences.
A few notes on the main issues discussed:
Is There A Seventh Amendment Violation? - Perhaps to the surprise of Tellabs' counsel, who had argued in his briefs that the Court did not have to reach this issue, the justices spent a fair amount of time discussing whether there needed to be uniformity between the pleading and proof standards for scienter. In their brief, the shareholders had argued that the heightened pleading standard for scienter improperly required a court to act as a fact-finder on the merits of the suit. Justice Scalia and Justice Breyer expressed skepticism over the idea that Congress could not create a heightened pleading standard, noting that there are lots of barriers to entry to federal courts (including diversity and amount in controversy requirements). Justice Breyer wondered whether there was really any difference between saying a plaintiff's case has to be "really strong" and saying that a plaintiff has to be "really suffering." That said, a number of justices (Justice Breyer most of all) seemed concerned that the "strong inference" pleading standard was higher than the "preponderance of the evidence" proof standard. Tellabs' counsel and government counsel both argued that if the Court wanted to address this question, it would need to reconsider the standard of proof, as opposed to watering down the PSLRA.
Can You Infer A CEO's Knowledge About Financial Issues Based On His Position? - Justice Kennedy appeared anxious to get an answer to this question, asking it of both parties. Tellabs' counsel responded that the CEO's title was insufficient; plaintiffs needed to provide particularized facts regarding the CEO's scienter. Shareholders' counsel, however, suggested that it was unlikely that a CEO would not know about important financial issues. Moreover, the confidential witnesses cited in the complaint confirmed the existence of scienter for Tellabs' CEO.
Competing Inferences - Justice Alito took center stage on the issue of how to evaluate competing inferences with the following analogy: if you see a person walking down the street toward the Supreme Court, this fact would create a strong inference that the person is going to the Supreme Court if it is the only building around. If there are a lot of other buildings, however, doesn't a court have to consider the inference that the person is going to another location? In response to this analogy and further prodding from Justice Ginsburg and Justice Souter, shareholders' counsel conceded that the court could consider other facts that were subject to judicial notice, but stopped short of agreeing that this constituted an evaluation of competing inferences.
How To Decide This Case - Justice Ginsburg noted that the phrase "strong inference" is not "self-defining" and other justices also appeared to struggle with its meaning. As to how to decide the case in front of them, Justice Scalia expressed a desire to provide lower courts with guidance on what is a "strong inference" of scienter and, during his rebuttal time, Tellabs' counsel urged the same course.
Prof. Miller v. Justice Scalia - By his own admission, Prof. Miller has a more "colloquial" argument style. That got him into some hot water with Justice Scalia, with whom he traded barbs. Justice Stevens asked Prof. Miller if he could translate the "strong inference" standard into a probability percentage. Justice Scalia quipped that he thought it was 66 2/3%, in response to which Prof. Miller asked if that was "because you never met a plaintiff you really liked?" Justice Scalia got his revenge a few minutes later when Prof. Miller stated "don't take me literally" on a certain comment and Justice Scalia replied that he would write that down. At that point, Justice Roberts called it a draw.
A transcript of the argument will be released later today. The 10b-5 Daily reserves the right to edit this post if it turns out that the transcript creates a "competing inference" as to the accuracy of the author's scribbled notes.
The U.S. Supreme Court has turned its gaze to securities litigation and does not appear to like the circuit splits it is seeing. This week features an unprecedented amount of Supreme Court activity on securities issues, with two arguments and a noteworthy grant of certiorari.
An early report on today's argument in the Credit Suisse case suggests that several justices were skeptical about applying antitrust law to the same allegations raised in the IPO allocation cases. Meanwhile, oral argument in the Tellabs case on scienter pleading is scheduled for tomorrow. Previews of the two cases can be found in the Wall Street Journal (subscrip. req'd), Bloomberg, and the Financial Times.
