Oral argument took place in the Halliburton case earlier this week. The case addresses whether the Fifth Circuit's requirement that plaintiffs establish loss causation at the class certification stage of a case exceeds what is required by Federal Rule of Civil Procedure 23. The transcript of the argument can be found here.
The defendants faced an uphill battle: other circuit courts have rejected the Fifth Circuit's approach and the government also weighed in against the decision. As a result, the defendants argued that the real import of the Fifth Circuit's decision was not that the plaintiffs must establish loss causation (as that term is generally understood in securities fraud cases), but rather that the plaintiffs must establish that the alleged misstatements resulted in a "price impact" so as to allow for a presumption of reliance based on the existence of an efficient market. To the extent that the defendants can successfully rebut the presumption and demonstrate that common issues will not predominate, they should be able to do so at the class certification stage. As the the transcript strongly suggests, the key question for the Court will be whether the predominance analysis under Federal Rule of Civil Procedure 23 allows for this extensive an inquiry (as opposed, for example, to just requiring plaintiffs to generally show that the market for the company's securities was efficient).
For a summary of the oral argument, the D&O Diary has a comprehensive guest post. In addition, The Conglomerate Blog has an academic roundtable that does an admirable job of analyzing the various considerations before the Court and offers some predictions about the Court's eventual decision (hint: it will be narrow).
It can be difficult for plaintiffs to adequately allege that an outside auditor acted with scienter when issuing its audit opinion. Accordingly, the Ninth Circuit's decision last week to reverse the dismissal of the securities fraud claims against an outside auditor is worth examining.
In New Mexico State Investment Council v. Ernst & Young LLP, 2011 WL 1419642 (9th Cir. April 14, 2011), the court addressed E&Y's alleged role in Broadcom's options backdating scheme. At issue was a 2005 unqualified audit opinion that covered three years of Broadcom's financial statements (2003–05). The court found that each of the following three allegations, whether taken individually or viewed collectively, were sufficient to find a strong inference that E&Y had acted with scienter:
(1) E&Y knew the material consequences of a May 2000 backdated option grant that would have resulted in a $700 million charge to Broadcom's financial results but, despite violations of GAAS, signed off on the grant without obtaining documentation;
(2) E&Y knew that several significant option grants in 2001 were approved on dates when Broadcom's compensation committee was not legally constituted due to the death of one of the two committee members; and
(3) E&Y presided over corrective reforms in 2003 to prevent and detect any future instances of improper stock option awards without questioning the integrity of Broadcom's accounting for options granted prior to the corrective reforms.
The court also examined several other factual allegations related to scienter, including allegations of insufficient documentation, weak internal controls, and red flags related to Broadcom's stock option grants.
Of particular concern to auditor defendants, however, may be the court's rejection of E&Y's argument that the plaintiffs had failed to show that any of the E&Y personnel who participated in the 2005 audit were aware of the earlier alleged backdating that impacted Broadcom's 2005 consolidated financial statements. E&Y described this as an attempt to apply "roving scienter" over a long time period. The court disagreed, concluding that "EY, despite serving continuously as Broadcom's auditor from 1998 until 2008, during which it attested to the accuracy of Broadcom's financial statements for the multiple years noted in the 2005 Opinion, cannot now disclaim those prior opinions simply because the same individuals were not involved."
Holding: Dismissal of claims against outside auditor reversed.
A round-up of significant securities class action settlements in the first quarter of 2011:
(1) Credit Suisse Group (NYSE: CS), a Switzerland-based financial services company, agreed to settle the securities class action pending against the company in the S.D. of New York. The case, originally filed in April 2008, stems from allegations that Credit Suisse made materially false statements regarding its mortgage-related exposure. The settlement is for $70 million. The D&O Diary has a detailed post.
(2) Tremont Group Holdings, Inc., a New York-based investment manager that is a subsidiary of Massachusetts Mutual Life Insurance Co., agreed to settle the securities litigation pending against the company in the S.D. of New York. The cases, originally filed starting in December 2008, stem from allegations that Tremont made material misstatements regarding the due diligence that was conducted on investment vehicles run by Bernard L. Madoff, to which Tremont transferred a substantial portion of its investment capital.
The partial settlement, which is for $100 million, resolves class action and derivative lawsuits. Additional money from Tremont will be added to the settlement fund following the wind-down of the company's operations. Class members also may receive a portion of any recovery Tremont obtains from claims against third parties. Reuters has an article on the settlement.
(3) Satyam Computer Services Ltd. (NYSE: SAY), an India-based global business and information technology services company, now doing business as Mahindra Satyam, agreed to settle the securities class action pending against the company in the S.D. of New York. The case, originally filed in January 2009, stems from allegations that Satyam and its two top executives issued materially false financial statements by, among other things, inflating the company’s revenue and understating its debt.
The settlement, which is for $125 million, resolves only the claims against Satyam and does not include claims against other defendants in the suit. Satyam also agreed to pay class members 25% of any net recovery that the company may in the future obtain based on claims against PricewaterhouseCoopers LLP or its subsidiaries. Bloomberg has an article on the settlement.
The U.S. Court of Appeals for the Third Circuit has weighed in on two controversial issues concerning loss causation and scheme liability. In In re DVI, Inc. Sec. Litig., 2011 WL 1125926 (3rd Cir. March 29, 2011), the court examined the lower court's decision to grant class certification, except as to the claims against the company's outside law firm. The key holdings are:
(1) Loss causation - The court addressed the issue currently before the U.S. Supreme Court in the Halliburton case, i.e., does a plaintiff have to establish loss causation to obtain class certification. In agreement with the Second Circuit and Seventh Circuit (but contrary to the Fifth Circuit), the court held that "a plaintiff need not demonstrate loss causation as a prerequisite to invoking the fraud-on-the-market presumption of reliance." Instead, the burden is on the defendant to introduce evidence "demonstrating an allegedly corrective disclosure did not move the market - that there was no market impact and therefore no loss causation" which "may in some circumstances rebut the presumption of reliance."
(2) Scheme liability - The plaintiffs argued that the Stoneridge decision created a "remoteness test" for assessing whether investors had relied on the fraudulent conduct of secondary actors. The remoteness test allegedly requires courts to assess: (a) the defendant's level of involvement in the fraudulent scheme, (b) whether the misrepresentation was the "necessary or inevitable" result of the defendant's conduct, and (c) whether the defendant's conduct took place in the "investment sphere." Like the Second Circuit, the court rejected this argument, finding that the only issue was whether the deceptive conduct "has been publicly disclosed and attributed to the actor." In the instant case, because the plaintiffs did "not contend that the outside law firm's role in masterminding the fraudulent 10-Q was disclosed to the public, they cannot invoke the [fraud-on-the-market presumption of reliance]."
Holding: Judgment affirmed.
The New York Law Journal has two securities litigation columns this week.
(1) In Lower Courts Divided on Standard for Pleading Loss Causation Post-Dura (3/31/11 - subscrip. req'd), the authors discuss the split over whether loss causation is merely subject to notice pleading (FRCP 8(a)(2)) or must be plead with particularity (FRCP 9(b)). The Supreme Court, in its Dura decision, left the issue open and no subsequent judicial consensus has emerged.
(2) In Most ARS Suits Tripped Up By Difficult Pleading Hurdles (3/31/11 - subscrip. req'd), the author examines what has happened to the flurry of securities class actions that were filed in the wake of the 2008 disruption in the market for auction rate securities. Most of the cases have been dismissed for failing to adequately plead various elements of a securities fraud claim, including scienter, loss causation or reliance.