A couple of items from around the web.
(1) The D&O Diary has a helpful summary of the Senate Financial Reform Bill. For securities litigators, however, the bill is probably more notable for what it does not include. A proposed amendment that would have restored aiding-and-abetting liability for private securities fraud actions failed to make it to a vote. Moreover, a provision in the related House bill that addressed the extraterritorial application of the federal securities laws was not included in the Senate version (but could turn up in the reconciled legislation).
(2) Law.com has a column on the Second Circuit's recent Pacific Investment decision. (The 10b-5 Daily's write-up on the case can be found here.) The authors argue that Pacific Investment confirms how difficult it is for plaintiffs to charge "secondary actors with securities fraud liability when no allegedly misleading statements were attributed to those persons at the time the statements in question were made."
Surprisingly, the U.S. Court of Appeals for the Second Circuit has never issued an opinion analyzing the PSLRA's safe harbor for forward-looking statements. It filled in that gap this week.
In Slayton v. American Express Co., 2010 WL 1960019 (2d Cir. May 18, 2010), the court considered whether the safe harbor shielded American Express from liability for a statement it made in its May 15, 2001 Form 10-Q. As paraphrased by the court, American Express had disclosed "that while it had lost $182 million from its high-yield debt investments in the first quarter of 2001, it expected futher losses from those investments to be substantially lower for the remainder of 2001." It turned out, however, that in July 2001 the company took a large write-down on those investments.
The court's decision contains a number of interesting holdings.
(1) Plain Language - Contrary to some other courts, the Second Circuit found that the safe harbor is "written in the disjunctive." Therefore, "a defendant is not liable if the forward-looking statement is identified and accompanied by meaningful cautionary language or is immaterial or the plaintiff fails to prove that it was made with actual knowledge that it was false or misleading."
(2) Scope of Financial Statement Exclusion - The safe harbor excludes forward-looking statements "included in a financial statement prepared in accordance with generally accepted accounting principles." The Second Circuit held that the Management's Discussion and Analysis ("MD&A") section of the Form 10-Q, which contained the alleged misstatement, was not part of the financial statement portion of the filing. As a result, the safe harbor could be applied.
(3) Meaningful Cautionary Language - The Second Circuit noted that it was difficult to follow Congress's instructions concerning the application of the safe harbor. To determine whether a defendant has identified the risks that realistically could cause results to differ, "the most sensible reference is the major factors that the defendants faced at the time the statement was made." But it is clear from the relevant Conference Report that Congress did not want courts to inquire into the defendant's knowledge of those risks.
The Second Circuit concluded that it did not have to "decide that thorny issue," however, because American Express's cautionary statement was too vague to satisfy the "meaningful" standard. While the company warned of the possibility of "potential deterioration in the high-yield sector," it did not warn of the risk that rising defaults on the bonds underlying its investments would cause that deterioration. Moreover, American Express's cautionary statement remained the same even as the problems related to its investments changed.
(4) Actual Knowledge - The Second Circuit held that the relevant pleading standard for actual knowledge is whether a reasonable person, based on the facts alleged, would "deem an inference that the defendants (1) did not genuinely believe the May 15 statement, (2) actually knew they had no reasonable basis for making the statement, or (3) were aware of undisclosed facts tending to seriously undermine the accuracy of the statement, 'cogent and at least as compelling as any opposing inference.'" In this case, the plaintiffs failed to allege sufficient facts to meet this standard.
Holding: Dismissal based on PSLRA's safe harbor affirmed.
Quote of note: "Congress may wish to give further direction on how to resolve this tension, and in particular, the reference point by which we should judge whether an issuer has identified the factors that realistically could cause results to differ from projections. May an issuer be protected by the meaningful cautionary language prong of the safe harbor even where his cautionary statement omitted a major risk that he knew about at the time he made the statement? In this case, however, we need not decide that thorny issue because we conclude that at any rate the cautionary statement the defendants point to here was vague."
Two items about inaccurate complaints in securities class actions.
(1) The Harvard Law School Forum on Corporate Governance and Financial Regulation has a post on a recent Second Circuit decision concerning confidential witnesses. In Campo v. Sears Holdings Corp., 2010 WL 1292329 (2d Cir. Apr. 6, 2010) (summary order), the district court permitted the defendants, as part of the motion to dismiss, to depose the plaintiffs' confidential witnesses to determine if they had made the statements attributed to them in the complaint. On appeal, the Second Circuit approved of the district court's use of the deposition testimony, in which the witnesses disowned or contradicted many of their alleged statements.