On Monday, the Supreme Court also granted cert in the Charter Communications case from the Eighth Circuit that addresses scheme liability. The timing could hardly have been better. As discussed in this recent post, the circuit split on the issue expanded just last week when the Fifth Circuit declined to grant class certification in the securities fraud case brought against Enron's banks.
The question presented in Charter Communications is: "Whether this Court’s decision in Central Bank , forecloses claims for deceptive conduct under [Section 10(b) and Rule 10b-5] where Respondents engaged in transactions with a public corporation with no legitimate business or economic purpose except to inflate artificially the public corporation’s financial statements, but where Respondents themselves made no public statements concerning those transactions." Chief Justice Roberts and Justice Breyer will not participate in the case (probably because of stock ownership). The Associated Press has an article and Securities Litigation Watch has a post.
(1) The Wall Street Journal had another op-ed (subscrip. req'd) this week, by Peter Wallison of the American Enterprise Institute, advocating the abolishment of private securities class actions. (For coverage of a similar WSJ op-ed from last month, see this post.)
Quote of note: "Yet the odd mystique of this costly compensation system lives on. Despite all the reports indicting securities class actions, only Mayor Bloomberg and Senator Schumer called for more than a mere study: 'The SEC,' they said 'should make use of its broad rulemaking and exemptive powers to deter the most problematic securities-related suits.' It's doubtbful that the SEC will pick up this baton, but even if it did history shows that courts cannot discipline themselves to distinguish effectively between the well-founded usits and the 'problematic' ones. The only solution is restoring what Congress originally intended - enforcement of Rule 10b-5 only by the SEC."
(2) The D&O Diary has an interesting post on a federal district court decision holding that the settlement of a Section 11 claim (i.e., for misrepresentations in a prospectus or registration statement) was not covered by the company's director and officer liability insurance. In CNL Hotel & Resorts, Inc. v. Houston Casualty Co., 2007 WL 788361 (M.D. Fla March 14, 2007), the court found that the settlement represented a disgorgement by the company of "wrongfully appropriated" money, which did not constitute a “loss” under the relevant policy provision and, therefore, was not insurable under applicable New York law.
Quote of note (The D&O Diary): "In light of the developing case law trend, and now a federal court’s affirmation of the trend, it is going to be indispensable for D & O insurers to clarify within the language of their policy the coverage that policyholders can expect for amounts paid in resolution of Section 11 claims. In that regard, it is critical to note that Judge Presnell specifically stated that 'Section 11 claims are not per se uninsurable.'"
In two decisions issued last year, the Eighth Circuit and the Ninth Circuit split over the extent to which secondary actors (e.g., accountants, lawyers, or bankers) can be held primarily liable under Rules 10b-5(a) and (c) for deceptive devices, schemes, and acts. The Eighth Circuit limited the scope of potential liability, holding that "any defendant who does not make or affirmatively cause to be made a fraudulent misstatement or omission, or who does not directly engage in manipulative securities trading practices, is at most guilty of aiding and abetting and cannot be held liable under Sec. 10(b) or any subpart of Rule 10b-5." In contrast, the Ninth Circuit created a broader test, finding that "to be liable as a primary violator of Sec. 10(b) for participation in a 'scheme to defraud,' the defendant must have engaged in conduct that had the principal purpose and effect of creating a false appearance of fact in furtherance of the scheme." In a decision issued yesterday, the Fifth Circuit has sided squarely with the Eighth Circuit and limited the scope of liability.
In Regents of the Univ. of California., et al. v. Credit Suisse First Boston (USA), Inc., et al., 2007 WL 816518 (5th Cir. March 19, 2007), the issue presented was whether the district court had properly granted class certification for Rule 10b-5 claims brought against three banks that had entered into transactions with Enron. The "common feature of these transactions is that they allowed Enron to misstate its financial condition; there is no allegation that the banks were fiduciaries of the plaintiffs [Enron investors], that they improperly filed financial reports on Enron's behalf, or that they engaged in wash sales or other manipulative activities directly in the market for Enron securities." Nevertheless, the district court held that class certification was appropriate because a "deceptive act" included participation in a transaction whose principal purpose and effect was to create a false appearance of revenues. Because the banks had failed in their duty not to engage in a fraudulent scheme, the district court found that plaintiffs were "entitled to rely on the classwide presumption of reliance for omissions and fraud on the market." On appeal, the Fifth Circuit disagreed.
