Big news in the long-running Coca-Cola securities class action. As previously posted in The 10b-5 Daily, the defendants have sought the denial of class certification based on alleged misconduct by lead counsel for the plaintiffs. In a report issued this week, the special master considering the issue agreed with the defendants. The report found that lead counsel engaged in improper conduct when it paid a former Coca-Cola employee to provide the plaintiffs with stolen company documents. The special master's recommendation that lead counsel be barred from serving as class counsel is subject to approval by the district court judge. Legal Pad has an extensive post on the decision, including a link to the report.
Quote of note (Special Master's Report and Recommendation): "Ordinarily, in the absence of any reason to suspect class counsel of inappropriate conduct, courts must assume that class counsel will properly and candidly discharge these duties. Here, however, the Court is faced with a very unusual situation in which Class Counsel engaged in extremely troubling conduct by paying for documents stolen from Coke, and then exacerbated the conclusions to be drawn from that initial conduct by refusing to accept responsibility for that conduct and by continuing, to this day, to defend that conduct through the use of arguments that appear to be pretextual. The administration of justice would be prejudiced should the court turn a blind eye to these circumstances."
Transkaryotic Therapies, Inc. (“TKT”), a Massachusetts-based biopharmaceutical company acquired by Shire plc in 2005, has announced the preliminary settlement of the securities class action pending against the company in the D. of Mass. (The settlement was agreed to in Oct. 2007.)
The case, originally filed in January 2003, alleges that executives at TKT failed to disclose material adverse information regarding the prospects for FDA approval of Replagal, TKT’s drug for the treatment of Farbry disease. The settlement is for $50 million, with Shire contributing $27 million and the remaining $23 million paid by its insurers.
Was the U.S. Supreme Court's Tellabs decision interpreting the "strong inference" pleading standard for scienter a victory for defendants? Not if the defendant is being sued in Boston (or any other locale within the U.S. Court of Appeals for the First Circuit).
In ACA Financial Guaranty Corp. v. Advest, Inc., 512 F.3d 46 (1st Cir. 2008), the First Circuit addressed the effect of Tellabs on its existing law. The court concluded that Tellabs was consistent with the scienter pleading standard previously applied by the court, except in one respect. Whereas the First Circuit had held "that where there were equally strong inferences for and against scienter, this resulted in a win for the defendant," it was now clear under the Supreme Court's "at least as compelling" standard for weighing inferences of scienter that "the draw goes to the plaintiff."
Holding: Dismissal affirmed.
Will the "Securities Litigation Attorney Accountability and Transparency Act" finally gain some traction? It's doubtful. Initially introduced in 2006 after the Milberg Weiss indictment, the legislation would permit fee shifting for successful defendants at the discretion of the court, require the disclosure of conflicts of interest between a plaintiff and his attorney, and allow courts to approve lead counsel through a competitive bidding process. SecuritiesLaw360 reports (subscrip. req'd) that the bill was reintroduced last week with support from House Minority Leader John Boehner (R-Ohio).
In the aftermath of the Dura decision, loss causation can be a contentious issue at every stage of a securities class action. Two recent decisions provide some insight on how courts are addressing the plaintiff's burden of proof on this element.
(1) In Ryan v. Flowserve Corp., 245 F.R.D. 560 (N.D. Tex. 2007), the court rejected the use of the "true financial condition" theory to establish loss causation. When Flowserve announced a financial restatement in 2004, the stock price only declined a few cents. According to the plaintiffs' expert, however, Flowserve's 2002 announcements of an earnings miss and a reduction in guidance were a "revelation of the Company's true financial condition" and served as corrective disclosures. As a result, the stock price declines associated with the 2002 announcements were losses related to the alleged fraud. The court disagreed and held that there needed to be a stronger relationship between the supposed corrective disclosures and the alleged fraud.
Held: Class certification denied.
Quote of note: "Plaintiffs' expert leads the court to a dangerous precipice. . . . [A] plaintiff, like here, with debatable evidence of fraud, can pick the largest stock price drop irrespective of the actual reason and still relate the fraud because the stock drop is nevertheless a revelation of the company's true financial health. The 'true financial condition' theory, if accepted, threatens to undermine the objective of securities laws and disregards precedent."
(2) In In re Omnicom Group, Inc. Sec. Litig., 2008 WL 243788 (S.D.N.Y. Jan. 29, 2008), the company had announced in 2001 that it was placing certain investments into a separate holding company. There was no statistically significant movement in the company's stock price following the disclosure. In June 2002, however, there was a flurry of negative news reports about Omnicom and the transaction, leading to a stock price decline. On summary judgment, the court held that (a) the news reports generally did not contain any new facts about the transaction or the company's accounting, and (b) to the extent any new facts were disclosed, they could not have qualified as corrective. (The court relied heavily on the Hunter decision from the Fourth Circuit.) Moreover, the court found that the event study done by the plaintiffs' expert failed to "isolate [any corrective disclosures'] effect on Omnicom's stock price from that of the negative reporting, which dwarfed any shreds of new information disclosed in June 2002."