Quote of note (opinion): "The anonymity of the sources of plaintiffs’ factual allegations concerning scienter frustrates the requirement, announced in Tellabs, [Inc. v. Makor Issues and Rights, Ltd., 551 U.S. 308, 314 (2007),] that a court weigh competing inferences to determine whether a complaint gives rise to an inference of scienter that is 'cogent and at least as compelling as any opposing inference of nonfraudulent intent.' . . . Because Fed. R. Civ. P. 11 requires that there be a good faith basis for the factual and legal contentions contained in a pleading, the district court’s use of the confidential witnesses’ testimony to test the good faith basis of plaintiffs’ compliance with Tellabs was permissible."
(2) The New York Law Journal has an article on a recent sanctions decision. In the Australia and New Zealand Banking Group case, a key scienter allegation concerned a set of internal e-mails that supposedly were sent in March 2007. The consolidated complaint dropped the allegation and, upon later examination by the court, plaintiffs' counsel admitted that the March 2007 date had been based on a misreading of a news article about the company. Judge Cote (S.D.N.Y.) found that the allegation "was not an isolated misstatement concerning a collateral or trivial fact, but rather, a material allegation central to the viability of the entire pleading" and ordered plaintiffs' counsel to pay sanctions.
Quote of note (opinion): "Such indifference to the truth of the pleading's single most important factual allegation -- coming, ironically, in the context of initiating a lawsuit that accuses another party of making reckless misstatements of material fact -- is the sort of conduct that Rule 11 and the PSLRA seek to deter."
The U.S. Court of Appeals for the Second Circuit has rejected creationism, at least when it comes to determining whether a secondary actor has "made" a statement for purposes of securities fraud liability. In Pacific Investment Management Co. LLC v. Mayer Brown LLP, 2010 WL 1659230 (2d Cir. April 27, 2010), the plaintiffs and the SEC urged the court to reconsider its "bright line" test for determining whether a defendant can be liable for a misstatement.
Under the "bright line" test, primary liability (as opposed to aiding and abetting liability, which is not available in private securities fraud actions) only exists if the misstatement is attributable on its face to the defendant. In other words, the defendant must have been identified to investors as the maker of the statement. The plaintiffs and the SEC argued that public attribution is unnecessary. Instead, a court should be able to find primary liability where the defendant "creates" the statement, even if investors are unaware of the defendant's involvement.
The Second Circuit disagreed. First, the panel found that an "attribution requirement is more consistent with the Supreme Court's guidance on the question of secondary actor liability." In particular, the Supreme Court's Stoneridge decision suggests that attribution is necessary to establish the existence of reliance on the defendant's deceptive acts. Second, the panel noted that the Second Circuit has consistently favored a "bright line" test to distinguish "primary violations of Rule 10b-5 from aiding and abetting." The attribution requirement makes it clear that secondary actors "who sign or otherwise allow a statement to be attributed to them expose themselves to liability," while "[t]hose who do not are beyond the reach of Rule 10b-5's private right of action."
As for the case at hand, the panel found that none of the alleged misstatements in Refco's public filings were attributed to Mayer Brown or any of its attorneys. Without this attribution, "plantiffs cannot show reliance on any statements of Mayer Brown." Moreover, plaintiffs' "scheme liability" claims failed because plaintiffs admitted that "they were unaware of defendants' deceptive conduct or 'scheme' at the time they purchased Refco securities."
In an interesting concurrence, one of the judges noted that the Second Circuit's decisions on the "attribution" issue have been somewhat inconsistent (including rejecting an attribution requirement for corporate insiders) and there is a split among the circuits. Accordingly, he opined that it might be appropriate for the full Second Circuit, as well as the Supreme Court, to consider the case.
Holding: Dismissal of the claims against Mayer Brown and its attorney affirmed.
Maxim Integrated Products, Inc. (NASDAQ:MXIM), a Sunnyvale-based company that designs, develops, manufactures, and markets analog integrated circuits, has announced the preliminary settlement of the securities class action pending against the company in the N.D. of California. The case, originally filed in 2008, stems from allegations that Maxim and certain of its former officers engaged in improper stock option backdating practices, resulting in the issuance of materially misleading financial statements. The company ultimately restated its financials to account for $773.5 million in additional stock-based compensation expense.
The settlement is for $173 million. The 10b-5 Daily has previously posted about the loss causation issues in the case. RiskMetrics Group has added the settlement to its tracking list of options backdating cases.