As an initial matter, the court found that it could address the district court's definition of "deceptive act" because it was the basis for the district court's determination that the plaintiffs were entitled to a presumption of reliance. Without that presumption, class certification would fail.
The court then turned to whether plaintiffs could properly rely on a presumption of reliance created by either the existence of actionable omissions or a fraud on the market. First, the court held that the banks had not made any actionable omissions because they "did not owe plaintiffs any duty to disclose the nature of the alleged transactions." Second, the court found that the district court's definition of "deceptive act" was "inconsistent with the Supreme Court's decision that Sec. 10 does not give rise to aiding and abetting liability." After examining relevant Supreme Court precedent, the court held that the Eighth Circuit's definition of "deceptive act" (i.e., conduct involving "either a misstatement or a failure to disclose by one who has a duty to disclose") was correct. In contrast, the banks' acts "at most aided and abetted Enron's deceit by making its misrepresentations more plausible." Finally, the court concluded that the transactions did not constitute market manipulation because the banks "did not act directly in the market for Enron securities." Because the banks' transactions with Enron were not deceptive acts and did not constitute market manipulation, there could be no fraud on the market presumption of reliance and class certification failed.
A few additional notes on the panel's decision:
(1) There is a "concurrence" that, in fact, is a vigorous dissent from the primary legal holdings in the majority opinion. In particular, the concurring judge found that the majority had overreached in deciding the substantive scope of Rule 10b-5 on an appeal from class certification and that its definition of "deceptive act" was too narrow.
(2) There has been a significant amount of commentary on the decision already. For an internet roundup, see this Point of Law post.
(3) One obvious question is whether this ruling will have any effect on the previous bank settlements in the Enron securities litigation totaling over $7 billion. According to a Wall Street Journal article in today's edition, the answer is "no," because the settlements are already final.
Quote of note (opinion): "We recognize, however, that our ruling on legal merit may not coincide, particularly in the minds of aggrieved former Enron shareholders who have lost billions of dollars in a fraud they allege was aided and abetted by the defendants at bar, with notions of justice and fair play. We acknowledge that the courts' interpretation of § 10(b) could have gone in a different direction and might have established liability for the actions the banks are alleged to have undertaken. Indeed, one of our sister circuits - the Ninth - believes that it did. We have applied the Supreme Court's guidance in ascribing a limited interpretation to the words of § 10, viewing the statute as the result of Congress's balancing of competing desires to provide for some remedy for securities fraud without opening the floodgates for nearly unlimited and frequently unpredictable liability for secondary actors in the securities markets."
In the post-Dura world, in-and-out traders (i.e., investors who both bought and sold their shares during the class period) continue to have difficulties pursuing securities fraud claims. Hard on the heels of the lead plaintiff decision in the Comverse case comes an opinion from the D. of Mass. declining to appoint an in-and-out trader as a class representative.
In In re Organogenesis Sec. Litig., 2007 WL 776425 (D. Mass. March 15, 2007), the court found that during the class period one of the proposed class representatives "sold almost six times as many shares as he purchased." Under the last-in, first out ("LIFO") methodology of assessing damages adopted by the court, these trades resulted in the investor making a profit on his trading during the class period and rendered him an unsuitable class representative. The court also rejected the other proposed class representative because the investor made his final stock purchase prior to the date one of the individual defendants joined the company and, therefore, lacked standing to proceed against that individual defendant. Finally, the court found that Milberg Weiss was not an adequate lead counsel based on: (a) the submission of erroneous stock certifications on behalf of one of the proposed class representatives; (b) the possible negative effects of the federal indictment against the firm; and (c) the firm's failure to clearly inform the court of the role of one of its indicted attorneys in the case.