Held: Summary judgment granted in favor of defendants.
Quote of note: "Because the law requires the disaggregation of confounding factors, disaggregating only some of them cannot suffice to establish that the alleged misrepresentations actually caused Plaintiffs' loss."
(1) Lyle Roberts (the author of The 10b-5 Daily) and Jonathan Miller have a column in the Feb. 8, 2008 edition of the New York Law Journal on the collective scienter theory. The column (subscrip. req'd) discusses the Dynex Capital and Tellabs II decisions.
(2) Securities Litigation Watch is keeping a close tab on securities class action filings. January 2008 was a big month, with at least 20 new filings (and not all of them subprime related).
(3) Professor Stephen Bainbridge posts his remarks on "Stoneridge and Capital Markets Policy" from an ABA panel presentation today.
The U.S. Court of Appeals for the Seventh Circuit is making up for lost time. Although it was one of the last circuits to issue an opinion interpreting the PSLRA's heightened pleading standards, the U.S. Supreme Court's decision to review (and reverse) the case has put the Seventh Circuit in the limelight.
In Tellabs, the Supreme Court held that courts must take into account "plausible opposing inferences" when examining whether a plaintiff has adequately plead a strong inference of scienter (i.e., fraudulent intent). A complaint can survive a motion to dismiss "only if a reasonable person would deem the inference of scienter cogent and at least as compelling as any opposing inference one could draw from the facts alleged." The Court then remanded the case back to the Seventh Circuit for further proceedings.
The Seventh Circuit's decision on remand - Makor Issues & Rights, Ltd. v. Tellabs, Inc., 2008 WL 151180 (7th Cir. Jan. 17, 2008) (Tellabs II) - may be just as controversial as its first decision. In an opinion by Judge Posner, the court touched on a number of hot button scienter pleading issues that were not addressed by the Supreme Court.
(1) Corporate scienter - In the Seventh Circuit's earlier decision, the court found that the plaintiffs had adequately plead scienter as to Tellabs' CEO and then imputed that scienter to the corporation. Judge Posner, however, decided that Tellabs' scienter should be examined separately. Although the court found that it was inappropriate to consider the collective knowledge of the corporation's employees in assessing Tellabs' scienter, it also declined to look to the state of mind of the CEO who made the allegedly false or misleading statements. Instead, the court appeared to embrace what The 10b-5 Daily has described as the "weak" or "narrow" version of the collective scienter theory, holding that it was "possible to draw a strong inference of corporate scienter without being able to name the individuals who concocted and disseminated the fraud." In this case, the court held that because the the alleged false or misleading statements concerned Tellabs' "most important products" and a significant amount of alleged channel-stuffing, it was much more likely that the statements were the result of an intent to deceive or recklessness on the part of management rather than "merely careless mistakes at the management level based on false information fed it from below." Given that the inference of corporate scienter was much more likely, it was also cogent.
(2) Motive - The court expressed little concern over the fact that the plaintiffs were unable to allege that any of the defendants profited from the fraud, finding that the "argument confused expected with realized profits." Judge Posner speculated that the CEO "may have thought there was a chance the situation regarding the two key products would right itself" and, therefore, wanted to conceal the truth and avoid causing volatility in the company's stock price.
(3) Confidential witnesses - Shortly after the Supreme Court decided Tellabs, the Seventh Circuit applied the holding in a different case. In Baxter, the court found that the failure to name sources cited in the complaint "conceals information that is essential to the sort of comparative evaluation required by Tellabs" because the court is unable to fully evaluate the reliability of the witnesses. Accordingly, allegations from confidential witnesses must be "discounted" in determining whether a plaintiff has plead a strong inference of scienter and that discount will usually be "steep." Although there is nothing in Baxter suggesting that the holding concerning confidential witnesses was limited to the facts of that case, Judge Posner concluded that the steep discount should not be applied to the more numerous and reliable confidential witnesses in the Tellabs complaint.
Holding: Reverse the judgment of the district court dismissing the suit.
Quote of note: "Suppose General Motors announced that it had sold one million SUVs in 2006, and the actual number was zero. There would be a strong inference of corporate scienter, since so dramatic an announcement would have been approved by corporate officials sufficiently knowledgeable about the company to know that the announcement was false."
The Apollo Group securities class action trial ended with a plaintiffs' verdict. A couple of news articles - from Portfolio.com and The Legal Intelligencer (Jan. 31, 2008 edition - subscrip. req'd) - offer some more background on what happened.
Quote of note (Portfolio.com): "While this might sound like the perfect case for the defense to rush to settle, that did not happen. At one point, there was a confidential mediation, but it went nowhere, says [plaintiffs' counsel]. 'They made it abundantly clear to us that they had every intention of trying this case to verdict,' he says. 'We had no intention of caving, we would never cave, and we made it abundantly clear we try cases to verdict.'"