Section 20(b) of the Exchange Act makes it unlawful for a person to effect a securities fraud through another person. Sometimes referred to as the "ventriloquist dummy" statute, it has rarely been invoked in securities cases. In the Supreme Court's recent Janus decision, however, the Court limited Section 10(b) securities fraud liability to persons who had "ultmate authority" over the alleged false statement. Not surprisingly, Janus has revived interest in Section 20(b) as a potential vehicle for claims against secondary actors.
The New York Law Journal has an interesting column (Sept. 29 - subscrip. req'd) on the potential application of Section 20(b). As a threshold matter, the authors note that "[t]here is so little authority on Section 20(b) that is is not even definitive that it affords a private right of action." Even assuming that a private right of action exists, plaintiffs will have to demonstrate both the existence of any underlying violation and that "the controlling person 'knowingly used' the controlled entity to violate the securities laws."
In a strange story, a court in the S.D.N.Y. has dismissed the lead plaintiff from a securities class action brought against Smith Barney Fund Management and Citigroup Global Markets because, after six years of litigation, it was revealed that the entity had not actually purchased the securities at issue. The lawsuit, originally filed in 2005, alleges various misrepresentations by an investment advisor for certain Smith Barney mutual funds, which later were acquired by Citigroup. According to counsel for the plaintiffs, the relevant brokerage documentation erroneously showed that the Operating Local 639 Annuity Trust Fund had invested in one of the relevant mutual funds (when, in reality, its investment was in a similarly named fund).
The court, in an apparently scathing decision, cited "epic failures" by the attorneys on both sides of the case in not investigating the issue earlier. For its part, "[h]ad Smith Barney simply checked its records, it would have avoided six years of sparring with a phantom opponent." Bloomberg and the WSJ Law Blog have articles on the decision.
At one point, it looked like the UBS securities class action would be a test case on the application of the Morrison decision (in which the U.S. Supreme Court rejected the extraterritorial application of Section 10(b) in private litigation). As it turned out, a number of district court decisions on the issue have been issued while the UBS court considered its ruling. This week, however, the court finally weighed in with a sweeping victory for the defendants. See In re UBS Sec. Litig., 1:07-cv-11225-RJS (S.D.N.Y. Sept. 13, 2011).
The court dismissed two sets of claims that Morrison arguably precluded. First, the court held that claims asserted by foreign plaintiffs who purchased UBS stock on a foreign exchange ("foreign-cubed claims") were barred even though UBS common stock is cross-listed on the New York Stock Exchange. The court found that Morrison "makes clear that its concern was with respect to the location of the securities transaction and not the location of an exchange where the security may be dually listed." Second, the court held that claims asserted by U.S. investors who purchased UBS stock on a foreign exchange ("foreign-squared claims") were barred even though the orders were placed from the United States. The court found that neither the location of the buy order nor the place of injury converted the purchase into a "domestic" securities transaction.
Holding: Foreign-cubed and foreign-squared claims dismissed.
The scope of the Securities Litigation Uniform Standards Act ("SLUSA"), which precludes certain class actions based upon state law that allege a misrepresentation in connection with the purchase or sale of nationally traded securities, continues to be the subject of litigation. In Atkinson v. Morgan Asset Mgmt., Inc., 2011 WL 3926376 (6th Cir. Sept. 8, 2011), the court considered whether SLUSA preempted claims brought by the holders of mutual fund shares, who were entitled to redeem their shares at any time for their "proportionate share of the issuer's current net assets."
The plaintiffs argued that as the holders of mutual fund shares, their claims were covered by what is known as the "first Delaware carve-out" to SLUSA, which preserves state-law class actions that involve "the purchase or sale of securities by the issuer or an affiliate of the issuer exclusively from or to holders of equity securities of the issuer." The first Delaware carve-out generally applies to cases challenging corporate transactions, such as tender offers and mergers, or share buybacks directed exclusively to existing shareholders. The plaintiffs claimed that it also should apply to the holders of mutual fund shares, because the "funds' obligation to redeem Plaintiffs' shares amounts to an ongoing contract to purchase them."
The Sixth Circuit rejected the plaintiffs' argument, holding that the redemption obligation did not convert the holders of mutual fund shares into continuous purchasers or sellers. Moreover, the U.S. Supreme Court, in its Dabit decision, has held that holder claims are precluded under SLUSA. Permitting the plaintiffs' construction of the first Delaware carveout would create an impermissible exception for mutual fund shareholders. The court also held that for purposes of SLUSA preclusion it was sufficient that the plaintiffs' claims included allegations of misrepresentations in connection with the buying and selling of securities; it was not necessary for fraud to be an element of the claims.
Holding: Dismissal affirmed.
Quote of note: "Plaintiffs' construction of the carve-out invites us to pull the rug out from under Dabit's holding, creating an exemption for a large set of the very holder claims over which Dabit extended SLUSA's bar. Indeed, Plaintiffs ask us to shield from PSLRA's federal protections nearly every class action involving shareholders in open-end mutual funds. In the absence of clear language, precedent, or policy supporting this exemption, we decline to extend the carve-out so far."
As noted by The 10b-5 Daily in its writeup of the Janus decision, a key open question was whether the Supreme Court's "ultimate authority" requirement for primary liability also applied to corporate insiders. Just a few months later, there is already a district court split on the issue.
In In re Merck & Co., Inc. Sec., Derivative & "ERISA" Litigation, 2011 WL 3444199 (D.N.J. Aug. 8, 2011) the company's executive vice president for science and technology argued that he did not have "ultimate authority" over the statements attributed to him in Merck's public filings. (It is the same Merck case that led to the Supreme Court's recent decision concerning the statute of limitations for securities fraud claims.) The court found that the holding in Janus was limited to cases involving a "separate and independent entity" and could not "be read to restrict liability for Rule 10b-5 claims against corporate officers to instances in which a plaintiff can plead, and ultimately prove, that those officers - as opposed to the corporation itself - had 'ultimate authority' over the statement." Accordingly, the court declined to dismiss the claims against the Merck officer on that basis.
The ink was barely dry on the Merck decision, however, before another district court disagreed with its analysis. In Hawaii Ironworkers Annuity Trust Fund v. Cole, No. 3:10CV371 (N.D. Ohio Sept. 1, 2011), the court found that "nothing in the Court's decision in Janus limits the key holding - the definition of the phrase 'to make . . . a statement' under Rule 10b-5 - to legally separate entities." Indeed, the dissent in Janus clearly believed that the majority's holding also applied to corporate insiders. In the instant case, the plaintiffs' own complaint made it clear that the defendants, who were officers in one of the company's business units, did not have ultimate authority over the alleged false statements in the company's filings. The court also noted that the alleged false statements, unlike in the Merck case, were not specifically attributed to the defendants (a fact that might otherwise be sufficient to establish "ultimate authority"). The court therefore dismissed the Rule 10b-5(b) claims against the defendants for making false statements, but declined to dismiss the related Rule 10b-5(a) and (c) claims based on deceptive conduct.
What will the next court to address the issue hold? Stay tuned.