Quote of note: "The court realizes that refusing to certify a class will make it more difficult to prosecute the fraud alleged in this case. But the allegation of fraud is not alone enough to merit class certification. The additional requirements exist for the important reason of ensuring that the named plaintiffs effectively represent the claims of the absent parties."
The briefing is complete in Tellabs, Inc. v. Makor Issues & Rights, Ltd., the scienter pleading case currently before the U.S. Supreme Court. The extensive list of amicus briefs can be found on the court docket. The briefs available via public link include:
Petitioners (Tellabs, Inc. and Richard Notebaert)
Respondents (Makor Issue & Rights, Ltd., et al.)
Securities Industry and Financial Markets Association and Chamber of Commerce of the United States of America (Amicus/Petitioners)
American Institute of Certified Public Accountants, et al. (Amicus/Petitioners)
Washington Legal Foundation (Amicus/Petitioners)
SEC and DOJ (Amicus/Petitioners)
North American Securities Administrators Association (Amicus/Respondents)
Ohio and 23 Other States, Territories and Commonwealths (Amicus/Respondents)
Council of Institutional Investors (Amicus/Respondents)
Arkansas, Seven Other States, and Two Public Pension Funds (Amicus/Respondents)
Oral argument is set for March 28, 2007. The question presented is: "Whether, and to what extent, a court must consider or weigh competing inferences in determining whether a complaint asserting a claim of securities fraud has alleged facts sufficient to establish a 'strong inference' that the defendant acted with scienter, as required under the Private Securities Litigation Reform Act of 1995."
Readers are encouraged to send in public links to any Tellabs briefs not listed here.
Addition: Thanks to Adam Savett for links to the Petitioners' brief and a few of the amicus briefs (added above).
While the Dura decision by the Supreme Court suggests that in-and-out traders (i.e., investors who both bought and sold their shares during the class period) cannot establish the existence of loss causation, lower courts have not uniformly applied this principle. In the latest case to consider the issue, In re Comverse Technology, Inc. Securities Litigation, a court in the E.D.N.Y. has issued a decision vacating a magistrate judge's order appointing the Plumbers and Pipefitters National Pension Fund (P&P) as lead plaintiff in the case. The court concluded that the magistrate judge improperly overvalued P&P's financial interest in the action by including losses resulting from in-and-out trades.
Citing Dura, the court held that "any losses that P&P may have incurred before Comverse's misconduct was ever disclosed to the public are not recoverable, because those losses cannot be proximately linked to the misconduct at issue in this litigation." P&P actually realized a gain on the Comverse shares that it purchased during the class period and held until after the alleged corrective disclosures were made. As a result, the court appointed a different lead plaintiff and lead counsel. The New York Law Journal has an article on the case.
Quote of note (opinion): "While the Dura Court decided a motion to dismiss, and not a lead plaintiff motion, the logical outgrowth of that holding is that [in-and-out] losses must not be considered in the recoverable losses calculation that courts engage in when selecting a lead plaintiff."
Securities Litigation Watch has posted the SCAS 50, which "lists the top 50 plaintiffs' law firms ranked by the total dollar amount of final securities class action settlements occurring in 2006 in which the law firm served as lead or co-lead counsel." At the head of the list this year is Lerach Coughlin. The full list, along with links to reports from previous years, can be found here.
Time Warner, Inc. (NYSE: TWX) has settled the claims of five large institutional shareholders who opted-out of a 2005 settlement of the the securities class action against the company over accounting fraud at AOL. Under the opt-out settlement, Time Warner will pay $400 million, $246 million of which will go to the University of California, with other smaller amounts being paid to the California Public Employees Retirement System, Amalgamated Bank, and two pension funds for Los Angeles County employees. The University of California claims that it will receive "between 16 and 24 times what we would have gotten through the class." (For an earlier post on the Time Warner opt-out cases, see here). The Wall Street Journal Law Blog and the New York Sun have reports on the settlement. Best In Class thinks it may be the largest opt-out settlement ever.